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Financial Statements according to GAAP

Income Statement (Statement of Operations) Shows profitability for a period of time

A summary statement of revenues, expenses, gains, andlosses

Must follow GAAP (financial accounting standards) Subject to much judgment by management and CPAs

Traditionally, bottom-line earnings from income statements

represented primary stock price drivers Currently, the move is on in the accounting profession todistinguish appropriately between earnings and qualityearnings

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The Balance Sheet (Financial Position)Determines Solvency Position of an organization on a

given date Assets (Resources): Future economic value owned or

controlled by the organization Current:--Cash and near cash assets

Non-currentRelatively permanent assets used to generaterevenue

Liabilities (Debts): Future claims by outsiders on assets ofthe organization

CurrentDue in the near future Long-termDue at least one year from the balance sheet date

Stockholders EquityOwners claim to organizationresources

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Statement of Cash Flows

Summarizes cash inflows and (outflows) for aperiod of time Includes all cash inflows (outflows) regardless of

source or use

Categories of cash flows Operating Activities: Shows cash flows from operating

income (from income statement)

Investing Activities: Shows cash flows to investments and

from sales of investments Financing Activities: Shows cash flows from borrowing

and sales of original equity issues and subsequent payback of loans, equity re-acquisitions, and dividends

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Sources of Financial Analysis Tools

Finance and Accounting Texts

Dess-Lumpkin Text pp 98-117

Stickney-Brown Text (5th Ed)

Handout Link in your tentative schedule (Best Source)

Uses averages instead of end-of-year figures whereappropriate and cost of goods sold instead of sales in

inventory turnover calculations Emphasizes DuPont Model for R.O.I. calculations

More cash flow analyses included

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Financial Statement Analysis

Profitability Analysis Return on Investment (ROI)

Return / Average Investment

DuPont Model Return / Sales X Sales / Average Investment

Sales Margin X Asset Turnover

Return on Equity (ROE)

Return / Average Stockholders Equity Others: PE Ratio; Dividend Yield; Dividend Payout

Also be sure to compare your company stock pricetrend with some of the major price indices.

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Why We Use Averages in Denominators

Assume Total Assets at Beginning of Year = $500 At July 1, we acquire $500 in new plant assets Net income (return on investment) for year is $50

If we use asset value at end of year ROI = .05 ($50/ $1,000)

If we use average asset value ROI = .067 ($50/ ($500 + 1,000)/2

Use of average assets gives a more accurateannual return on your investment (The $50 wasearned during the last six months of the year)

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Advantage of Using DuPont Model

Identifies cause of change in ROI from year to yearUses the product of two intermediate calculations forsales margin (efficiency measure) and asset turnover

(effective utilization of assets to generate revenue)Assume the following information as an example

Year 01: Net Income-$50; Average Assets-$800; Sales-$1,000

Year 02: Net Income-$50; Average Assets-$1,000; Sales-$2,000

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Calculation of ROI Both Methods

Year 01 Year 02Regular $50/$800 = .0625 $50/$1,000= .05

DuPont

50/1,000 * 1,000/800 50/2,000 * 2000/1000

.05 * 1.25 = .025 * 2 =

.0625 .05

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Liquidity Analysis

Working Capital Working Capital =$Current Assets$ Current Liabilities

Current Ratio = Current Assets / Current Liabilities

Acid Test Ratio = Cash, Temporary Investments and Receivables

/ Current Liabilities

Cash and Equivalents

Cash Flow Adequacy

Debt Coverage (Debt Payback) Operations Index

Others include Reinvestment ratio, cash flow to sales, and cashflow return on average assets

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Activity and Efficiency Measures

Property-Plant-Equipment Turnover

Inventory Turnover (Days sales in inventory)Accounts Receivable Turnover (Days sales inaccounts receivable)

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Financial Leverage Analysis

Debt RatioDebt to Equity Ratio

Times Interest Earned

Times Interest Covered by Cash Flow from OperatingActivities

Wisely used outside capital injections greatly improveowners return on equity

Unwise use of outside capital adds burdensome fixed costsand contribute to increased risk of the organization

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WHY FINANCIAL ANALYSIS?

Solvency Evaluation (Short-range and Long-range)

Changes in Company Value (Owners net worth)

Earnings and Quality of Earnings TrendManagement Efficiency

Utilization and Control of Organization Resources

(Assets)Cash Generation Efficiency of Organization

Risk Assessment