1. 14 Financial Statement Analysis Bodie, Kane, and Marcus
Essentials of Investments, 9th Edition

2. 14.1 Major Financial Statements
Income Statement
Financial statement showing firm’s revenues and expenses during specified period
Economic Earnings
Real flow of cash firm could pay without impairing productive capacity
Accounting Earnings
Earnings of a firm as reported on income statement

3. 14.1 Major Financial Statements
Balance Sheet
Accounting statement of firm’s financial position at specified time
Statement of Cash Flows
Financial statement showing firm’s cash receipts and cash payments during specified period

4. Table 14.1 Home Depot’s Income Statement
Percent of
$ Million
Revenue
Operating Revenues
Net sales
67,997
100.0%
Operating Expenses
Cost of goods sold
42,975
63.2%
Selling, general, & administrative expenses
15,849
23.3%
Other
1,652
2.4%
Depreciation
1,718
2.5%
Earnings before interest and income taxes
5,803
8.5%
Interest expense
530
0.8%
Taxable income
5,273
7.8%
Taxes
1,935
2.8%
Net income
3,338
4.9%
Allocation of net income
Dividends
1,569
2.3%
Addition to retained earnings
1,769
2.6%
Note: Sums subject to rounding error

5. Table 14.2 Home Depot’s Balance Sheet
Panel A: (millions of dollars)
Percent of
Assets
$ million
total assets
Liabilities and shareholders' equity
Current assets
Cash and marketable securities
545
1.4%
Current liabilities
Receivables
1,085
2.7%
Debt due for repayment
1,042
2.6%
Inventories
10,625
26.5%
Accounts payable
7,903
19.7%
Other current assets
1,224
3.1%
Other current liabilities
1,177
2.9%
Total current assets
13,479
33.6%
Total current liabilities
10,122
25.2%
Fixed assets
Long-term debt
8,707
21.7%
Tangible fixed assets
Other long-term liabilities
2,407
6.0%
Property, plant, and equipment
25,060
62.5%
Long-term Investments
139
0.3%
Total liabilities
21,236
52.9%
Total tangible fixed assets
25,199
62.8%
Shareholders' equity
Intangible fixed assets
Common stock and other paid-in capital
3,894
9.7%
Goodwill
1,187
3.0%
Retained earnings
14,995
37.4%
Total shareholders' equity
18,889
47.1%
Total fixed assets
26,386
65.8%
Total liabilities and shareholders' equity
40,125
100.0%
Other assets
260
0.6%
Total assets
Source: Home Depot Annual Report, year ending January 2011

6. Table 14.3 Home Depot’s Statement of Cash Flows
$ Million
Cash provided by operations
Net income
$3,338
Adjustments to net income
Depreciation
1,718
Changes in working capital
Decrease (increase) in receivables
(102)
Decrease (increase) in inventories
(355)
Increase (decrease) in other current liabilities
(269)
Changes due to other operating activities
255
Total adjustments
$1,247
4,585
Cash flows from investments
Gross investment in tangible fixed assets
($1,096)
Investments in other assets 84
Cash provided by (used for) investments
($1,012)
Cash provided by (used for) financing activities
Additions to (reductions in) long-term debt
($31)
Net issues (repurchases of) shares
(2,504)
Dividends
(1,569)
Other
(347)
($4,451)
Net increase in cash
($878)
Source: Home Depot Annual Report, year ending January 2011.

7. 14.2 Measuring Firm Performance
Investment Decisions
Efficiency of assets
Profitability of sales
Financing Decisions
Leverage
Liquidity

8. Figure 14.1 Ratios

9. 14.3 Profitability Measures

10. Table 14.4 Nodett’s Profitability over Business Cycle

11. Table 14.5 Impact of Financial Leverage on ROE
*Somdett’s after-tax profits equal .6(EBIT − $3.2 million).
†Somdett’s equity is only $60 million.

12. 14.3 Profitability Measures
Economic Value Added
Measure of dollar value of firm’s return in excess of opportunity cost
Also known as residual income
Spread between ROA and cost of capital multiplied by capital invested in firm

13. Table 14.6 Economic Value Added, 2011
EVA
($ billion)
Capital ($ billion)
ROA (%)
Cost of
Capital (%)
ExxonMobil
6.90
171.31
10.8
6.8
Intel
4.29
52.87
16.1
8.0
Walmart
3.87
125.80
8.6
5.5
GlaxoSmithKline
3.02
34.75
15.3
6.6
Google
2.60
61.38
12.0
7.7
Hewlett Packard
-0.91
68.86
5.9
7.2
AT&T
-1.60
183.99
4.6
Honda
-3.63
105.20
1.7
5.1
Source: Authors' calculations using data from finance.yahoo.com

14. 14.4 Ratio Analysis

15. 14.4 Ratio Analysis Decomposition of ROE Total asset turnover (ATO)
Annual sales generated by each dollar of assets (Sales/Assets)
Interest coverage ratio
Financial leverage measure
EBIT divided by interest expenses

16. 14.4 Ratio Analysis Decomposition of ROE Leverage ratio
Measure of debt to total capitalization of firm
ROE = Tax burden × Interest burden × Margin × Turnover × Leverage
ROA = Margin × Turnover

17. Figure 14.2 Median ROA, Profit Margin, and Asset Turnover for 23 Industries

18. Table 14.7 Ratio Decomposition Analysis for Nodett and Somdett

19. Table 14.8 Differences between Profit Margin and Asset Turnover across Industries

20. 14.4 Ratio Analysis

21. 14.4 Ratio Analysis Liquidity Ratios
Liquidity: Ability to convert assets into cash at short notice
Current ratio: Current assets/Current liabilities
Quick ratio: Measure of liquidity similar to current ratio; excludes inventories
Cash ratio: Cash and marketable securities to current liabilities

22. Table 14.9 Growth Industries Financial Statements
2011
2012
2013
2014

23. 14.4 Ratio Analysis

24. Table 14.10A Summary of Financial Ratios

25. Table 14.10B Summary of Financial Ratios

26. Figure 14.3 DuPont Composition for Home Depot
Turnover x 10

27. Table 14.11 Financial Ratios: Major Industry Groups
LT Debt
Assets
Interest
Coverage
Current
Ratio
Quick
Asset
Turnover
Profit
Margin (%)
Return on
Assets (%)
Equity (%)
Payout
All manufacturing
0.21
5.01
1.42
0.98
0.84
8.03
6.78
17.12
0.27
Food products
0.29
3.83
1.28
0.76
1.15
5.95
6.87
5.59
0.87
Clothing
0.19
7.02
2.32
1.31
9.29
11.91
22.03
Printing/publishing
0.40
3.04
1.52
1.19
1.32
7.40
9.75
25.69
0.23
Chemicals
0.26
4.41
0.94
0.51
14.08
7.14
17.38
0.30
Drugs
0.25
4.47
1.00
0.35
20.44
7.08
16.26
0.28
Machinery
0.17
5.18
1.39
0.92
0.83
8.78
7.25
16.27
Electrical
0.12
4.37
1.17
0.75
7.06
3.63
11.47
0.59
Motor vehicles
0.14
4.28
1.29
0.99
4.15
4.86
22.58
Computer and electronic
0.15
5.12
1.62
1.33
0.55
7.42
4.11
15.23
0.18
Source: U.S. Department of Commerce, Quarterly Financial Report for Manufacturing, Mining and Trade Corporations, third quarter 2011.
Available at

28. 14.5 Illustration of Financial Statement Analysis
Example: Growth Industries
Sales, assets, operating income increased 20%
ROE declining
ROA not declining
Rapid increase in year-to-year short-term debt and interest expense

29. Table 14.12 Key Financial Ratios: Growth Industries

30. Table 14.13 Growth Industries Cash Flows

31. 14.6 Comparability Problems
Inventory Valuation
LIFO
Last-in first-out inventory valuation
FIFO
First-in first-out inventory valuation

32. 14.6 Comparability Problems
Depreciation
Economic
Amount of operating cash flow that must be reinvested in firm to sustain real cash flow
Accounting
Amount of acquisition cost of asset that is allocated to each accounting period over arbitrarily specified life of asset

33. 14.6 Comparability Problems
Fair Value Accounting
Use of current market values rather than historic costs in firm’s financial statements
Relies heavily on estimates

34. 14.6 Comparability Problems
Quality of Earnings
Realism and sustainability of reported earnings
Factors that affect quality of earnings
Allowance for bad debt
Nonrecurring items
Earnings smoothing
Revenue recognition
Off-balance-sheet assets and liabilities

35. 14.6 Comparability Problems
International Accounting Conventions
Reserving practices
Subject to more managerial discretion in U.S.
Depreciation
Other countries do not allow dual sets of accounts
Most firms in foreign countries use accelerated depreciation
Intangibles
Treatment varies wildly from country to country

36. 14.6 Comparability Problems
International Accounting Conventions
International Financial Reporting Standards (IFRS)
Principles-based set of accounting rules adopted by around 100 countries, including European Union

37. Figure 14.4 Adjusted versus Reported Price-Earnings Ratios