Financial Statement_Ch07


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Financial Statement_Ch07

  1. 1. Analysis of Financial Statements Requests for permission to make copies of any part of the work should be mailed to: Thomson/South-Western 5191 Natorp Blvd. Mason, OH 45040 Chapter 7
  2. 2. Financial Statements and Reports <ul><li>Annual Report </li></ul><ul><ul><li>a report issued annually by a corporation to its stockholders </li></ul></ul><ul><ul><li>management’s opinion of the past year’s operations and the firm’s future prospects </li></ul></ul>
  3. 3. Financial Statements and Reports <ul><li>Annual Report </li></ul><ul><ul><li>basic financial statements </li></ul></ul><ul><ul><ul><li>income statement </li></ul></ul></ul><ul><ul><ul><li>balance sheet </li></ul></ul></ul><ul><ul><ul><li>statement of retained earnings </li></ul></ul></ul><ul><ul><ul><li>statement of cash flows </li></ul></ul></ul>
  4. 4. Financial Statements and Reports <ul><li>Income Statement </li></ul><ul><ul><li>a statement summarizing the firm’s revenues and expenses over an accounting period, generally a quarter or a year </li></ul></ul>
  5. 5. Financial Statements and Reports <ul><li>Balance Sheet </li></ul><ul><ul><li>a statement of the firm’s financial position at a specific point in time </li></ul></ul>
  6. 6. Financial Statements and Reports <ul><li>Balance Sheet - points worth noting </li></ul><ul><ul><li>Cash versus other assets </li></ul></ul><ul><ul><li>Liabilities versus stockholders equity </li></ul></ul><ul><ul><li>Preferred versus common stock </li></ul></ul><ul><ul><li>Breakdown of common equity account </li></ul></ul><ul><ul><ul><li>common stock </li></ul></ul></ul><ul><ul><ul><li>paid in capital </li></ul></ul></ul><ul><ul><ul><li>retained earnings </li></ul></ul></ul>
  7. 7. Financial Statements and Reports <ul><li>Balance Sheet - points worth noting </li></ul><ul><ul><li>Accounting alternatives </li></ul></ul><ul><ul><ul><li>FIFO (first-in, first-out) </li></ul></ul></ul><ul><ul><ul><li>LIFO (last-in, first-out) </li></ul></ul></ul><ul><ul><ul><li>Accelerated or straight-line depreciation </li></ul></ul></ul><ul><ul><li>The time dimension </li></ul></ul><ul><ul><ul><li>balance sheet is at a point in time </li></ul></ul></ul>
  8. 8. Financial Statements and Reports <ul><li>Statement of Retained Earnings </li></ul><ul><ul><li>a statement reporting changes in the firm’s retained earnings as a result of the income generated and retained during the year </li></ul></ul><ul><ul><li>the balance sheet figure for retained earnings is the sum of the earnings retained for each year the firm has been in business </li></ul></ul>
  9. 9. Financial Statements and Reports <ul><li>Accounting income versus cash flow </li></ul><ul><ul><li>Cash Flows </li></ul></ul><ul><ul><ul><li>the cash receipts and the cash disbursements, as opposed to the revenues and expenses reported for computation of net income, generated by a firm during some specified period </li></ul></ul></ul>
  10. 10. Financial Statements and Reports <ul><li>Accounting income versus cash flow </li></ul><ul><ul><li>Accounting profit </li></ul></ul><ul><ul><ul><li>a firm’s net income as reported on its income statement </li></ul></ul></ul><ul><ul><li>Operating cash flows </li></ul></ul><ul><ul><ul><li>those cash flows that arise from normal operations </li></ul></ul></ul><ul><ul><ul><li>the difference between cash collections and cash expenses </li></ul></ul></ul>
  11. 11. <ul><li>Statement of cash flows </li></ul><ul><ul><li>a statement reporting the impact of a firm’s operating, investing, and financing activities on cash flows over an accounting period </li></ul></ul>Financial Statements and Reports
  12. 12. Financial Statements and Reports <ul><li>Statement of cash flows </li></ul><ul><ul><li>sources of cash </li></ul></ul><ul><ul><ul><li>increase in liability or equity account </li></ul></ul></ul><ul><ul><ul><li>decrease in an asset account </li></ul></ul></ul><ul><ul><li>uses of cash </li></ul></ul><ul><ul><ul><li>decrease in a liability or equity account </li></ul></ul></ul><ul><ul><ul><li>increase in an asset account </li></ul></ul></ul>
  13. 13. Argile Textiles: Cash Sources & Uses 2007
  14. 14. Argile Textiles: Statement of Cash Flows ( for the period ending Dec. 31, 2007)
  15. 15. Ratio Analysis <ul><li>Liquid asset </li></ul><ul><ul><li>an asset that can be easily converted into cash without significant loss of its original value </li></ul></ul><ul><li>Liquidity ratios </li></ul><ul><ul><li>ratios that relates the firm’s cash and other assets to its current liabilities </li></ul></ul>
  16. 16. <ul><li>Current ratio </li></ul><ul><ul><li>indicates the extent to which current liabilities are covered by assets expected to be converted into cash in the near future </li></ul></ul>Ratio Analysis
  17. 17. <ul><li>Quick (acid test) Ratio </li></ul><ul><ul><li>deducts inventories from current assets and divides the remainder by current liabilities </li></ul></ul><ul><ul><li>a variation of the current ratio </li></ul></ul>Ratio Analysis
  18. 18. Ratio Analysis <ul><li>Asset management ratios </li></ul><ul><ul><li>ratios that measure how effectively a firm is managing its assets </li></ul></ul>
  19. 19. <ul><li>Inventory Turnover Ratio </li></ul>Ratio Analysis
  20. 20. <ul><li>Days Sales Outstanding (DSO) </li></ul>Ratio Analysis
  21. 21. Ratio Analysis <ul><li>Fixed Assets Turnover Ratio </li></ul>
  22. 22. Ratio Analysis <ul><li>Total Assets Turnover Ratio </li></ul>
  23. 23. Ratio Analysis <ul><li>Debt management ratios </li></ul><ul><ul><li>analyze the company’s use of debt </li></ul></ul><ul><li>Financial leverage </li></ul><ul><ul><li>the use of debt financing </li></ul></ul>
  24. 24. Ratio Analysis <ul><li>Debt ratio </li></ul>
  25. 25. Ratio Analysis <ul><li>Times-Interest-Earned (TIE) Ratio </li></ul>
  26. 26. Ratio Analysis <ul><li>Fixed Charge Coverage Ratio </li></ul>
  27. 27. Ratio Analysis <ul><li>Profitability ratios </li></ul><ul><ul><li>ratios showing the effect of liquidity, asset management, and debt management on operating results </li></ul></ul>
  28. 28. Ratio Analysis <ul><li>Net profit margin on sales </li></ul>
  29. 29. Ratio Analysis <ul><li>Return on Total Assets (ROA) </li></ul>
  30. 30. Ratio Analysis <ul><li>Return On common Equity (ROE) </li></ul>
  31. 31. Ratio Analysis <ul><li>Market Value Ratios </li></ul><ul><ul><li>ratios that relate the firm’s stock price to its earnings and book value per share </li></ul></ul>
  32. 32. Ratio Analysis <ul><li>Earnings per share (EPS) </li></ul>
  33. 33. Ratio Analysis <ul><li>Price/Earnings (P/E) Ratio </li></ul>
  34. 34. Ratio Analysis <ul><li>Book value per share </li></ul>
  35. 35. Ratio Analysis <ul><li>Market/Book (M/B) Ratio </li></ul>
  36. 36. Ratio Analysis <ul><li>Trend analysis </li></ul><ul><ul><li>an analysis of a firm’s financial ratios over time </li></ul></ul><ul><ul><li>used to determine improvement or deterioration in its financial situation </li></ul></ul>
  37. 37. Ratio Analysis <ul><li>Summary of ratio analysis: The Du Pont Chart </li></ul><ul><ul><li>a chart designed to show the relationships among return on investment, asset turnover, the profit margin, and leverage </li></ul></ul>
  38. 38. Ratio Analysis <ul><li>Du Pont Equation </li></ul>
  39. 39. Ratio Analysis <ul><li>Comparative ratio analysis </li></ul><ul><ul><li>an analysis based on a comparison of a firm’s ratios with those of other firms in the same industry </li></ul></ul>
  40. 40. Uses and Limitations of Ratio Analysis <ul><li>Large firms operate divisions in different industries </li></ul><ul><ul><li>difficult to develop meaningful industry averages </li></ul></ul><ul><li>If the goal is to be better than average, industry averages are not the target </li></ul><ul><ul><li>focus on the industry leaders’ ratios </li></ul></ul>
  41. 41. Uses and Limitations of Ratio Analysis <ul><li>Inflation distorts balance sheets </li></ul><ul><ul><li>depreciation and inventory costs affect income statements </li></ul></ul><ul><ul><li>comparative analysis of firm over time </li></ul></ul><ul><ul><li>comparing firms of different ages </li></ul></ul>
  42. 42. Uses and Limitations of Ratio Analysis <ul><li>Seasonal factors distort ratios </li></ul><ul><ul><li>use monthly averages as base for inventory and receivables instead of one particular month </li></ul></ul><ul><li>Window dressing techniques </li></ul><ul><ul><li>make financial statements appear better than they actually are </li></ul></ul><ul><ul><li>borrowing “long-term” to be repaid quickly distorts liquidity ratios </li></ul></ul>
  43. 43. Uses and Limitations of Ratio Analysis <ul><li>Different accounting practices </li></ul><ul><ul><li>distorts comparisons </li></ul></ul><ul><ul><li>inventory valuation </li></ul></ul><ul><ul><li>depreciation methods </li></ul></ul>
  44. 44. Uses and Limitations of Ratio Analysis <ul><li>Difficult to generalize about “good” or “bad” ratios </li></ul><ul><ul><li>high current ratio can indicate strong liquidity or excessive cash </li></ul></ul><ul><ul><li>high fixed assets turnover can indicate efficient use or undercapitalized </li></ul></ul>
  45. 45. Uses and Limitations of Ratio Analysis <ul><li>Firm may have some “good” ratios and others that look “bad” </li></ul><ul><ul><li>difficult to tell whether overall the company is strong or weak </li></ul></ul><ul><ul><li>statistical procedures can analyze the net effects of a set of ratios </li></ul></ul>
  46. 46. End of Chapter 7 <ul><li>Analysis of Financial Statements </li></ul>