Financial Statements: Basic Concepts and Comprehensive Analysis 15 Financial Statements: Basic Concepts and Comprehensive Analysis

Financial Statements Balance Sheet Assets - economic resources expected to benefit future activities Liabilities - economic obligations to non owners Shareholders' s equity - excess of assets over liabilities or owners' interest in the firm A = L + O/E Income Statement Measures the operating performance of the organization by matching revenues and expenses Revenues - amounts earned by selling goods or services Expenses - amounts incurred to earn revenues Liabilities Assets Shareholders’ Equity Revenues Expenses Net income

Dividends and Retained Earnings Sum of all net incomes earned less all dividends paid to shareholders since the firm began operations Dividends Distribution of net income to shareholders Not an expense Balance Sheet Dec 31 Year 1 Balance Sheet Dec 31 Year 2 Liabilities Liabilities Assets Assets Shareholders’ Equity Shareholders’ Equity Beginning Net Dividends Ending Retained + income - Declared = Retained Earnings for year 2 in year 2 Earnings

Ratio Analysis Ratio analysis is the basis of most financial statement analysis Compare ratios in three ways Time-series analysis compare with firm's own ratios in past Cross-sectional analysis compare with other companies' ratios Benchmarking compare with common rules of thumb

Four Categories of Ratios 1. Liquidity Ratios Whether company is able to meet its short-term financial obligations 2. Profitability Ratios Examination of levels of profits earned 3. Stability Ratios Measure of long-term financial strength 4. Growth Ratios Show areas where company has increased or decreased in size

Liquidity Ratios Current Ratio = Current assets / Current liabilities Quick Ratio = Cash + Accounts receivable / Current liabilities Working capital = Current assets - Current liabilities Age of Receivables = Accounts receivable / (Sales / No. of days) Age of Inventory = Inventory / (Cost of goods sold / No. of days) Age of Payables = Accounts payable / (Purchases / No. of days) Inventory Turnover = Cost of goods sold / Inventory

Profitability Ratios Return on Assets (ROA) = Net income / Total assets Net Income Margin = Net income / Sales Asset Turnover = Sales / Assets Return on Shareholders’ Equity = Net income / Shareholders’ equity

Stability Ratios Equity to Assets = Equity / Assets Debt to Assets = Debt / Assets Equity to Assets = Equity / Assets Times Interest Earned = (Net income before taxes + Interest) / Interest

Growth Ratios Sales = (Current year’s sales - Last year’s sales) / Last year’s sales Profit = (Current year’s profit - Last year’s profit) / Last year’s profit Assets = (Current year’s assets - Last year’s assets) / Last year’s assets Equity = (Current year’s equity - Last year’s equity) / Last year’s equity

Cash Flow Analysis Statement of Cash Flows Where cash came from and what cash was used for Operating Activities Net income $240,000 + Non-cash expenses 130,000 - Non-cash revenues (20,000) +/- Working capital changes (100,000) Cash from Operations $250,000 Investing Activities + Purchase of plant and equipment (200,000) Cash used for Investing Activities (200,000) Financing Activities + Sale of stock $200,000 - Retirement of long-term debt (150,000) - Payment of dividends (40,000) Cash from Financing Activities 10,000 Net increase in cash for the year $ 60,000