Introduction to Financial Statement AnalysisIntroduction to Financial Statement Analysis

C H A P T E R 5

Learning Objective 1

Explain the purpose of financial statement analysis.

What’s the Purpose of Financial Statement Analysis?

Define Financial Ratios

Discuss the Need for Financial Statement Analysis

External Users: Internal Users:

Learning Objective 2

Understand the relationships between financial statement numbers and use ratios in analyzing and describing a company’s performance.

What Is the Debt Ratio and Its Purpose?

What Is the Current Ratio and Its Purpose?

What Is Return on Sales and Its Purpose?

What Is Asset Turnover and Its Purpose?

What Is Return on Equity and Its Purpose?

What Is the Price-Earnings Ratio and Its Purpose?

Match Financial Ratios

Debt ratio

Total liabilitiesTotal assets

Current assetsCurrent liabilities

SalesTotal assets

Net incomeSales

Net incomeOwners’ equity

Market price per shareEarnings per shareCurrent ratio

Asset turnover

Return on sales

Return on equity

Price-earnings ratio

Learning Objective 3

Use common-size financial statements to perform comparison of financial statements across years and between companies

$5,400

Common-Size Financial Statements

Resolves the problem of size or scale in comparisons

Divide all income statement numbers for a given year by the total revenues or all balance sheet items by total revenues for the year.

All amounts are then shown as a percentage of revenues for that year.

Helps to pinpoint problem areas.SEC requires multiple years of financial

statements be provided by publicly traded companies

Example: Common-Size Income Statement

Uncommon CompanyCommon-Size Income Statement

For the Year Ended 12/31/02

Revenues. . . . . . . . . . . . . . . . $10,000 100%Cost of sales. . . . . . . . . . . . 5,000 50 Selling & admin. exp. . . . . . 1,500 15

Income before taxes. . . . . . . . $ 3,500 35%Income tax expense. . . . . . . . 1,000 10 Net income. . . . . . . . . . . . . . . $ 2,500 25%

Learning Objective 4

Understand the DuPont framework and how return on equity can be decomposed into its profitability, efficiency and leverage components

What Does The DuPont Framework Do?

Match Term to Definition

Return on Sales

Asset Turnover

Assets to Equity Ratio

Profitability

Efficiency

Leverage

Net income divided by sales

Ability to generate sales through the use of assets

Ability to generate net income per sales dollar

Using borrowed funds instead of invested funds

Assets divided by equity

Sales divided by assets

What Are the Components of ROE?

Learning Objective 5

Use cash flow information to evaluate cash flow ratios

Discuss Cash Flows

What is the Cash Flow to Net Income Ratio?

What is the Cash Flow Adequacy Ratio?

Learning Objective 6

Understand the limitations of financial statement analysis

$

What are the Limitations of Financial Statement Analysis?

End Chapter 5