Ch 2 Learning GoalsCh 2 Learning Goals

Content and format of income statement and balance sheet.

Uses of financial ratios.Calculate and interpret financial ratios.DuPont analysis.

Financial StatementsFinancial Statements

Income statement: a summary of

◦__________________

◦and __________________

during a specified period.

The Income Statement

Financial StatementsFinancial Statements

Balance sheet: summary of a firm’s financial

position at a given ___________________ in time.

◦Assets: what the firm ________________

◦Liabilities: what the firm ________________

Assets – liabilities = ______________

____________________ represents the owners’ investment.

The Balance Sheet

Using Financial Ratios

• Ratio analysis: calculating and ________________

financial ratios to assess a firm’s financial condition

and performance.

• It is of interest to shareholders, creditors, and the

firm’s own management.

Interested Parties

Trend or time-series analysis

Used to evaluate a firm’s performance over time

Using Financial Ratios

Types of Ratio Comparisons

• cross-sectional analysis

Used to compare different firms at the same point in time

Using Financial Ratios

Types of Ratio Comparisons

To do a cross-sectional analysis,

compare the firm’s ratios with:

________________ norms

industry _______________

Using Financial Ratios

Cross-sectional analysis

Using Fin’l RatiosUsing Fin’l Ratios

There are no ____________________ _____________________ for ratios!◦Example: the current ratio should be 2.◦Not necessarily! ◦Ratios should be interpreted in comparison to

other similar firms (same industry, similar size, etc)

• Ratios must be considered together; a single ratio by

itself means little.

• Financial statements being compared should be from

the same time.

• Use audited financial statements if possible.

• The financial data being compared should have been

developed in the same way.

• Inflation distorts the results.

Using Financial RatiosCautions for Doing Ratio Analysis

• Liquidity Ratios

• Activity (efficiency) Ratios

• Leverage Ratios

• Profitability Ratios

• Common-size statements

• DuPont Analysis

Ratio Analysis

DuPont System of AnalysisDuPont System of Analysis

The DuPont system is not a method of calculating ROA and ROE, rather it is a technique for _____________________ financial performance.

DuPont System of AnalysisDuPont System of Analysis

DuPont analysis merges the income statement and balance sheet into two summary measures of profitability: _________ and ____________.

DuPont System of AnalysisDuPont System of Analysis

The DuPont system breaks ROE into:◦A ___________________________ component ◦An __________________________ component◦A ___________________________ (financing) component.

DuPont AnalysisDuPont Analysis

ROA = NPM X TATOAndROE = ROA X FLMWhere:FLM = Financial Leverage Multiplier = Total Assets / Common Equity

DuPont AnalysisDuPont Analysis

The two formulas can be combined to get:

NPM X TATO X FLM = ROE

By putting the values for this formula for both the firm and the industry into a table, we can determine why a firm’s ROA and ROE are higher or lower than its competition.