REVIEW OF FINANCIAL STATEMENT

PREPARATION,ANALYSIS
AND INTERPRETATION
THE FOUR FINANCIAL STATEMENTS

Companies present four basic financial statements:

1. Balance Sheet
2. Income Statement
3. Statement of Stockholders Equity
4. Statement of Cash Flows
What does the company own and who has claims
against the company?

The BALANCE SHEET provides a snapshot of a companys

financial position as of a certain date. It reports assets, items of
value such as inventory and equipment, and whether the assets are
financed with liabilities (debts) or stockholders equity (owners
shares).
How profitable is the company?

The INCOME STATEMENT reports the companys profitability

during an accounting period. It reports revenues, amounts
received from customers for products sold or services provided,
and expenses, the costs incurred to produce revenues. Their
difference is net income (also called earnings).
Who owns the company?

The STATEMENT OF STOCKHOLDERS EQUITY reports if

the earnings (net income) of this accounting period are
distributed as dividends or retained in the business as retained
earnings. It also reports amounts paid (contributed) to the
company by stockholders to purchase common
stock and preferred stock.
Does the company generate cash flow?

The STATEMENT OF CASH FLOWS reports cash inflows

and cash outflows during an accounting period.
FOUR FINANCIAL STATEMENTS

1. Balance Sheet
2. Income Statement
3. Statement of Stockholders' Equity
4. Statement of Cash Flow

Together, these four financial statements help investors

understand a companys finances.
THE BALANCE SHEET

The Balance Sheet reports assets and the amount of assets

financed with liabilities and stockholders equity as of a certain
date. It is based on the accounting equation:

ASSETS= LIABILITIES+STOCKHOLDERS' EQUITY

In this chapter, we explore the financial statements of
Nike, Inc.:
Nike is the largest seller of athletic footwear and athletic apparel
in the world, selling in over 170 countries. Focus is on innovation
and high-quality construction. It also markets apparel with
licensed college team, professional team, and league logos.
Almost all of Nikes products are manufactured by independent
contractors and virtually all footwear and apparel products are
produced outside the United States.
Nike also sells products under the Cole Haan, Converse, Chuck
Taylor, All Star, One Star, Jack Purcell,
Hurley, and Umbro brands.
Here is Nikes May 31, 2011 Balance Sheet:
ASSETS

Are items of value that a corporation has a right to use. Typical

asset accounts include cash, accounts receivable, inventory,
equipment, buildings, and land. Accounts receivable are amounts
to be received in the future from customers.
Notice that Nikes largest reported asset is accounts receivable,
net of $3,138 million. These are moneys that customers owe to
Nike for items purchased. The second largest asset item is
inventory, items held for sale to retailers, of $2,715 million. Nike
had $1,955 million in cash on May 31, 2011.
Nike had $2,115 of property, plant, and equipment, which consist
of land, buildings, vehicles, and other equipment. Because almost
all of Nikes products are manufactured by independent
contractors, it has not had to invest in factories to manufacture its
own goods. Therefore, property, plant, and equipment is relatively
low.
LIABILITIES

Are amounts owed to creditors; the amount of debt owed to third

parties. Typical liability accounts include accounts payable,
wages payable, notes payable, and bonds payable. The key word
found in many liability accounts is payable. Accounts Payable
are amounts that the corporation must pay to suppliers in the
future. Accounts payable of $1,469 million was Nikes second-
largest liability. The companys largest liability item was other
current liabilities of $2,302 million.
STOCKHOLDERS EQUITY

Is the portion of assets the owners own free and clear of any
liabilities. Stockholders equity may also be referred to as
shareholders equity or owners equity.
Typical stockholders equity accounts include:

Contributed Capitalamounts paid-in (contributed) to the

company by stockholders to purchase common stock and
preferred stock.

Retained Earningsnet income earned by the company since its

incorporation and not yet distributed as dividends.
Since Nike opened in 1968, it received $3,947 million in
investments from stockholders. The retained earnings account
indicates that, over these years, Nike has earned $5,801 million in
net income that has not yet been distributed to stockholders as
dividends.
Based on the accounting equation, assets can be financed either
with liabilities or with stockholders
equity. For example, Nikes $14,998 million in assets were
financed with $5,155 million worth of liabilities
(debt) and $9,843 million in stockholders equity.
THE INCOME STATEMENT
The income statement reports a companys profitability during an
accounting period.
REVENUES

Are amounts received from customers for products sold and

services provided. Sales Revenue and Service Revenue are
amounts earned engaging in the primary business activity.

Nike sold $20,862 million worth of footwear, apparel, equipment,

and accessories.
EXPENSES

Are the costs incurred to produce revenues. Obviously, it would

only make sense for companies to incur expenses that will
generate revenue and increase profits. The largest expense item
for manufacturers and retailers is usually cost of sales expense
(also referred to as cost of goods sold), which reports the
wholesale costs of inventory sold to customers during the
accounting period.
Nikes largest expense is Cost of sales of $11,354 million. It
also incurred $6,694 in selling and administrative expense and $4
million in interest expense. Related income taxes were $711
million.
NET INCOME

Is the difference between revenues and expenses. Net income is

also referred to as profit (loss), earnings, or the bottom line.

Nike was profitable. It earned $2,133 million, or approximately

$2.1 billion in profits for the year ending May 31, 2011
THE STATEMENT OF STOCKHOLDERS' EQUITY

The Statement of Stockholders Equity reports changes in the

contributed capital and retained earnings accounts during an
accounting period.
Retained earnings, earnings not distributed as dividends, is
increased by net income (earnings) of the accounting period and
decreased when earnings are distributed as dividends to the
stockholders.

Contributed capital is increased when the company receives

new investments from investors in exchangefor newly issued
stock. It is decreased when the company buys back and retires
stock.
Nike received $503 million in investments from owners, which
increased contributed capital to $3,947 million. It issued new
stock certificates in exchange for these investments. Nikes
retained earnings increased by $2,133 million in net income the
company earned, but decreased by the $569 million paid as
dividends to stockholders, resulting in ending retained earnings
of $5,801 million.
THE STATEMENT OF CASH FLOWS

The Statement of Cash Flows reports cash inflows and outflows

during an accounting period.
Business activity can be divided into three distinct areas

1. Operating Activities
2. Investing Activities
3. Financing Activities
OPERATING ACTIVITIES

Relate to a companys main business: selling products or services

to earn net income.
INVESTING ACTIVITIES

Relate to the need for investing in property, plant, and equipment

or expanding by making investments in other companies.
FINANCING ACTIVITIES

Relate to how a company finances its assetswith debt or

stockholders equity. The Statement of Cash Flows describes a
companys cash inflows and outflows for each of these three
areas.
Nikes sales generated $1,812 million in cash flow after paying
the companys expenses. Nike paid $1,021 for new investing
activities. The company paid $1,972 for financing activities. Most
of these payments went to repurchase stock and to pay dividends.
RATIO ANALYSIS

Ratio analysis can reveal valuable information about a companys

financial attributes, such as profitability, efficiency in managing
assets, and whether the company has too much debt. When
computing ratios, analysts often compare a companys ratios with
prior periods, competitors, or industry averages.
We will compute certain financial ratios for Nike (NKE), and
compare them with those of two competitors:

Under Armour (UA) and Adidas (ADDYY). The financial

statements of the three companies appear on the
following page.
DEBT RATIO

The Debt Ratio reveals the proportion of assets financed with

debt.
Companies owing too much debt might not be able to make
regular payments of interest or the full amount due at maturity. If
a company cannot pay its debts on time it could lose assets to
creditors or even go bankrupt.

Although Adidas Groups financial statements are denominated in

euros, the three companies ratios can still be compared.
Whereas Nike and Adidas both have more than $10 billion in
assets (10,618 million equals approximately $13,700 million),
Under Armour is significantly smaller with only 5% of the assets
of Nike. Under Armours $178 million in debt looks much
smaller than the other two companies. However, Under Armours
liabilities are still 26% of assets. Nikes liabilities are 34% of
assets (0.34 in decimal form) and Adidas has significantly more
debt56% of assets.
ASSET TURNOVER RATIO

Asset Turnover, computed by dividing total revenues by total

assets, measures how efficiently the company uses assets to
generate revenue.
How well does a company produce revenues from its assets? The
more assets a company has, the higher its revenues should be. For
example, one would expect Under Armour to have lower
revenues than Nike because it is smaller. Under Armour has fewer
assets available to produce revenues than Nike.
However, even though Nike is larger than Under Armour, the
asset turnover ratios indicate that Under Armour is more
efficient. Nike has an asset turnover of 1.39, whereas Under
Armours is 1.57. Adidas was much less efficient at using its
assets to produce revenues, delivering an asset turnover ratio of
just 1.13.
RETURN ON SALES (ROS) RATIO

The Return on Sales (ROS) ratio, (also referred to as Net Profit

Margin), measures the profitability of each dollar of revenue.
How well does a company control expenses? A high ROS ratio
depends on controlling expenses to keep net income high.
Nikes ROS is 10.2% (0.102 in decimal form), nearly twice that
of Under Armours 6.5%, indicating that Nike earns, on average,
more than 10 cents of profit for each dollar of revenue, compared
to Under Armours average earnings of 6.5 cents of profit per
revenue dollar. Another way of looking at this is that it takes Nike
approximately 89.8 cents of expense to generate a dollar of
revenue, whereas Under Armour uses 93.5 cents of expense to
generate a dollar of revenue. Either way, Nike is better at
controlling expenses than both Under Armour and Adidas,
resulting in higher profits.
RETURN ON ASSETS (ROA) RATIO

The Return on Asset (ROA) ratio reveals how efficiently assets

are used to generate profit (net income).
A high ROA ratio depends on managing asset investments and
controlling expenses to keep net income high. Return on Assets is
the broadest measure of profitability.

With Return on Assets of 14.2% (0.142 in decimal form), Nike

outperforms its competitors. Under Armour
is second, with an ROA of 10.2%, whereas Adidas Group comes
in third with 5.3%
Return on Assets can also be computed by multiplying the
two components, Return on Sales by Asset Turnover:
Analyzing the two components of Return on Assets will help
describe corporate strategy. Some companies focus on return on
sales, relying on product differentiation to boost profits. Others
focus on asset turnover, using high volume to gain strong net
income.
RETURN ON ASSETS
Even though Under Armour has about 5% of the assets of Nike, it
generated higher asset turnover. However, Nike showed its ability
to control costs with its strong return on sales of 10.2%, resulting
in return of assets almost 50% higher than that of Under Armour.
This indicates that Nike is able to follow the business strategy of
product differentiation. Customers are willing to pay more for
Nikes strong brand names.
Adidas, on the other hand, is not faring as well. The company is
less profitable than the other two, earning its investors a weak
5.3% return on assets, comprised of a meager return on sales of
4.7%, and a less
efficient asset turnover of 1.13.