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Financial Statements,  Cash Flows, and Taxes Fin 200
Balance Sheet <ul><li>Pont in time summary of: </li></ul><ul><ul><li>What is owned by the firm, </li></ul></ul><ul><ul><li...
Balance Sheet <ul><li>Assets </li></ul><ul><li>Current Assets </li></ul><ul><li>Life < 1yr </li></ul><ul><li>Fixed Assets ...
Net Working Capital <ul><li>NWC = Current Assets – Current Liabilities </li></ul><ul><li>Cash to be received is greater th...
Who uses the Balance sheet? <ul><li>Creditors look at liquidity and financial leverage </li></ul><ul><li>Internal managers...
Market vs. Book Value <ul><li>The balance sheet presents the  Book Value  of the firm based on GAAP principles,  Market Va...
Income Statement <ul><li>Measure of the firms performance over a given period of time. </li></ul><ul><li>Based on the basi...
Basic Income Statement <ul><li>Revenues </li></ul><ul><li>-Operating Costs </li></ul><ul><li>Earnings B-4 Interest Taxes D...
EPS <ul><li>Net income is often expressed as Earnings Per Share (EPS) </li></ul><ul><li>Net Income  </li></ul><ul><li>Tota...
Note: <ul><li>Revenues are recorded at the time of sale as are expenses </li></ul><ul><li>Both short term costs and long t...
Cash Flow vs. Accounting Earnings <ul><li>GAAP is based on accrual accounting </li></ul><ul><ul><li>Revenues are realized ...
Cash Flow <ul><li>Cash Flow represents the movement of actual cash </li></ul><ul><li>Simple definition </li></ul><ul><ul><...
Why Cash Flows? <ul><li>Cash represents the ability of the firm to operate (you can’t spend earnings) </li></ul><ul><li>Ac...
Cash Flow Identity <ul><li>CF to Creditors = Interest Paid-Net new borrowing </li></ul><ul><li>CF to Stockholders = Divide...
Cash Flow From Assets <ul><li>Three Components </li></ul><ul><ul><li>Operating Activities   - Net income, depreciation, ch...
Cash Flow Statement <ul><li>Net Income Before Dividends </li></ul><ul><li>+ Sources of Cash (additions of cash) </li></ul>...
A closer look at Cash Flows <ul><li>Sources of Cash </li></ul><ul><ul><li>Activities by a firm that generate cash </li></u...
Sources of Cash <ul><li>Increases on the RHS of Balance sheet </li></ul><ul><ul><li>Increase in Accounts payable </li></ul...
Uses of Cash <ul><li>Decreases on the RHS of Balance sheet </li></ul><ul><ul><li>Decrease in Notes payable </li></ul></ul>...
Net Cash Flow <ul><li>Net Cash Flow represents the actual net amount of cash a firm generates during a specified period. <...
Operating Cash Flow <ul><li>Cash Flow that results from daily activities </li></ul><ul><li>Op CF = EBIT – Taxes + (Deprec....
NOPAT <ul><li>Net Operating Profit After Taxes (NOPAT) can be thought of as the amount of operating profit a company would...
Operating Cash Flow vs. NOPAT <ul><li>Operating Cash flow is based off of the Net Operating profit after taxes (NOPAT). </...
Operating CF and NOPAT calculations.  <ul><li>Previously we defined Operating Cash flow as: </li></ul><ul><li>Op CF = EBIT...
Capital Spending <ul><li>Net Capital Spending is the amount spent on fixed assets minus the amount of money received from ...
Standardizing Financial  Statements <ul><li>Comparing across Firms and in one firm across years is often difficult.  There...
Common Size <ul><li>Balance Sheet </li></ul><ul><ul><li>Usually Presented as a % of assets </li></ul></ul><ul><li>Income S...
Example <ul><li>Current Assets 1999 2000 </li></ul><ul><li>Cash 230 250 </li></ul><ul><li>Accounts Receivable 340 370 </li...
Example <ul><li>Current Assets 2001 % of Assets </li></ul><ul><li>Cash 230 </li></ul><ul><li>Accounts Receivable 340 </li>...
Example <ul><li>Current Assets 1999 2000 1999 2000 </li></ul><ul><li>Cash   230 230 .116 .107 </li></ul><ul><li>Accounts R...
Common Base Year <ul><li>You want to set all changes relative to a base year. </li></ul><ul><li>For each entry you divide ...
Example 2 <ul><li>Current Assets 1999 2000   2000 Base Year </li></ul><ul><li>Cash   230 230 </li></ul><ul><li>Accounts Re...
Combined Common  Size and Base Year <ul><li>Find the common size balance sheet first, as assets grow so will most entries....
Example <ul><li>Com Size BseYr   Comb </li></ul><ul><li>CurrAssets 1999 2000 1999 2000 2000 </li></ul><ul><li>Cash   230 2...
Tax Terms <ul><li>Average Tax Rate  </li></ul><ul><ul><li>Your tax bill divided by your taxable income (the percentage of ...
Ratio Analysis <ul><li>Designed to allow comparison across firms </li></ul><ul><li>Each Ratio addresses specific questions...
Basic Questions <ul><li>How is it computed? </li></ul><ul><li>What is it intended to Measure? </li></ul><ul><li>What is th...
Liquidity Ratios <ul><li>Measure the ability of the firm to meet its short term obligations. </li></ul><ul><li>Also termed...
Current Ratio <ul><li>Generally, the higher the current ratio the better. </li></ul><ul><li>Is it possible that an extreme...
Quick Ratio <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Inventory is less liquid than cash </li>...
Cash Ratio <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>More important to very short term credito...
NWC to Total Assets <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Measure of liquidity </li></ul>
Interval Measure <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Measures the number of days the fir...
Long Term Solvency <ul><li>Also considered leverage ratios </li></ul><ul><li>Measure the level of indebtedness and the abi...
Total Debt Ratio <ul><li>Takes into account all debt of all maturities </li></ul><ul><li>Measures the percentage of debt f...
Equity Multiplier <ul><li>Equity Multiplier, Debt Equity and Total Debt all report the same thing – given one you can calc...
Long Term Debt Ratio <ul><li>Denominator is the total capitalization </li></ul><ul><li>Short term changes quickly this is ...
Times Interest Earned <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Measures how many times the fi...
Cash Coverage <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Measures how many times the firm can c...
Asset Management <ul><li>Intended to describe how intensively a firm uses its assets to generate sales </li></ul>
Inventory Turnover <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>The number of times the firsm tur...
Days Sales in Inventories <ul><li>Represents how many days inventory sits on the self prior to being sold. </li></ul>
Receivables Turnover <ul><li>Number of times the firm collects its credit accounts and reloaned the money </li></ul>
Days’ Sales in Receivables <ul><li>Also called average collection period </li></ul><ul><li>Represents how long it takes th...
Asset Turnover Ratios
Profitability Measures <ul><li>Most widely used ratios </li></ul><ul><li>Focus is Net Income </li></ul><ul><li>Measure the...
Profit Margin <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Measures the amount in profit that is ...
Return on Assets <ul><li>Measures the profit per dollar of assets </li></ul><ul><li>Also called return on investment </li>...
Return on Equity <ul><li>Measures how the shareholders did over the course of the data </li></ul><ul><li>Both ROA and ROE ...
Market Value Measures
Dupont Identity
 
Decomposition <ul><li>The Dupont Identity breaks the ROE into three parts </li></ul><ul><ul><li>Operating Efficiency (Prof...
Why Evaluate Financial Statements <ul><li>Internal Uses </li></ul><ul><ul><li>Compare across divisions </li></ul></ul><ul>...
Choose a Benchmark <ul><li>Time Trend Analysis </li></ul><ul><ul><li>What has happened over the last 5 or 10 years? </li><...
Problems <ul><li>No theory relating to choice of benchmarks or which ratios are important </li></ul><ul><li>Consolidated F...
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Financial Statements

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Transcript of "Financial Statements"

  1. 1. Financial Statements, Cash Flows, and Taxes Fin 200
  2. 2. Balance Sheet <ul><li>Pont in time summary of: </li></ul><ul><ul><li>What is owned by the firm, </li></ul></ul><ul><ul><li>What is owed by the firm </li></ul></ul><ul><ul><li>Equity of the firm </li></ul></ul><ul><li>Basic idea: </li></ul><ul><ul><li>Assets = Liabilities + Shareholder Equity </li></ul></ul>
  3. 3. Balance Sheet <ul><li>Assets </li></ul><ul><li>Current Assets </li></ul><ul><li>Life < 1yr </li></ul><ul><li>Fixed Assets </li></ul><ul><li>Life > 1 yr </li></ul><ul><li>Liabilities and Equity </li></ul><ul><li>Current Liabilities </li></ul><ul><li>Life <1yr </li></ul><ul><li>Long Term Debt </li></ul><ul><li>Life > 1yr </li></ul><ul><li>Shareholder Equity </li></ul><ul><li>Assets – Liabilities </li></ul>
  4. 4. Net Working Capital <ul><li>NWC = Current Assets – Current Liabilities </li></ul><ul><li>Cash to be received is greater than the cash to be paid out. </li></ul>
  5. 5. Who uses the Balance sheet? <ul><li>Creditors look at liquidity and financial leverage </li></ul><ul><li>Internal managers track inventory and cash on hand. </li></ul><ul><li>Does the Balance sheet provide a good measure of the value of the firm? </li></ul>
  6. 6. Market vs. Book Value <ul><li>The balance sheet presents the Book Value of the firm based on GAAP principles, Market Value is different </li></ul><ul><li>Are there other things that do not show up on the Balance Sheet that add value to the firm? </li></ul>
  7. 7. Income Statement <ul><li>Measure of the firms performance over a given period of time. </li></ul><ul><li>Based on the basic idea that </li></ul><ul><li>Revenues - Expenses = Income. </li></ul><ul><li>Provides a report on operations over a period of time, not a point in time like the Balance Sheet. </li></ul>
  8. 8. Basic Income Statement <ul><li>Revenues </li></ul><ul><li>-Operating Costs </li></ul><ul><li>Earnings B-4 Interest Taxes Deprec. & Amort. (EBITDA) </li></ul><ul><li>-Depreciation and Amoritzation </li></ul><ul><li>Earnings Before Interest and Taxes (EBIT) </li></ul><ul><li>-Interest Payments </li></ul><ul><li>Taxable Income </li></ul><ul><li>-Taxes </li></ul><ul><li>Net Income </li></ul>
  9. 9. EPS <ul><li>Net income is often expressed as Earnings Per Share (EPS) </li></ul><ul><li>Net Income </li></ul><ul><li>Total Shares Outstanding </li></ul>
  10. 10. Note: <ul><li>Revenues are recorded at the time of sale as are expenses </li></ul><ul><li>Both short term costs and long term costs are included on the income statement. </li></ul><ul><li>Net Income does not equal cash flow </li></ul>
  11. 11. Cash Flow vs. Accounting Earnings <ul><li>GAAP is based on accrual accounting </li></ul><ul><ul><li>Revenues are realized at the time of the sale, not when cash is received (Expenses are realized at the time acquired, not when paid for </li></ul></ul><ul><ul><li>Operating Expenditures </li></ul></ul><ul><ul><li>Produce benefits only in the current period </li></ul></ul><ul><li>Capital Expenditures </li></ul><ul><ul><li>produce benefits over multiple periods </li></ul></ul><ul><li>Non - Cash Charges (depreciation etc) </li></ul><ul><ul><li>Reduce accounting income, but cash exists </li></ul></ul>
  12. 12. Cash Flow <ul><li>Cash Flow represents the movement of actual cash </li></ul><ul><li>Simple definition </li></ul><ul><ul><li>The amount of cash flowing into the firm minus the amount of cash flowing out of the firm. </li></ul></ul>
  13. 13. Why Cash Flows? <ul><li>Cash represents the ability of the firm to operate (you can’t spend earnings) </li></ul><ul><li>Accounting earnings are often manipulated to impress shareholders. </li></ul>
  14. 14. Cash Flow Identity <ul><li>CF to Creditors = Interest Paid-Net new borrowing </li></ul><ul><li>CF to Stockholders = Dividends Paid –Net New Equity </li></ul>
  15. 15. Cash Flow From Assets <ul><li>Three Components </li></ul><ul><ul><li>Operating Activities - Net income, depreciation, changes in net working capital other than cash and short term debt </li></ul></ul><ul><ul><li>Investing Activities - Investment in or sale of fixed assets </li></ul></ul><ul><ul><li>Financing Activities – cash raised from ST debt, LT debt and stock, Cash distributed to shareholders, buy backs of outstanding stock and bonds. </li></ul></ul>
  16. 16. Cash Flow Statement <ul><li>Net Income Before Dividends </li></ul><ul><li>+ Sources of Cash (additions of cash) </li></ul><ul><li>- Uses of Cash (subtractions of cash) </li></ul><ul><li>Net Cash Provided by operating activities </li></ul><ul><li>- Cash Used to Acquire Fixed Assets (including Dep) </li></ul><ul><li>+ Increase in notes payable </li></ul><ul><li>+ Increase in bonds </li></ul><ul><li>- Payment of common and pref. Dividends </li></ul><ul><li>Net Cash from Financing Activities </li></ul><ul><li>-Net decrease in cash and marketable securities </li></ul><ul><li>+Cash and Securities at beginning of year </li></ul><ul><li>Cash and Securities at the end of the year. </li></ul>Operating Activities Invest Financing Activities
  17. 17. A closer look at Cash Flows <ul><li>Sources of Cash </li></ul><ul><ul><li>Activities by a firm that generate cash </li></ul></ul><ul><li>Uses of Cash </li></ul><ul><ul><li>Activities by a firm that spends cash </li></ul></ul>
  18. 18. Sources of Cash <ul><li>Increases on the RHS of Balance sheet </li></ul><ul><ul><li>Increase in Accounts payable </li></ul></ul><ul><ul><li>Increase in Common Stock </li></ul></ul><ul><ul><li>Increase in Retained Earnings </li></ul></ul><ul><li>Decreases on the LHS of the balance sheet </li></ul><ul><ul><li>Decrease in Current or Fixed Assets </li></ul></ul><ul><ul><li>Decrease in Accounts Receivable </li></ul></ul><ul><ul><li>Decrease in Inventory </li></ul></ul><ul><li>Depreciation and Amortization </li></ul>
  19. 19. Uses of Cash <ul><li>Decreases on the RHS of Balance sheet </li></ul><ul><ul><li>Decrease in Notes payable </li></ul></ul><ul><ul><li>Decrease in Long Term Debt </li></ul></ul><ul><li>Increases on the LHS of the balance sheet </li></ul><ul><ul><li>Increases in Current or Fixed Assets </li></ul></ul><ul><ul><li>Increases in Accounts Receivable </li></ul></ul><ul><ul><li>Increases in Inventory </li></ul></ul>
  20. 20. Net Cash Flow <ul><li>Net Cash Flow represents the actual net amount of cash a firm generates during a specified period. </li></ul><ul><li>Primary noncash items are depreciation and amortization, so net cash flow can be approximated: </li></ul>
  21. 21. Operating Cash Flow <ul><li>Cash Flow that results from daily activities </li></ul><ul><li>Op CF = EBIT – Taxes + (Deprec. and Amort.) </li></ul><ul><li>Note: In accounting circles Interest expense is often included in the calculation of Op CF. In Finance we assume that interest is a financing expense and do not include it. </li></ul>
  22. 22. NOPAT <ul><li>Net Operating Profit After Taxes (NOPAT) can be thought of as the amount of operating profit a company would have if it had no debt and held no nonoperating assets. </li></ul><ul><li>NOPAT = EBIT(1-Tax rate) </li></ul><ul><li> = EBIT – EBIT(Tax Rate) </li></ul><ul><li> = EBIT – Taxes </li></ul>
  23. 23. Operating Cash Flow vs. NOPAT <ul><li>Operating Cash flow is based off of the Net Operating profit after taxes (NOPAT). </li></ul><ul><li>If two firms had identical operations, but different debt, there performance for the period would be the same but they would have different net income. </li></ul><ul><li>NOPAT attempts to measure the true performance of operations. </li></ul>
  24. 24. Operating CF and NOPAT calculations. <ul><li>Previously we defined Operating Cash flow as: </li></ul><ul><li>Op CF = EBIT – Taxes + (Deprec. and Amort.) </li></ul><ul><li>Previously we defined NOPAT as </li></ul><ul><li>NOPAT = EBIT(1-Tax rate) = EBIT – Taxes </li></ul><ul><li>Combining the two it is easy to see that: </li></ul>
  25. 25. Capital Spending <ul><li>Net Capital Spending is the amount spent on fixed assets minus the amount of money received from the sale of fixed assets. </li></ul>
  26. 26. Standardizing Financial Statements <ul><li>Comparing across Firms and in one firm across years is often difficult. Therefore it is often convenient to standardize financial statements </li></ul><ul><li>Common Size Financial Statements </li></ul><ul><li>Common Base Year </li></ul><ul><li>Common Size and Year </li></ul>
  27. 27. Common Size <ul><li>Balance Sheet </li></ul><ul><ul><li>Usually Presented as a % of assets </li></ul></ul><ul><li>Income Statement </li></ul><ul><ul><li>Presented as a % of sales </li></ul></ul><ul><li>Cash Flow Statement </li></ul><ul><ul><li>No Convention </li></ul></ul>
  28. 28. Example <ul><li>Current Assets 1999 2000 </li></ul><ul><li>Cash 230 250 </li></ul><ul><li>Accounts Receivable 340 370 </li></ul><ul><li>Inventory 400 410 </li></ul><ul><li>Fixed Assets </li></ul><ul><li>Net Plant and Equip 1,000 1100 </li></ul><ul><li>Total Assets 1970 2130 </li></ul>
  29. 29. Example <ul><li>Current Assets 2001 % of Assets </li></ul><ul><li>Cash 230 </li></ul><ul><li>Accounts Receivable 340 </li></ul><ul><li>Inventory 400 </li></ul><ul><li>Fixed Assets </li></ul><ul><li>Net Plant and Equip 1,000 </li></ul><ul><li>Total Assets 1970 </li></ul>230/1970 = .116 340/1970 =.173 400/1970 = .203 1,000/1970 = .508 1.00
  30. 30. Example <ul><li>Current Assets 1999 2000 1999 2000 </li></ul><ul><li>Cash 230 230 .116 .107 </li></ul><ul><li>Accounts Rec 340 390 .173 .183 </li></ul><ul><li>Inventory 400 410 .203 .192 </li></ul><ul><li>Fixed Assets </li></ul><ul><li>Net Plant & Eq 1,000 1,100 .508 .516 </li></ul><ul><li>Total Assets 1,970 2130 1.00 1.00 </li></ul>
  31. 31. Common Base Year <ul><li>You want to set all changes relative to a base year. </li></ul><ul><li>For each entry you divide the entry for that year by the corresponding entry for the base year. </li></ul><ul><li>This allows you to look for trends over time. </li></ul>
  32. 32. Example 2 <ul><li>Current Assets 1999 2000 2000 Base Year </li></ul><ul><li>Cash 230 230 </li></ul><ul><li>Accounts Rec 340 390 </li></ul><ul><li>Inventory 400 410 </li></ul><ul><li>Fixed Assets </li></ul><ul><li>Net Plant & Eq 1,000 1,100 </li></ul><ul><li>Total Assets 1,970 2130 </li></ul>230/230=1.0 390/340=1.14 410/400 =1.025 1100/1000=1.1 2130/1970=1.08
  33. 33. Combined Common Size and Base Year <ul><li>Find the common size balance sheet first, as assets grow so will most entries. </li></ul><ul><li>Then calculate base year. </li></ul>
  34. 34. Example <ul><li>Com Size BseYr Comb </li></ul><ul><li>CurrAssets 1999 2000 1999 2000 2000 </li></ul><ul><li>Cash 230 230 .116 .107 1.0 </li></ul><ul><li>Accts Rec 340 390 .173 .183 1.14 </li></ul><ul><li>Inventory 400 410 .203 .192 1.025 </li></ul><ul><li>Fixed Assets </li></ul><ul><li>Net P& E 1,000 1,100 .508 .516 1.10 </li></ul><ul><li>Total Assets 1,970 2130 1.00 1.00 1.08 </li></ul>.922 1.058 .946 1.016 1.000
  35. 35. Tax Terms <ul><li>Average Tax Rate </li></ul><ul><ul><li>Your tax bill divided by your taxable income (the percentage of taxable income you pay in taxes) </li></ul></ul><ul><li>Marginal Tax Rate </li></ul><ul><ul><li>The tax rate you would pay on an additional dollar of income </li></ul></ul>
  36. 36. Ratio Analysis <ul><li>Designed to allow comparison across firms </li></ul><ul><li>Each Ratio addresses specific questions about the firms financial position.Basic idea: </li></ul>
  37. 37. Basic Questions <ul><li>How is it computed? </li></ul><ul><li>What is it intended to Measure? </li></ul><ul><li>What is the unit of measurement? </li></ul><ul><li>What does a high or low value tell us? </li></ul><ul><li>Are there problems using it? </li></ul><ul><li>Could it be improved? </li></ul>
  38. 38. Liquidity Ratios <ul><li>Measure the ability of the firm to meet its short term obligations. </li></ul><ul><li>Also termed short term solvency ratios </li></ul><ul><li>Of interest to short term creditors </li></ul><ul><li>Focus on current assets and current liabilities </li></ul>
  39. 39. Current Ratio <ul><li>Generally, the higher the current ratio the better. </li></ul><ul><li>Is it possible that an extremely high ratio may be bad? Can a low ratio be good? </li></ul><ul><li>Do you see any problems? </li></ul>
  40. 40. Quick Ratio <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Inventory is less liquid than cash </li></ul><ul><li>Manpower Wal Mart Current Ratio 1.68 1.34 </li></ul><ul><li>Quick Ratio 1.68 0.20 </li></ul>
  41. 41. Cash Ratio <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>More important to very short term creditor </li></ul>
  42. 42. NWC to Total Assets <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Measure of liquidity </li></ul>
  43. 43. Interval Measure <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Measures the number of days the firm could survive if it was not receiving any cash </li></ul>
  44. 44. Long Term Solvency <ul><li>Also considered leverage ratios </li></ul><ul><li>Measure the level of indebtedness and the ability to service debt </li></ul>
  45. 45. Total Debt Ratio <ul><li>Takes into account all debt of all maturities </li></ul><ul><li>Measures the percentage of debt for each dollar in assetsn, </li></ul><ul><li>There is (1-total debt ratio) dollars in equity for every dollar in assets </li></ul>
  46. 46. Equity Multiplier <ul><li>Equity Multiplier, Debt Equity and Total Debt all report the same thing – given one you can calculate the other two. </li></ul>
  47. 47. Long Term Debt Ratio <ul><li>Denominator is the total capitalization </li></ul><ul><li>Short term changes quickly this is more stable </li></ul>
  48. 48. Times Interest Earned <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Measures how many times the firm can cover its interest expense </li></ul><ul><li>Is this a good measure of Cash availabe to spend? </li></ul>
  49. 49. Cash Coverage <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Measures how many times the firm can cover its interest expense </li></ul><ul><li>Numerator measures the firms ability to generate income from operations </li></ul>
  50. 50. Asset Management <ul><li>Intended to describe how intensively a firm uses its assets to generate sales </li></ul>
  51. 51. Inventory Turnover <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>The number of times the firsm turns over its inventory </li></ul>
  52. 52. Days Sales in Inventories <ul><li>Represents how many days inventory sits on the self prior to being sold. </li></ul>
  53. 53. Receivables Turnover <ul><li>Number of times the firm collects its credit accounts and reloaned the money </li></ul>
  54. 54. Days’ Sales in Receivables <ul><li>Also called average collection period </li></ul><ul><li>Represents how long it takes the firm on average to collect on its payables </li></ul>
  55. 55. Asset Turnover Ratios
  56. 56. Profitability Measures <ul><li>Most widely used ratios </li></ul><ul><li>Focus is Net Income </li></ul><ul><li>Measure the ability of the firm to control expenses generated in order to make sales </li></ul>
  57. 57. Profit Margin <ul><li>Generally, the higher the ratio the better. </li></ul><ul><li>Measures the amount in profit that is generated for each dollar of income </li></ul><ul><li>Can profit Margin decrease and total profit increase? </li></ul>
  58. 58. Return on Assets <ul><li>Measures the profit per dollar of assets </li></ul><ul><li>Also called return on investment </li></ul>
  59. 59. Return on Equity <ul><li>Measures how the shareholders did over the course of the data </li></ul><ul><li>Both ROA and ROE are accounting returns </li></ul>
  60. 60. Market Value Measures
  61. 61. Dupont Identity
  62. 63. Decomposition <ul><li>The Dupont Identity breaks the ROE into three parts </li></ul><ul><ul><li>Operating Efficiency (Profit Margin) </li></ul></ul><ul><ul><li>Asset Use Efficiency (Total Asset Turnover) </li></ul></ul><ul><ul><li>Financial Leverage (Equity Multiplier) </li></ul></ul>
  63. 64. Why Evaluate Financial Statements <ul><li>Internal Uses </li></ul><ul><ul><li>Compare across divisions </li></ul></ul><ul><ul><li>Compensation </li></ul></ul><ul><li>External Uses </li></ul><ul><ul><li>Suppliers and Credit </li></ul></ul><ul><ul><li>Evaluate Competition </li></ul></ul><ul><ul><li>M&A </li></ul></ul>
  64. 65. Choose a Benchmark <ul><li>Time Trend Analysis </li></ul><ul><ul><li>What has happened over the last 5 or 10 years? </li></ul></ul><ul><li>Peer Group Analysis </li></ul><ul><ul><li>SIC Codes </li></ul></ul><ul><ul><li>Industry Averages </li></ul></ul>
  65. 66. Problems <ul><li>No theory relating to choice of benchmarks or which ratios are important </li></ul><ul><li>Consolidated Firms </li></ul><ul><li>Global Accounting Standards </li></ul>
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