Chapter 2:
Financial Statement and
Cash Flow Analysis
Corporate Finance, 3e
Graham, Smart, and Megginson
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Financial Statements

Company managers, investors, and outside analysts
use financial statements to conduct…
 Cash flow analysis
 Performance (ratio) analysis

The SEC requires U.S. companies to produce
financial statements conforming to Generally
Accepted Accounting Principles (GAAP), developed
by the Financial Accounting Standards Board (FASB).
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Four Key Financial Statements
1. Balance sheet
2. Income statement
3. Statement of retained earnings
4. Statement of cash flows
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Key Measures of Cash Flow
Net operating profit
after taxes (NOPAT)
Operating cash
flow (OCF)
= EBIT (1 – T)
= NOPAT + Depreciation
= EBIT (1 – T) + Depreciation
Free cash = OCF – FA – (CA – AP – Accruals)
flow (FCF)
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Table 2.4 The Inflows and Outflows of
Corporate Cash
Inflows





Decrease in any asset
Increase in any liability
Net profits after taxes
Depreciation and other
non-cash charges
Sale of stock
Outflows





Increase in any asset
Decrease in any liability
Net loss
Dividends paid
Repurchase or retirement
of stock
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Liquidity Ratios
Current
ratio
Quick
ratio
=
Current assets
Current liabilities
=
Current assets  Inventory
Current liabilities
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Activity Ratios
Inventory
=
turnover
Cost of goods sold
Inventory
Average
collection =
period
Accounts receivable
Average daily sales
Average
payment
period
Accounts payable
Average daily purchases
=
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Activity Ratios
Fixed asset
=
turnover
Sales
Net fixed assets
Total asset
turnover
Sales
Total assets
=
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Debt Ratios
Debt ratio =
Total liabilities
Total assets
Equity
multiplier
Total assets
Common stock equity
=
Debt-to-equity
=
ratio
Long-term debt
Stockholders’ equity
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Debt Ratios
Times
interest
earned
=
EBIT
Interest expense
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Profitability Ratios
Gross profit
=
margin
Gross profit
Sales
Operating
profit
=
margin
Operating profit
Sales
Net profit
margin =
Earnings available for
common shareholders
Sales
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Profitability Ratios
Earnings per
share (EPS) =
Return on
total assets
(ROA)
=
Return on
common
=
equity (ROE)
Earnings available for common stockholders
Number of common shares outstanding
Earnings available for common stockholders
Total assets
Earnings available for common stockholders
Common stock equity
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DuPont System of Analysis
ROA =
Net profit 
margin
ROE =
ROA  A/E
Net profit 
ROE =
margin
Total asset
turnover
Total asset
turnover
 A/E
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Market Ratios
Price/earnings
(P/E) ratio =
Book value
per share
Market/book
(M/B) ratio
=
=
Market price per share of common stock
Earnings per share (EPS)
Common stock equity
Number of common shares outstanding
Market price per share of common stock
Book value per share of common stock
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