Understanding

Financial
Statements
Types of Financial Statement
§ Income Statement
§ Balance Sheet
§ Statement of Change in Equity
§ Statement of Cash Flows
 SALES Income Statement
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
 SALES Income Statement
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
 SALES Income Statement
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
 Balance Sheet

Outstanding
Debt
Total Assets = +
Shareholders’
Equity
 Balance Sheet
Assets Liabilities (Debt) & Equity
Current Assets Current Liabilities
Cash Accounts Payable
Marketable Securities Accrued Expenses
Short-term notes
Accounts Receivable
Inventories
Long-Term Liabilities
Long-term notes
Prepaid Expenses Mortgages
Fixed Assets Equity
Machinery & Preferred Stock
Equipment Common Stock (Par
Buildings and Land value)
Other Assets Paid in Capital
Retained Earnings
Investments & patents
 Free Cash Flows
Free cash flow: cash flow that is free and
available to be distributed to the firm’s
investors (both debt and equity investors).
 The Interrelations among the Financial
Statements
Income Statement
2012

Balance Sheet Statement of Cash Flows Balance Sheet

2011 2012
2012

Statement of Retained Earnings

2012
Evaluating a Firm’s
Financial Performance
 Financial Ratio Analysis

§ Are our
decisions
maximizing
shareholder
wealth?
We will want to answer
questions about the firm’s

§ Liquidity
§ Efficient use of Assets
§ Leverage (financing)
§ Profitability
We will want to answer
questions about the firm’s

§ Liquidity
§ Efficient use of Assets
§ Leverage (financing)
§ Profitability
 Financial Ratios
§ Tools that help us determine the
financial health of a company.
§ We can compare a company’s financial
ratios with its ratios in previous years
(trend analysis).
§ We can compare a company’s financial
ratios with those of its industry
(benchmark)
 Liquidity Ratios
§ Do we have enough liquid
assets to meet approaching
obligations?
 Efficiency Ratios
§ Do firm has good ability to use its
assets on its operations?

§  Measure how efficiently

the firm’s assets generate
operating profits.
 Leverage Ratios
(financing decisions)
§ Measure the impact of using debt capital
to finance assets.
§ Firms use debt to lever (increase)
returns on common equity.
 Profitability Ratios

§ Measure the ability of the

company to produce earnings/
profit.
LIQUIDITY
RATIOs
Current Ratio (CR)

current assets
current liabilities
Acid Test Ratio (Quick Ratio/QR)

current assets - inventories

current liabilities
Cash Ratio (CR)

cash + marketable securities

current liabilities
EFFICIENCY RATIOS
Inventory Turnover

cost of goods sold

inventory
Day’s Sales in Inventory
Low inventory turnover:

The firm may have too much

inventory, which is expensive
because:
§ Inventory takes up costly
warehouse space.
§ Some items may become
spoiled or obsolete.
Accounts Receivable Turnover
Average Collection Period
(Day’s sales outstanding)
Total Asset Turnover
Fixed Asset Turnover
Leverage RATIOs
Debt Ratio

total debt
total assets
Debt to Equity Ratio

total debt
total equity
Equity Ratio

total equity
total assets
Equity Multiplier
Times Interest Earned Ratio

operating income (EBIT)

interest expense
PROFITABILITY RATIOS
Gross Profit Margin
Operating Profit Margin

operating income (EBIT)

sales
Net Profit Margin

Net income
Net sales
Operating Income Return on Investment
(OIROI) / EBIT Return on Assets (EROA)

operating income (EBIT)

total assets

• The OIROI reflects product pricing and the

firm’s ability to keep costs down.
Return on Asset (ROA)?

Net Income (EAT)

Total Assets
 Return on Equity

How well are the firm’s

managers maximizing
shareholder wealth?
Return on Equity (ROE)

net income (EAT)

total equity
MARKET VALUE RATIOS
Earnings Per Shares (EPS)

Net Income (EAT)

Shares Outstanding
Dividend Per Shares (DPS)
Dividend Payout Ratio (DPR)
Plowback Ratio
DuPont Analysis
The DuPont Model

Brings together:

§ Profitability
§ Efficiency
§ Leverage
 DuPont System (2)
The system identifies three areas where management
should focus its efforts in order to maximize the firm’s
ROE:
1.  How much profit management can earn on sales
2.  How efficient management is in using the firm’s
assets
3.  How much financial leverage management is
using.
 DuPont Equation

§