Chapter 9Chapter 9

The Analysis of the Balance Sheet and the

Income Statement

The Analysis of the Balance Sheet The Analysis of the Balance Sheet and the Income Statementand the Income Statement

Chapter 8 reformulated the statement of owners’ equity.

Link to Previous Chapter

This chapter continues the reformulation and analysiswith the balance sheet and

income statement.The reformulation follows the

design in Chapter 7.

This Chapter

Chapters 10 reformulates the cash flow statement.

Link to Next Chapter

More applications and discussion are on the web page.

Link to Web Page

What assets and liabilities are classified as operating ? As financing ?

What items in the income

statement are classified as

operating ? As financing ?

How are taxes allocated to the operating and

financing components of

the income statement ?

What ratios are calculated

from reformulated statements ?

What do they mean ?

What you will learn from this What you will learn from this chapterchapter

•Why reformulated income statements and balance sheets are desirable

•How knowledge of the business is incorporated in reformulated statements

•How operating and financing components of the two statements are identified

•What assets and liabilities typically fall into operating and financing categories

•Why income taxes are allocated to different parts of the income statement

•What balance sheet and income statement ratios reveal

Analysis of Balance Sheet and Analysis of Balance Sheet and Income Statement: the StepsIncome Statement: the Steps

1. Reformulate to distinguish between operating and financing activities

2. Carry out common size and trend analysis

3. Calculate balance sheet and income statement ratios

The Standard Balance SheetThe Standard Balance Sheet

The Reformulated Balance The Reformulated Balance SheetSheet

Assets Liabilities and Stockholders’ Equity

Financial assets: Financial liabilities: - Cash equivalents - Short-term borrowings - Short-term investments - Current maturities of long-term debt - Short-term notes receivable (?) - Short-term notes payable (?) - Long-term non-marketable - Long-term borrowing (bank loans, debt investments bonds, payable, notes payable) - Long-term marketable - Lease obligations debt securities - Preferred stock Operating assets: Operating liabilities: all else all else Common equity

Issues in Reformulating Issues in Reformulating Balance SheetsBalance Sheets

•Cash: working cash and excess cash

•Short term notes receivable: trade receivables?

•Finance receivables: an operating asset

•Debt investments: financial assets

•Short-term equity investments: excess cash?

•Short-term notes payable: trade notes?

•Leases

•Deferred tax assets and liabilities: operating

•Deferred revenues and accrued expenses

•Minority interest: not a financial obligation

Nike, Inc.: GAAP Balance Nike, Inc.: GAAP Balance SheetSheet

MAY 31,

---------------------------------------------- 1996 1995 1994 ---------- ---------- ---------- (in thousands)

ASSETSCurrent Assets: Cash and equivalents $ 262,117 $ 216,071 $518,816 Accounts receivable, less allowance for doubtful accounts of $43,372 and $32,663 1,346,125 1,053,237 703,592 Inventories (Note 2) 931,151 629,742 470,023 Deferred income taxes (Note 6) 93,120 72,657 37,603 Prepaid expenses 94,427 74,221 40,307 Total current assets 2,726,940 2,045,928 1,770,431Property, plant and equipment, net (Notes 3 and 5) 643,459 554,879 405,845Identifiable intangible assets and goodwill (Note 1) 474,812 495,907 163,036Deferred income taxes and other assets 106,417 46,031 34,503Total assets $3,951,628 $3,142,745 $2,373,815

LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Current portion of long-term debt (Note 5) $ 7,301 $ 31,943 $3,857 Notes payable (Note 4) 445,064 397,100 127,378 Accounts payable (Note 4) 455,034 297,656 210,576 Accrued liabilities 480,407 345,224 181,889 Income taxes payable 79,253 35,612 38,287 Total current liabilities 1,467,059 1,107,535 561,987

Long-term debt (Notes 5 and 13) 9,584 10,565 12,364Deferred income taxes (Note 6) 1,883 17,789 18,228Other liabilities (Note 1) 41,402 41,867 39,987Commitments and contingencies (Notes 11 and 14) -- -- -- Redeemable Preferred Stock (Note 7) 300 300 300Shareholders' equity (Note 8): Common Stock at stated value: Class A convertible 51,120, and 51,790 shares outstanding 153 155 159Class B 92,509 and 91,100 shares outstanding 2,702 2,698 2,704 Capital in excess of stated value 154,833 122,436 108,284 Foreign currency translation adjustment (16,501) 1,585 (15,123) Retained earnings 2,290,213 1,837,815 1,644,925 Total shareholders' equity 2,431,400 1,964,689 1,740,949 Total liabilities and shareholders' equity $3,951,628 $3,142,745 $2,373,815Notes refer to notes to the published financial statements. Refer to the 1996 10K

Nike, Inc.: Reformulated Nike, Inc.: Reformulated Balance SheetBalance Sheet

1996 1995 1994

Net Operating Assets

Operating Assets: Cash1 $ 27 $ 20 $ 15 Account receivable (less doubtful accounts of $43, $33 and $28) 1,346 1,053 704 Inventories 931 630 470 Prepaid expenses 94 74 40 Property, plant and equipment (net) 643 555 406 Goodwill $ 328 $330 $182 Trademarks and other intangibles 210 209 12 Accumulated amortization (63) 475 (43) 496 (31) 163 Deferred income taxes and other assets 200 119 72 3,716 2,947 1,870 Operating Liabilities: Accounts payable2 (455) (298) (211) Accrued liabilities (480) (345) (182) Income taxes payable (79) (36) (38) Deferred income taxes (2) (18) (18) Other liabilities3 (41) (1,057) (42) (739) (40) (489) 2,659 2,208 1,381 Net Financial Obligations Cash equivalents1 (235) (196) (503) Current portion of long-term debt 7 32 4 Notes payable4 446 397 127 Long-term debt 10 11 12 Redeemable preferred stock5 0 228 0 244 0 (360) Common Stockholders’ Equity 2,431 1,964 1,741

Reebok: GAAP Balance Reebok: GAAP Balance SheetSheet

December 31, 1996 1995 1994 =============================================================================================================== ASSETS Current assets: Cash and cash equivalents $ 232,365 $ 80,393 $ 83,936 Accounts receivable, net of allowance for doubtful accounts ($43,527 and $46,401) 590,504 506,563 532,475 Inventory 544,522 635,012 624,625 Deferred income taxes 69,422 65,484 66,456 Prepaid expenses and other current assets 26,275 45,418 29,952 ----------------------------------------- Total current assets 1,463,088 1,332,870 1,337,444 ----------------------------------------- Property and equipment, net 185,292 192,033 164,848 Non-current assets: Intangibles, net of amortization 69,700 64,436 96,196 Deferred income taxes 7,850 5,455 2,910 Other 60,254 56,825 69,063 ----------------------------------------- 137,804 126,716 147,164 ----------------------------------------- Total Assets $1,786,184 $1,651,619 $1,649,461 LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities: Notes payable to banks $ 32,977 $ 66,682 $ 63,837 Current portion of long-term debt 52,684 946 5,180 Accounts payable 196,368 166,037 170,622 Accrued expenses 169,344 144,585 152,479 Income taxes payable 65,588 47,956 102,392 Dividends payable 5,742 6,068 ----------------------------------------- Total current liabilities 516,961 431,948 505,588 ----------------------------------------- Long-term debt, net of current portion 854,099 254,178 131,799 Minority interest 33,890 31,081 21,569 Commitments and contingencies Outstanding redemption value of equity put options 39,123 Stockholders' equity: Common stock, par value $.01; authorized 250,000,000 shares; issued 92,556,295 and 111,015,133 shares in 926 1,096 169,125 Retained earnings 992,563 1,487,006 1,428,058 Less 36,716,227 and 36,210,902 shares in treasury at cost (617,620) (603,241) (603,241) Unearned compensation (283) (1,208) (2,598) Foreign currency translation adjustment 5,648 11,636 (839) --------------------------------------- 381,234 895,289 990,505 ----------------------------------------- Total Liabilities and Stockholders' Equity $1,786,184 $1,651,619 $1,649,461

Reebok: Reformulated Reebok: Reformulated Balance SheetBalance Sheet

1996 1995 1994

Net Operating Assets

Operating Assets: Cash 1 $ 12 $ 8 $ 8 Account receivable (less doubtful Accounts of $44, $46 and $45) 591 507 532 Inventory 545 635 625 Deferred taxes 77 71 69 Prepaid expenses 26 45 30 Property, plant and equipment 185 192 165 Goodwill $ 34 $152 Trademarks and other intangibles 116 116 Accumulated amortization (80) 70 (204) 64 96 Other assets 60 57 50 Operating assets 1,566 1,579 1,575 Operating Liabilities: Accounts payable (196 (166) (171) Accrued expenses (169) (145) (157) Income taxes payable (66) (431) (48) (359) (102) (430) 1,135 1,220 1,145 Net Financial Obligations 2 Cash equivalents 1 (220) (72) (76) Notes payable 33 67 64 Current portion of long-term debt 53 1 5 Long-term debt 854 252 131 Put option liability - . 720 39 287 - . 124 CSE and Minority Interest 415 933 1021

Minority Interest 34 31 22 Common Stockholders’ Equity 382 902 999

Microsoft Corporation: Microsoft Corporation: Reformulated Balance SheetReformulated Balance Sheet

1 Cash and cash equivalents split between working cash and financial assets. 2 Equity and other investments on GAAP statement split between equity and debt investments (financial assets) based on footnote information. 3 Convertible debt of AT&T Corp. in connection with investment in broadband.

Year ending June 30 2002 2001 Net Operating Assets Operating assets:

Working cash1 $ 50 $ 50

Account receivable, net 5,129 3,671 Inventories 673 83 Deferred income taxes 2,112 1,522 Property and equipment, net 2,268 2,309 Equity investments2 9,151 8,780 Convertible preferred debt3 3,036 3,925 Goodwill 1,426 1,511 Intangible assets, net 243 401 Other assets 2,952 3,372

27,040 25,624 Operating liabilities

Accounts payable 1,208 $ 1,188 Accrued compensation 1,145 742 Income taxes payable 2,022 1,468 Unearned revenue 7,743 5,614 Preferred income taxes 398 409 Other liabilities 2,950 15,466 2,120 11,541

11,574 14,083 Net financial assets

Cash equivalents 2,966 3,872 Short-term investments 35,636 27,678 Long-term debt investments 2,004 40,606 1,656 33,206

Common Stockholders’ Equity 52,180 47,289

The Standard Income The Standard Income StatementStatement

The Reformulated Income The Reformulated Income StatementStatement

Operating income as reported, minus any interest income included + Share of subsidiary income Discontinued operations Cumulative effects of an accounting change Abnormal gains and losses on operations Dirty surplus operating items in Table 8.1 = Operating income before tax - Tax on operating income: + Tax as reported + Tax benefit from net interest expenses = Operating income after tax - Net financial expenses after tax + Interest expense - Interest revenue = Net interest expense before tax + Tax benefit from net interest expenses = Net interest expenses after tax Gains and losses on debt retirement. Realized gains and losses on financial assets Dirty surplus financial items in Table 8.1

(other than preferred items) + Preferred dividends Gains and losses on redemption of preferred stock

- Tax benefit from preferred dividends (if any) - Minority Interest

= Comprehensive Income to Common

The Allocation of TaxesThe Allocation of Taxes• In the income statement only one tax number is

reported: It must be allocated to the operating and financial components to put both on an after-tax basis

• First, calculate the tax benefit (tax shield) provided by deducting interest expense

where t is the marginal (not effective) tax rate

• From the operating income deduct both the total tax and the tax shield, to capture what the operating income would have been if there had been no financing activities

• To the net financial expense add the tax shield, because its net effect is attributable to the financing activities

tExpenseInterest Net BenefitTax

Nike, Inc. : GAAP Income Nike, Inc. : GAAP Income StatementsStatements

_____________________________________________________________ Year ended May 1996 1995 1994

Revenues $6,470,625 $4,760,834 $3,789,668 Costs and expenses: Costs of sales 3,906,746 2,865,280 2,301,423 Selling and administrative 1,588,612 1,209,760 974,099 Interest expense (Notes 4 and 5) 39,498 24,208 15,282 Other income/expense, net (Notes 1, 9 and 10) 36,679 11,722 8,270 5,571,535 4,110,970 3,299,074 Income before income taxes 899,090 649,864 490,594 Income taxes (Note 6) 345,900 250,200 191,800 Net income $ 553,190 $ 399,664 $ 298,794 Net income per common share (Note 1) $ 3.77 $ 2.72 $ 1.98 _________________________________________________________________________________________ Notes refer to notes in the published statements. Refer to 1996 10-K.

Nike, Inc.: Reformulated Nike, Inc.: Reformulated Income StatementsIncome Statements

1996 1995 1994 Operating Income Revenues $6,471 $4,761 $3,790 Cost of sales 3,907 2,865 2,301 Gross margin 2,564 1,896 1,489 Operating expenses Administrative expenses $977 $730 $614 Advertising1 643 495 373 Amortization of intangibles2 22 1,642 13 1,238 8 995 Operating income from sales 922 658 494 (before tax) Taxes Tax as reported 346 250 192 Tax on other operating income 4 3 Tax on financial items 9 355 (1) 253 (2) 193 Operating income from sales 567 405 301 Other operating income (expense) Nonrecurring change2 (11) (7) Tax on other items 4 3 (7) (4) Currency translations (18) (18) 16 9 (7) 11) Operating income 549 414 290 Financing Expense (Income) Interest expense 39 24 15 Interest income2 (16) 23 (27) (3) (19) (4) Tax effect3 (9) 1 2 Net interest expense 14 (2) (2) Preferred dividends (0) (0) (0) 14 (2) (2) Comprehensive income to Common 535 416 292

1 Broken out from selling and administrative expenses in published income statement.2 Included in “other expense” in income statement. The nonrecurring charges in 1995 and 1994 relate to shutdown of certain facilities.3 Tax rate was 38.5%, 38.5% and 39.1% in 1996, 1995 and 1994, respectively.

Reebok: GAAP Income Reebok: GAAP Income StatementsStatements

Year ended December 1996 1995 1994 _________________________________________________________________________________________ Net sales $3,478,604 $3,481,450 $3,280,418 Other income 4,325 3,126 7,165 ------------------------------------------ 3,482,929 3,484,576 3,287,583 ------------------------------------------ Costs and expenses: Cost of sales 2,144,422 2,114,084 1,966,138 Selling, general and administrative 1,065,792 999,731 889,590 Special charges 72,098 Amortization of intangibles 3,410 4,067 4,345 Interest expense 42,246 25,725 16,515 Interest income (10,609) (7,103) (6,373) ------------------------------------------ 3,245,261 3,208,602 2,870,215 ------------------------------------------ Income before taxes and minority interest 237,668 275,974 417,368 Income taxes 84,083 99,753 153,994 ------------------------------------------ Income before minority interest 153,585 176,221 263,374 Minority interest 14,635 11,423 8,896 ------------------------------------------ Net income $ 138,950 $ 164,798 $ 254,478

Net income per common share $ 2.00 $ 2.07 $ 3.02

Reebok: Reformulated Reebok: Reformulated Income StatementsIncome Statements

1996 1995 1994 Operating Income Sales $3,479 $3,481 $3,280 Cost of sales 2,144 2,114 1,966 Gross margin 1,355 1,367 1,314 Operating expenses Administrative expenses $864 $842 $727 Advertising1 202 158 163 Amortization of intangibles 4 1,070 4 1,004 3 893 Operating income from sales 265 363 421 (before tax) Taxes Tax as reported 84 99 154 Tax on other operating income (2) 25 (3) Tax on financial items 11 93 7 131 4 155 Operating income from sales 172 232 266 Other operating income (expense) Other income 4 3 7 Nonrecurring charge2 ____ (72) ___ 4 (69) 7 Tax on other items (2) 25 (3) 2 (44) 4 Currency translations (6) (4) 12 (32) 12 16 Operating income 168 200 282 Financing Expense (Income) Interest expense 42 26 17 Interest income (11) 31 (7) 19 (6) 11 Tax effect3 (11) (7) (4) 20 12 7 Premium from put options _(40) 3 _____ (20) 9 7 Minority Interest 15 . 11 9 Comprehensive income to Common 173 180 266

1 Broken out from selling and administrative expenses in published income statement.2 The change in 1995 is due to consolidation and streamlining of facilities and to the sale of the Avia subsidiary.3 Tax rate was 35.4%, 36.2% and 36.9% for 1996, 1995 and 1994, respectively.

Track Nike on BYOAPTrack Nike on BYOAP

2002 2001 2000 1999 1998 1997 1996 Sales 9,893 9,489 8,995 8,777 9,553 9,187 6,471 Operating income (after tax)

644 577 557 449 410 797 549

Comprehensive income

623 549 537 430 384 777 535

Net operating assets 4,400 4,517 4,402 3,993 4,042 3,674 2,659 Net financial obligations

56 1,022 1,254 658 780 518 228

Common shareholders’ equity

3,893 3,495 3,148 3,335 3,262 3,156 2,431

Microsoft Corporation: Microsoft Corporation: GAAP Income StatementsGAAP Income Statements

Year Ended June 30 2002 2001 _________________________________________________________________________________________ Revenue $ 28,365 $ 25,296 Operating expenses: Cost of revenue 5,191 3,455 Research and development 4,307 4,379 Sales and marketing 5,407 4,885 General and administrative 1,550 857 -------------------------------------------------------- - ------ - - ------ - Total operating expenses 16,455 13,576 -------------------------------------------------------- - ------ - - ------ -

Operating income 11,910 11,720 Losses on equity investees and other (92) (159) Investment income(loss) (305) (36) -------------------------------------------------------- - ------ - - ------ - Income before income taxes 11,513 11,525 Provision for income taxes 3,684 3,804 -------------------------------------------------------- - ------ - - ------ -

Income before accounting change 7,829 7,721 Cumulative effect of accounting change (net of tax) (375) -------------------------------------------------------- - ------ - - ------ - Net income $ 7,829 $ 7,346 __________________________________________________________________________________

Microsoft Corporation: Microsoft Corporation: Reformulated Income StatementsReformulated Income Statements

Year ended June 2002 2001 Revenue $ 28,365 $ 25,296 Operating expenses:

Cost of revenue 5,191 3,455 Research and development 4,307 4,379 Sales and marketing 5,407 4,885 General and administrative 1,550 857

16,455 13,576 Operating income from sales, before tax 11,910 11,720 Tax as reported $ 3,684 $ 3,804 Tax on other operating income 872 756 Tax on financing income (758) 3,798 (743) 3,817 Operating income from sales, after tax 8,112 7,903

Investment income in income statement:1 Dividends 357 377 Realized gains on sales of investments 2,121 3,003 Permanent impairment of investments (4,323) (4,804) Unrealized losses on derivatives (480) (2,325) (592) (2,016) Tax on investment income (at 37.5%)2 872 756

(1,453) (1,260) Investment income in equity statement (after tax):

Unrealized loss on convertible debt -- (829) Gains (losses) on derivatives (91) 634 Unrealized losses on equity investments (281) (707) Total investment income (1,825) (2,162) Losses in equity subsidiaries (92) (159) Currency translation and other 82 (39) Cumulative effect of accounting change -- (450)

Total other income (1,835) (2,810) Total operating income 6,277 5,093 Net financing income

Interest income3 1,762 1,808 Realized gains on short-term investments 258 172 2,020 1,980 Tax at 37.5%4 758 743 1,262 1,237 Financing income in equity statement (after tax):

Unrealized gain on financial assets 286 76 Total financing income 1,548 1,313 Comprehensive income 7,825 6,406 1 Included in investment income is the GAAP statement; details from footnotes.

2 Losses on investments draw a tax deduction. 3 Interest income is included in investment income in the GAAP statement. 4 With net financing income, financing activities draw further taxes rather than a tax benefit.

Common Size AnalysisCommon Size Analysis

Comparison to other firms is called cross-sectional analysis

Common size analysis gives a ready comparison:

• The Income Statement

– Each item/Total revenues

• The Balance Sheet

– Operating items/Totals

– Financing items/Totals

Common Size Analysis : Nike Common Size Analysis : Nike and Reebok Income Statementsand Reebok Income Statements

Nike Reebok $ % $ % Operating income

Revenue 6,471 100.0 3,479 100.0 Cost of sales 3,907 60.4 2,144 61.6 Gross margin 2,564 39.6 1,335 38.4

Operating expenses

Administrative 977 15.1 864 24.8 Advertising 643 9.9 202 5.8 Amortization 22 0.3 4 0.1

Operating income from sales (before tax)

922 14.2 265 7.6

Tax on operating income from sales

355 5.5 93 2.7

Other operating income from sales (after tax)

567 8.8 172 4.9

Other operating income (18) (0.3) (4) (0.1) Operating income 549 8.5 168 4.8 Net financing expense (income) 14 0.2 (20) (0.6) Minority interest 15 0.4 Comprehensive income 535 8.3 173 5.0

Common Size Analysis: Nike Common Size Analysis: Nike and Reebok Balance Sheetsand Reebok Balance Sheets

Nike Reebok Operating assets

$ % $ %

Cash 27 0.7 12 0.8 Accounts renewable 1,346 36.2 591 37.7 Inventories 931 25.1 545 34.8 Prepaid expenses 94 2.5 26 1.7 Property, plant and equipment 643 17.3 185 11.8 Goodwill 328 8.8 34 2.2 Trademarks and other intangibles 210 5.7 116 7.4 Accumulated amortization (63) (1.7) (80) (5.1) Deferred taxes and other assets 200 5.4 137 8.7

3,716 100.0 1,566 100.0 Operating liabilities

Accounts payable 455 43.0 196 45.5 Accrued liabilities 480 45.4 169 39.2 Income taxes payable 79 7.5 66 15.3 Deferred taxes and other 43 4.0 -- --

1,057 100.0 431 100.0 Net financial obligations

Cash equivalents (235) (103.1) (220) (30.6) Notes payable 7 3.1 33 4.6 Current portion of long-term debt 446 195.6 53 7.4 Long-term debt 10 4.4 854 118.6 Redeemable preferred stock 0 0.0 -- --

228 100.0 720 100.0 Minority interest 34 Common stockholders’ equity 2,431 381

Trend Analysis: Nike, Inc.Trend Analysis: Nike, Inc. 2000 1999 1998 1997 1996

Base in 1995 ($ millions)

Sales 188.9 184.3 200.7 193.0 135.9 4,761 Cost of sales 188.6 191.7 211.7 192.1 136.4 2,865 Gross margin 189.4 173.2 183.9 194.3 135.2 1,896 Operating expenses 213.5 198.8 215.0 190.3 132.6 1,238 Operating income from sales (before tax)

144.1 125.0 125.6 201.7 140.2 658

Taxes 138.7 128.4 126.8 202.3 140.3 253 Operating income from sales (after tax)

147.5 122.8 124.9 201.4 140.1 405

Operating income 134.5 108.3 99.1 192.4 132.7 414 Comprehensive income 129.1 103.3 92.2 186.8 128.6 416

Balance Sheet

Accounts receivable 148.8 146.3 159.0 166.6 127.8 1,053 Inventories 229.5 185.5 221.7 212.5 147.9 630 Property, plant and equipment 285.3 228.1 207.8 166.2 115.9 555 Intangible assets 82.8 86.0 87.9 93.6 95.6 496 Deferred taxes and other assets 317.4 345.4 363.6 234.8 167.6 119 Operating assets 192.7 173.0 180.4 170.6 127.4 2,947 Accounts payable 182.5 158.9 198.6 230.6 152.7 298 Accrued liabilities 180.3 160.3 176.4 165.4 139.1 345 Other liabilities 114.9 83.1 84.6 100.0 127.7 96 Operating liabilities 172.7 149.7 172.4 183.2 143.2 739 Net operating assets 199.4 180.8 183.0 166.4 120.4 2,208 Net financial obligations 514.0 269.6 319.7 212.2 93.4 244 Common shareholders’ equity 160.3 169.8 166.1 160.7 123.8 1,964

Income Statement RatiosIncome Statement Ratios

• Revenue composition ratios– Operating Revenue Composition Ratio:

– Financial Income Composition Ratio:

• Profit margin ratios

– Operating Profit Margin:

– Sales Profit Margin:

– Other Items Profit Margin:

Income Statement Ratios Income Statement Ratios (cont.)(cont.)

• Profit Margin Ratios (cont.)

– Financial Income Contribution Ratio:

– Net Income Profit Margin

• Expense Ratios

– Expense Ratio

– 1 - Sales PM = Sum of Expense Ratios

SalesIncome FinancialNet

SalesIncomeNet iveComprehens

SalesActivityan for Expense

Balance Sheet RatiosBalance Sheet Ratios

• Composition Ratios

– Operating Asset Composition Ratio

– Operating Liability Composition Ratio

– Financial Asset Composition Ratio

– Financial Liability Composition Ratio

Assets Operating TotalAsset Operating

sLiabilitie Operating TotalLiability Operating

Assets Financial TotalAsset Financial

sObligation Financial Total

Obligation Financial

Balance Sheet Leverage RatiosBalance Sheet Leverage Ratios

• Financial Leverage Ratios:

– Capitalization Ratio:

– Financial Leverage Ratio (FLEV)

It is always the case that

Capitalization Ratio - Leverage Ratio = 1.0

• Operating Liability Leverage Ratio

Operating Liability Leverage (OLLEV) =

CSENOA

CSENFO

Assets OperatingNet sLiabilitie Operating

Growth RatiosGrowth Ratios

G r o w t h R a t e i n S a l e s = Sales sPeriod'Prior

Salesin Change

G r o w t h R a t e i n O p e r a t i n g I n c o m e = OI sPeriod'Prior

Tax)(after Income Operatingin Change

G r o w t h i n N O A = NOA Beginning

Assets OperatingNet in Change

G r o w t h i n C S E = CSE Beginning

CSEin Change

Summary Profitability Summary Profitability MeasuresMeasures

Operating Profitability:

Financing Profitability:

All measures are after tax.

1tt

t

t

NOANOA21

OIRNOA

1tt

t

t

NFONFO21

NFENBC

o r

1tt

t

t

NFANFA21

NFIRNFA

A Financial Statement Analysis A Financial Statement Analysis ProceduresProcedures

1. Reformulate the statement of stockholders’ equity on clean surplus basis (Chapter 8)

2. Calculate comprehensive rate of return on common equity, ROCE, from reformulated statement of common stockholders’ equity (Chapter 8)

3. Reformulate the balance sheet to distinguish operating and financial assets and obligations

4. Reformulate the income statement on clean surplus basis and distinguish operating and financing income

5. Compare reformulated balance sheets and income statements with reformulated statements of comparison firms and over time through a common size analysis and a trend analysis

6. Calculate balance sheet and income statement ratios

7. Carry out the analysis of ROCE: Chapter 11

8. Carry out the analysis of growth: Chapter 12