GAAP Financial Statement Analysis

Financial Analysis technique: there are three common technique used to analyze
financial statements (Vertical analysis, Trend analysis, Ratio analysis).
Vertical analysis: the use of common-size statements to highlight basic relationships
among items within a single set of financial statements. (Looks at any unusual
percentages in the common-size statements with small or large values in comparing two
different companies regarding: size, inflation, multiple years).
Trend analysis: identifies patterns in past data and then projects these patterns into the
future and through time. It uses period-to-period percentage changes in (total assets,
sales, cost of good sold, gross profit, operating expenses and net income profitability for
two or more years data). Also can be applied to other comprehensive income.
Ratio analysis: used to study the fanatical condition of an account; two or more data
items from accounting records of a company are reacted to one another and the results is
compared o results for prior accounting period or for similar businesses. So it evaluate a
companys profitability and examine relationships between amounts, companies of
different sizes and in different industries can be directly compared. Its categorized into:
(efficiency, liquidity, leverage and profitability). Page 4.5
Common-size statement: a financial statement in which amounts are reported as a
percentage of a base figure.
Vertical analysis starts with construction of common0size statements, which can reveal
items with unusual percentages that indicate an excessively large or small value relative
to other values reported in the same accounting period. Vertical analysis could be (Single
or Multiple) P4.7
Gross margin: the percentage of sales remaining after deducting the cost of goods sold
from sales, calculated by dividing gross profit by sales.
Net profit margins: the percentage of sales remaining ager deducting all expenses.
Efficiency ratios: examine how well a company managers uses its assets. The measures
used in GAAP are: (account receivable ratio, the asset turnover ratio, and the inventory
turnover ratio).
Account receivable turnover ratio: an efficiency ratio that indicates how quickly a
business collects the amounts owned by its customers. An alternative measure of
efficiency for accounts receivable is the days sales outstanding. (pg 4.15)
o Account rec. turnover ratio = credit sales/account rec.
Days Sales outstanding: a measure of the number of days it takes on average for a
company to collect its account receivable.
Assets turnover ratio: measures the use of assets. The more efficiently a company
uses its assets to generate sales, the higher the total assets turnover.
o Assets turnover ratio = sales/total assets.
Inventory turnover ratio: an efficiency ratio that indicates how quicly inventory is
sold, generating either cash (from cash sales) or accounts receivable (from credits
sales).

o Inventory turnover ratio= cost of goods sold/inventory

Net profit margin: measures percentage of sales remaining after deducting all
expenses that indicates how effective an insurer is at cost control, uses income
statement data, and is calculate as:
o Net profit margin= net income/sales
Return on Assets: shows how well a company has used its resources by
comparing net income to the assets invested to generate that income.
o ROA = net income/total assets
Return on equity: shows the rate of return that shareholders are earning on the
equity in the companys assets.
o ROE = net income/shareholders equity
DuPont identity: an analysis of ROA and Roe by breaking them down into their
component ratios. Pg 4.18
Leveage: the practice of using borrowed money to invest.
Leverage ratio: a financial ratio that indicates the relationship between the amount
of funds supplied by creditors and the funds supplied by the owners of the
company.
Working capital: a liquidity measure that is calculated by:
o Working capital = current assets current liability
Current ratio: a liquidity ratio that indicates the companys ability to meet its short
term financial obligations calculated by
o Current ratio = current assets / current liabilities
Acid-test ratio: a liquidity ratio that provides a measure of a companys ability to
meet its current obligations If it cannot sell its inventory.
Debt-to-equity ratio: a leverage ratio that measures the extent to which a company
is financed using borrowings rather than its own funds
Debt-to-assets ratio: a leverage ratio shows the extent to which a companys assets
are financed by debt; uses balance sheet data and is calculated by
o Debt-to-assets = total liab. / total assets
Assets turnover: a ratio that emphasizes the efficiency of the companys use of its
assets.
Quick ratio acid test ratio: a liquidity ratio that provides a measure of a
companys ability to meet its current obligations if it cannot sell its inventory.
Chapter 5
GAAP: a common set of accounting standards and procedures used in the preparation of
finical statements to ensure consistency of presentation and reported results.
Accounting equation: used to represent the contents of a SAP balance sheet and
illustrates that a balance sheet must always remain in balance.
Admitted assets = liabilities + policy holders surplus
Policy holders surplus = admitted assets liability

Matching principle: an accounting rule that requires expenses incurred in generating

revenues to be matched against those revenues.
Statutory accounting pricnbles SAP compared with GAAP:
SAAP and GAAP are similar in many ways, they differ in terms of how they value many
assets and liabilities and recognize many revenues and expenses. Major areas where they
differ include:
1. No admitted and admitted assets
2. Bond investments
3. Premium balances due from agents
4. Reinsurance recoverable
5. Provision for reinsurance
6. Policy acquisition costs
7. Reporting of subsidiaries and affiliates
8. Pension accounting
9. Statements of comprehensive income
Non-admitted assets: types of property, such as office furniture and equipment, that
regulators do not allow insurers to show as assets on financial statements because these
assets cannot readily be converted to cash at or near their market value.
Admitted assets: assets meeting minimum, standards of liquidity that an insurer is
allowed to report on its balance sheet in accordance with statutory accounting principles.
Reinsurance recoverable: amounts for losses and loss adjustment expenses owed to an
insurer under reinsurance agreements covering paid losses.
Unauthorized reinsurer: a reinsurer that is not licensed or otherwise authorized to do
businesses in the primary insurers state of domicile.
NAIC annual statement: the primary financial statement prepared by insurers and
required by every state insurance department.
Loss reserve an estimate of the amount of money the insurer expects to pay in the future
for losses that have already occurred and been reported, but are not yet settled.
Loss adjustment expenses reserves: estimates the future expense that an insurer experts
to incur to investigate, defend, and settle claims for losses that have already occurred.
The income statements breaks down earnings into three main categories:
Underwriting income, invested income and other income. Pg 5.14
Cash flow: pg 5.17
Capital and surplus account: pg 5.16
Authorized reinsurer: a reinsurer that is authorized to do business in the primary
insurers state of domicile
Certified reinsurer: