Mathematically, the current ratio is expressed as current assets divided by

Explain the uses of dollar and percentage changes, trend percentages, component percentages, and ratios.

An important aspect of financial statement analysis is determining relevant relationships among specific items of information. Companies typically present financial information for more than one time period, which permits users of the information to make comparisons that help them understand changes over time. Dollar and percentage changes and trend percentages are tools for comparing information from successive time periods. Component percentages and ratios, on the other hand, are tools for establishing relationships and making comparisons within an accounting period. Both types of comparisons are important in understanding an enterprise's financial position, results of operations, and cash flows.

LO 2

Discuss the quality of a company's earnings, assets, and working capital.

Assessing the quality of information is an important aspect of financial statement analysis. Enterprises have significant latitude in the selection of financial reporting methods within generally accepted accounting principles. Assessing the quality of a company's earnings, assets, and working capital is done by evaluating the accounting methods selected for use in preparing financial statements. Management's choice of accounting principles and methods that are in the best long-term interests of the company, even though they may currently result in lower net income or lower total assets or working capital, leads to a conclusion of high quality in reported accounting information.

LO 3

Explain the nature and purpose of classifications in financial statements.

In classified financial statements, items with certain common characteristics are placed together in a group, or classification. The purpose of these classifications is to develop subtotals that will assist users in analyzing the financial statements.

LO 4

Prepare a classified balance sheet and compute widely used measures of liquidity and credit risk.

In a classified balance sheet, assets are subdivided into the categories of current assets, plant and equipment, and other assets. Liabilities are classified either as current or long term.

The liquidity measures derived from the balance sheet are as follows:

Working capital. Current assets minus current liabilities.

Current ratio. Current assets divided by current liabilities.

Quick ratio. Quick assets divided by current liabilities.

A measure of long-term credit risk is the debt ratio, which is total liabilities expressed as a percentage of (divided by) total assets.

LO 5

Prepare a multiple-step and a single-step income statement and compute widely used measures of profitability.

In a multiple-step income statement, the cost of goods sold is deducted from net sales to provide the subtotal, gross profit. Operating expenses then are deducted to arrive at income from operations. As a final step, nonoperating items are added together and subtracted from income from operations to arrive at net income. In a single-step income statement, all revenue items are listed first, and then all expenses are combined and deducted from total revenue.

The profitability measures discussed in this chapter are as follows:

Percentage change. The dollar amount of change in a financial statement item from one period to the next, expressed as a percentage of (divided by) the item value in the earlier of the two periods being compared.

Gross profit rate. Dollar amount of gross profit divided by net sales. A measure of the profitability of a company's products.

Net income as a percentage of sales. Net income divided by net sales. A measure of management's ability to control expenses.

Earnings per share. In the simplest case, net income divided by shares of capital stock outstanding. Indicates the earnings applicable to each share of stock.

Price-earnings ratio. Market price of the stock, divided by earnings per share. A measure of investors' expectations regarding future profitability.

Return on assets. Operating income divided by average total assets. Measures the return generated by assets, regardless of how the assets are financed.

Return on equity. Net income divided by average total equity. Indicates the rate of return earned on owners' equity.

LO 6

Put a company's net income into perspective by relating it to sales, assets, and stockholders' equity.

Financial accounting information is most useful if viewed in comparison with other relevant information. Net income is an important measure of the financial success of an enterprise. To make the amount of net income even more useful than if it were viewed simply in isolation, it is often compared with the sales from which net income results, the assets used to generate the income, and the amount of stockholders' equity invested by owners to earn the net income.

LO 7

Compute the ratios widely used in financial statement analysis and explain the significance of each.

Ratios are simply mathematical calculations that compare one financial statement item with another financial statement item. The two items may come from the same financial statement, such as the current ratio, which compares the amount of current assets with the amount of current liabilities, both of which appear in the statement of financial position (balance sheet). On the other hand, the items may come from two different financial statements, such as the return on stockholders' equity, which compares net income from the income statement with the amount of stockholders' equity from the statement of financial position (balance sheet). Accountants and financial analysts have developed many ratios that place information from a company's financial statements in a context to permit better understanding to support decision making.

LO 8

Analyze financial statements from the viewpoints of common stockholders, creditors, and others.

Different groups of users of financial statements are interested in different aspects of a company's financial activities. Short-term creditors are interested primarily in the company's ability to make cash payments in the short term; they focus their attention on operating cash flows and current assets and liabilities. Long-term creditors, on the other hand, are more interested in the company's long-term ability to pay interest and principal and would not limit their analysis to the company's ability to make cash payments in the immediate future. The focus of common stockholders can vary from one investor to another, but generally stockholders are interested in the company's ability to pay dividends and increase the market value of the stock of the company. Each group may focus on different information in the financial statements to meet its unique objectives.

This chapter completes our study of financial accounting  - providing information for external users (primarily investors and creditors) to support investment, credit, and other decisions. We have focused attention exclusively on business and accounting in the United States. In Chapter 15 we introduce the subject of international business and accounting, after which we turn our attention to the subject of management accounting for the remainder of the textbook.

What ratio is current assets divided by current liabilities?

Is the quotient of the current assets divided?

Which of the following is the formula for the current ratio?

Is current ratio the same as current asset ratio?