1. Financial Statements and Ratios
Text: Chapter 2

2. How do you describe a firm’s financial situations ?

3. Financial Statements Balance sheet Income statement
Statement of cash flow

4. What assets do you own?

5. Asset = Liability + Shareholders’ Equity
The Balance Sheet
An accountant’s snapshot of the firm’s ACCOUNTING value as of a particular date.
Concept of Stock, rather than Flow
The Balance Sheet Identity is:
Asset = Liability + Shareholders’ Equity

6. The Balance Sheet of the NCKU Corp.
(in $ millions)
20X2 and 20X1
Balance Sheet
NCKU COMPOSITE CORPORATION
Liabilities (Debt)
Assets
20X2
20X1
and Stockholder's Equity
20X2
20X1
Current assets:
Current Liabilities:
Cash and equivalents
$140
$107
Accounts payable
$213
$197
Accounts receivable
294
270
Notes payable 50 53
Inventories
269
280
Accrued expenses
223
205
Other 58 50
Total current liabilities
$486
$455
Total current assets
$761
$707
Long-term liabilities:
Fixed assets:
Deferred taxes
$117
$104
Property, plant, and equipment
$1,423
$1,274
Long-term debt
471
458
Less accumulated depreciation
-550
-460
Total long-term liabilities
$588
$562
Net property, plant, and equipment
873
814
Intangible assets and other
245
221
Stockholder's equity:
Total fixed assets
$1,118
$1,035
Preferred stock
$39
$39
Common stock ($1 per value) 55 32
Capital surplus
347
327
Accumulated retained earnings
390
347
Less treasury stock
-26
-20
Total equity
$805
$725
Total assets
$1,879
$1,742
Total liabilities and stockholder's equity
$1,879
$1,742

7. Items of Current Assets
Cash
easy and exact measurement
could change in short time.
Marketable securities
Receivables
pay attention to increase of AR
Inventory
Change of inventory policy (LIFO vs.. FIFO)

8. Items of Fixed Assets Property, Plant and Equipment Other assets
depreciation policy
Other assets
Intangible assets
Patent, copyright, Trademark, Goodwill
Recorded at costs
R&D is an expense
How to estimate Patents, human capital in labor, management skills, growth opportunity and goodwill?

9. Balance Sheet Analysis
When analyzing a balance sheet, the financial manager should be aware of three concerns:
Accounting liquidity
Debt versus equity
Value versus cost

10. Accounting Liquidity
Refers to the ease and quickness with which assets can be converted to cash.
Current assets are the most liquid.
The more liquid a firm’s assets, the less likely the firm is to experience problems meeting short-term obligations.
Liquid assets frequently have lower rates of return than fixed assets.

11. Debt versus Equity
Generally, when a firm borrows it gives the bondholders first claim on the firm’s cash flow.
Thus shareholder’s equity is the residual difference between assets and liabilities.

12. Value versus Cost
Under GAAP audited financial statements of firms in the NCKU carry assets at cost.
Market value is a completely different concept.

13. The Income Statement
The income statement measures operating performance over a specific period of time.

14. NCKU COMPOSITE CORPORATION
NCKU Income Statement
NCKU COMPOSITE CORPORATION
Income Statement
20X2
(in $ millions)
The operations section of the income statement reports the firm’s revenues and expenses from principal operations
Total operating revenues
$2,262
Cost of goods sold
- 1,655
Selling, general, and administrative expenses
- 327
Depreciation
- 90
Operating income
$190
Other income 29
Earnings before interest and taxes
$219
Interest expense
- 49
Pretax income
$170
Taxes
- 84
Current: $71
Deferred: $13
Net income
$86
Retained earnings: $43
Dividends: $43

15. NCKU COMPOSITE CORPORATION
NCKU Income Statement
NCKU COMPOSITE CORPORATION
Income Statement
20X2
(in $ millions)
The non-operating section of the income statement includes all financing costs, such as interest expense.
Total operating revenues
$2,262
Cost of goods sold
- 1,655
Selling, general, and administrative expenses
- 327
Depreciation
- 90
Operating income
$190
Other income 29
Earnings before interest and taxes
$219
Interest expense
- 49
Pretax income
$170
Taxes
- 84
Current: $71
Deferred: $13
Net income
$86
Retained earnings: $43
Dividends: $43

16. NCKU COMPOSITE CORPORATION
NCKU Income Statement
NCKU COMPOSITE CORPORATION
Income Statement
20X2
(in $ millions)
Total operating revenues
$2,262
Cost of goods sold
- 1,655
Selling, general, and administrative expenses
- 327
Depreciation
- 90
Operating income
$190
Other income 29
Earnings before interest and taxes
$219
Usually a separate section reports as a separate item the amount of taxes levied on income.
Interest expense
- 49
Pretax income
$170
Taxes
- 84
Current: $71
Deferred: $13
Net income
$86
Retained earnings: $43
Dividends: $43

17. NCKU COMPOSITE CORPORATION
NCKU Income Statement
NCKU COMPOSITE CORPORATION
Income Statement
20x2
(in $ millions)
Total operating revenues
$2,262
Cost of goods sold
- 1,655
Selling, general, and administrative expenses
- 327
Depreciation
- 90
Operating income
$190
Other income 29
Earnings before interest and taxes
$219
Interest expense
- 49
Net income is the “bottom line”.
Pretax income
$170
Taxes
- 84
Current: $71
Deferred: $13
Net income
$86
Retained earnings: $43
Dividends: $43

18. Deferred Tax Results from difference in accounting and taxable income
Accounting purpose is usually to match revenue and costs to present firm performance
Tax purpose may be to reducing current tax payable to government.

19. Example Accounting Purpose Y1 50000 30000 20000 5000
Tax Purpose Y Y Y
Accounting Income Before Depreciation and Tax
Income tax expense (25%)
Straight Line Depreciation
Accounting Income before Tax
Taxable Income
Income Tax payable
Increase in Deferred Tax
Tax Depreciation

20. Income Statement Analysis
None Cash Items
Depreciation is the most apparent. No firm ever writes a check for “depreciation”.

21. Statement of Cash Flow Cash flow comes in from three channels:
Operating activities
Non-cash flow items from income statement
Changes in operation-related items
Investment activities
Balance sheet
Financing activities
Right-hand side of balance sheet

22. Cash Flow from Operating Activities

23. NCKU Cash Flow from Operations
Net Income
Depreciation
Deferred Taxes
$86 90 13

24. To Estimate Operating Cash Flow
NCKU COMPOSITE CORPORATION
Income Statement
20X2
(in $ millions)
Collect all revenues?
Total operating revenues
$2,262
Cost of goods sold
- 1,655
Related with  inventory
Selling, general, and administrative expenses
- 327
Depreciation
- 90
Operating income
$190
Related with AP
Other income 29
Earnings before interest and taxes
$219
Interest expense
- 49
Pretax income
$170
Taxes
- 84
Current: $71
Deferred: $13
Net income
$86
Retained earnings: $43
Dividends: $43

25. An example Sales: $2262 Minus AR $269 this year?
Plus AR $280 last year
$ $269 + $280
= $ ($269 - $280) = $2273 > $2262
Changes in AR
 in assets: inflow, so………. in assets : outflow

26. Cash Inflow vs. Outflow Increase in asset Increase in liability
Increase in inventory
Increase in AR

27. Estimate Operating Cash Flow (DIY)
(in $ millions)
20X2 and 20X1
Balance Sheet
NCKU COMPOSITE CORPORATION
Liabilities (Debt)
Assets
20X2
20X1
and Stockholder's Equity
20X2
20X1
Current assets:
Current Liabilities:
Cash and equivalents
$140
$107
Accounts payable
$213
$197
Accounts receivable
294
270
Notes payable 50 53
Inventories
269
280
Accrued expenses
223
205
Other 58 50
Total current liabilities
$486
$455
Total current assets
$761
$707
Long-term liabilities:
Fixed assets:
Deferred taxes
$117
$104
Property, plant, and equipment
$1,423
$1,274
Long-term debt
471
458
Less accumulated depreciation
-550
-460
Total long-term liabilities
$588
$562
Net property, plant, and equipment
873
814
Intangible assets and other
245
221
Stockholder's equity:
Total fixed assets
$1,118
$1,035
Preferred stock
$39
$39
Common stock ($1 per value) 55 32
Capital surplus
347
327
Accumulated retained earnings
390
347
Less treasury stock
-26
-20
Total equity
$805
$725
Total assets
$1,879
$1,742
Total liabilities and stockholder's equity
$1,879
$1,742

28. NCKU Cash Flow from Operations
To calculate cash flow from operations, start with net income, add back non-cash items like depreciation and adjust for changes in current assets and liabilities (other than cash).
Operations
Net Income
Depreciation
Deferred Taxes
Changes in Assets and Liabilities
Accounts Receivable
Inventories
Accounts Payable
Accrued Expenses
Other
Total Cash Flow from Operations
$86 90 13
-24 11 16 18
$202 -8

29. Cash Flow from Investment Activities
What are they?

30. The Balance Sheet of the NCKU Corp.
(in $ millions)
20X2 and 20X1
Balance Sheet
NCKU COMPOSITE CORPORATION
Liabilities (Debt)
Assets
20X2
20X1
and Stockholder's Equity
20X2
20X1
Current assets:
Current Liabilities:
Cash and equivalents
$140
$107
Accounts payable
$213
$197
Accounts receivable
294
270
Notes payable 50 53
Inventories
269
280
Accrued expenses
223
205
Other 58 50
Total current liabilities
$486
$455
Total current assets
$761
$707
Net = 149
Long-term liabilities:
Fixed assets:
Deferred taxes
$117
$104
Property, plant, and equipment
$1,423
$1,274
Long-term debt
471
458
Less accumulated depreciation
-550
-460
Total long-term liabilities
$588
$562
Net property, plant, and equipment
873
814
Intangible assets and other
245
221
Stockholder's equity:
Total fixed assets
$1,118
$1,035
Preferred stock
$39
$39
Net = 24
Common stock ($1 per value) 55 32
Capital surplus
347
327
Accumulated retained earnings
390
347
Less treasury stock
-26
-20
Total equity
$805
$725
Total assets
$1,879
$1,742
Total liabilities and stockholder's equity
$1,879
$1,742

31. NCKU Flow from Investing
Cash flow from investing activities involves changes in capital assets: acquisition of fixed assets and sales of fixed assets (i.e., net capital expenditures).
Acquisition of fixed assets
Sales of fixed assets
Total Cash Flow from Investing Activities
-$198 25
-$173

32. Cash Flow from Financing Activities
What are they?

33. The Balance Sheet of the NCKU Corp.
(in $ millions)
20X2 and 20X1
Balance Sheet
NCKU COMPOSITE CORPORATION
Liabilities (Debt)
Assets
20X2
20X1
and Stockholder's Equity
20X2
20X1
Current assets:
Current Liabilities:
Cash and equivalents
$140
$107
Accounts payable
$213
$197
Accounts receivable
294
270
Notes payable 50 53
Inventories
269
280
Accrued expenses
223
205
Other 58 50
Total current liabilities
$486
$455
Total current assets
$761
$707
Long-term liabilities:
Fixed assets:
Deferred taxes
$117
$104
Property, plant, and equipment
$1,423
$1,274
Long-term debt
471
458
Less accumulated depreciation
-550
-460
Total long-term liabilities
$588
$562
Net property, plant, and equipment
873
814
Intangible assets and other
245
221
Stockholder's equity:
Total fixed assets
$1,118
$1,035
Preferred stock
$39
$39
Common stock ($1 per value) 55 32
Capital surplus
347
327
Accumulated retained earnings
390
347
Less treasury stock
-26
-20
Total equity
$805
$725
Total assets
$1,879
$1,742
Total liabilities and stockholder's equity
$1,879
$1,742

34. NCKU Cash Flow from Financing
Net = 13
Cash flows to and from creditors and owners include changes in equity and debt.
Retirement of debt (includes notes)
Proceeds from long-term debt sales
Dividends
Repurchase of stock
Proceeds from new stock issue
Total Cash Flow from Financing
-$73 86
-43 43 $4 -6
Change in notes payable

35. The Balance Sheet of the NCKU Corp.
(in $ millions)
20X2 and 20X1
Balance Sheet
NCKU COMPOSITE CORPORATION
Liabilities (Debt)
Assets
20X2
20X1
and Stockholder's Equity
20X2
20X1
Current assets:
Current Liabilities:
Cash and equivalents
$140
$107
Accounts payable
$213
$197
Accounts receivable
294
270
Notes payable 50 53
Inventories
269
280
Accrued expenses
223
205
Other 58 50
Total current liabilities
$486
$455
Total current assets
$761
$707
Long-term liabilities:
Fixed assets:
Deferred taxes
$117
$104
Property, plant, and equipment
$1,423
$1,274
Long-term debt
471
458
Less accumulated depreciation
-550
-460
Total long-term liabilities
$588
$562
Net property, plant, and equipment
873
814
Intangible assets and other
245
221
Stockholder's equity:
Net = 43
Total fixed assets
$1,118
$1,035
Preferred stock
$39
$39
Common stock ($1 per value) 55 32
Capital surplus
347
327
Accumulated retained earnings
390
347
Less treasury stock
-26
-20
Total equity
$805
$725
Total assets
$1,879
$1,742
Total liabilities and stockholder's equity
$1,879
$1,742

36. NCKU Cash Flow from Financing
Retirement of debt (includes notes)
Proceeds from long-term debt sales
Dividends
Repurchase of stock
Proceeds from new stock issue
Total Cash Flow from Financing
-$73 86
-43 43 $4 -6
Change in notes payable

37. NCKU Statement of Cash Flows
Operations
Net Income
Depreciation
Deferred Taxes
Changes in Assets and Liabilities
Accounts Receivable
Inventories
Accounts Payable
Accrued Expenses
Other
Total Cash Flow from Operations
$86 90 13
-24 11 16 18
$202 -8
Acquisition of fixed assets
Sales of fixed assets
Total Cash Flow from Investing Activities
-$198 25
-$173
Investing Activities
Financing Activities
Retirement of debt (includes notes)
Proceeds from long-term debt sales
Dividends
Repurchase of stock
Proceeds from new stock issue
Total Cash Flow from Financing
-$73 86
-43 43 $4 -6
Change in Cash (on the balance sheet)
$33

38. Current Assets – Current Liability
Net Working Capital
Net Working Capital =
Current Assets – Current Liability
NWC is usually growing with the sales.

39. The Balance Sheet of the NCKU
(in $ millions)
20X2 and 20X1
Balance Sheet
NCKU COMPOSITE CORPORATION
$252m = $707- $455
Liabilities (Debt)
Assets
20X2
20X1
and Stockholder's Equity
20X2
20X1
Current assets:
Current Liabilities:
Cash and equivalents
$140
$107
Accounts payable
$213
$197
Accounts receivable
294
270
Notes payable 50 53
Inventories
269
280
Accrued expenses
223
205
$275m = $761m- $486m
Other 58 50
Total current liabilities
$486
$455
Total current assets
$761
$707
Here we see NWC grow to $275 million in 20X2 from $252 million in 20X1.
Long-term liabilities:
Fixed assets:
Deferred taxes
$117
$104
Property, plant, and equipment
$1,423
$1,274
Long-term debt
471
458
Less accumulated depreciation
-550
-460
Total long-term liabilities
$588
$562
Net property, plant, and equipment
873
814
Intangible assets and other
245
221
Stockholder's equity:
$23 million
Total fixed assets
$1,118
$1,035
Preferred stock
$39
$39
Common stock ($1 par value) 55 32
Capital surplus
347
327
This increase of $23 million is an investment of the firm.
Accumulated retained earnings
390
347
Less treasury stock
-26
-20
Total equity
$805
$725
Total assets
$1,879
$1,742
Total liabilities and stockholder's equity
$1,879
$1,742

40. Financial Ratios

41. Leverage Ratios Problem with high leverage?
The effect of high leverage 3

42. Leverage Ratios total liabilities Total debt ratio = total assets
Times interest earned =
EBIT
interest payments
Cash cover
age ratio =
EBIT +
depreciation
interest payments 4

43. Liquidity Ratios 6

44. Some points To have better-looking current ratio
Shift short-term debt to long-term debt
Importance of maturity match between financing and investment

45. Efficiency Ratios # of days for the goods to be produced and sold
How Quickly customers pay their bills 8

46. Profitability Ratios 9

47. Profitability Improvement?
Earnings Management
Early reorganization of sales
Cuts in R&D spending
Assets sales
Increase in other incomes
Changes in accounting policies

48. Other Profitd-related Ratios10

49. Market Value Ratios
Multiples 11

50. The DuPont System
A breakdown of ROE and ROA into component ratios: 13

51. The DuPont System 14

52. The DuPont System
Asset
turnover
Net profit
margin 15

53. The DuPont System 16

54. The DuPont System leverage ratio asset turnover profit margin debt
burden 17

55. Problems of Ratios Accounting value is not market value
Account receivable may never get into your pocket
The choice of accounting method
Diversification reduces the clarity of financial statements
How to choose appropriate benchmark?
Window Dressing

56. Lessons from Using FS Analysis
FSs are generally not exact
estimation of inventory, bad debts and others
There is a wide managerial latitude in accounting policy
Accounting looks backward
FSs are just a snapshot in time, providing little most recent information
Ratios help, but not always trust-worthy

57. Lessons from Using FS Analysis
You should keep in mind:
Measures of profitability do not take risk or timing of cash flows into account.
Financial ratios are linked to one another.

58. Conclusions
Financial analysis is like a lamp shining on a dim landscape, it neither shines very far into the future, nor completely illuminating current conditions