FINANCIAL STATEMENTS
Financial Health of Firm
 Firms produce good and services by using assets
 Financial condition of firm’s Assets
 Financing of these assets
 Shareholder equity = Assets - Liabilities
 Balance Sheet gives state of Assets & Liabilities
 Firms sell their goods and services over time
 Financial performance and profitability
 Income Statement gives summary of performance
over accounting period
 Statement of Cash Flow tells what has happened to
cash
Balance Sheet, Current Items
 Assets and Liabilities
 Items turning into cash in less than one year current Assets
and Liabilities
 Listed based on liquidity
CURRENT ASSETS
CURRENT LIABILITIES
Cash & Cash Equivalent
Taxes
Inventory
Short term borrowing
Accounts Receivables
Accounts Payable
Prepaid Expenses
Accrued Expenses
Balance Sheet, Long term Item
 Long Term Assets
 Tangible Fixed Assets: Land, Factories, …
 Intangibles: Goodwill
 Long Term Liabilities
 Long term debt
 Retained Earnings
 Shareholder equity
 Current Assets – Current Liabilities = Working Capital
 Retained earning is an item to ensure
Total Assets = Total Liabilities
Income Statement

Sales Revenue
- Cost of Goods Sold
 Gross Margin or Gross Profit
- Operating Expenses
 Operating Revenue before Depreciation =
Earnings Before Interest Tax Depreciation and Amortization =
EBITDA
- Depreciation
 Earnings Before Interest and Taxes = EBIT
- Interest Expense
 Earnings before Taxes
 - Income Tax Expenses
 Net Income = Profit

Statement of Cash Flow
 Cash is life blood of company
 Company might be profitable on accrual basis but go bankrupt
Capital Investment
Stock
Borrowings
$
Service Debt
Investment
$
$
Company
G&S
Inventory
Dividend
Operating
expenses
Taxes
Statement of Cash Flow
 Cash Receipts
 From customers for selling goods & services
 From borrowing
 From issuing new capital stocks
 Cash Disbursements
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For purchasing inventory that are or will be sold
For Interest and principal payment of debt
For Income Taxes
For Investment in machinery, improvements, ..
For dividend payments to stock holders
 Three statements are interlocked
Cash Flow from Operating Activities
 Net Income
 Change in Accounts Receivable
 Change in Inventory
 Change in Prepaid expenses
 Change in Accounts payable
 Change in Accrued expenses
 Change in Income Tax
 Operating Cash Flow Before Depreciation
 Depreciation
 Cash Flow From Profit-Making Activities
Cash Flow from non-Operating Activities
 Cash Flow From Investing Activities
 Purchase of Plant, Properties & Equipments
 Cash Flow From Financing Activities
 Change in short term debt
 Long term Borrowings
 Capital Stock Issue
 Cash Dividends to Stock Holders
Interlocking Nature of Statements
 Cash Flow From Profit-Making Activities
 Cash Flow From Investing Activities
 Cash Flow From Financing Activities
 Net Change in Cash During Year
 Profitability Cannot be Measured by Cash Flow Only
 How to compare Financial Statements of companies of
different sizes?
 Common-Size Income Statement all quantities as a % of Sales
 Common-Size Balance Sheet all quantities as a % of Total Assets
DuPont Model
 A main metric of performance is ROE = Net Income/Equity
 To better analyze factors affecting ROE it is decomposed into
a series of ratios
 Each ratio component is meaningful and sheds light on the
company and its performance and capital structure
 This decomposition is called DuPont System
 ROE = (Net Income/Pretax Profit) * (Pretax Profit/EBIT)
*(EBIT/Sales)*(Sales/Assets)*(Assets/Equity)
Interpretation of DuPont Model
 Net Income/Pretax Profit= Tax Burden Ratio
 Ratio of Net Income after tax to pretax profit and is
not affected by capital structure of the company
 Pretax Profit/EBIT = (EBIT – Interest Expense)/EBIT =
Interest Burden Ratio and depends on the capital
structure of the company. A closely related ratio is
Interest Coverage Ratio or Times Interest Earned =
EBIT/Interest Expense
 EBIT/Sales = Profit Margin = Return on Sale
(ROS) =
Operating profit per 1$ of sale
Interpretation of DuPont Model
 Sales/Assets = Total Asset Turn Over (ATO)
 Measures how efficiently management is utilizing
assets of the company
 Assets/Equity = Leverage Ratio = 1+ Debt/Equity
(depends on capital structure)
 ROE = Tax Burden * Interest Burden * Profit Margin * Asset Turn
Over * Leverage
Operating Cycle
 Operating Cycle =
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Inventory Period + Accounts Receivable period =
Accounts Payable Period + Cash Cycle
Inventory Turnover =
Cost of Goods Sold/Average Inventory
Inventory Period = 365/ Inventory Turnover
Receivable Turnover =
Credit Sales/Average Accounts Receivable
Receivable Period = 365/ Receivable Turnover
Cash Cycle
 Payables Turnover
Cost of Goods Sold/Average Payables
 Payables Period = 365/ Payables Turnover
 Cash Cycle =
Operating Cycle – Accounts Payable Period
Solvency and Liquidity Measures
 Short Term:
 Current Ratio = Current Assets/Current Liabilities
 Quick Ratio =
(Current Assets – Inventory)/Current Liabilities
Cost of Goods Sold/Average Payables
 Cash Ratio = Cash/Current Liabilities
 Long Term:
 Long-term Debt Ratio =
Long-Term Debt/ (Long-Term Debt +Equity )

Solvency and Liquidity Measures
 Long Term:
 Long-term Debt Ratio =
Long-Term Debt/ (Long-Term Debt +Equity )
 Times Interest Earned Ratio = EBIT/Interest
 Cash Coverage= ( EBIT+ Depreciation)/Interest