Chapter 4
Analysis of Financial Statements
We will use the financial statements of Paglia Pasta, Inc. to illustrate the concepts in this chapter.
Paglia Pasta, Inc.
Balance Sheets as of December 31, 2007 and 2008
2007
2008
2007
2008
Assets
Liabilities and Owner’s Equity
Current assets
Current Liabilities
Cash
$520
$322
Accounts payable
$852
$936
Accounts receivable
1,452
1,906
Accruals
30
209
Inventory
3,109
2,955
Notes payable
413
429
Total
$5,081
$5,183
Total
$1,295
$1,574
Fixed assets
Long-term debt
$3,117
$2,500
Net plant and equipment
$9,544 $10,033
Owners’ Equity
Common stock
$10,000
$10,000
Retained earnings
213
1,142
Total
$10,213
$11,142
Total assets
$14625 $15,216
Total
$14,625
$15,216
Paglia Pasta, Inc.
2008 Income Statement
Net sales
Operating costs (except deprec & amort)
Depreciation and amortization
Operating income (EBIT)
Interest paid
Taxable income
Taxes (34%)
Net income
Dividends
Addition to retained earnings
RATIO ANALYSIS
Categories of Financial Ratios
$11,200
3,900
650
$6,650
585
$6,065
2,062
$4,003
$3,074
929
4-2. Short-Term Solvency, or Liquidity measures
1. Current Ratio 
2. Quick Ratio 
Current Assets
Current Liabilitie s
Current Assets  Inventory
Current Liabilitie s
4-3. Asset Management ratios
1. Inventory Turnover 
Sales
Inventory
Alternate definition: Inventory Turnover 
2. DSO 
Costs of Goods Sold
Inventory
365 days
Re ceivables

 annual sales  Re ceivables turnover


365


3. Fixed Asset Turnover 
4. Total Asset Turnover 
Sales
Net fixed Assets
Sales
Total Assets
4-4. Debt Management ratios
1. Debt Ratio 
Total Assets  Total Equity
Total Assets
Variations:
Debt/Equity = (Total assets - Total equity)/Total equity
Equity multiplier = Total assets/Total equity = 1 + Debt/Equity
2. Times Interest Earned Ratio 
4-5. Profitability ratios
EBIT
Interest Expense
1. Operating M arg in 
2. Pr ofit M arg in 
EBIT
Sales
Net Income
Sales
3. Re turn on Total Assets 
4. BEP 
EBIT
Total Assets
5. ROE 
Net Income
Common Equity
Net Income
Total Assets
4-6. Market value ratios
Paglia Pasta has 500 shares of common stock outstanding, and the market price for a share
at the end of 1999 was $63.
1. PE Ratio 
Pr ice per Share
Earnings per Share
2. Market  to  Book Ratio 
MarketValue per Share
Book Value per Share
4-8. The DuPont Equation
ROE  ROA  Equity multiplier  Profit margin  Total asset turnover  Equity multiplier
ROE 
Net Income Sales
Assets


Sales
Assets


 Total Equity
Re turn on Assets , ROA
4-X. Miscellaneous
A.
B.
C.
D.
Why Evaluate Financial Statements?
Trend Analysis
Benchmarking
Uses/Limitations of ratios