FINANCIAL STATEMENTS

Financial Health of FirmFirms produce good and services by using

assets Financial condition of firm’s AssetsFinancing of these assetsShareholder 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 ItemsAssets and LiabilitiesItems turning into cash in less than one

year current Assets and LiabilitiesListed 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 ItemLong Term Assets

Tangible Fixed Assets: Land, Factories, …Intangibles: Goodwill

Long Term LiabilitiesLong term debtRetained EarningsShareholder equity

Current Assets – Current Liabilities = Working Capital

Retained earning is an item to ensureTotal Assets = Total Liabilities

Income Statement Sales Revenue

- Cost of Goods SoldGross Margin or Gross Profit

- Operating ExpensesOperating Revenue before Depreciation = Earnings Before Interest Tax Depreciation and

Amortization = EBITDA- Depreciation Earnings Before Interest and Taxes = EBIT - Interest ExpenseEarnings before Taxes- Income Tax ExpensesNet Income = Profit

Statement of Cash FlowCash is life blood of companyCompany might be profitable on accrual

basis but go bankrupt

CompanyG & S

$

Taxes

Operating expenses

Dividend

$Inventory

Investment

$Borrowings

Capital Stock

Investment

Service Debt

Statement of Cash FlowCash Receipts

From customers for selling goods & servicesFrom borrowing From issuing new capital stocks

Cash DisbursementsFor purchasing inventory that are or will be soldFor Interest and principal payment of debtFor Income TaxesFor Investment in machinery, improvements, ..For dividend payments to stock holders

Three statements are interlocked

Cash Flow from Operating Activities

Net Income Change in Accounts ReceivableChange in InventoryChange in Prepaid expensesChange in Accounts payableChange in Accrued expensesChange in Income Tax

Operating Cash Flow Before DepreciationDepreciation

Cash Flow From Profit-Making Activities

Cash Flow from non-Operating Activities

Cash Flow From Investing ActivitiesPurchase of Plant, Properties &

Equipments

Cash Flow From Financing ActivitiesChange in short term debtLong term BorrowingsCapital Stock IssueCash Dividends to Stock Holders

Interlocking Nature of StatementsCash Flow From Profit-Making ActivitiesCash Flow From Investing ActivitiesCash Flow From Financing ActivitiesNet Change in Cash During YearProfitability Cannot be Measured by Cash Flow

OnlyHow to compare Financial Statements of

companies of different sizes?Common-Size Income Statement all quantities as a %

of SalesCommon-Size Balance Sheet all quantities as a % of

Total Assets

DuPont ModelA main metric of performance is ROE = Net

Income/EquityTo better analyze factors affecting ROE it is

decomposed into a series of ratiosEach ratio component is meaningful and

sheds light on the company and its performance and capital structure

This decomposition is called DuPont SystemROE = (Net Income/Pretax Profit) * (Pretax

Profit/EBIT) *(EBIT/Sales)*(Sales/Assets)*(Assets/Equity)

Interpretation of DuPont ModelNet 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 CycleOperating Cycle =

Inventory Period + Accounts Receivable period =

Accounts Payable Period + Cash CycleInventory Turnover = Cost of Goods Sold/Average

InventoryInventory Period = 365/ Inventory Turnover Receivable Turnover = Credit Sales/Average Accounts

ReceivableReceivable Period = 365/ Receivable Turnover

Cash CyclePayables Turnover Cost of Goods Sold/Average

PayablesPayables Period = 365/ Payables

Turnover Cash Cycle =

Operating Cycle – Accounts Payable Period

Solvency and Liquidity MeasuresShort Term:Current Ratio = Current Assets/Current LiabilitiesQuick Ratio = (Current Assets – Inventory)/Current

Liabilities Cost of Goods Sold/Average PayablesCash Ratio = Cash/Current LiabilitiesLong Term:Long-term Debt Ratio = Long-Term Debt/ (Long-Term Debt

+Equity )

Solvency and Liquidity MeasuresLong Term:Long-term Debt Ratio = Long-Term Debt/ (Long-Term

Debt +Equity ) Times Interest Earned Ratio =

EBIT/InterestCash Coverage= ( EBIT+

Depreciation)/Interest