1. 3-0 Working with Financial Statements Chapter 3 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2. Chapter Outline Statement of Cash Flow Standardized Financial Statements Ratio Analysis The Du Pont Identity Why Evaluate Financial Statements? Benchmarking Potential Problems 1

3. Statement of Cash Flow Sources of Cash = cash inflow Uses of Cash = cash outflow 2

4. Standardized Financial Statements 1. Common-Size Statements: - Common-Size Balance Sheet: reports ever item as % of total assets - Common-Size Income Statement: reports every item as % of sales 2. Common-Base Year Statements: reports every item as % of the same item in another year 3. Combined Common-Size and Common-Base Year Statements: reports every item as a % of the % of the same item in another year 3

5. Standardized Financial Statements 4

6. Ratio Analysis: Categories of Financial Ratios 1. Short-term solvency or liquidity ratios 2. Long-term solvency or financial leverage ratios 3. Asset management or turnover ratios 4. Profitability ratios 5. Market value ratios Du Pont Identity 5

7. 1. Short-Term Solvency Ratios 6

8. 2. Long-Term Solvency or Leverage Ratios 7

9. 8

10. 3. Asset Management Ratios 9

11. 10

12. 4. Profitability Ratios 11

13. 5. Market Value Ratios Assume: there are 30 mil shares outstanding selling at $350/share 12 Assume : g=5%.

14. DuPont Identity 13 The DuPont Identity decomposes the ROE into an operating efficiency ratio (day-to-day activities) x asset use efficiency (investment s) x financial leverage (financing) ROE = NI/equity ROE = NI/equity x sales/sales x assets/assets ROE= NI/sales x sales/assets x assets/equity profit margin x asset turnover x equity multiplier

15. Why Evaluate Financial Statements? Internal uses –Performance evaluation – compensation and comparison between divisions –Planning for the future – guide in estimating future cash flows External uses –Creditors –Suppliers –Customers –Stockholders 14

16. Benchmarking Statements and ratios are not very helpful by themselves; they need to be compared to something. Use: - Time and Trend Analysis - Peer Group Analysis 15

17. Potential Problems Which ratios are most relevant? Diversified firms are hard to compare Differences in international accounting regulations Varying accounting procedures, i.e. FIFO vs. LIFO Different fiscal years Extraordinary events 16