3-1

Working with Financial Statements

Chapter 3

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter Outline

• Statement of Cash Flow

• Standardized Financial Statements

• Ratio Analysis

• The Du Pont Identity

• Why Evaluate Financial Statements?

• Benchmarking

• Potential Problems

2

Statement of Cash Flow

• Sources of Cash = cash inflow

• Uses of Cash = cash outflow

3

Standardized Financial Statements

• 1. Common-Size Statements: - Common-Size Balance Sheet: reports ever item as % of total assets - Common-Size Income Statement:reports every item as % of sales

• 2. Common-Base Year Statements:reports every item as % of the same item in another year

• 3. Combined Common-Size and Common-Base Year Statements:reports every item as a % of the % of the same item in another year 4

Standardized Financial Statements

5

Ratio Analysis:Categories of Financial

Ratios• 1. Short-term solvency or liquidity ratios

• 2. Long-term solvency or financial leverage ratios

• 3. Asset management or turnover ratios

• 4. Profitability ratios

• 5. Market value ratios

Du Pont Identity6

1. Short-Term Solvency Ratios

7

94.11255

2429

sliabilitiecurrent

assetscurrent ratiocurrent 1.

8996.1255

13002429

sliabilitiecurrent

inventory-assetscurrent ratioquick 2.

2. Long-Term Solvency or Leverage Ratios

8

3314.10079

3340

assets

debtratiodebt 1.

4956.6739

3340

equity

debtratioy debt/equit

4956.16739

10079

equity

debt1

equity

debtequity

equity

assetsmultiplierequity

2363.67392085

2085

equitydebt termlong

debt termlongratiodebt termlong 2.

67.3314.110079

6739

assets

equityratioequity

2. Long-Term Solvency or Leverage Ratios

9

7.4196

922

interest

EBIT(TIE) ratio earnedinterest times3.

56.9196

952922

interest

ondepreciatiEBITratio coveragecash 4.

3. Asset Management Ratios

10

03.21300

2633

inventory

sold goods of costs turnover inventory 1a)

18003.2

365

turnoverinventory

days 365 inventory in sales days' b) 1

3. Asset Management Ratios

11

39.6705

4507

receivable accounts

sales turnover sreceivable a) 2

5738.6

365

turnoversreceivable

days 365 period collection average b) 2

4472.10079

4507

assets total

sales over asset turn total3.

4. Profitability Ratios

12

1047.4507

472

sales

incomenet PMmargin profit 1.

0468.10079

472

assets

incomenet ROA assetson return 2.

07.6739

472

equity

incomenet ROE equity on return 3.

5. Market Value RatiosAssume: there are 30 mil shares outstanding selling at $350/share

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Assume : g=5%.

25.2273.15

350

30472350

shareper earnings

shareper price PE ratio ingsprice/earn 1.

4%5

25.22

g%

PE PEG 2.

56.163.224

350

306739350

shareper book value

shareper uemarket val ratiobook -to-market 3.

DuPont Identity

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The DuPont Identity decomposes the ROE into an operating efficiency ratio (day-to-day activities) x asset use efficiency (investment s) x financial leverage (financing)

• ROE = NI/equity• ROE = NI/equity x sales/sales x assets/assets• ROE= NI/sales x sales/assets x assets/equity

profit margin x asset turnover x equity multiplier

4956.1 x 0.4472 x 0.1047 ROE 0.07 ROE

Why Evaluate Financial Statements?

• Internal uses– Performance evaluation – compensation

and comparison between divisions– Planning for the future – guide in

estimating future cash flows

• External uses– Creditors– Suppliers– Customers– Stockholders

15

Benchmarking

• Statements and ratios are not very helpful by themselves; they need to be compared to something.

• Use:- Time and Trend Analysis- Peer Group Analysis

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Potential Problems

• Which ratios are most relevant?• Diversified firms are hard to compare• Differences in international accounting

regulations• Varying accounting procedures, i.e. FIFO

vs. LIFO• Different fiscal years• Extraordinary events

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