• Reflecting on this week's lesson about financial statement analysis, identify five financial ratios that you feel are the most important and why.
• Lesson Below::::::::::

Financial Analysis: The Big Picture Financial analysis is the final topic and an excellent way to end the session because financial analysis combines all that you have learned about financial statements. Analysis and ratios are decision tools used to analyze financial statements and to determine a company's financial health. Analysis can be performed on a single company or can be conducted to compare results to competitors and compare results to industry averages. These decision tools are some of the methods investors use to analyze a company's financial health before investing in the companies' stocks or bonds. Additionally, creditors, like bank loan officers, use some of these decision analysis tools and ratios to determine a company's ability to repay a loan. It is through financial statement analysis and ratio calculations that individuals and businesses can determine if a company is financially stable or financially unstable.

Sustainable income is income that will be repeated and excludes any usual or out-of-the-ordinary income, expenses, gains, and losses. By excluding that which is unusual or a one-time event, it will provide the ability to better understand the income level for a company in the future. Income statements present information in an operating and nonoperation section so the readers of financial statements can see the usual items. Two types of usual items include discontinued operations and other comprehensive income. Refer to Figure 1, which presents the statement of comprehensive income (Weygandt, Kimmel, & Kieso, 2018). A company may have discontinued operations when the company sells a significant portion of the business (Weygandt et al., 2018). For example, Wells Fargo Bank had a substantial business in personal and commercial insurance. That business was sold to USI in November 2017, so for their 2017 financial statements, Wells Fargo Bank needed to disclose the income or loss from this business segment on their annual financial statements. Comprehensive income is the total of net income and other comprehensive income items such as certain gains and losses that bypass net income. Gains and losses occur from transactions outside of normal business activities, such as a sale of equipment. If a piece of equipment is sold for more or less than the book value, it could result in a gain or loss. One example is an investment in other companies' stocks or bonds. If the market price moves up or down on the balance sheet date, the stocks or bonds would have an unrealized gain or loss available for sale securities; refer to Illustration 18.5 on p. 18-6 of your textbook (Weygandt et al., 2018). Quality of earnings is another important analysis when evaluating a company's financials because it provides complete information so that users of the financial statements are not misled about financial statements. There are methods that companies use to affect the quality of earnings; these include alternate accounting methods such as last-in, first-out (LIFO); first-in, first-out (FIFO); or pro forma income, which excludes unusual or non-recurring items and improper recognition, such as improperly recorded revenue (Weygandt et al., 2018). The horizontal analysis is an important analysis that allows a company to compare the income statement from period to period or the balance sheet from period to period. This analysis will enable companies to see areas of the financial statement in which there is growth or any declines over two periods of time. The presentation includes the two periods being compared, the difference between the two periods, and the percentage of the base (Weygandt et al., 2018).

The vertical analysis is also referred to as the common-size analysis. This analysis allows a company to show one period compared to another or one company compared to its competition or one company compared to industry averages. Vertical analysis is another way for companies to see how they are doing financially in each area against the prior period or compared to a competitor (Weygandt et al., 2018).

The final analysis is one of the most popular methods, and it is called ratio analysis. Ratio analysis shows the relationship between figures in the financial statements. A calculation will be made based on a formula, and the relationship will be expressed in terms of a percentage, rate, or proportion. There are several categories of ratios; the specific focus for this lesson will be liquidity, solvency, and profitability ratios. Liquidity ratios: Liquidity ratios are important within or outside an organization. There are several different liquidity ratios that can be calculated, which help determine a debtor's ability to pay current debt obligations. Solvency ratios: Solvency ratios are another group of important metrics inside or outside an organization. The solvency ratio helps an organization to determine whether the company's cash flow is sufficient to meet its short-term obligations and long-term obligations. Profitability ratios: There are several different profitability ratios that can be used inside or outside an organization. These ratios help to determine the ability of the company to create earnings (Weygandt et al., 2018). The importance of financial analysis is the process of evaluating businesses, projects, efforts, or budgets to determine if it is worthwhile in terms of performance and suitable to the organization. The analysis is used to determine the stability, solvent, liquidity, or profitability to determine if the monetary investment is worthwhile and if a project, effort, or budget should be recommended.