FSA2PPT

Chapter 2
Financial
Statements
and Analysis
Copyright © 2009 Pearson Prentice Hall. All rights reserved.

The Four Key Financial Statements:
The Income Statement
• The income statement provides a financial

summary of a company’s operating results
during a specified period.
• Prepared annually for reporting purposes
– Computed monthly by management
– Computed quarterly for tax purposes.
Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-2

The Four Key Financial Statements

The Balance Sheet
• The Balance Sheet presents a summary of a

firm’s financial position at a given point in time.
– Assets indicate what the firm owns
– Equity represents the owners’ investment
– Liabilities indicate what the firm has borrowed.


The Four Key
Financial Statements (cont.)

Statement of Retained Earnings
• The statement of retained earnings reconciles the

net income earned and dividends paid during the
year, with the change in retained earnings.


Statement of Cash Flows
• The statement of cash flows provides a

summary of the cash flows over the period of
concern, typically the year just ended.
• This statement not only provides insight into a
company’s investment, financing and operating
activities, but also ties together the income
statement and previous and current balance
sheets.


Using Financial Ratios:
Interested Parties
• Ratio analysis involves methods of calculating

and interpreting financial ratios to assess a
firm’s financial condition and performance.

Types of Ratio Comparisons
• Trend or time-series analysis
• Cross-sectional analysis
* Industry comparative analysis
* Benchmarking
* Combined

Cautions for Doing Ratio Analysis
1. Ratios must be considered together; a single ratio by

itself means relatively little.
2. Financial statements that are being compared should
be dated at the same point in time.
3. Use audited financial statements when possible.
4. The financial data being compared should have been
developed in the same way.
5. Be wary of inflation distortions.

Ratio Analysis Example
• We will illustrate the use of financial ratios for

analyzing financial statements using the Bartlett
Company Income Statements and Balance
Sheets presented earlier in Tables 2.1 and 2.2.

Ratio Analysis
• Liquidity Ratios
– Current Ratio
Current ratio = total current assets

total current liabilities
Current ratio = $1,233,000 = 1.97

$620,000

Ratio Analysis (cont.)
– Current Ratio
– Quick Ratio
Quick ratio = Total Current Assets - Inventory

total current liabilities
Quick ratio = $1,233,000 - $289,000 = 1.51

$620,000
• Activity Ratios
– Inventory Turnover
Inventory Turnover = Cost of Goods Sold

Inventory
Inventory Turnover = $2,088,000 = 7.2

$289,000
• Activity Ratios
– Average Age of Inventory
Average Age of Inventory = 365

Inventory Turnover
Inventory Turnover = 365 = 50.7 days

7.2
• Activity Ratios
– Average Collection Period
ACP = Accounts Receivable

Net Sales/365
ACP = $503,000 = 59.7 days

$3,074,000/365
• Activity Ratios
– Average Payment Period
APP = Accounts Payable

Annual Purchases/365
APP = $382,000 = 95.4 days

(.70 x $2,088,000)/365
• Activity Ratios
– Total Asset Turnover
Total Asset Turnover = Net Sales

Total Assets
Total Asset Turnover = $3,074,000 = .85

$3,597,000
Table 2.6 Financial Statements Associated with Patty’s

Alternatives

• Activity Ratios
• Financial Leverage Ratios
– Debt Ratio
Debt Ratio = Total Liabilities/Total Assets
Debt Ratio = $1,643,000/$3,597,000 = 45.7%

• Activity Ratios
• Leverage Ratios
– Times Interest Earned Ratio
Times Interest Earned = EBIT/Interest
Times Interest Earned = $418,000/$93,000 = 4.5

• Activity Ratios
• Leverage Ratios
– Fixed-Payment coverage Ratio (FPCR)
FPCR = EBIT + Lease Payments________________
Interest + Lease Pymts + {(Princ Pymts + PSD) x [1/(1-t)]}
FPCR = $418,000 + $35,000 = 1.9

$93,000 + $35,000 + {($71,000 + $10,000) x [1/(1-.29)]}

• Activity Ratios
• Leverage Ratios
• Profitability Ratios
– Common-Size Income Statements


• Activity Ratios
• Leverage Ratios
– Gross Profit Margin
GPM = Gross Profit/Net Sales
GPM = $986,000/$3,074,000 = 32.1%

• Activity Ratios
• Leverage Ratios
– Operating Profit Margin (OPM)
OPM = EBIT/Net Sales
OPM = $418,000/$3,074,000 = 13.6%

• Activity Ratios
• Leverage Ratios
– Net Profit Margin (NPM)
NPM = Earnings Available to Common Stockholders

Sales
NPM = $221,000/$3,074,000 = 7.2%

• Activity Ratios
• Leverage Ratios
– Earnings Per Share (EPS)
EPS = Earnings Available to Common Stockholders

Number of Shares Outstanding
EPS = $221,000/76,262 = $2.90

• Activity Ratios
• Leverage Ratios
– Return on Total Assets (ROA)
ROA = Earnings Available to Common Stockholders

Total Assets
ROA = $221,000/$3,597,000 = 6.1%

• Activity Ratios
• Leverage Ratios
– Return on Equity (ROE)
ROE = Earnings Available to Common Stockholders

Total Equity
ROE = $221,000/$1,754,000 = 12.6%

• Activity Ratios
• Leverage Ratios
• Market Ratios
– Price Earnings (P/E) Ratio
P/E = Market Price Per Share of Common Stock

Earnings Per Share
P/E = $32.25/$2.90 = 11.1

• Activity Ratios
• Leverage Ratios
• Market Ratios
– Market/Book (M/B) Ratio
BV/Share = Common Stock Equity

Number of Shares of Common Stock
BV/Share = $1,754,000/72,262 = $23.00

• Activity Ratios
• Leverage Ratios
• Market Ratios
– Market/Book (M/B) Ratio
M/B Ratio = Market Price/Share of Common Stock

Book Value/Share of Common Stock
M/B Ratio = $32.25/$23.00 = 1.40

Summarizing All Ratios
Table 2.8 Summary of Bartlett Company Ratios
(2007–2009, Including 2009 Industry Averages)

Summarizing All Ratios (cont.)
Table 2.8 Summary of Bartlett Company Ratios
(2007–2009, Including 2009 Industry Averages)

DuPont System of Analysis
• The DuPont system of analysis is used to dissect the firm’s

financial statements and to assess its financial condition.
• It merges the income statement and balance sheet into two summary
measures of profitability.
• The Modified DuPont Formula relates the firm’s ROA to its ROE
using the financial leverage multiplier (FLM), which is the ratio of
total assets to common stock equity:
• ROA and ROE as shown in the series of equations on the following
slide and in Figure 2.2 on the following slide.

DuPont System of Analysis

DuPont System of Analysis (cont.)
Figure 2.2 DuPont

System of Analysis

Modified DuPont Formula (cont.)
• Use of the FLM to convert ROA into ROE reflects the

impact of financial leverage on the owner’s return.
• Substituting the values for Bartlett Company’s ROA of
6.1 percent calculated earlier, and Bartlett’s FLM of
2.06 ($3,597,000 total assets ÷ $1,754,000 common
stock equity) into the Modified DuPont formula yields:
ROE = 6.1% X 2.06 = 12.6%

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Chapter 2

Copyright © 2009 Pearson Prentice Hall. All rights reserved.

• The income statement provides a financial

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-2

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-3

• The Balance Sheet presents a summary of a

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-4

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-5

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-6

• The statement of retained earnings reconciles the

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-7

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-8

• The statement of cash flows provides a

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-9

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-10

• Ratio analysis involves methods of calculating

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-11

• Trend or time-series analysis

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-12

1. Ratios must be considered together; a single ratio by

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-13

• We will illustrate the use of financial ratios for

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-14

Current ratio = total current assets

Current ratio = $1,233,000 = 1.97

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-15

Quick ratio = Total Current Assets - Inventory

Quick ratio = $1,233,000 - $289,000 = 1.51

Inventory Turnover = Cost of Goods Sold

Inventory Turnover = $2,088,000 = 7.2

Average Age of Inventory = 365

Inventory Turnover = 365 = 50.7 days

ACP = Accounts Receivable

ACP = $503,000 = 59.7 days

APP = Accounts Payable

APP = $382,000 = 95.4 days

Total Asset Turnover = Net Sales

Total Asset Turnover = $3,074,000 = .85

Table 2.6 Financial Statements Associated with Patty’s

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-22

Debt Ratio = Total Liabilities/Total Assets

Debt Ratio = $1,643,000/$3,597,000 = 45.7%

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-23

Times Interest Earned = EBIT/Interest

Times Interest Earned = $418,000/$93,000 = 4.5

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-24

FPCR = $418,000 + $35,000 = 1.9

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-25

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-26

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GPM = Gross Profit/Net Sales

GPM = $986,000/$3,074,000 = 32.1%

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-28

OPM = EBIT/Net Sales

OPM = $418,000/$3,074,000 = 13.6%

NPM = Earnings Available to Common Stockholders

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 2-30

EPS = Earnings Available to Common Stockholders

EPS = $221,000/76,262 = $2.90

ROA = Earnings Available to Common Stockholders

ROA = $221,000/$3,597,000 = 6.1%

ROE = Earnings Available to Common Stockholders

ROE = $221,000/$1,754,000 = 12.6%

P/E = Market Price Per Share of Common Stock