Chapter 3
Financial Statement Analysis
Chapter Overview
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The Statement of Financial Position
The Income Statement
Taxes
Net Working Capital
Cash Flow
Financial Statement Analysis
Ratio Analysis
The DuPont Identity
Using Financial Statement Information
Overview
Three Important Accounting Statements
The Statement of
Financial Position
The Income
Statement
The Cash Flow
Statement
The Statement of
Financial Position
What are the firm’s assets and
how are they funded?
The Statement of Financial Position
The Accounting Equation
Liabilities
Shareholders’
Equity
Assets
The Statement of Financial Position
Centrica plc 2018
Non-Current Assets
£m Non-Current Liabilities
£m
Property, Plant and Equipment
4,059 Bank Loans and other Borrowings
4,359
Intangible Assets
2,009 Other Long-Term Liabilities
4,234
Interests in Joint Ventures
1,727
8,593
Goodwill
2,678 Current Liabilities
Other Non-Current Assets
1,779 Trade Payables
12,252 Other Current Liabilities
Current Assets
Trade Receivables
Inventories
Bank Overdrafts and Loans
4,524
347 Total Liabilities
Other Current Assets
1,597 Total Shareholders’ Equity
Cash and Cash Equivalents
1,538
4,995
1,749
898
7,642
16,235
4,023
8,006
Total Assets
20,258 Total Assets
20,258
The Statement of Financial Position
Important Characteristics of Statements of Financial
Position
Current
and NonCurrent
Assets
Current
and NonCurrent
Liabilities
Equity
Net
Working
Capital
The Income Statement
How has the firm performed over
the previous period?
The Income Statement
The Income Equation
Revenues
Expenses
Income
The Income Statement
Centrica plc 2018
Revenue
Expenses
Profit Before Interest and Taxes
Finance Costs
Profit Before Tax
Tax
Profit After Tax
Number of Shares
EPS
£m
15,321
14,617
704
289
415
177
238
5667
0.042
The Income Statement
Important Characteristics of Income Statements
Non-Cash
Items
Variable
and Fixed
Costs
Tax
Operating
Profit and
Net
Income
Taxes
How to calculate tax
Taxes
Average vs. Marginal Tax Rates
Average Tax
Rate
Marginal Tax
Rate
•Tax paid/profit
before taxes
•Tax (%) you
pay if you earn
one more unit
of currency
Taxes
Average vs. Marginal Tax Rates
The first €200,000 earned by Dutch firms pay 16 per cent tax; extra earnings pay
22.25 per cent tax.
Suppose Dutch corporation has taxable income of €400,000.
Tax Paid
• 16% × €200 +
22.25% × €200 =
€76.5
Tax Rates
• Average:
76.5/400 =
19.125%
• Marginal: 22.25%
Net Working Capital
How to calculate net working
capital
Net Working Capital
How to Calculate Net Working Capital
Current
Assets
Current
Liabilities
Net
Working
Capital
Net Working Capital
Centrica plc 2018
The Cash Flow Statement
Where has the cash come from
and what has the firm spent?
The Cash Flow Statement
Centrica plc 2018
Financial Statement
Analysis
How to assess firm performance,
risk and liquidity
Financial Statement Analysis
Important to Compare Like for Like
Financial Ratios
Common Size
Statements
Ratio Analysis
The important financial ratios
Ratio Analysis
What do Ratios Measure?
Short-Term Solvency or Liquidity
Long-Term Solvency or Leverage
Asset Management or Turnover
Profitability
Market Value
Ratio Analysis
Short-Term Solvency Ratios
Current assets
Current ratio =
Current liabilities
Quick ratio =
Cash ratio =
Current assets - Inventory
Current liabilities
Cash and cash equivalents
Current liabilities
Ratio Analysis
Long-Term Solvency Ratios
Total assets - Total equity
Total debt ratio =
Total assets
Debt-equity ratio = Total debt/Total equity
Equity multiplier = Total assets/Total equity
Times interest earned ratio =
Profit Before Interest and Taxes
Interest
Cash coverage ratio =
EBIT + Depreciation
Interest
Ratio Analysis
Asset Management Ratios
Inventory turnover =
Inventory turnover =
Cost of goods sold
Inventory
Operating Expenses
Inventory
Days’ sales in inventory =
Receivables turnover =
Days’ sales in receivables =
365 days
Inventory turnover
Revenues
Trade receivables
365 days
Receivables turnover
Total asset turnover =
Revenues
Total assets
Ratio Analysis
Profitability Ratios
Net income
Profit margin =
Revenues
Net income
Return on assets =
Total assets
Net income
Return on equity =
Total equity
Ratio Analysis
Market Value Ratios
Net income
EPS =
Shares outstanding
PE ratio =
Price per share
Earnings per share
Market-to-book ratio =
Market value per share
Book value per share
The DuPont Identity
Disassembling return on equity
The Du Pont Identity
What Drives Performance?
Net income
Net income Assets
Return on equity =
=
x
Total equity Total equity Assets
Net income
Assets
=
x
Assets
Total equity
Using Financial Statement
Information
Practical aspects of financial
statement analysis
Using Financial Statement Information
Choosing a Benchmark
Time Trend
Analysis
Peer Group
Analysis
Concept Quiz
How Much do You Understand?
Quiz
Identify two circumstances where negative operating cash flow might not
necessarily be a sign of deteriorating financial health. When can negative operating
cash flow become problematic for a company?
Both ROA and ROE measure profitability. Which one is more useful for comparing
two companies? Why?
A financial ratio by itself tells us little about a company because financial ratios vary
a great deal across industries. There are two basic methods for analysing financial
ratios for a company: time trend analysis and peer group analysis. Why might each
of these analysis methods be useful? What does each tell you about the company’s
financial health?