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Business Analysis and Reporting/Blueprint/1.A

Financial statement analysis and forecasting

Area 1: Business Analysis (40-50%)

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Topics

  • Ratio analysis and trend analysis
  • Prospective financial information
  • Cost-volume-profit analysis

Lessons

  • Financial Statement Analysis
  • Prospective Analysis and Forecasting

Study Frameworks

Financial Ratio Framework

Financial Statement Analysis
Liquidity Ratios
Current ratio = CA / CL
Quick ratio = (Cash + ST Inv + AR) / CL
Cash ratio = Cash / CL
Solvency Ratios
Debt-to-equity = Total liabilities / Equity
Times interest earned = EBIT / Interest
Equity multiplier = Assets / Equity
Profitability Ratios
Gross margin = (Rev − COGS) / Rev
Operating margin = Operating income / Rev
ROA = NI / Avg assets
ROE = NI / Avg equity
Activity Ratios
Inventory turnover = COGS / Avg inventory
Receivables turnover = Net credit sales / Avg AR
Asset turnover = Revenue / Avg assets

External Financing Needed (EFN)

(A/S)(ΔS) − (L/S)(ΔS) − PM × S₁ × (1 − d)

Additional capital needed to support sales growth. Negative EFN means surplus funds.

DuPont ROE Decomposition

ROE = Net Profit Margin × Asset Turnover × Equity Multiplier

Decomposes return on equity into profitability, efficiency, and leverage drivers.

Exponential Smoothing

New Forecast = α(Actual) + (1 − α)(Previous Forecast)

α closer to 1 = more responsive; α closer to 0 = smoother. 0 < α < 1.

Degree of Operating Leverage (DOL)

Contribution Margin / EBIT

% change in EBIT for a 1% change in sales. Higher DOL = more fixed costs = more operating risk.

Economic Indicators Classification

TypeIndicatorTiming
LeadingStock market returnsChanges before economy
LeadingBuilding permitsChanges before economy
LeadingConsumer confidenceChanges before economy
CoincidentReal GDPMoves with economy
CoincidentIndustrial productionMoves with economy
CoincidentEmployment levelsMoves with economy
LaggingUnemployment rateChanges after economy
LaggingCPIChanges after economy
LaggingPrime rateChanges after economy
PLEASEProfit margin, Leverage (equity multiplier), Efficiency (asset turnover), Analyze, Separate, Evaluate

DuPont analysis components and process. PLEASE decompose ROE into its three drivers before drawing conclusions.

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