FinTut is a computer-based
tutorial that students can
work through at their own
pace. It is used to develop
and reinforce a better
understanding of financial
statements, their
interpretation, and analysis.
It is to be used in
PowerPoint’s play mode
FinTut features 3 sections:
The components of financial
statements, the information each
conveys, and definitions.
Ratios and performance measures,
and how they are calculated.
A benchmarking exercise based on
GizmoWorks financials and the Auto
Parts industry.
Max Does Financial Analysis
In addition to
Spend a few moments
traditional accounting
with me as I conduct an
activities, I am very
analysis of a new client,
involved in providing
The GizmoWorks
consulting services to
Company. They
my clients.
manufacture and sell
aftermarket parts to
I always start with a
auto enthusiasts.
thorough financial
check up. It still
The insight I am about
amazes me how much I
to gain will benefit me
can learn about a
immensely as I work
client’s strengths, and
with them on strategic
opportunities for
issues.
improvement by
conducting a thorough
financial analysis.
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Finance 101
Analysis
Summary
Finance 101
Financial Statements
summarize a firm’s position and
performance. The two principal
statements are the Balance
Sheet and the Income
Statement.
Accountants prepare these statements on a periodic basis
(monthly or quarterly) using consistent standards that are
accepted by the profession. Generally, the balance sheet
is oriented toward the present and future, and the Income
Statement is a reflection of past activities.
Balance Sheet
A Balance Sheet summarizes what a firm has to
work with (assets), and how these assets were
financed (borrowed or contributed by the owners).
A balance sheet provides insight into asset
efficiency, risks, and how the firm is positioned for
the future.
Key Definition:
Balance Sheet - A financial statement that
summarizes a firm’s assets, liabilities, and
owner’s equity at a given point in time.
Balance Sheet Structure
Assets - Things of value a firm
Current
Assets
- The
owns.
Assets
are grouped
in 3
ways:
Current
assets,
long-term
or
assets
of a Receivable
company
that
Accounts
Dollars
Intangible
Assets
- Assets
with
fixed
assets,
and -to
intangible
assets.
Fixed
Assets
Assets
that
are
are
expected
be
realized
to a attributes,
firm by customers
a
noowed
physical
butbasis
are as
Assets
are
valued
on
the
of
not
consumed
during
aAccounts
one-year
Cash
-ofCoin
and
currency
held by
result
credit
sales.
in
cash,
sold,
or
consumed
valuable
because
of
advantages
historical
cost
or
market
value
–
period,
are
valuable
in
the
Inventory
Goods
held
for
a
Receivable
firm
plus
checking
are
valued
account
on
the
during
a isone-year
period. basis
or
rights they
give a business.
whichever
lower
production,
sale and
distribution
of
balances.
resale
of
net
by
realizable
a
Some
retailer
short-term
value
or
distributor.
–
the
highly
Examples
include
patents,
The
bulkand
of services,
current assets
products
and
are
liquid
A
amount
manufacturer
investments
that
likely
willsuch
will
list raw
be
as
collected.
copyrights,
trademarks,
high
will
be comprised
ofwork
cash,
needed
for
thevalue
operation
of in
the
Treasury
materials,
Bills
the
are
considered
of
to be
customer loyalty, or a superior
accounts
receivable,
and
firm. equivalents.
Most
fixed
assetsgoods.
will
be
cash
process,
plus
workforce
(the finished
latter 2 are
categorized
asand
property,
plant, and
Inventory
isgoodwill).
valued
at
historical
inventories,
are
considered
Intangible
equipment.
cost,
orare
market
– whichever
described
as value
the
firm’s
Assets
valued
at cost
and
is
lower.
must
be evidenced
working
capital. by an arm’s
length market transaction.
Balance Sheet Structure
Current Liabilities - Shortterm (less than 1 year) debts or
payments a firm is obligated to
Long-term Liabilities - Debts
pay. The bulk or current assets
that the principal amounts need
are likely to include accounts
to be paid back over periods
payable (generally dollars owed
greater than 1 year. Long-term
suppliers), notes payable, taxes
liabilities
valued at present
Equityand
-are
owed,
wages payable.
value
and notstake
the sum
of future
The owner’s
in the
payments.
Long-term
debtisis
business. Owner’s
equity
generally
as initial
comprisedincurred
of their direct
capitalization
firm or to
investment in of
thethe
business
finance
opportunities.
(capital growth
stock), plus
undistributed profits (retained
earnings).
Income Statement
An Income Statement (sometimes referred to as a
profit and loss (P&L)statement) summarizes the
profitability of a firm’s activities over a stated time
period. It is also useful in evaluating growth,
operating efficiencies, and value creation. Income
and Profit mean the same thing.
Key Definition
Income Statement - A financial statement that reports
revenues and expenses and shows the profitability of
a business for a stated time period.
Revenue
Inflow of assets (usually
cash or accounts
receivable) generated
by the sale of goods
and services (note: not
the sale of fixed assets).
Revenue is recognized
on the financial
statements at the time
ownership of the goods
is transferred (usually
when shipped) or when
the service is rendered.
“Net sales”, or just
“Sales” is often
substituted on the
income statement for
revenue. They mean
the same thing.
Cost of Goods Sold
(COGS)
The price paid by the
distributor for the
product being sold or
the cost to manufacture
goods that are sold
during an accounting
period. COGS for a
manufacturer is the
direct labor, materials,
and manufacturing
overhead.
Formula:
COGS = Beginning Inventory + Cost
of Goods Manufactured (or
purchases) – Ending Inventory
Gross Profit Dollars
The difference between
revenues and the cost
of goods sold over a
stated time period.
When stated as a
percentage, this
measure is considered
the gross profit margin.
Formula:
Gross Profit =
Revenue - COGS
Operating Expenses
Expenses other than cost
of goods sold incurred in
the operation of the
business. Included are
sales expenses (including
marketing costs), general
expenses (rents, insurance
payments, office supplies),
and administrative
expenses (salaries for
executives, accountants,
office support, etc).
Sometimes these
expenses are classified as
sales, general and
administrative expenses
(S,G & A).
Operating Profit
An important measures of
profitability that reflects the
profit derived from the
normal functions of running
a business. It is the
remaining revenue after cost
of goods sold and the cost of
operations (sales, general
and administrative costs) are
accounted for. When stated
as a percentage this measure
is referred to as the
operating margin. Operating
income and operating profit
are the same thing.
Formula:
Operating Profit (or Income) =
Revenue - COGS - Operating Expenses
Interest Expense
The charges incurred
during the income
statement period on
interest bearing loans and
notes. These costs are
considered and reported
separately from normal
operating expenses.
Tax Expense
The total federal, state,
and local income taxes
owed on the business
profits.
Net Income
The remaining profit after
all expenses (cost of
goods sold, operating
expenses, interest,
special charges, and
taxes) are subtracted.
Net Income and Profit are
the same thing. When net
income is expressed as a
percentage of revenue it
is known as net profit
margin or return on sales.
Formula:
Net Income (or Profit) =
Rev - COGS - Op Exp - Int Exp - Tax Exp
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Finance 101
Analysis
Summary
Financial Analysis
Using performance measures derived
from the financial statements, and
comparing these measures for
GizmoWorks to standards in the Auto
Parts industry in which they compete, it
is possible to obtain many insights into
the firm’s past performance and position
for the future.
Financial Analysis
•
•
•
•
Measures of short-term liquidity
Measures of long-term credit risk
Measures of profitability
Measures for evaluating the current
market price of common stock
Measures of short-term liquidity
Current Ratio: A measure of shortterm debt-paying ability
Current Assets / Current Liabilities
184,092 / 18,732 = 9.8
The industry standard is 2.1.
GizmoWorks has a strong
ability to pay short-term
debts!
Measures of short-term liquidity
Quick Ratio: A measure of shortterm debt-paying ability
Quick Assets [cash + accounts receivable]
/ Current Liabilities
132,425 / 18,732 = 7.1
The industry standard is 1.2.
GizmoWorks has a strong
ability to pay short-term
debts!
Measures of short-term liquidity
Receivables turnover rate:
Indicates how quickly receivables
are collected.
Net Sales / Avg Accounts Receivable
750,000 / 125,000 = 6
The industry standard is 5.9.
GizmoWorks collection
experience is similar to its
industry.
Measures of short-term liquidity
Day’s to collect accounts receivable:
Indicates how many days on average
it takes to collect accounts
receivable. Also referred to a DSO’s
(days sales outstanding)
365 days / Receivable Turnover Rate
365 / 6 = 61
The industry standard is 62.
GizmoWorks collection
experience is similar to its
industry.
Measures of short-term liquidity
Inventory Turnover Rate:
Indicates how quickly inventory
sells
COGS / Average Inventory
228,333 / 51,667 = 4.4
The industry standard is 4.6.
GizmoWorks sells its
inventory slightly slower than
their competitors.
Measures of short-term liquidity
Days to sell the average inventory:
Indicates in days how quickly
inventory sells.
365 days / Inventory Turnover Rate
365 / 4.4 = 83
The industry standard is 79.
It takes GizmoWorks slightly
longer than their competitors
to sell inventory.
Measures of short-term liquidity
Operating Cycle:
Indicates in days how quickly
inventory converts to cash.
Days to sell inventory +
Days to collect receivables
83 + 61 = 144
The industry standard is 141.
GizmoWorks has an operating
cycle much like the rest of
their industry.
Measures of long-term credit risk
Debt ratio:
Percentage of assets financed by
creditors; indicates relative size of
the equity position.
Total Liabilities / Total Assets
68,732 / 224,094 = 30.7%
The industry standard is 63%.
GizmoWorks has a much
stronger equity position than
the typical firm in their
industry! This puts them in a
better position to finance
investment opportunities!
Measures of long-term credit risk
Interest coverage ratio:
Indicator of a company’s ability to
meet its interest payment
obligations.
Operating Profit /
Annual Interest Expense
96,262 / 4000 = 24 times
The industry average is 4.4
times.
Creditors are often reluctant
to lend money to firms if the
coverage ratio is less than 4.
GizmoWorks has a very
strong balance sheet!
Measures of Profitability
Gross profit rate:
A measure of the profitability of
the company’s products.
Gross Profit / Net Sales
521,667 / 750,000 = 69.9%
The industry standard is 53%.
GizmoWorks makes over 25%
producing and selling its
products than their typical
competitor!
Measures of Profitability
Operating expense ratio:
A measure of management’s
ability to control expenses.
Operating Expenses / Net Sales
425,400 / 750,000 = 56.7%
The industry standard is 40%.
GizmoWorks has relatively
high operating expenses.
Management should
determine whether these
expenditures are contributing
value to the firm.
Measures of Profitability
Net income as a percentage of
sales:
An indicator of management’s
ability to control costs.
Net Income / Net Sales
55,360 / 750,000 = 7.4%
The industry standard is 3.4%.
GizmoWorks has a significantly
higher profit margin than its
competitors!
Measures of Profitability
Earnings per share:
Net income applicable to each
share of common stock
Shares outstanding =
capital stock / par value
Net Income / Shares Outstanding
100,000 / 1 = 100,000 shares
55,360 / 100,000 = .55
There is no industry standard
– each firm is different.
Investors expect this number
to increase consistently over
time
Measures of Profitability
Return on assets:
A measure of the productivity of
assets, regardless of how the
assets were financed.
Operating Income / Total Assets
96,267 / 224,092 = 43.0%
The industry standard is 15%.
GizmoWorks is using their
assets very productively!
Measures of Profitability
Return on equity:
The rate of return on the
stockholders’ equity in the
business.
Net Income / Total Equity
55,360 / 155,360 = 35.6%
The industry standard is
13.3%.
GizmoWorks is making
considerably more profit on
invested capital than most
firms in this industry.
Measures for Evaluating Stock Price
Price-earnings ratio:
A measure of investors’
expectations about the company’s
future prospects.
Stock Price / Earnings per share
8.17 / .55 = 14.85 times
The industry standard is 12
times.
The market places a greater
value on the future earnings
prospects of GizmoWorks
than most frims in the
industry.
Stock price = $8.17 Earnings per share = $.55 Dividend per share = $.08
Measures for Evaluating Stock Price
Dividend yield:
Dividends expressed as a rate of
return on the market price of the
stock.
Dividends Per Share / Stock Price
.08 / 8.17 = 1%
The industry standard is 1.5%.
Many public companies pay
no dividends. Dividend policy
can be studied in more
advanced financial
management courses.
Stock price = $8.17 Earnings per share = $.55 Dividend per share = $.08
Measures for Evaluating Stock Price
Book value per share:
The recorded value of net assets
underlying each share of common
stock.
Stockholders’ Equity /
Shares Outstanding
$155,360 / 100,000 shares = $1.55
Firms with a stock price of
less than book value is often
an indicator of problems with
the firm.
Stock price = $8.17 Earnings per share = $.55 Dividend per share = $.08
Max Does Financial Analysis
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recommendations:
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stock price doesn’t double in a
couple years. And besides, I don’t
see much downside risk here!
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Finance 101
Analysis
Summary
Measures of Short-term Liquidity
• Current ratio = current assets / current liabilities
• Quick ratio = quick assets / current liabilites
• Receivables turnover rate = net sales / average
accounts receivable
• Days to collect receivables = 365 days / accounts
receivable turnover rate
• Inventory turnover rate = cost of goods sold / average
inventory
• Days to sell inventory = 365 days / inventory turnover
rate
• Operating cycle = days to sell inventory + days to
collect receivables
Measures of Long-term Credit Risk
• Debt ratio = total liabilities / total assets
• Interest coverage ratio = operating income /
annual interest expense
Measures of Profitability
• Gross profit rate = gross profit / net sales
• Operating expense ratio = operating expenses / net
sales
• Net income as a % of net sales = net income / net
sales
• Earnings per share = net income / shares
outstanding
• Return on assets = operating income / average total
assets
• Return on equity = (net income – preferred dividends)
/ average common stockholders’ equity
Measures for Evaluating Stock Price
• Price-earning ratio = current stock price /
earnings per share
• Dividend yield = annual dividend / current
stock price
• Book value per share = common
stockholders’ equity / shares of common
stock outstanding
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Finance 101
Analysis
Summary