Introduction to Financial Statement Analysis Introduction to Financial Statement Analysis C H A P T E R 5

Learning Objective 1 Explain the purpose of financial statement analysis.

What’s the Purpose of Financial Statement Analysis?

Define Financial Ratios

Discuss the Need for Financial Statement Analysis External Users:Internal Users:

Learning Objective 2 Understand the relationships between financial statement numbers and use ratios in analyzing and describing a company’s performance.

What Is the Debt Ratio and Its Purpose?

What Is the Current Ratio and Its Purpose?

What Is Return on Sales and Its Purpose?

What Is Asset Turnover and Its Purpose?

What Is Return on Equity and Its Purpose?

What Is the Price-Earnings Ratio and Its Purpose?

Match Financial Ratios Debt ratio Total liabilities Total assets Current assets Current liabilities Sales Total assets Net income Sales Net income Owners’ equity Market price per share Earnings per share Current ratio Asset turnover Return on sales Return on equity Price-earnings ratio

Learning Objective 3 Use common-size financial statements to perform comparison of financial statements across years and between companies $5,400

Common-Size Financial Statements Resolves the problem of size or scale in comparisons Divide all income statement numbers for a given year by the total revenues or all balance sheet items by total revenues for the year. All amounts are then shown as a percentage of revenues for that year. Helps to pinpoint problem areas. SEC requires multiple years of financial statements be provided by publicly traded companies

Example: Common-Size Income Statement Uncommon Company Common-Size Income Statement For the Year Ended 12/31/02 Revenues $10,000100% Cost of sales , Selling & admin. exp , Income before taxes $ 3,500 35% Income tax expense , Net income $ 2,500 25%

Learning Objective 4 Understand the DuPont framework and how return on equity can be decomposed into its profitability, efficiency and leverage components

What Does The DuPont Framework Do?

Match Term to Definition Return on Sales Asset Turnover Assets to Equity Ratio Profitability Efficiency Leverage Net income divided by sales Ability to generate sales through the use of assets Ability to generate net income per sales dollar Using borrowed funds instead of invested funds Assets divided by equity Sales divided by assets

What Are the Components of ROE?

Learning Objective 5 Use cash flow information to evaluate cash flow ratios

Discuss Cash Flows

What is the Cash Flow to Net Income Ratio?

What is the Cash Flow Adequacy Ratio?

Learning Objective 6 Understand the limitations of financial statement analysis $

What are the Limitations of Financial Statement Analysis?

End Chapter 5