A Framework of Financial Statement
Analysis for Investment Decisions
by
Dr. Mizanur Rahman
Professor of Accounting & Public Policy
University of Dhaka
E-mail: mizan@univdhaka.edu
7 March 2025
Information Content of Balance Sheet
⚫ A description of assets, liabilities and shareholders’ equity based on a mixed system
of accounting involving both historical cost accounting and fair value accounting
(also called mark-to-market accounting).
⚫ Assets and liabilities are grouped in terms of current/non-current distinction and in
order of liquidity. A traditional focus is therefore on assessing liquidity of a going
concern.
⚫ A restatement of assets and liabilities is however possible
for defining productive
capacity of a business and for discerning managerial decisions to finance them.
⚫ Restatement is done in terms of operating and financial types and in line with
corporate management’s operating and financial policies. It will thus lead to
measuring management’s policy effectiveness and more towards informed
investment decisions.
⚫ A set of stock variables so defined will be matched with
their counterparts flow
variables in the income statement and cash flow statement.
⚫ Taken together, a coherent set of accounting ratios will be identified predicting
future earnings and growth in earnings.
2
The Balance Sheet Identity
⚫
The statement of financial position , commonly called the balance sheet, assets, liabilities and
stockholders’ equity of a company. It is an identity showing economic resources owned by a
company and claims against those resources. Shareholders, creditors and bondholders are
generally claimants.
⚫
Total Assets TA =Total Liabilities TL +Total Shareholders′ Equity CSE
𝑻𝑨 = 𝑻𝑳 + 𝑪𝑺𝑬
𝟏
⚫
We find that Square reported its assets in order of liquidity and between current and noncurrent categories. An investor will however be interested to learn about productive capacity
of the company. Productive capacity of a company is better defined by its operating assets.
Structure of operating assets will be indicative of a company’s operating policies. By
operating policies we mean management’s strategic plan of production, sales, capital
accumulation, procurement of intermediate inputs and inventory of goods. Examples of
operating assets in the present case include (i) property, plant and equipment, (ii) capital
work-in progress, (iii) inventories, (iv) trade debtors and (v) advances, deposits and
prepayments. Note that operating assets can be current and/or non-current. The remaining
assets are financial assets of the company. Corporate management shall define a level of
financial assets primarily for mitigating short-term financial obligations.
3
A Reformulation of Balance Sheet Identity
⚫
Total Assets TA =Current Assets CA +Non−current Assets NCA
Total Assets TA =Operating Assets OA +Financial Assets FA
𝑻𝑨 = 𝑪𝑨 + 𝑵𝑪𝑨 = 𝑶𝑨 + 𝑭𝑨
•
⚫
𝟐
Note that 𝐎𝐀 ≠ 𝑵𝑪𝑨 and FA ≠ 𝑪𝑨.
Total Liabilities TL =Current Liabilities CL +Non−Current Liabilities NCL
Total Liabilities TL =Operating Liabilities OL +Financial Obligations FO
TL=CL+NCL=OL+FO, CL ≠ OL, NCL ≠ FO
3
𝑇𝐴 = 𝑇𝐿 + 𝐶𝑆𝐸
𝐶𝐴 + 𝑁𝐶𝐴 = 𝐶𝐿 + 𝑁𝐶𝐿 + 𝐶𝑆𝐸
𝑂𝐴 + 𝐹𝐴 = 𝑂𝐿 + 𝐹𝑂 + 𝐶𝑆𝐸
𝑂𝐴 − 𝑂𝐿 = 𝐹𝑂 − 𝐹𝐴 + 𝐶𝑆𝐸
𝑵𝑶𝑨 = 𝑵𝑭𝑶 + 𝑪𝑺𝑬
If the company has NFA,
4
𝑁𝑂𝐴 = 𝐶𝑆𝐸 − 𝑁𝐹𝐴
𝐶𝑆𝐸 = 𝑁𝑂𝐴 + 𝑁𝐹𝐴
⚫
Net Operating Assets (NOA) is indicative of productive capacity of a business enterprise.
⚫
NOA is Operating Assets (OA) net of Operating Liabilities (OL). If OA is indicative of productive potential, a firm’s
ability to depend on low-cost operating liabilities will enhance profitability by a number of ways. To be explained
later.
⚫
NOA is financed by Net Finance Obligations and Common Stockholders’ Equity (CSE). Ratio of NFO to CSE is
called financial leverage and a measure of financing risk.
⚫
In presence of corporate and personal taxes, the prudential use of NFO is essential. A failing to do so will destroy
profitability and bring about insolvency. To be shown later.
4
Balance Sheet Relationships
The balance sheet is reformulated to separate operating and financing components, leading to the
following relationships:
•
Net Operating Assets (NOA):
NOA represents the net investment in operating activities.
NOA = Operating Assets - Operating Liabilities
o
Operating Assets: Include accounts receivable, inventory, property, plant, and equipment
(PPE), etc.
o
Operating Liabilities: Include accounts payable, accrued expenses, etc.
•
Net Financial Obligations (NFO):
NFO reflects the net financing position of the company.
NFO = Financial Obligations - Financial Assets
o
Financial Obligations: Interest-bearing debt (e.g., loans, bonds).
o
Financial Assets: Cash equivalents, investments, etc.
•
Equity Relationship:
Equity is the residual claim after accounting for operating and financing components.
Equity = NOA – NFO
•
The balance sheet identity that 𝑇𝐴 = 𝑇𝐿 + 𝐶𝑆𝐸 can also be usefully rewritten as either a 𝑁𝑂𝐴 =
𝑁𝐹𝑂 + 𝑁𝐹𝑂 or b 𝑂𝐴 = 𝑂𝐿 + 𝑁𝐹𝑂 + 𝐶𝑆𝐸. The relation (a) indicates that net operating business
of an enterprise is financed by net financial obligations (NFO) and common stock equity (CSE). On
the other hand, the expression (b) indicates that gross operating assets of the business can be
financed by a combination of operating liabilities (OL), net financial obligations (NFO) and common
stockholders’ equity (CSE).
5
GAAP Consolidated Balance Sheets
NIKE, INC.
6
GAAP Consolidated Balance Sheets
NIKE, INC.
7
Reformulated Balance Sheets
NIKE, INC.
8
Income Statement Relationships
The income statement is split to isolate operating profitability from financing costs:
•
Operating Income (OI):
OI measures the profit from core operating activities, excluding financing effects.
OI = Revenue - Operating Expenses
o
Financing costs (e.g., interest) and investment income are excluded.
•
Net Financial Expense (NFE):
NFE captures the net cost of financing activities.
NFE = Interest Expense - Interest Income
⚫ Net Income (NI):
NI is the bottom-line profit after accounting for both operating and financing
activities.
NI = OI - NFE
9
Income Statement Relationships
⚫
We now focus on interdependency between stock variables as reported in the balance sheet and flow variables that are reported
in either income statement or cashflow statement.
⚫
Comprehensive Net Income CNI =
Earnings After Taxes (EAT)+Other Comprehensive Income
𝟓
⚫
Assume no other comprehensive income. Thus,Comprehensive Net Income CNI =Earnings After Taxes EAT .
⚫
Earnings before interest and taxes (EBIT) is an ideal measure of operating profitability of a business. It is also called net
operating income, a flow measure directly attributable to the net operating assets of the business. Let 𝑥 be 𝑁𝑂𝐼.
⚫
The accounting presentation of the income statement is that This is however not the case for finance costs and finance income.
Thus, the net financial expense (NFE) is easily measurable and it is finance expenses net of finance income (if any).
⚫
⚫
Net Financial Expenses NFE =Financial Costs− Financial Income
6
If 𝐷𝐿 denotes the volume of net financial obligations and 𝑟 be the weighted-average net borrowing costs, the net financial
expenses will therefore be 𝑟 ⋅ 𝐷𝐿 . Given that the effective corporate tax rate is 𝜏𝐶 , the earnings after taxes (CNI) is thus
shown below:
⚫ 𝑪𝑵𝑰 = 𝑬𝑩𝑻 − 𝑻𝒂𝒙𝒆𝒔 =
𝒙 − 𝒓. 𝑫𝑳 − 𝝉𝑪 ∙ 𝒙 − 𝒓. 𝑫𝑳 = 𝟏 − 𝝉𝑪 𝒙 − 𝒓. 𝑫𝑳
𝐶𝑁𝐼 = 1 − 𝜏𝐶 𝑥 − 1 − 𝜏𝐶 𝑟 ⋅ 𝐷𝐿
𝟏 − 𝝉𝑪 𝒙 = 𝑪𝑵𝑰 + 𝟏 − 𝝉𝑪 𝒓 ⋅ 𝑫𝑳
𝟕
𝑵𝒆𝒕 𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑰𝒏𝒄𝒐𝒎𝒆 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙𝒆𝒔 = 𝑪𝑵𝑰 + 𝑵𝒆𝒕 𝑭𝒊𝒏𝒂𝒏𝒄𝒊𝒂𝒍 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙
𝑶𝑰 = 𝑪𝑵𝑰 + 𝑵𝑭𝑬
In case of net financial assets, Equation (7) is:
𝑪𝑵𝑰 = 𝑵𝒆𝒕 𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑰𝒏𝒄𝒐𝒎𝒆 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙 + 𝑵𝒆𝒕 𝑭𝒊𝒏𝒂𝒏𝒄𝒊𝒂𝒍 𝑰𝒏𝒄𝒐𝒎𝒆 (𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙)
⚫ Eq (*) indicates that a proper identification of net financial expense (income) is imperative for defining net operating income,
(1-τ)x. This is an accrual measure of earnings which is produced by net operating assets of the company. Whether this accrual
earnings is supported by comparable operating cash flows (c) is another issue to be examined.
10
GAAP Income Statements
NIKE, INC.
11
Reformulated Income Statements
NIKE, INC.
12
Relating Flow to Stock Variables & Measures of
Profitability
⚫ Equations (4) and (7) establish a finer correspondence between stock variables and
flow variables. NOA produces the net operating income which is 1 − 𝜏𝐶 𝑥; NFO
which is the claim of the bondholders will require net borrowing costs (NBC) which is
1 − 𝜏𝐶 𝑟 ⋅ 𝐷𝐿 ; and CSE will demand distribution of CNI. We can therefore define
three accounting ratios which will be independent of company size.
NOI
𝟏 − 𝝉𝑪 𝒙
=
NOA
𝑵𝑶𝑨
NFE
𝟏 − 𝝉𝑪 𝒓. 𝑫𝑳
Net Borrowing Costs NBC =
=
NFO
𝑵𝑭𝑶
CNI
𝟏 − 𝝉𝑪 𝒙 − 𝒓𝑫𝑳
Return on Common Equity ROCE =
=
CSE
𝑪𝑺𝑬
Return on Net Operating Assts RNOA =
𝟖. 𝟏
𝟖. 𝟐
𝟖. 𝟑
13
Drivers of Return on Common Equity
⚫We will now focus on return on common equity (ROCE) and see how it is related to profitability
of net operating assets, financial leverage, net borrowing costs and spread between profitability of
operating assets and net borrowing costs.
𝐶𝑁𝐼𝑡
𝐶𝑆𝐸𝑡−1
1 − 𝜏𝐶 𝑥𝑡 − 1 − 𝜏𝐶 𝑟 ⋅ 𝑁𝐹𝑂𝑡−1
=
𝐶𝑆𝐸𝑡−1
𝑥𝑡
𝑁𝑂𝐴𝑡−1
𝑁𝐹𝑂𝑡−1
= 1 − 𝜏𝐶
⋅
− 1 − 𝜏𝐶 𝑟 ⋅
𝑁𝑂𝐴𝑡−1 𝐶𝑆𝐸𝑡−1
𝐶𝑆𝐸𝑡−1
1 − 𝜏𝐶 𝑥𝑡
1 − 𝜏𝐶 𝑥𝑡
1 − 𝜏𝐶 𝑁𝐹𝐸𝑡 𝑁𝐹𝑂𝑡−1
=
+
−
𝑁𝑂𝐴𝑡−1
𝑁𝑂𝐴𝑡−1
𝑁𝐹𝑂𝑡−1
𝐶𝑆𝐸𝑡−1
= 𝑅𝑁𝑂𝐴𝑡 + 𝑅𝑁𝑂𝐴𝑡 − 𝑁𝐵𝐶𝑡 𝐹𝐿𝐸𝑉𝑡−1
𝑅𝑂𝐶𝐸𝑡 =
⚫
10
Return on common equity is thus primarily driven by the return on net operating assets with
additional return from the use of financial leverage. This additional return depends on both on
the extent of leverage and spread between RNOA and NBC. Should this spread turns
negative, a relatively large leverage will dramatically affect ROCE and future earnings after
taxes.
14
Drivers of Return on Net Operating Assets
⚫ Note that the return on net operating assets (RNOA) is a measure of profitability of
net operating assets being
employed by a business enterprise. Note that the denominator is the net operating assets (NOA) not the total assets. A
choice to use total assets as the scalar will not distinguish between operating and financial assets and ignore a possibility
that a business may depend on operating liabilities to finance its operations. A prudential management of operating
liabilities will increase RNOA. Another way to understand RNOA is to decompose it into two multiplicative terms.
RNOA𝑡 =
NOI𝑡
NOI𝑡
Sales𝑡
=
×
=PM𝑡 ×ATO𝑡
NOAt−1 Sales𝑡 NOAt−1
9
Return on net operating assets thus depends on both profit margin and asset turnover and in a multiplicative manner.
Profit margin (PM) captures after-tax profitability of each dollar of sales. In the presence of substantial other
operating income, a core measure of sales profitability can be ‘sales PM.’
NOI Sales OI+Other OI
Sales OI Sales
Other OI
RNOA=
=
=
×
+
NOA
NOA
Sales
NOA
NOA
Other OI
= Sales PM × ATO +
10
NOA
Equations (9) and (10) constitute an analytical framework and produce the following derivers of ROCE:
⚫
⚫
•
•
•
•
•
Sales Profit Margin (Sales PM)
Asset Turnover (ATO)
Other OI/NOA
Net Borrowing Costs and Spread between NBC and RNOA
Financial Leverage (FLEV)
Operating Liabilities Leverage (OLLEV)
15
Interpretation of Three Key Financial Ratios
⚫
Return on Common Equity (ROCE) is a measure of profitability of shareholders’ equity. It depends on a
number of derivers including (1) Return on net operating assets (RNOA), (2) Extent of financial leverage
(FLEV) and (3) Spread between RNOA and net borrowing costs (NBC).
⚫
RNOA is a ratio of net operating income (OI) at (t) relative to net operating assets at (t-1) and represents
profitability of net operating assets. Note that either an increasing (OI) or a decreasing NOA or both will
increase RNOA. The definition that NOA=(OA-OL) implies that management’s capacity to depend on
low-cost operating liabilities (OL) may increase RNOA by decreasing the level of NOA.
⚫
FLEV is called the financial leverage measuring net financial obligations relative to common equity.
Provided that net borrowing cost (NBC) is expected to be less than RNOA, a higher FLEV will imply a
greater ROCE. There may be times when spread turns negative and thus the impact of leverage will be
adverse.
⚫
The term FLEV×(RNOA-NBC) is multiplicative and implies that if (RNOA-NBC)>0, a greater leverage
will mean greater ROCE.
⚫
Note that EPS=(B×ROCE), where B=Net Asset Value per Share (NAV). Future EPS will thus depend on
the accounting value of equity (NAV) and return on common equity (ROCE). ROCE in turn depends on
NOA (Operating assets net of operating liabilities), its profitability (as measured by RNOA), financial
structure (FLEV), net borrowing costs (NBC) and spread between RNOA and NBC. While RNOA will be
indicative of operating efficiency, the other three variables including FLEV, NBC and spread btw RNOA &
NBC are the measures of financial policy effectiveness.
16
The Role of Operating Liability Leverage on Operating
Profitability
⚫
⚫
⚫
⚫
Earlier we argued that the use of operating liabilities would reduce the
volume of net operating assets (NOA) and thus scale up return on net
operating assets (RNOA).
Operating liabilities are non-interest liabilities. They carry no explicit costs
but may involve implicit costs. This leverage is a driver of profitability and
it is distinct from financial leverage (Nissim and Penman, 2001).
Suppliers who advance payables to a business enterprise will likely
overstate prices of their raw materials and other inputs in order to
compensate for opportunity costs and/or potential default costs.
If one assumes that financial markets are competitive, short-term borrowing
costs will likely approximate these implicit costs of operating liabilities.
Consider that represents the implicit costs of operating liabilities. Since is
unobserved, it can be approximated by , where indicates the short-term
borrowing costs for working capital loans.
17
The Role of Operating Liability Leverage on Operating
Profitability
o We know the net operating income (NOI) is a measure of profitability
attributable to net operating assets. Adding the implicit cost of operating
liabilities (icol) to NOI, we get total operating income (OI) of the business.
RNOAt =
NOI t
NOI t + icolt icolt
=
−
NOAt −1
NOAt −1
NOAt
 NOI t + icolt OAt −1   icolt OLt −1 
=

−


NOAt −1   OLt −1 NOAt −1 
 OAt −1
OI t
OLt −1
=
+
 ROAt − t 
NOAt −1 NOAt −1
= ROAt + OLLEVt −1   ROAt −  t 
o Equation (11) sheds light on a number of derivers of profitability. If a firm
can significantly depend on operating liability leverage and with minimum
implicit costs, such OLLEV would lever up return on net operating assets by
two mechanisms. One is the extent of OLLEV itself and the other is the
spread by which ROA exceeds θ, the implicit costs of operating liabilities. A
firm with persistent market reputation and strong fundamentals can minimize18
this θ to zero.
How does Total Leverage affect ROCE?
⚫ An alternative formulation will show that the return on common equity (ROCE) is
determined by return on total operating assets (ROA) and an additional return
depending on the spread between (ROA) and total borrowing costs (TBC) and the
degree of total leverage (TLEV) of a business enterprise.
𝐶𝑁𝐼𝑡
⚫ 𝑅𝑂𝐶𝐸𝑡 =
𝐶𝑆𝐸
𝑡−1
1 − 𝜋𝑐 𝑥𝑡 − 1 − 𝜋𝑐 ∙ 𝑁𝐹𝐸𝑡
𝑅𝑂𝐶𝐸 =
𝐶𝑆𝐸𝑡−1
1 − 𝜋𝑐 (𝑥𝑡 + 𝑖𝑐𝑜𝑙𝑡 )
1 − 𝜋𝑐 𝑁𝐹𝐸𝑡 + 𝑖𝑐𝑜𝑙𝑡
=
−
𝐶𝑆𝐸𝑡−1
𝐶𝑆𝐸𝑡−1
1 − 𝜋𝑐 (𝑥 + 𝑖𝑐𝑜𝑙) 𝑂𝐴
1 − 𝜋𝑐 𝑁𝐹𝐸 + 𝑖𝑐𝑜𝑙 𝑇𝐿
=
∙
−
∙
𝑂𝐴
𝐶𝑆𝐸
𝑇𝐿
𝐶𝑆𝐸
1−𝜋𝑐 (𝑥𝑡 +𝑖𝑐𝑜𝑙𝑡 )
𝑇𝐿𝑡−1
1−𝜋𝑐 𝑁𝐹𝐸𝑡 +𝑖𝑐𝑜𝑙𝑡
𝑇𝐿𝑡−1
=
∙ 1 + 𝐶𝑆𝐸
−
∙ 𝐶𝑆𝐸
𝑂𝐴𝑡−1
𝑇𝐿𝑡−1
𝑡−1
𝑡−1
𝑇𝐿𝑡−1
= 𝑅𝑂𝐴𝑡 + 𝑅𝑂𝐴𝑡 − 𝑇𝐵𝐶𝑡 ∙
𝐶𝑆𝐸𝑡−1
=𝑅𝑂𝐴𝑡 + 𝑅𝑂𝐴𝑡 − 𝑇𝐵𝐶𝑡 ∙ 𝑇𝐿𝐸𝑉𝑡−1
(12)
⚫ The Equation (12) indicates that profitability of total operating assets as measured
by ROA, relative gap between ROA and total borrowing costs (TBC) and the
degree of total lability leverage (TLEV) also determine return on common equity of19
a business enterprise.
Third-Level Breakdown of Profitability Analysis
1. Profit Margin Drivers
𝑃𝑀 = 𝑆𝑎𝑙𝑒𝑠 𝑃𝑀 + 𝑂𝑡ℎ𝑒𝑟 𝑖𝑡𝑒𝑚𝑠 𝑃𝑀
𝑆𝑎𝑙𝑒𝑠 𝑃𝑀 = 𝐺𝑟𝑜𝑠𝑠 𝑚𝑎𝑟𝑔𝑖𝑛 𝑟𝑎𝑡𝑖𝑜 − 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 𝑟𝑎𝑡𝑖𝑜𝑠
𝐺𝑟𝑜𝑠𝑠 𝑚𝑎𝑟𝑔𝑖𝑛 𝐴𝑑𝑚𝑖𝑛𝑠𝑡𝑟𝑎𝑡𝑖𝑜𝑛 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
=
−
−
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝑅&𝐷
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑡𝑎𝑥𝑒𝑠
−
−
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝑂𝑡ℎ𝑒𝑟 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑡𝑒𝑚𝑠 𝑃𝑀
𝑆𝑢𝑏𝑠𝑖𝑑𝑖𝑎𝑟𝑦 𝑖𝑛𝑐𝑜𝑚𝑒 𝑂𝑡ℎ𝑒𝑟 𝑒𝑞𝑢𝑖𝑡𝑦 𝑖𝑛𝑐𝑜𝑚𝑒
=
+
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝑆𝑝𝑒𝑐𝑖𝑎𝑙 𝑖𝑡𝑒𝑚𝑠 𝑂𝑡ℎ𝑒𝑟 𝑔𝑎𝑖𝑛𝑠 𝑎𝑛𝑑 𝑙𝑜𝑠𝑠𝑒𝑠
+
+
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
20
Third-Level Breakdown of Profitability Analysis
1. Turnover Drivers
1
𝑁𝑂𝐴 𝑂𝐴 − 𝑂𝐿
𝑂𝐴
𝑂𝐿
=
=
=
−
𝐴𝑇𝑂 𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠 𝑆𝑎𝑙𝑒𝑠
1
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑦
𝑃𝑃𝐸
=
+
+ ⋯+
𝐴𝑇𝑂
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒 𝑃𝑒𝑛𝑠𝑖𝑜𝑛 𝑜𝑏𝑙𝑖𝑔𝑎𝑡𝑖𝑜𝑛𝑠
−
−
−⋯
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
365
𝐷𝑎𝑦𝑠 𝑖𝑛 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 =
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝑆𝑎𝑙𝑒𝑠
𝑃𝑃𝐸 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝑃𝑟𝑜𝑝𝑒𝑟𝑡𝑦, 𝑝𝑙𝑎𝑛𝑡 𝑎𝑛𝑑 𝑒𝑞𝑢𝑖𝑝𝑚𝑒𝑛𝑡 (𝑛𝑒𝑡)
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
356
𝐷𝑎𝑦𝑒𝑠 𝑖𝑛 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 =
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒
𝐷𝑎𝑦𝑠 𝑖𝑛 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒 = 365 ×
,
𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
𝑤ℎ𝑒𝑟𝑒 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 + 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
21
Third-Level Breakdown of Profitability Analysis
1. Borrowing Cost Drivers
𝑁𝐹𝐸
𝐴𝑓𝑡𝑒𝑟 − 𝑡𝑎𝑥 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝐹𝑂
𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝑁𝐵𝐶 =
=
+
𝑁𝐹𝑂
𝑁𝐹𝑂
𝑁𝐹𝑂
𝐴𝑓𝑡𝑒𝑟 − 𝑡𝑎𝑥 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝐹𝐴
𝑈𝑛𝑟𝑒𝑎𝑙𝑖𝑧𝑒𝑑 𝑔𝑎𝑖𝑛𝑠 𝑜𝑛 𝐹𝐴
−
−
𝑁𝐹𝑂
𝑁𝐹𝑂
𝐹𝑂
𝐴𝑓𝑡𝑒𝑟 − 𝑡𝑎𝑥 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝐹𝑂
=
×
𝑁𝐹𝑂
𝐹𝑂
𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑆𝑡𝑜𝑐𝑘 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
+
×
𝑁𝐹𝑂
𝑃𝑟𝑒𝑓𝑟𝑒𝑒𝑑 𝑠𝑡𝑜𝑐𝑘
𝐹𝐴
𝐴𝑓𝑡𝑒𝑟 − 𝑡𝑎𝑥 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝐹𝐴
−
×
𝑁𝐹𝑂
𝐹𝐴
𝐹𝐴
𝑈𝑛𝑟𝑒𝑎𝑙𝑖𝑧𝑒𝑑 𝑔𝑎𝑖𝑛𝑠 𝑜𝑛 𝐹𝐴
−
×
𝑁𝐹𝑂
𝐹𝐴
22
Determinants of Expected Net Asset Value (NAV) of Share
o An investor is primarily interested to forecast earnings per share at (t + 1) as
specified below:
E 
o Et +1 = Bt   t +1  = Bt  ROCE t +1 ,
 Bt 
(
)
(12 )
o Here E represents the earnings per share (EPS), B indicates the net asset
value (NAV) per share and ROCE is the forecast return on common equity
(ROCE). While B is observed and available in the balance sheet, ROCE is
not. The entire valuation task is therefore conditional on an unbiased
estimation of ROCE .
t +1
t
t +1
t
t +1
t +1
23
Determinants of Expected Net Asset Value (NAV) of Share
o In equation (12) we further observe that the net asset value (NAV) per share B  ,  = 1, ,  , will
depend on some key accounting ratios and evolve according to the following specification:
t+
CSE t =Sales t 
NOAt CSEt
1
1

= Salest 

Salest NOAt
ATOt 1 + FLEVt
o CSE t+ =Sales t+ 
= Salest + 
NOAt + CSEt +

Salest + NOAt +
1
1

,  = 1,
ATOt + 1 + FLEVt +
, .
(13)
o Equation (13) shows that the future evolution of book value will depend on three drivers. The first
is forecast sales of the enterprise. The second is (1 ATO  ) which indicates the amount of net
operating assets (NOA) that has to be put in place to produce a dollar of sales. The third driver is
1 (1 + FLEV  ) and it captures financing decisions of the business. Should there be a larger financial
leverage, it would essentially replace equity financing. A multiplicative relationship between the
three terms is noteworthy. A rising sales or an effective use of net operating assets or both will
enhance the common stockholders’ equity. A constant debt-equity ratio, a measure of financial
leverage, will be therefore invariant for forecast equity.
t+
t+
24
Nike’s Profitability, 2000-2008
25
Second- and Third-Level Breakdown of Profitability, 2009-2010
26
Consolidated Financial Statements: Square Pharmaceuticals Ltd.
Consolidated Balance Sheet Data
Assets:
Non-Current Assets
Property, plant and equipment, net
Investment in associates
Investment in marketable securities
Long term investments, others
Intangible assets, net
Current Assets:
Inventories
Trade and other receivable, net
Advances, deposits and prepayments
Short Term Loans
Cash and cash equivalents
Total Current Assets
Total Assets
2020
2021
2022
2023
2024
20,873.8
8,077.5
2,691.9
2,792.0
22,884.1
9,277.3
4,624.5
3,590.2
27,182.7
12,874.3
4,346.8
5,006.4
26,058.8
15,076.8
4,589.9
5,603.7
27,750.0
17,397.1
9,292.4
6,992.2
34,435.2
40,376.1
49,410.1
51,329.2
61,431.7
5,687.4
1,520.3
2,727.9
4,884.3
32,564.3
47,384.2
81,819.4
7,245.4
1,636.1
2,830.8
8,214.1
3,395.1
1,776.0
12,227.2
6,122.3
2,043.3
12,582.2
4,503.4
2,106.5
43,364.0
55,076.4
95,452.4
48,962.5
62,347.7
111,757.9
50,094.3
70,487.1
121,816.3
52,013.5
71,205.5
132,637.2
27
Consolidated Financial Statements: Square Pharmaceuticals Ltd.
Total Liabilities
Non-Current Liabilities:
Long-term Loan
Deferred tax liabilities
Non-Current Liabilities:
Current Liabilities:
Long-term loan-Current portion
Trade payables
Other payables
Current tax liabilities
Accrued expenses
Unclaimed dividends
Current Liabilities:
Total Liabilities
Shareholders' Equity
Share capital
Share premium
Retained earnings
Other reserves
Total Shareholders' Equity
Total Liabilities and Equity
Number of shares outstanding
Net asset value per share (B)
2020
2021
2022
2023
2024
0.0
1,212.9
1,212.9
103.7
1,274.8
1,378.5
1,714.3
1,178.7
2,893.0
1,368.4
1,022.2
2,390.5
814.5
619.1
1,433.6
0.0
553.8
2,228.3
0.0
681.5
1,938.8
129.0
330.4
3,241.5
183.0
375.2
3,178.6
200.0
626.0
1,613.9
911.5
180.8
129.6
3,661.8
618.6
1,001.8
1,878.0
356.1
215.7
159.0
4,229.1
614.5
1,455.4
1,820.9
912.3
286.8
192.0
5,281.9
4,454.4
4,557.1
6,554.8
6,619.6
6,715.5
8,442.4
2,035.5
64,980.3
1,906.7
77,364.9
81,819.3
844.2
91.6
8,864.5
2,035.5
78,749.5
1,245.1
90,894.6
95,451.7
886.5
102.5
8,864.5
2,035.5
93,357.1
945.5
105,202.6
111,757.4
886.5
118.7
8,864.5
2,035.5
103,339.1
956.9
115,195.9
121,815.5
886.5
130.0
8,864.5
2,035.5
114,139.1
882.6
125,921.6
132,637.2
886.5
142.1
28
Consolidated Financial Statements: Square Pharmaceuticals Ltd.
Consolidated Income Statements
Income Statement Data
Turnover/Revenue (net)
Cost of Goods sold
Gross profit
Selling & Distribution Expenses
Administrative expenses
Finance costs
Operating expenses
Other operating income
Profit from operations
Income from investments
Profit before contributions to WPPF
Contributions to WPPF
Profit before income tax
Income tax expenses
Net Profit after taxes
Profit from Associate Undertakings
Profit for the year
45,876.5
50,703.0 57,597.9
60,707.9
70,101.0
(22,536.7) (24,800.0) (27,958.0) (31,641.6) (37,028.6)
23,339.8
25,903.0
29,639.9
29,066.4
33,072.4
(7,382.8) (8,564.5) (10,439.3) (9,775.3) (12,065.9)
(1,227.2) (1,216.9) (1,402.3) (1,665.7) (1,869.9)
(0.0)
(0.1)
(0.0)
(119.0)
(244.0)
(8,610.0) (9,781.5) (11,841.5) (11,560.0) (14,179.8)
618.1
715.3
338.7
14,729.8
16,121.5
18,416.4
18,221.7
19,231.3
3,126.4
3,485.1
3,388.2
3,957.3
4,650.6
17,856.2
19,606.6
21,804.6
22,179.0
23,881.9
(859.3)
(937.8) (1,051.2) (1,079.6) (1,160.1)
16,996.9
18,668.8
20,753.4
21,099.4
22,721.8
(4,229.4) (4,013.5) (4,607.1) (4,641.7) (4,388.9)
12,767.5
14,655.3
16,146.3
16,457.7
18,332.9
586.2
1,291.2
2,010.8
2,522.5
2,594.6
13,353.7
15,946.5
18,157.1
18,980.2
20,927.4
Other comprehensive income
Comprehensive Net Income (CNI)
Earningss per share
(555.1)
12,798.0
15.06
2020
2021
1,550.0
17,497.7
17.99
2022
(299.7)
17,857.4
20.48
2023
(122.0)
18,858.2
21.41
2024
(894.7)
20,032.7
23.61
29
Consolidated Financial Statements: Square Pharmaceuticals Ltd.
Consolidated Statement of Cash flows
Net cash flows from operating activities (C)
Net cash used for investments (I)
Net Cash flows from financing activities (F)
Net change in cash and cash equivalents
Operating cash flow (per share)
Free cash flows
Free cash flow (Per share)
2020
10,760.0
(1,865.8)
(3,313.8)
5,580.3
12.75
8,894.2
10.54
2021
11,021.1
3,606.7
(3,863.7)
10,764.1
12.43
14,627.8
16.50
2022
12,874.7
(3,969.7)
(3,753.7)
5,151.4
14.52
8,905.0
10.05
2023
8,545.6
787.7
(8,762.5)
570.9
9.64
9,333.3
10.53
2024
18,528.8
(7,049.0)
(9,832.6)
1,647.2
20.90
11,479.8
12.95
30
Reformulation of Financial Statements
Assets:
Operating Assets (OA)
Property, plant and equipment, net
Investment in associates
Long term investments, others
Inventories
Trade and other receivable, net
Advances, deposits and prepayments
Operating Assets (OA)
Financial Assets (FA)
Investment in marketable securities
Short Term Loans
Cash and cash equivalents
Financial Assets (FA)
Total Assets
Total Liabilities
Financial Obligations (FO)
Long-term Loan
Long-term loan-Current portion
Liabilities for other finances
Financial Obligations (FO)
Operating Liabilities (OL)
Deferred tax liabilities
Trade payables
Current tax liabilities
Accrued expenses
Unclaimed dividends
Operating Liabilities (OL)
Total Liabilities
2020
2021
2022
2023
2024
20,873.8
8,077.5
2,792.0
5,687.4
1,520.3
2,727.9
41,678.9
22,884.1
9,277.3
3,590.2
7,245.4
1,636.1
2,830.8
47,463.9
27,182.7
12,874.3
5,006.4
8,214.1
3,395.1
1,776.0
58,448.6
26,058.8
15,076.8
5,603.7
12,227.2
6,122.3
2,043.3
67,132.1
27,750.0
17,397.1
6,992.2
12,582.2
4,503.4
2,106.5
71,331.3
2,691.9
4,884.3
32,564.3
40,140.5
81,819.4
4,624.5
4,346.8
4,589.9
9,292.4
43,364.0
47,988.5
95,452.4
48,962.5
53,309.3
111,757.9
50,094.3
54,684.2
121,816.3
52,013.5
61,305.9
132,637.2
0.0
0.0
2,228.3
2,228.3
103.7
0.0
1,938.8
2,042.5
1,714.3
200.0
1,613.9
3,528.2
1,368.4
618.6
1,878.0
3,864.9
814.5
614.5
1,820.9
3,250.0
1,212.9
553.8
1,274.8
681.5
129.0
330.4
2,226.1
4,454.4
183.0
375.2
2,514.6
4,557.1
1,178.7
626.0
911.5
180.8
129.6
3,026.7
6,554.8
1,022.2
1,001.8
356.1
215.7
159.0
2,754.7
6,619.6
619.1
1,455.4
912.3
286.8
192.0
3,465.5
6,715.5
31
Reformulation of Financial Statements
Shareholders' Equity
Share capital
Share premium
Retained earnings
Other reserves
Total Shareholders' Equity
Total Liabilities and Equity
2020
8,442.4
2,035.5
64,980.3
1,906.7
77,364.9
81,819.3
2021
8,864.5
2,035.5
78,749.5
1,245.1
90,894.6
95,451.7
2022
8,864.5
2,035.5
93,357.1
945.5
105,202.6
111,757.4
2023
8,864.5
2,035.5
103,339.1
956.9
115,195.9
121,815.5
2024
8,864.5
2,035.5
114,139.1
882.6
125,921.6
132,637.2
Operating Assets (OA)
Operating Liabilities (OL)
Financial Obligations (FO)
Financial Assets (FA)
Net Operatng Assets (NOA)
Net Financial Assets (NFA)
Total Shareholders' Equity (CSE)
2020
41,678.9
2,226.1
2,228.3
40,140.5
39,452.9
37,912.2
77,364.9
2021
47,463.9
2,514.6
2,042.5
47,988.5
44,949.3
45,946.0
90,894.6
2022
58,448.6
3,026.7
3,528.2
53,309.3
55,421.9
49,781.1
105,202.6
2023
67,132.1
2,754.7
3,864.9
54,684.2
64,377.4
50,819.3
115,195.9
2024
71,331.3
3,465.5
3,250.0
61,305.9
67,865.8
58,055.9
125,921.6
Number of shares outstanding
Net asset value per share (B)
844.2
91.6
886.5
102.5
886.5
118.7
886.5
130.0
886.5
142.1
32
Reformulation of Financial Statements
Income Statement Data
Turnover/Revenue (net)
Cost of Goods sold
Gross profit
Selling & Distribution Expenses
Administrative expenses
Finance costs
Operating expenses
Other operating income
Profit from operations
Income from investments
Profit before contributions to WPPF
Contributions to WPPF
Profit before income tax
Income tax expenses
Net Profit after taxes
Profit from Associate Undertakings
Profit for the year
Other comprehensive income
Comprehensive Net Income (CNI)
Earningss per share
2020
2021
2022
2023
2024
45,876.5
50,703.0 57,597.9
60,707.9
70,101.0
(22,536.7) (24,800.0) (27,958.0) (31,641.6) (37,028.6)
23,339.8
25,903.0
29,639.9
29,066.4
33,072.4
(7,382.8) (8,564.5) (10,439.3) (9,775.3) (12,065.9)
(1,227.2) (1,216.9) (1,402.3) (1,665.7) (1,869.9)
(0.0)
(0.1)
(0.0)
(119.0)
(244.0)
(8,610.0) (9,781.5) (11,841.5) (11,560.0) (14,179.8)
618.1
715.3
338.7
14,729.8
16,121.5
18,416.4
18,221.7
19,231.3
3,126.4
3,485.1
3,388.2
3,957.3
4,650.6
17,856.2
19,606.6
21,804.6
22,179.0
23,881.9
(859.3)
(937.8) (1,051.2) (1,079.6) (1,160.1)
16,996.9
18,668.8
20,753.4
21,099.4
22,721.8
(4,229.4) (4,013.5) (4,607.1) (4,641.7) (4,388.9)
12,767.5
14,655.3
16,146.3
16,457.7
18,332.9
586.2
1,291.2
2,010.8
2,522.5
2,594.6
13,353.7
15,946.5
18,157.1
18,980.2
20,927.4
(555.1)
1,550.0
(299.7)
(122.0)
(894.7)
12,798.0 17,497.7
17,857.4
18,858.2
20,032.7
15.06
17.99
20.48
21.41
23.61
33
Key Financial Ratios
2020
24.88%
13,353.7
3,126.4
(0.0)
3,126.42
2,348.46
11,005.28
-59.24
11,064.52
2021
21.50%
15,946.5
3,485.1
(0.1)
3,485.02
2,735.80
13,210.73
555.10
12,655.63
2022
22.20%
18,157.1
3,388.2
(0.0)
3,388.16
2,636.02
15,521.11
1,192.96
14,328.15
2023
22.00%
18,980.2
3,957.3
(119.0)
3,838.29
2,993.89
15,986.29
1,773.23
14,213.06
2024
19.32%
20,927.4
4,650.6
(244.0)
4,406.60
3,555.43
17,372.01
1,855.39
15,516.62
Key Financial Ratios
Return on net operating assets (RNOA)
Financial Leverage (FLEV)
Net Financial income (NBC)
Return on Equity (ROCE)
2020
27.89%
-0.49
6.19%
17.26%
2021
29.39%
-0.51
5.95%
17.54%
2022
28.01%
-0.47
5.30%
17.26%
2023
24.83%
-0.44
5.89%
16.48%
2024
25.60%
-0.46
6.12%
16.62%
Profit Margin (PM)
Asset Turnover (ATO)
Sales PM
Other OI/NOA
23.99%
1.16
24.12%
-0.15%
26.06%
1.13
24.96%
1.23%
26.95%
1.04
24.88%
2.15%
26.33%
0.94
23.41%
2.75%
24.78%
1.03
22.13%
2.73%
Implicit tax rate (t)
Earnings after Taxes (NPAT)
Finance Income
Finance Costs
Net Finance Income (NFI)
Net Financial Income (after tax)
Net Operating Income (after tax)
Other operating income (Other OI)
Sales operating income (Sales OI)
34
Exercise 12.2
35
Exercise 12.6
36
Exercise 12.7
37