1. Principles of Investing FIN 330
Chapter 8
Financial Statement Analysis
Dr. David P Echevarria
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2. Review of Financial Statements
Balance Sheet
Snapshot of company’s assets, Liabilities and Equity at end of fiscal year
Income statement
Sales, expenses, and taxes incurred to operate
Earnings per share: Net Income / # Shares Out.
Cash flow statement
Sources and uses of funds
Are financial statements reliable?
G.A.A.P. vs Cleverly Rigged Accounting Ploys
Principal motive for Sarbanes-Oxley (2002)
Dr. David P Echevarria
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3. Sources of Information
Financial Statement Data
Quarterly, Annual Reports issued by companies to stockholders
Computerized Data Bases such as Compustat (WRDS)
Standard & Poor' Industrial Manuals, Moody's
EDGAR database at the SEC (
Industry Averages
Robert Morris Associates
Dun & Bradstreet
Federal Agencies;
Commerce Department
Federal Reserve
Dr. David P Echevarria
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4. Ratio Categories Liquidity ratios
Measure ability to pay maturing obligations
Current ratio
Current assets / current liabilities
Quick ratio
Current assets less inventories / current liabilities
Cash ratio
(Cash + M/S)  current liabilities
Defensive Interval
= [(Cash + M/S + A/R) * 365 ]  (COGS + SGA).
Dr. David P Echevarria
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5. Ratio Categories B. Asset Management [Activity] ratios
Measure effectiveness of asset management
Days Sales Outstanding (DSO)
Average receivables / Sales per day
Inventory turnover (times per year)
Cost of Goods Sold / average inventory
Total asset turnover
Sales / average total assets
Fixed asset turnover
Sales / average net fixed assets
Dr. David P Echevarria
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6. Ratio Categories C. Debt Management [Leverage] ratios
Measure extent to which firm uses debt to finance asset investment (risk attribute)
Debt-equity ratio
Total long-term debt / total equity
Total debt to total assets ratio (Debt Ratio)
Current liabilities + long-term debt / total assets
Times interest earned
EBIT / interest charges
Fixed charge coverage ratio
(EBIT + Lease Exp.) / (Int. Exp. + Lease Exp.)
Dr. David P Echevarria
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7. Ratio Categories D. Profitability ratios Gross profit margin (%)
Gross profit / sales
Operating Profit Margin (%)
Operating profits / sales
(Sales - COGS - operating expenses) / sales
Net profit margin (%)
Net profit after taxes / sales
Return on total capital (%)
Net income + interest expense / Total long-term capital
Return on stockholders’ equity (ROE) (%)
Net income after taxes / common stock equity
Dr. David P Echevarria
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8. Ratio Categories Valuation Ratios Price / Earnings: Price / EPS
Book Value: Total Assets –Total Liabilities
TA – TL = [Total Common] Equity
Book Value Per Share = BV / # Shares Out.
Earnings per Share = Net Income / # Shares Out
Dr. David P Echevarria
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9. DuPont System ROE = ROA * Equity Multiplier Objective of DuPont System
ROA = Net Income / Total Assets
Equity Multiplier = Total Assets / Common Equity
Objective of DuPont System
Assist management in identifying areas where performance can be improved. It also helps to understand the impact of changes in the debt ratio on ROE – which in turn affects stock price.
Dr. David P Echevarria
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10. Estimating Earnings and Fair Market Value for Equity
Six Steps (Review)
Estimate next year’s sales revenues
Estimate next year’s expenses
Earnings = Revenue - Expenses
Estimate next year’s dividend per share
= Earnings Per Share * dividend payout ratio
Estimate the fair market value of stock given next years earnings, dividend, ROE, and growth rate for dividends Using Gordon Growth model or P/E Model
Dr. David P Echevarria
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11. Estimating Earnings and Fair Market Value for Equity
Implications for investors
Fundamental analysis assumes company performance and stock performance are correlated
Forecasting EPS and P/E helps predict expected returns
Remember: The market is always and everywhere an expectations phenomenon –
We Buy the future not the past.
Dr. David P Echevarria
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12. Homework Discussion Questions: 4, 7, 8, 10, 12
Problems: 1, 10, 15 (parts a thru e)
Dr. David P Echevarria
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