FINANCIAL STATEMENTS

AND RATIO ANALYSIS

FINANCIAL MANAGEMENT
Be inspired…char…

“It is a capital mistake to theorize before one

has data.”
- Sherlock Holmes, my idol

“The goal is to turn data into information, and

information into insight.”
- Carly Florina, former executive, president, and chair of
Hewlett-Packard Co.
LEARNING GOALS
 Review the contents of the stockholders’
report and the procedure for consolidating
international financial statements.

 Understand who uses financial ratios and

how.

 Use ratio to analyze a firm’s liquidity and

activity.
LEARNING GOALS (cont.)

 Discuss the relationship between debt and financial

leverage and the ratios used to analyze a firm’s
debt.

 Use ratios to analyze a firm’s profitability and its

market value.

 Use a summary of financial ratios and the DuPont

system of analysis to perform a complete ratio
analysis.
STOCKHOLDERS’ REPORT

 A STOCKHOLDERS’ REPORT is annual

report that publicly owned corporations
must provide to stockholders; it
summarizes and documents the firm’s
financial activities during the past year.
STOCKHOLDERS’ REPORT (cont.)

 GAAP or Generally Accepted Accounting

Principles. The practice and procedure
guidelines used to prepare and maintain
financial records and reports; authorized
by the Financial Accounting Standards
Board (FASB)
STOCKHOLDERS’ REPORT (cont.)

 FINANACIAL ACCOUNTING STANDARDS

BOARD or FASB. The accounting
profession’s rule-setting body, which
authorizes GAAP.
Sarbanes-Oxley Act of 2002

 The Sarbanes-Oxley Act of 2002, passed

to eliminate the many disclosure and
conflict of interest problems of
corporations, established the Public
Company Accounting Oversight Board
(PCAOB), which is a not-for-profit
corporation that oversees auditors.
 TRIVIA:

 IF SOMEONE KNOWS, A REWARD IS WAITING…

THE SARBANES-OXLEY ACT OF 2002 IS NAMED

AFTER… WHO ARE THEY?

Senator Paul Sarbanes and Congressman

Michael Oxley, sponsors of the said act.
PCAOB

 The PCAOB is charged with protecting

the interests of investors and
furthering the public interest in the
preparation of informative, fair, and
independent audit reports.
 Global Focus
 More Countries Adopt International Financial Reporting
Standards
 International Financial Reporting Standards (IFRS) are
established by the International Accounting Standards
Board (IASB).
 More than 80 countries now require listed firms to
comply with IFRS, and dozens more permit or require
firms to follow IFRS to some degree.
 In the United States, public companies are required to
report financial results using GAAP, which requires more
detail than IFRS.
 Focus on Ethics

 Take Earnings Reports at Face Value

 Near the end of each quarter, many companies
unveil their quarterly performance.
 Firms that beat analyst estimates often see
their share prices jump, while those that miss
estimates by even a small amount, tend to
suffer price declines.
 The practice of manipulating earnings in order
to mislead investors is known as earnings
management.
STOCKHOLDERS’ REPORT (cont.)

 The LETTER TO STOCKHOLDERS.

Typically, the first element of the annual
stockholders’ report and the primary
communication from management.
THE FOUR KEY FINANCIAL STATEMENTS

 INCOME STATEMENT

 BALANCE SHEET

 STATEMENT OF STOCKHOLDERS’
EQUITY

 STATEMENT OF CASH FLOWS

Be inspired…char again…

“You can have data without information,

but you cannot have information without
data.”
-Daniel Keys Moran, an American computer programmer
and science fiction writer
INCOME STATEMENT

 Provides a financial summary of the firm’s

operating results during a specified period.
 Although they are prepared quarterly for
reporting purposes, they are generally
computed monthly by management and
quarterly for tax purposes.
 Fiscal
 Calendar
Table 3.1 Bartlett Company Income
Statements ($000)
BALANCE SHEET
 Summary statement of the firm’s
financial position at a given period in
time.

 Composed of:
>Assets: current and noncurrent
>Liabilities: current and noncurrent
>Stockholder’s Equity
Table 3.2 Bartlett Company Balance Sheets
($000)
Table 3.2 Bartlett Company Balance
Sheets ($000) (cont.)
STATEMENT OF RETAINED EARNINGS

The statement of retained earnings

reconciles the net income earned
during a given year, and any cash
dividends paid, with the change in
retained earnings between the start
and the end of that year.
Table 3.3 Bartlett Company Statement of
Retained Earnings ($000) for the Year Ended
December 31, 2015
 STATEMENT OF CASH FLOWS
 The statement of cash flows provides a summary of
the firm’s operating, investment, and financing cash
flows and reconciles them with changes in its cash
and marketable securities during the period.

 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.
Table 3.4 Bartlett Company Statement of Cash Flows
($000) for the Year Ended December 31, 2015
Using Financial Ratios:
Interested Parties

 Ratio analysis involves methods of calculating and

interpreting financial ratios to analyze and monitor
the firm’s performance.
 Interested parties:
• Current and prospective shareholders are interested in
the firm’s current and future level of risk and return,
which directly affect share price.
• Creditors are interested in the short-term liquidity of
the company and its ability to make interest and
principal payments.
• Management is concerned with all aspects of the firm’s
financial situation, and it attempts to produce financial
ratios that will be considered favorable by both owners
and creditors.
 Using Financial Ratios:
Types of Ratio Comparisons

 Cross-sectional analysis is the comparison of different

firms ’ financial ratios at the same point in time;
involves comparing the firm’s ratios to those of other
firms in its industry or to industry averages
 Benchmarking is a type of cross-sectional
analysis in which the firm’s ratio values are
compared to those of a key competitor or
group of competitors that it wishes to
emulate.
 Comparison to industry averages is also
popular, as in the following example.
Using Financial Ratios:
Types of Ratio Comparisons (cont.)

 Caldwell Manufacturing’s calculated inventory

turnover for 2015 and the average inventory
turnover were as follows:

Inventory turnover, 2015

Caldwell Manufacturing 14.8
Industry average 9.7
Table 3.5 Financial Ratios for Select
Firms and Their Industry Median Values
Using Financial Ratios:
Types of Ratio Comparisons (cont.)

 Time-series analysis is the evaluation of

the firm’s financial performance over time
using financial ratio analysis
WORKING CAPITAL

 Current assets – Current Liabilities

Measures the company’s ability

to repay current liabilities using only
current assets
LET’S START!!!

 MIGHT WANT TO GET YOUR CALCULATOR, A PIECE OF PAPER AND A PEN.

LIQUIDITY RATIO:
CURRENT RATIO
 Current assets ÷ Current liabilities
The current ratio for Bartlett Company in 2015 is:

$1,223,000 ÷ $620,000 = 1.97

Test of short-term debt-paying ability

LIQUIDITY RATIO:
ACID-TEST (QUICK) RATIO
 (Current assets - inventory) ÷ Current liabilities

The quick ratio for Bartlett Company in 2015 is:

Test of short-term debt-paying ability

without having to rely on inventory
ACTIVITY RATIO:
INVENTORY TURNOVER RATIO
 Cost of Goods Sold ÷ Inventory

Applying this relationship to Bartlett Company in 2015

yields:

$2,088,000 ÷ $289,000 = 7.2

Measure of how many times a

company’s inventory has been sold during the
year
 AVERAGE SALE PERIOD/ AVERAGE
AGE OF INVENTORY
(turnover in days)

 365 days ÷ Inventory turnover

Measure of the average number

of days taken to sell the inventory one time
 AVERAGE COLLECTION PERIOD
(AGE OF RECEIVABLES)
 365days ÷ Accounts receivable turnover
or
Accounts Receivable ÷ Average Sales per Day
Accounts Receivable ÷ Annual Sales/365

Measure of the average number of

days taken to collect an account receivable
 AVERAGE PAYMENT PERIOD
 Accounts Payable ÷ Average Purchases per day
or
Accounts Payable ÷ Annual Purchases/365

Average amount of time needed to

pay accounts payable.
ACTIVITY RATIO:
TOTAL ASSET TURNOVER
 Sales ÷ Total Assets

indicates the efficiency with which

the firm uses its assets to generate
sales.
DEBT RATIOS

 Total Liabilities ÷ Total Assets

Measures the proportion of

total assets financed by the firm’s
creditors.
DEBT-TO-EQUITY RATIO

 Total liabilities ÷ Stockholders’ equity

Measure of the amount of assets

being provided by creditors for each dollar of
assets being provided by the stockholders
TIMES INTEREST EARNED
RATIO
 Earningsbefore interest expense and
income taxes ÷ Interest expense

Measure of the company’s ability

to make interest payments
 FIXED-PAYMENT COVERAGE RATIO
 Earnings before interest and taxes + Lease Payments
÷
Interest + Lease Payments + ((Principal payments
+ Preferred Stock Dividends) X (1/(1-T)))

Measures the firm’s ability to meet all fixed-

payment obligations.
PROFITABILITY RATIO:
GROSS MARGIN PERCENTAGE

 Gross margin ÷ Sales

A broad measure of profitability

OPERATING PROFIT MARGIN

 Operating Profit ÷ Sales

Measures the percentage of each sales

dollar remaining after all costs and expenses
other than interest, taxes, and preferred stock
dividends are deducted.
NET PROFIT MARGIN

 (Netincome – Preferred dividends) ÷

Sales

Measures the percentage of each sales

dollar remaining after all cost and expenses
including interest, taxes, and preferred stock
dividends, have been deducted.
EARNINGS PER SHARE
 (Netincome – Preferred dividends) ÷
Average number of common shares
outstanding

Tends to have an effect on the

market price per share, as reflected in the
price-earnings ratio
DIVIDENDS PER SHARE

 Dividendspaid to common stockholders ÷

Number of shares of common stock
outstanding

the amount of cash distributed

during the period on behalf of each
outstanding share of common stock.
RETURN ON TOTAL ASSETS

 NetIncome + [Interest expense X (1 –

Tax Rate)] ÷ Average total assets

Measure of how well assets have

been employed by management
RETURN ON COMMON
STOCKHOLDERS’ EQUITY

 (Net
income – Preferred dividends) ÷
Average common stockholders’ equity

When compared to the return

on total assets, measures the extent to
which financial leverage is working for or
against common stockholders
MARKET RATIO:
PRICE-EARNINGS RATIO
 Market price per share ÷ Earnings per
share

An index of whether a stock is

relatively cheap or relatively expensive in
relation to current earnings
 MARKET/BOOK RATIO

 Market Price per share ÷ Book Value per share

Provides an assessment of how investors

view the firm’s performance.
BOOK VALUE PER SHARE

 Common stock equity ÷ number of

shares of common stock outstanding
Measures the amount that would
be distributed to holders of common stock if
all assets were sold at their balance sheet
carrying amounts and if all creditors were
paid off
DuPONT SYSTEM OF ANALYSIS

 Used to dissect the firm’s financial

statements and to assess its financial
condition.
 Merges the income statement and
balance sheet into two summary
measures of profitability, return on
total assets (ROA) and return on
common equity (ROE).
DuPONT FORMULA

 Multipliesthe firm’s net profit margin by its

total asset turnover to calculate the firm’s
return on total assets (ROA).

ROA= Net profit margin x Total asset

turnover
 DuPONT FORMULA

To simplify:

ROA= (earnings available for common stockholders/sales)

x (sales/total assets)
(earnings available for common stockholders/total assets)
MODIFIED DuPONT FORMULA

 Relatesthe firm’s return on total

assets (ROA) to its return on equity
(ROE) using the financial leverage
multiplier (FLM).

 Financialleverage multiplier (FLM) is

the ratio of the firm’s total assets to its
common stock equity.
 MODIFIED DuPONT FORMULA

ROE = ROA X FLM

OR to simplify:

ROE= (earnings available for common stockholders/total assets)

X (Total assets/common stock equity)
(earnings available for common stockholders/common
stock equity)
STOP!!! CAUTION!!!

 Ratios that reveal large deviations from the

norm merely indicate the possibility of a
problem.
 A single ratio does not generally provide
sufficient information from which to judge the
overall performance of the firm.
 The ratios being compared should be calculated
using financial statements dated at the same
point in time during the year.
STOP!!! CAUTION!!!

 It is preferable to use audited financial

statements.
 The financial data being compared should
have been developed in the same way.
 Results can be distorted by inflation.
 “Things get done only if data we gather can inform and inspire those in a
position to make a difference.”
 - Mike Schmoker, English teacher and football coach, author
I hope you’ve learned something. If
none, IBALIK ANG SNACKS!!!