Three basic accounting statements:
• Income statement – provides information on the
revenues and expenses of the firm, and the resulting
income made by the firm, during a period.
• Balance sheet – summarizes the assets owned by a
firm, the value of these assets, and the mix of
financing used to finance these assets at a point in
time.
• Statement of cash flows – specifies the sources and
uses of cash to the firm from operating, investing,
and financing activities during a period.
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Typical financial statements we encounter in the classroom
Income Statement
Sales
Cost of Goods Sold
Gross Profit
Selling, General, & Administrative Expenses
Earnings Before Interest and Taxes
Income Tax Expense
Net Income
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Revenue
Usually part of CGS or
Cost of goods sold
SG&A. Make sure that if
Gross profit
you break it out this way,
Operating expenses
that you subtract it from
Selling, general and adminstrative expenses
CGS or SG&A
EBITDA
Depreciation and amortization
Make sure these are really
EBIT
non-recurring. If they
Interest
always appear think about
Interest expense
whether it should be
Interest income
included as part of
EBT
operations.
Income tax expense
Net income before non-recurring events and non-controlling interests
Non-recurring events
Discontinued operations
Net income after non-recurring events
Distributions
Income attributable to non-controlling interests
Net income
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Measures of profitability from operating activities
Sales  CGS
Sales
EBITDA
EBITDA Margin 
Sales
EBIT 1  t 
Operating Margin 
Sales
NetIncome
Net Income Margin 
Sales
Gross Profit Margin 


One way to generate these ratios is to construct common-size Income
Statements.
Quick review: common-size financial statements are financial
statements expressed in percentage terms. For example, common-size
Income Statements would express line items as a percentage of sales;
common-size Balance Sheets would express line items as a percentage
of Total Assets
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Typical financial statements we encounter in the classroom
Cash
Accounts Receivable
Inventory
Other Current Assets
Total Current Assets
Property, Plant & Equipment
Intangible Assets
Goodwill
Total Assets
Balance Sheet
Accounts Payable
Notes Payable
Accrued Liabilities
Total Short-term Liabilities
Long-Term Debt
Capital Leases
Total Liabilities
Stockholders' Equity
Total Liabilities & Stockholders' Equity
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Measures of Profitability
• Return on Equity – examines profitability from the
equity investor’s perspective
NetIncome
ROE 
BVEquity
– DuPont Identity – shows the components of ROE; useful
for tracking down the sources of profitability from a
shareholders’ perspective
ROE 
NetIncome
Sales
TotalAssets NetIncome



Sales
TotalAssets BVEquity
BVEquity
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• Asset turnover – measures how effectively a
company utilizes its capital.
Sales
AssetTurnover 
TotalAssets
• Equity multiplier – another measure of leverage
EquityMultiplier 
TotalAssets
BVEquity
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• Return on capital – measures the profitability of the
overall firm
ROC 
EBIT 1  t 
EBIT 1  t 

BVCapital BVDebt  BVEquity
• Return on Assets – measures operating efficiency in
generating profits from assets, before the effects of
financing
EBIT 1  t 
ROA 
TotalAssets
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Measures of Financial Stability
Debt
Equity
Debt
Debt to Capital Ratio 
Debt  Equity
Debt to Equity Ratio 
• Debt refers to interest-bearing debt: S/T debt + Current
portion of L/T debt + L/T debt + Capital leases. It does not
include payments to suppliers such as Accounts Payable
• We can use book values or market values when calculating
the ratios above. In most instances, we will be using market
values.
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• Gearing – this ratio shows how much net debt is
covered by shareholders’ equity
Debt  CashAndCashEquivalents
Gearing 
Shareholde rs ' Equity
• Capex ratio – measures how much capital investments
are needed to generate profits
CapitalExpenditures
CapexRatio 
OperatingC ashFlow
Operating cash flows = EBIT(1- tax rate) + depreciation
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• Goodwill ratio – this can be used as a measure of
“latent” impairments that could significantly affect
the balance sheet (impairments reduce total assets
and shareholders’ equity)
Goodwill
GoodwillRa tio 
Shareholde rs ' Equity
Goodwill
GoodwillRa tio 
TotalAssets
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A note on “Comprehensive Income” and dirty surplus accounting
• Comprehensive income = net income + other comprehensive
income
• Dirty surplus items are items that are allowed under GAAP to
bypass the income statement and be reported directly either into
shareholders’ equity or as a footnote to the financial statements or
in a separate statement
• These items are gains and/or losses that have not yet been realized
(usually changes in assets or liabilities, arising from changes in
market prices. See items on next slide). Once they are realized (e.g.,
sale of securities, subsidiaries), these items are moved to net
income.
• These items are usually collectively labeled as
– Accumulated other comprehensive income/loss
– Other comprehensive income/loss
– Accumulated non-owner equity account changes
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• Dirty surplus items allowed under GAAP
– Unrealized fair value gains and losses on availablefor-sale investment securities
– Foreign currency translation gains and losses
– Changes in assets and liabilities related to
pensions and postemployment benefits
– Effects of cash flow hedges
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• Sources:
– Damodaran, Investment Valuation, 2nd ed.
– Palepu and Healy, Business Analysis and Valuation Using Financial
Statements, 4th ed.
– Schmidlin, The Art of Company Valuation and Analysis
– Wahlen, Baginski, and Bradshaw, Financial Reporting, Financial
Statement Analysis, and Valuation
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