Lecture 1/28/16 and 2/02/16 for chapters 3+4 3 Evaluation methods for working with financial statements. The first is RATIO ANALYSIS.  This helps you evaluate the financial performance of a company. Chapter 3+4 are combined. You try to answer one main question: How ratio  analysis is used to evaluate the financial performance of a company. In order to do ratio analysis you need data, and the data comes from financial  statements. The two main statements that we used to calculate the ratio: balance  sheet and income statement. 3 & 4 chapters are accounting review. He imported info  that reminds us of those two statements. All we need to study is this power point.  Review of balance sheet: How finance people read balance sheet is a bit different because it fits our needs. Balance sheet is two sides. One side is called assets and other side is called liabilities  and equity.  The assets side is everything the company owns.  The liability side is everything the company owes others.  Other definition could be, the assets could be considered the companies investment.  If asset is the companies the investments then liabilities is where we get the money  from to fund the investments.  Capital budgeting team from finance determines if they can afford the projects and  liabilities they can afford before accounting department gets its it.  Assets should always equal the liabilities.  Bonds are long term debt. Total debt equals depts. Plus equity. Short‐term debt is  current liabilities and long term debt is bonds. Short term is like A.P., s‐t notes  payable, current liabilities.   Total assets tell you the value of the company.  The value=D + E.  Income statements = revenues‐expenses=net income or net loss.  They show whether the company makes profit or losses, revenues and expenses. The very important number is net income. Whether it is positive or negative.  If it positive then perfect, everyone is happy…to a certain extent. As soon as you have profit, you have to deduct taxes (corporate taxes) The rest is divided between dividends and retained earnings, depends how much is  distributed where. Depends on many factors. They usually start by putting a lot in  retained earning and use it as an internal source of finance, the management will do  anything they can do in order to maximize RE.  The ratio we use to calculate the RE from Net Income is called the  RETENTION RATIO= THE RATIO THAT WE USE TO CALCULATE RETAINED  EARNING FROM NET INCOME.  The name of the ratio that goes to dividends from net income is called dividend  payout ratio. Revenues maybe up to 90% of them comes from SALES. The other 10% come from  like investments from shares  you receive dividends, you receive INTERESTS from  BONDS.  Expenses, since most of the money comes from sales then the most of the expenses  come from COGS. The rest is salaries, maintenance etc.  Sales‐COGS=Gross profit‐rest=net incomes‐taxes=real net income that goes two  ways. Earning per share=EPS =Total ne ...

1. Lecture 1/28/16 and 2/02/16 for chapters 3+4
3 Evaluation methods for working with financial statements.
The first is RATIO ANALYSIS.
This helps you evaluate the financial performance of a company
.
Chapter 3+4 are combined. You try to answer one main question
: How ratio
analysis is used to evaluate the financial performance of a comp
any.
In order to do ratio analysis you need data, and the data comes f
rom financial
statements. The two main statements that we used to calculate t
he ratio: balance
sheet and income statement. 3 & 4 chapters are accounting revie
w. He imported info
that reminds us of those two statements. All we need to study is
this power point.
Review of balance sheet:
How finance people read balance sheet is a bit different because
it fits our needs.
Balance sheet is two sides. One side is called assets and other si
de is called liabilities
and equity.
The assets side is everything the company owns.
The liability side is everything the company owes others.
Other definition could be, the assets could be considered the co
mpanies investment.
If asset is the companies the investments then liabilities is wher
e we get the money
from to fund the investments.

2. Capital budgeting team from finance determines if they can affo
rd the projects and
liabilities they can afford before accounting department gets its
it.
Assets should always equal the liabilities.
Bonds are long term debt. Total debt equals depts. Plus equity.
Short‐term debt is
current liabilities and long term debt is bonds. Short term is like
A.P., s‐t notes
payable, current liabilities.
Total assets tell you the value of the company.
The value=D + E.
Income statements = revenues‐expenses=net income or net loss.
They show whether the company makes profit or losses, revenue
s and expenses.
The very important number is net income. Whether it is positive
or negative.
If it positive then perfect, everyone is happy…to a certain exten
t.
As soon as you have profit, you have to deduct taxes (corporate
taxes)
The rest is divided between dividends and retained earnings, de
pends how much is
distributed where. Depends on many factors. They usually start
by putting a lot in
retained earning and use it as an internal source of finance, the
management will do
anything they can do in order to maximize RE.
The ratio we use to calculate the RE from Net Income is called t
he
RETENTION RATIO= THE RATIO THAT WE USE TO CALC
ULATE RETAINED
EARNING FROM NET INCOME.
The name of the ratio that goes to dividends from net income is
called dividend

3. payout ratio.
Revenues maybe up to 90% of them comes from SALES. The ot
her 10% come from
like investments from shares you receive dividends, you receiv
e INTERESTS from
BONDS.
Expenses, since most of the money comes from sales then the m
ost of the expenses
come from COGS. The rest is salaries, maintenance etc.
Sales‐COGS=Gross profit‐rest=net incomes‐taxes=real net inco
me that goes two
ways.
Earning per share=EPS =Total net incomes/shares outstanding.
Means like
$162/100= $1.62 means every share earns $1.62 per share but o
nly if management
says they are going to pay out dividends. It is not how much yo
u get necessarily.
If you want to calculate how much you get per share then calcul
ate dividends per
share ratio.
Dividends per share ratio= Total dividends paid/shares outstandi
ng
Example=$100/100=$1.00 per share YOU WILL ACTUALLY G
ET.
Five categories of ratios: 4 groups with 4 ratios. Each group me
asures
different things in the company.
EC and HW
Liquidity Ratios (short-term solvency)
Measure the liquidity, before you invest you want to get this rat
io.

4. Efficiency Ratios (asset utilization)
How efficient is the company management in running and gener
ating sales.
Leverage Ratios (long-term solvency)
Talking about how much the company uses the debt to cover…
Profitability Ratios
Market Value Ratios (To be discussed later)
Liquidity Ratios
The more info and ratios you can calculate the more informed d
ecision you will be
able to make.
Measures the ability of the firm to meet its short‐term financial
obligations.
Does the firm have short‐term assets to pay off short‐term liabil
ities?
I need to measure this before I invest my money in this compan
y.
Current ratio= Current Ratio
Current Liabilities
Is there a sufficient amount of current assets to pay off current l
iabilities? What is
the cushion of safety?
How we use the current ratio to evaluate the financial performa
nce of the
company? Answer=
There are 3 steps to the first main question:
-Calculation, you calculate the ratio
-Interpretation, what does that ratio mean
-Evaluation; So what, is this good or bad? You try to determine
if the ratio is
good or bad you have to compare the ratio with a benchmark (so
mething
similar)

5. There are 3 benchmarks
‐Compare the ratio of the firm with a comparable firm
‐You compare the ratio of this firm with the past year’s ratio (fo
r the same firm)
-You compare the ratio with the industry ratio
Now apply ration analysis.
How do we use current ratio, step number one…calculate curren
t ratio.
Current assets is brought from balance sheet, Current liabilities
from balance sheet.
Example $1,230/$230=5.35x.
What does this mean, assets are five times as much as it’s liabili
ties.
Evaluation, compare the number based on benchmark.
Well, based on previous years ratio for this company then bad b
ecause every year it
has been decreasing. I would not invest in this company.
The easiest way for this class would be to find current ratio wit
h previous years and
also compare with another company.
This is the first member of the liquidity group.
The second member of the liquidity group is QUICK RATIO
Quick Ratio is more accurate measure of liquidity than current r
atio.
Inventory is the least liquid asset so you remove it.
Quick Ratio or Acid Test Ratio= Current liabilities-Inventory
Current Liabilities
Example= $1,230-$625/$230=2.63x
Interpret‐the first is only has 2.63 times more than the liabilities
.

6. NWC to TA we are not going to have to calculate this ratio, he
will substitute it.
Now you subtract everything you don’t need and get cash ratio.
Cash Ratio= Cash/Current Liabilities
$175/$230= .75
Efficiency Ratio is the second group of 5
How well is the firm utilizing all of its resources (financial reso
urces, money, land,
capital, machinery, labor, physical) to generate sales. Profitabili
ty does not mean
efficiency.
Receivables turnover ratio= Sales
Accounts Receivable
Is the level of accounts receivable, appropriate given the firm’s
sales.
How well people are paying you. These are sales on credit.
Bring sales from Income Statement, AR from Balance Sheet.
Example= $1450/$430=3.37x
Accounts receivable sale on credit is almost 30% the sales volu
me
Compare this number to the benchmark, compare it to a compara
ble…others is 15%
and I am 30%. I failed to liquidate as much as I can from my iss
ues.
I will not know I have a problem until I compare to the benchma
rk.
Average Collection Period= Accounts Receivables
(Day’s sales in receivables) Daily Credit Sales
How long does it take the firm to collect the credits or money fr
om its customers?
ACP=$430

7. $1450/365 (days in a year)
=108.24 days
Compare this number to benchmark to see if it’s good or bad.
Inventory Turnover Ratio=Cost of goods sold
Inventory
Tells us the level of inventory appropriate given the firm’s sales
.
How many times the company is capable of turning the inventor
y into cash or liquid.
The comparable firm’s ratio in benchmark is very important in t
his one.
Perishable goods rate should be higher, so when you compare th
en it is important to
compare it to another firm. Cannot be a different industry when
comparing.
Example= $875/$625=1.40x
1.4 time the company turns inventory into cash
We have to compare this with a benchmark.
Fixed asset turnover ratio= Sales
Net Fixed Assets
It is used to calculate how effective is the firm in utilizing its fi
xed assets to generate
sales.
Example: $1,450/$1,300=1.12x
For every dollar we spent in fixed of assets we generate 1.12 do
llars in sales.
The higher the number the more efficient because you get more
money per dollar
you spent.
Over investing is when the number is two low because you are i
nvesting more than
what you are actually getting back in sales.

8. Total Asset Turnover Rate= Sales
Total Assets
Number tells us how efficient is the firm in using its total assets
to generate sales.
Example= $1450/$2530=0.57X
Interpret= for every dollar you spend in total assets you get onl
y .57 in sales
Compare from benchmark.
Leverage Ratios Only Two Ratios
Used to measure the extent to which non‐owner supplied funds
have been used to
finance the firm’s assets.
Two types: Balance Sheet leverage ratios, Coverage Ratios
How much the company uses debt to finance its operation or ass
ets.
The money comes from stocks and bonds.
Why do we care about debt? Debt is a measure of risk so you ca
n measure how
much risk the company has.
Why debt is risky: As a company, I am obligated by law to pay
back the debt with
interest whether I am doing good or bad over a period of time.
You are exposed to bankruptcy if you don’t. If word leaks that y
ou don’t pay on time
then that doesn’t look good.
Lets measure how risky a company is.
We use leverage ratio.
Debt Ratio= Total Debt
Total Assets

9. Measures how much debt the company uses to fund its total asse
ts.
Example: $230+$600 (current liabilities+ bonds)
If debt ratio equals 33% it means that almost all capital comes f
rom debt, or 33% of
capital comes from debt.
Don’t learn equity multiplier
For average investor, they are risk adverse so a company looks
better if they are less
risky. If debt is good or bad it depends on who is looking.
More Debt, Less TIE
Times Interest Earned Ratio= Operating Income
Interest Expense
If we have too much debt, it will impact our TIE ratio.
Do we have enough money, how many times can we cover the in
terest that we have
to pay to our debt holder.
Do we have enough op income then how many times can we pay
the interest to our
debt holders.
5.50 time is the answer to example.
Our op income is as 5.5 times the interest owed to our debt hold
ers.
Profitability Ratios
How effective or efficient is the firm in generating profit.
3 main ratios.
Net Profit Margin= Net Income
Sales

10. The portion of every dollar of sales that is dedicated to profit or
the percentage.
The amount of net profit for each dollar of sales
If the answer is 11% mean that almost 11% of every dollar of sa
les is dedicated to
profit.
Compare to the benchmark before you make a decision.
ROA= Net Income
Total Assets
Powerpoint example. Almost 6.4 percent spent on each dollar is
dedicated to profit.
Return on Equity= Net Income
Common Equity
This measures whether this management is effective in using the
shareholders
money. Using or investing the money from shareholders.
So if we end up almost 10%, almost 10% of share holders mone
y is dedicated to
profit.
WE don’t have to learn dupont system.
Summary of Simsboro Computer & Industry
More liquidity is good, so if the company number is higher tha
n its better.
Acid-test ratio, if it is lower than it is not cool.
Extra Credit- Create table of a company that compares to bench
mark.
Interpret the table, briefly.

11. ALL OF THE RATIOS FOR THE EXTRA CREDIT
Make a power point with clusters of the ratios per group and a li
ttle
explanation on the bottom of the each slide
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