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Chapter 3 Working With Financial Statements 3.1Cash Flow and Financial Statements: A Closer Look 3.2Standardized Financial Statements 3.3Ratio Analysis.

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Presentation on theme: "Chapter 3 Working With Financial Statements 3.1Cash Flow and Financial Statements: A Closer Look 3.2Standardized Financial Statements 3.3Ratio Analysis."— Presentation transcript:

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2 Chapter 3 Working With Financial Statements 3.1Cash Flow and Financial Statements: A Closer Look 3.2Standardized Financial Statements 3.3Ratio Analysis 3.4The Du Pont Identity 3.5Using Financial Statement Information

3 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.1Cash Flow and Financial Statements: A Closer Look Sources and Uses of Cash  Activities that bring in cash are sources Firms raise cash by selling assets, borrowing money or selling securities  Activities that involve cash outflows are uses Firms use cash to buy assets or make payments to providers of capital. Sources:  Decreases in assets  Increases in equity and liabilities Uses:  Increases in assets  Decreases in equity and liabilities

4 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.2 Hermetic, Inc., Balance Sheet Hermetic, Inc. Balance Sheet as of December 31 ($ in thousands) Assets Current Assets Cash$ 45$ 50 Accounts receivable Inventory Total$ 625$ 745 Fixed assets Net plant and equipment Total assets$1610$1845

5 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.2 Hermetic, Inc., Balance Sheet (concluded) Liabilities and equity Current liabilities Accounts payable$ 210$ 260 Notes payable Total$ 320$ 435 Long-term debt Stockholders’ equity Common stock and paid-in surplus Retained earnings Total Total liabilities and equity$1610$1845

6 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.3 Hermetic, Inc., Income Statement ($ in thousands) Net sales$ Cost of goods sold Depreciation30.00 Earnings before interest and taxes$ Interest20.00 Taxable income Taxes53.45 Net income$ Retained earnings $ Dividends 26.55

7 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.4 Statement of Cash Flows Operating activities  + Net income  + Depreciation  + Any decrease in current assets (except cash)  + Increase in accounts payable  – Any increase in current assets (except cash)  – Decrease in accounts payable Investment activities  + Ending fixed assets  – Beginning fixed assets  + Depreciation

8 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.4 Statement of Cash Flows (concluded) Financing activities – Decrease in notes payable + Increase in notes payable – Decrease in long-term debt + Increase in long-term debt + Increase in common stock – Dividends paid

9 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.5 Hermetic, Inc., Statement of Cash Flows Operating activities + Net income Depreciation Increase in payables – Increase in receivables– – Increase in inventory– Investment activities + Ending fixed assets+1, – Beginning fixed assets– Depreciation (145.00)

10 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.5 Hermetic, Inc., Statement of Cash Flows (concluded) Financing activities + Increase in notes payable Increase in long-term debt – Dividends– Putting it all together – = 5.00

11 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.6 Common-Size Statements Common-Size Balance Sheet  Express individual accounts as a percent of total assets Common-Size Income Statement  Express individual items as a percent of sales

12 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.7 Hermetic, Inc., Common-Size Balance Sheet Assets Current Assets Cash 2.8%2.7% Accounts receivable Inventory Total 38.8%40.4% Fixed assets Net plant and equipment61.2%59.6% Total assets 100% 100%

13 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.7 Hermetic, Inc., Common-Size Balance Sheet (continued) Liabilities and equity Current liabilities Accounts payable13.0%14.1% Notes payable Total19.9%23.6% Long-term debt12.7%12.2% Stockholders’ equity Common stock and paid-in surplus18.0%15.7% Retained earnings Total Total liabilities and equity100% 100%

14 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.7 Hermetic, Inc., Common-Size Income Statement Net sales100.0 % Cost of goods sold67.6 Depreciation4.2 Earnings before interest and taxes28.2 Interest2.8 Taxable income25.4 Taxes7.5 Net income17.8 % Retained earnings14.1 % Dividends3.7 %

15 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.8 Categories of Financial Ratios Short-Term Solvency or Liquidity  Ability to pay bills in the short-run Long-Term Solvency  Ability to meet long-term obligations Asset Management  Intensity and efficiency of asset use Profitability  The bottom line Market Value  Going beyond financial statements

16 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.9 Common Financial Ratios (Table 3.8) I. Short-Term Solvency or Liquidity Ratios Current ratio = Current assets /Current liabilities Quick ratio = (Current assets - Inventory)/ Current liabilities Cash ratio = Cash/Current liabilities Net working capital to total assets = Net working capital Total assets Interval measure = Current assets Average daily operating costs

17 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.9 Common Financial Ratios (Table 3.8) (continued) II. Long-Term Solvency Total assets - Total equity Total debt ratio = Total assets Debt/equity ratio = Total debt/Total equity Equity multiplier = Total assets/Total equity Long-term debt Long-term debt ratio = Long-term debt + Total equity EBIT Times interest earned ratio = Interest EBIT + depreciation Cash coverage ratio = Interest

18 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.9 Common Financial Ratios (Table 3.8) (continued) III. Asset Utilization or Turnover Ratios Cost of goods sold Inventory turnover = Inventory 365 days Days’ sales in inventory = Inventory turnover Sales Receivables turnover = Accounts receivable 365 days Days’ sales in receivables = Receivables turnover Sales NWC turnover = NWC Sales Fixed asset turnover = Net fixed assets Sales Total asset turnover = Total assets

19 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.9 Common Financial Ratios (Table 3.8) (continued) IV. Profitability Ratios Net income Profit margin = Sales Net income Return on assets (ROA) = Total assets Net income Return on equity (ROE) = Total equity Net income Sales Assets ROE = Sales Assets Equity

20 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.9 Common Financial Ratios (Table 3.8) (concluded) V. Market Value Ratios Price per share Price / earnings ratio = Earnings per share Price per share Market-to-book ratio = Book value per share

21 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo Return on equity (ROE) can be decomposed as follows: ROE = (Net income/Sales) x (Sales/Assets) x (Assets/Total equity) = Profit margin x Asset turnover x Equity multiplier Check: = 17.8% x.385 x 1.56 = 10.7% = Operating efficiency x Asset efficiency x Financial leverage = _ROA_ x Equity multiplier = Profitability Check: 6.86% x 1.56 = 10.7% 3.11 The Du Pont Identity

22 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.14 Chapter 3 Quick Quiz Wal-Mart, Venture Stores, and KMart collectively represent the majority of sales in the discount retail industry in this country. The following data are from quarterly financial statements filed with the SEC and retrieved from the SEC website. ROE Wal-Mart = (.0276)(.6578)(2.463) =.0447 Current share price = $ week high share price = $28.25 ROE Venture = (-.0116)(.4474)(3.073) = Current share price = $ week high share price = $8.50 ROE KMart = (.0041)(.5276)(2.534) =.0055 Current share price = $ week high share price = $14.25 Which firm is the market leader? Do you think its ROE is the cause or the result of its leadership position? The two secondary firms have not performed as well as the leader. In what area(s) have they done particularly poorly?

23 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.15 Solution to Problem 3.2 Determine net income, ROA, and ROE for a company with sales of $25 million, total assets of $36 million, and total debt of $7 million. The profit margin is 6%. Profit margin = Net income / Sales.06 = Net income / $25 million Net income = $1,500,000 ROE = Net income / Stockholders’ equity Total assets = Total debt + Stockholders’ equity Stockholders’ equity = Total assets – Total debt Stockholders’ equity = ________ ROE = $1,500,000 / ______ = _______ ROA= Net income / Total assets = $1,500,000 / _______ = _______

24 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.16 Solution to Problem 3.9 Based only on the following information for Asset Liquidation Corp., did cash go up or go down? By how much? Classify each event as a source or use of cash.  Decrease in inventory $420  Decrease in accounts payable 260  Decrease in notes payable 750  Increase in accounts receivable900

25 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.16 Solution to Problem 3.9 (continued) Sources of cash include:  Net income  Depreciation  Decrease in assets  Increase in liabilities  Sale of stock Uses of cash include:  Net loss  Increase in assets  Decrease in liabilities  Dividends paid  Repurchase of stock

26 Vigdis BoassonMgf301 School of Management, SUNY at Buffalo 3.16 Solution to Problem 3.9 (concluded) S or U  Decrease in inventory $420______  Decrease in accounts payable 260______  Decrease in notes payable 750______  Increase in accounts receivable 900______ Change in cash = sources – uses = $____ – ($____ + ______ + ______) = $______


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