Chapter 3
Working with Financial Statements
3-1
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
• Cash Flows and Financial Statements:
A Closer Look
• Standardized Financial Statements
• Ratio Analysis
• The DuPont Identity
• Using Financial Statement
Information
3-2
Chapter Outline
• Cash Flows and Financial Statements: A
Closer Look
• Standardized Financial Statements
• Ratio Analysis
• The DuPont Identity
• Using Financial Statement Information
3-3
Sample Balance Sheet
XYZ Corporation
December 31, 201X
(Figures in millions of dollars)
2011
3-4
2010
2011
2010
Cash
696
58 A/P
307
303
A/R
956
992 N/P
26
119
Inventory
301
361 Other CL
1,662
1,353
Other CA
303
264 Total CL
1,995
1,775
Total CA
2,256
1,675 LT Debt
843
1,091
Net FA
3,138
3,358 C/S
2,556
2,167
Total
Assets
5,394
5,033 Total Liab.
& Equity
5,394
5,033
Sample Income Statement
XYZ Corporation
January 1 – December 31, 201X
( Figures in millions of dollars)
Revenues
$5,000
Cost of Goods Sold
(2,006)
Expenses
(1,740)
Depreciation
(116)
EBIT
1,138
Interest Expense
3-5
(7)
Taxable Income
1,131
Taxes
(442)
Net Income
$689
EPS
$3.61
Dividends per share
$1.08
Sources and Uses of Cash
Sources
• Cash inflow – occurs when we “sell”
something and we add to the cash
account
• Decrease in asset account
• Accounts receivable, inventory, and net
fixed assets
• Increase in liability or equity account
• Accounts payable, other current liabilities,
and common stock
3-6
Sources and Uses of Cash
Uses
• Cash outflow – occurs when we
“buy” something
• Increase in asset account
• Cash and other current assets
• Decrease in liability or equity
account
• Notes payable and long-term debt
3-7
Statement of Cash Flows
Statement that summarizes the
sources and uses of cash
3-8
Statement of Cash Flows
Changes divided into three major
categories:
1. Operating Activity – includes net income
and changes in most current accounts
2. Investment Activity – includes changes in
fixed assets
3. Financing Activity – includes changes in
notes payable, long-term debt, and equity
accounts, as well as dividends
3-9
Sample Statement of Cash Flows
(Numbers in millions of dollars)
Cash, beginning of year
58
Operating Activity
Decrease in Notes Payable
Net Income
689
Decrease in LT Debt
Plus: Depreciation
116
Decrease in C/S (minus RE)
Decrease in A/R
36
Decrease in Inventory
60
Increase in A/P
Increase in Other CL
Dividends Paid
Net Cash from Financing
-93
-248
-94
-206
-641
4
309
Less: Increase in other CA
-39
Net Cash from Operations
1,175
Investment Activity
3-10
Financing Activity
Sale of Fixed Assets
104
Net Cash from Investments
104
Net Increase in Cash
638
Cash End of Year
696
Chapter Outline
• Cash Flows and Financial Statements: A
Closer Look
• Standardized Financial Statements
• Ratio Analysis
• The DuPont Identity
• Using Financial Statement Information
3-11
Standardized Financial Statements
• Standardized statements make it easier to
compare financial information,
particularly as the company grows
• They are also useful for comparing
companies of different sizes, particularly
within the same industry
3-12
Standardized Financial Statements
Common-Size Balance Sheets:
Compute all accounts as a
percent of total assets
Common-Size Income Statements:
Compute all line items as a
percent of sales
3-13
Chapter Outline
• Cash Flows and Financial Statements: A
Closer Look
• Standardized Financial Statements
• Ratio Analysis
• The DuPont Identity
• Using Financial Statement Information
3-14
Ratio Analysis
The goal of ratio analysis is to take the
numerous lines from both the income
statement and balance sheet and to
interpret this information in a
meaningful way.
There is simply too much information to
grasp at one time.
3-15
3-16
Ratio Analysis
Ratios are simply the
construction of a
numerator
and a denominator
using data from a
balance sheet and/or
an income statement.
3-17
Numerator
____________
Denominator
Ratio Analysis
• Ratios allow for better comparison
through time or between
companies
• As we look at each ratio, ask
yourself what the ratio is trying to
measure and why that information
is important?
3-18
Categories of Financial Ratios
1. Short-term solvency or liquidity
ratios
2. Long-term solvency or financial
leverage ratios
3. Asset management or turnover
ratios
4. Profitability ratios
3-19
5. Market value ratios
Categories of Financial Ratios
1. Short-term solvency or liquidity
ratios
2. Long-term solvency or financial
leverage ratios
3. Asset management or turnover
ratios
4. Profitability ratios
3-20
5. Market value ratios
Sample Balance Sheet
XYZ Corporation
December 31, 201X
(Figures in millions of dollars)
2011
Cash
A/R
Inventory
Other CA
Total CA
3-21
2010
2011
2010
696
58 A/P
307
303
956
992 N/P
26
119
1,662
1,353
1,995
1,775
843
1,091
301
303
2,256
361 Other CL
264
Total CL
1,675 LT Debt
Net FA
3,138
3,358 C/S
2,556
2,167
Total
Assets
5,394
5,033 Total Liab.
& Equity
5,394
5,033
Computing Liquidity Ratios
Current Ratio = CA / CL
2,256 / 1,995 = 1.13 times
Quick Ratio = (CA – Inventory) / CL
(2,256 – 301) / 1,995 = .98 times
3-22
Sample Income Statement
XYZ Corporation
January 1 – December 31, 201X
( Figures in millions of dollars)
Revenues
$5,000
Cost of Goods Sold
(2,006)
(1,740)
Expenses
Depreciation
(116)
EBIT
1,138
Interest Expense
3-23
(7)
Taxable Income
1,131
Taxes
(442)
Net Income
$689
EPS
$3.61
Dividends per share
$1.08
Categories of Financial Ratios
1. Short-term solvency or liquidity
ratios
2. Long-term solvency or financial
leverage ratios
3. Asset management or turnover
ratios
4. Profitability ratios
3-24
5. Market value ratios
Sample Balance Sheet
XYZ Corporation
December 31, 201X
(Figures in millions of dollars)
2011
3-25
2010
2011
2010
Cash
696
58 A/P
307
303
A/R
956
992 N/P
26
119
Inventory
301
361 Other CL
1,662
1,353
Other CA
303
264 Total CL
1,995
1,775
Total CA
2,256
1,675 LT Debt
843
1,091
Net FA
3,138
3,358
2,556
2,167
5,394
5,033
Total
Assets
5,394
C/S
5,033 Total Liab.
& Equity
Computing Long-term Solvency
Ratios
Total Debt Ratio = (TA – TE) / TA
(5,394 – 2,556) / 5,394 = 52.61%
Debt/Equity = TD / TE
(5,394 – 2,556) / 2,556 = 1.11 times
3-26
Sample Balance Sheet
XYZ Corporation
December 31, 201X
(Figures in millions of dollars)
2011
2011
2010
Cash
696
58 A/P
307
303
A/R
956
992 N/P
26
119
Inventory
301
361 Other CL
1,662
1,353
Other CA
303
264 Total CL
1,995
1,775
843
2,556
1,091
5,394
5,033
Total CA
2,256
1,675
Net FA
3,138
3,358
Total
Assets
3-27
2010
5,394
LT Debt
C/S
5,033 Total Liab.
& Equity
2,167
Computing Long-term Solvency
Ratios
Equity Multiplier = EM
= TA / TE = 1 + D/E
1 + 1.11 = 2.11
3-28
Categories of Financial Ratios
1. Short-term solvency or liquidity
ratios
2. Long-term solvency or financial
leverage ratios
3. Asset management or turnover
ratios
4. Profitability ratios
3-29
5. Market value ratios
Sample Income Statement
XYZ Corporation
January 1 – December 31, 201X
( Figures in millions of dollars)
Revenues
$5,000
Cost of Goods Sold
(2,006)
Expenses
(1,740)
Depreciation
EBIT
Interest Expense
3-30
(116)
1,138
(7)
Taxable Income
1,131
Taxes
(442)
Net Income
$689
Categories of Financial Ratios
1. Short-term solvency or liquidity
ratios
2. Long-term solvency or financial
leverage ratios
3. Asset management or turnover
ratios
4. Profitability ratios
3-31
5. Market value ratios
Computing Profitability
Measures
Profit Margin = PM = Net Income / Sales
689 / 5,000 = 13.78%
Return on Assets (ROA) = Net Income / Total
Assets
689 / 5,394 = 12.77%
Return on Equity (ROE) = Net Income / Total
Equity
3-32
689 / 2,556 = 26.96%
Categories of Financial Ratios
1. Short-term solvency or liquidity
ratios
2. Long-term solvency or financial
leverage ratios
3. Asset management or turnover
ratios
4. Profitability ratios
3-33
5. Market value ratios
Computing Market Value
Measures
If the Market Price = $87.65 per share
and if the number of shares of common
stock outstanding is:
190.9 million,
Then the PE Ratio = Price per share /
Earnings per share
87.65 / 3.61 = 24.28 times
3-34
Computing Market Value
Measures
If the Market Price
= $87.65 per share and
If the number of shares of common stock outstanding
is: 190.9 million,
and the book value of the equity is $2,556,
Then the Market-to-book ratio =
Market value per share / book value per share
87.65 / 3.61 = 24.28 times
3-35
Computing Market Value
Measures
The Price/Earnings (P/E) ratio focuses on the market
price of a share of stock and compares it to the Net
Earnings of a company.
3-36
Work the Web
• The Internet makes ratio analysis much
easier than it has been in the past
• Click on the web surfer to go to
www.reuters.com
• Click on Stocks, then choose a company and
enter its ticker symbol
• Click on Ratios to see what information is
available
3-37