ONE PAGE OF NOTES

Income Statement: Shows manufacturing and selling activities resulting in profit or loss
Summarizes the sales revenue and expenses for a period at time
Balance Sheet: shows what the company owes and owns, including the owner’s stake for a period in time
Cash Flow: tracks movement of cash (inflows and outflows) through the company for a period of time
Connections
1. Ending cash balance on cash flow statement = cash on balance sheet
2. Balance sheet: total assets = total liabilities and shareholders’ equity – when you subtract from asset account you must add to another asset account or subtract from liabilities
3. Net income on Income Statement ADDed TO retained earnings on balance sheet and thus shareholders equity goes up (increases)

Translate Income & Balance Sheet into Cash Flow (Steps):

1. Calculate change in Balance sheet accounts over accounting period
2. Determine which changes used cash and which provided cash
3. Segregate sources from uses and examine

TRICK: when showing use changes in CFS- make sure to make increases in assets NEGATIVE because an increase in asset=decrease in cash (ex: increase A/R, increase in INV, and increase in Prepaid Expenses)

SOURCES (Inflows of cash) USES (Outflows of cash)

Company generate cash by (Positive on Cash Company consume cash by (Negative on Cash
Flow) Flow)

↑ Liabilities, ↑ Owner’s Equity, ↑ Profit ↑ Assets

↓ Assets ↓ Liabilities, ↓ Owner’s Equity, ↓ Losses

CASH CONVERSION CYCLE (DIO + DSO – DPO = CCC)

DIO = Days inventory outstanding= (Average Inventory/COGS) x 365;
Numbers of days to sell the entire inventories, the lower the better
Inventory Turnover = COGS/Inventory
Effectiveness of the company’s inventory management policy. Higher turnover, less capital needed to carry these assets.
DSO = Days Sales outstanding= (A.R/Revenue) x 365; A/R Turnover = Revenue/A.R
Numbers of day to collect A.R, the lower the better CFS
DPO = Days payable outstanding= (A.P/COGS) x 365; A/P Turnover = COGS/A.P Tracks the movement of cash through the company for a period of time 

Numbers of days for company to pay their bills, the higher the better
Profitability Ratios:
~Return on Equity = Net income/ Shareholder’s Equity OR net income/sales* sales/assets* assets/shareholders’ equity Higher better! Efficiency of how  Cash on hand at start 

 Plus, Cash received 

firm employs its owner’s capital. Percentage return to owners on their investment.  Less, Cash spent 

~Return on Assets = Net income/ Assets A basic measure of efficiency with which the company allocates and manages resources. Measures profit as a  Equals Cash on hand at end 

percent of total assets. Want it to be high.
~Return on invested Capital = ((EBIT*(1-tax rate))/(interest bearing debt + shareholders’ equity) Represents the rate of return earned on the total capital
invested in the business including equity and debt. Basic Elements: 

~Profit Margin = Net income/Sales; Measures the portion of each dollar of sales that makes it through the income statement to profits. Reflects
company’s pricing strategy and ability to control operating costs.
 Cash/ Revenue inflows from Operations 

~Gross Margin = Gross Profit/ Sales; Distinguishes between fixed and variable costs and how much each sales dollar contributes to covering fixed costs.  Expense Outflows 

~Price to Earnings = Price per share/Earning per share; Measures the amount of money investors are willing to pay for one dollar of current  Cash from Financing/ other activities 
Only cash transactions
earnings. The PE depends upon a company’s future earnings and the risk associated with those earnings. affect cash flow
Leverage Ratios:
~Assets to Equity (times) = Total Assets/ Shareholders Equity
An indicator of the extent to which a company is leveraging invested capital. A high ratio is acceptable in industries with stable earnings and less so
where earnings are low and less predictable. Cash From Operations 

~Debt to Assets = Total debt/ Total Assets
Reflects the extent to which debt is being used to finance the acquisition of assets.
~Debt to Equity = Total Debt/ Total Shareholder’s Equity
Indicator of the extent to which a company is using financial leverage. % of each dollar supplied by creditors to company  Represents cash transactions for normal day-to-day running of
~Times Burden Covered (times) = EBIT/(Interest & principal payments/(1+tax rate)); ability to cover all financial burden, want >1, which shows you
can cover the burden business
pay the interest on total debt.
~Times Interest Earned (times) = EBIT/Interest Expense – how many time ebit will cover interest expenses  Inflows: Receipts or collections increase cash on hand 

Turnover-control Ratios:
~Asset Turnover = Sales/Assets
 Outflows: Disbursements or payments reduce cash on hand 

Measures the sales generated by each dollar of assets. Measure of capital intensity - a low asset turnover signifies a capital-intensive business.
~Fixed-asset Turnover= Operating Leverage = Sales/Net PP&E
Measures the sales generated by each dollar of fixed assets. Measure of capital intensity (particularly long-term capital assets)  Good indicator of how well management runs day-to-day
~Days Sales in Cash (days) = cash and securities/sales per day
Number of days sales the company is carrying in cash and securities as a compensating balance. operations 
Cash from Financing and other activities 

~Working Capital Turnover = Sales/ (Current Assets – Current Liabilities); working capital required to produce sales.
Liquidity Ratios:  Present Income Statement & Balance Sheet as % of
~Net Working Capital = Current Assets – current liabilities; Measures of the dollar effect of completing the business cycle.
~Working Capital to Assets = (current assets-current liabilities)/total assets a total - Income Statement: scale all #s in proportion
Proportion of W.C to total assets as an indicator of liquidity. Growth without sufficient working capital is not good!
~Current Ratio=CA/CL; Company’s ability to pay its bill within the next accounting period. >1 preferred to net sales 
- Balance Sheet: present each asset
~Acid Test (Quick Ratio)=(CA – Inventory)/CL; if <1 no liquid A to pay L, Too high∵ accumulated cash  not productive
& liability as % of total assets 
 -
Measures for Shareholders:
~Market Price per share = EPS* Industry Multiple; Value of the company as determined by the market.
~Book Value per share= Equity/Shares Outstanding; Value of the company as shown on the balance sheet.  Horizontal (Growth or Change)
 ■ %
~Dividend Payout= Dividend Paid/Net income after taxes; Proportion of Net Income after Taxes that is returned to the shareholders as dividends.
Common Size Statements: change=(current period-previous period)/(previous
Income Statement: Scale all numbers in proportion to Net Sales
Balance Sheet: Present each asset and liability as a percent of Total Assets period)
Horizontal (Growth or Change) = % change = (Current Period – Previous Period)/Previous Period
Vertical (Percent of, or Margin) = % Margin = Metric/Revenue  Vertical (% of or margin)
 ■ %

Accrual Basis VS Cash Basis Margin=(metric)/(Rev.)

Accrual Basis = revenue is recognized when the product is accepted by the customer
Cash Basis = income is recognized when cash is received
 Translate Income & Balance Sheet into Cash Flow Steps:

Profit (Net Income) does not equal Cash Flow

1. Profit is determined by accounting principles  Calculate change in Balance sheet accounts over accounting
2. Income Statement includes accruals (non cash flows)
3. Income Statement records sales over a specific period period 

4. While useful in determining financial health, it does not tell the entire story
 Determine which changes used cash and which provided cash

 Segregate sources from uses and examine 


Start: $7M inventory
 Buy: $2M
 End: $4M
 Meaning you spent $9M- $4M= COGS=$5M Gross

Profit/Revenue=Gross Profit Margin (high GPM indicates Good long-term economics 
Durable competitive

advantage allows pricing in excess of costs 
Rule: 40% or better is preferred)
 - (Operating Expenses;


SGA: Direct and indirect expense to sell product and run business 
R&D: Cost associated with making

new product, typically high in start-ups 
Depreciation: Estimated amount that machineries, equipment and

building wear out during a 
period 
Non cash charging to earnings, but it can give you a false read if you

ignore it) - (
Interest Paid out is a financial cost, not an operating cost Reflects total debt burden 
 Rule:

Less than 15% of operating income payout is preferred, but can vary from industry to industry, so look for

the business with the lowest ratio
 For assets other than inventory sold
 Usually a non-recurring event

Worth understanding what happened Rule: Remove these events from any calculation of Net earnings Net

earnings: What is left after all costs and taxes Look for trends and consistency 
Note any share

repurchases or anything that might affect denominator for EPS 
Ratio of NE to Revenue is a good indicator

of economics of business as compared to others in 
the same industry
 Some companies might be short of

cash, but still show profit)