1. Financial Statement Analysis
Financial Statements
Balance Sheet
Income Statement
Flow of Funds Statement
Ratio Analysis

2. Primary Types of Financial Statements
Balance Sheet
A summary of a firm’s financial position on a given date that shows total assets = total liabilities + owners’ equity.
Income Statement
A summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period.

3. Flow of Funds Statement
A summary of a firm’s changes in financial position from one period to another; it is also called a sources and uses of funds statement or a statement of changes in financial position.
Has been replaced by the cash flow statement (1989) in U.S. audited annual reports.

4. Basket Wonders’ Balance Sheet (Asset Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003a
Cash and C.E $ Acct. Rec.c Inventories Prepaid Exp d Accum Tax Prepay Current Assetse $1,195 Fixed Assets Less: Acc. Depr. g (329) Net Fix. Assets $ Investment, LT Other Assets, LT Total Assets b $2,169
a. How the firm stands on a specific date.
b. What BW owned.
c. Amounts owed by customers.
d. Future expense items already paid.
e. Cash/likely convertible to cash within 1 year.
f. Original amount paid.
g. Acc. deductions for wear and tear.

5. Basket Wonders’ Balance Sheet (Liability Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003
Notes Payable $ Acct. Payablec Accrued Taxes d Other Accrued Liab. d Current Liab. e $ Long-Term Debt f 530 Shareholders’ Equity Com. Stock ($1 par) g 200 Add Pd in Capital g 729 Retained Earnings h Total Equity $1,139
Total Liab/Equitya,b $2,169
a. Note, Assets = Liabilities + Equity.
b. What BW owed and ownership position.
c. Owed to suppliers for goods and services.
d. Unpaid wages, salaries, etc.
e. Debts payable < 1 year.
f. Debts payable > 1 year.
g. Original investment.
h. Earnings reinvested.

6. Basket Wonders’ Income Statement
Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2003a
Net Sales $ 2,211 Cost of Goods Sold b 1,599 Gross Profit $ SG&A Expenses c EBITd $ Interest Expensee EBT f $ Income Taxes EATg $ Cash Dividends Increase in RE $
a. Measures profitability over a time period.
b. Received, or receivable, from customers.
c. Sales comm., adv., officers’ salaries, etc.
d. Operating income.
e. Cost of borrowed funds.
f. Taxable income.
g. Amount earned for shareholders.

7. Flow of Funds Statement
What are “funds”?
All of the firm’s investments and claims against those investments.
Extends beyond just transactions involving cash.

8. Sources and Uses Statement
The letters labeling the boxes stand for Uses, Sources, Assets, and Liabilities (broadly defined). The pluses (minuses) indicate increases (decreases) in assets or liabilities.
A L S U

9. Use of Financial Ratios
Types of Comparisons
Internal Comparisons
External Comparisons
A Financial Ratio is an index that relates two accounting numbers and is obtained by dividing one number by the other.

10. External Comparisons and Sources of Industry Ratios
Examples:
Robert Morris Associates
Dun & Bradstreet
Almanac of Business and Industrial Financial Ratios
This involves comparing the ratios of one firm with those of similar firms or with industry averages.
Similarity is important as one should compare “apples to apples.”

11. For Basket Wonders December 31, 2003
Liquidity Ratios
Current
Current Assets
Current Liabilities
For Basket Wonders December 31, 2003
Balance Sheet Ratios
Liquidity Ratios
Shows a firm’s ability to cover its current liabilities with its current assets.
$1,195
$500
= 2.39

12. Liquidity Ratio Comparisons
Current Ratio
Year
2003
2002
2001
BW Industry
Ratio is stronger than the industry average.

13. For Basket Wonders December 31, 2003
Liquidity Ratios
Acid-Test (Quick)
Current Assets - Inv
Current Liabilities
For Basket Wonders December 31, 2003
Balance Sheet Ratios
Liquidity Ratios
Shows a firm’s ability to meet current liabilities with its most liquid assets.
$1,195 - $696
$500
= 1.00

14. Liquidity Ratio Comparisons
Acid-Test Ratio
Year
2003
2002
2001
BW Industry
Ratio is weaker than the industry average.

15. Summary of the Liquidity Ratio Comparisons
Ratio BW Industry
Current
Acid-Test
Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account.
Note that this industry has a relatively high level of inventories.

16. Current Ratio -- Trend Analysis Comparison

17. Acid-Test Ratio -- Trend Analysis Comparison

18. Summary of the Liquidity Trend Analyses
The current ratio for BW has been rising at the same time the acid-test ratio has been declining.
The current ratio for the industry has been rising slowly at the same time the acid-test ratio has been relatively stable.
This indicates that inventories are a significant problem for BW.

19. Financial Leverage Ratios
Debt-to-Equity
Total Debt
Shareholders’ Equity
For Basket Wonders December 31, 2003
Balance Sheet Ratios
Financial Leverage
Ratios
Shows the extent to which the firm is financed by debt.
$1,030
$1,139
= .90

20. Financial Leverage Ratio Comparisons
Debt-to-Equity Ratio
Year
2003
2002
2001
BW Industry
BW has average debt utilization
relative to the industry average.

21. Financial Leverage Ratios
Debt-to-Total-Assets
Total Debt
Total Assets
For Basket Wonders December 31, 2003
Balance Sheet Ratios
Financial Leverage
Ratios
Shows the percentage of the firm’s assets that are supported by debt financing.
$1,030
$2,169
= .47

22. Financial Leverage Ratio Comparisons
Debt-to-Total-Asset Ratio
Year
2003
2002
2001
BW Industry
BW has average debt utilization
relative to the industry average.

23. Financial Leverage Ratios
Total Capitalization
Total Debt
For Basket Wonders December 31, 2003
Balance Sheet Ratios
(i.e., LT-Debt + Equity)
Financial Leverage
Ratios
Shows the relative importance of long-term debt to the long-term financing of the firm.
$1,030
$1,669
= .62

24. Financial Leverage Ratio Comparisons
Total Capitalization Ratio
Year
2003
2002
2001
BW Industry
BW has average long-term debt utilization
relative to the industry average.

25. Coverage Ratios Interest Coverage
EBIT
Interest Charges
For Basket Wonders December 31, 2003
Income Statement
Ratios
Coverage Ratios
Indicates a firm’s ability to cover interest charges.
$210
$59
= 3.56

26. Coverage Ratio Comparisons
Interest Coverage Ratio
Year
2003
2002
2001
BW Industry
BW has below average interest coverage
relative to the industry average.

27. Coverage Ratio -- Trend Analysis Comparison

28. Summary of the Coverage Trend Analysis
The interest coverage ratio for BW has been falling since It has been below industry averages for the past two years.
This indicates that low earnings (EBIT) may be a potential problem for BW.
Note, we know that debt levels are in line with the industry averages.

29. Annual Net Credit Sales For Basket Wonders December 31, 2003
Activity Ratios
Receivable Turnover
Annual Net Credit Sales
Receivables
For Basket Wonders December 31, 2003
Income Statement /
Balance Sheet
Ratios
(Assume all sales are credit sales.)
Activity Ratios
Indicates quality of receivables and how successful the firm is in its collections.
$2,211
$394
= 5.61

30. Activity Ratios Avg Collection Period Income Statement / Balance Sheet
Days in the Year
Receivable Turnover
For Basket Wonders December 31, 2003
Income Statement /
Balance Sheet
Ratios
Activity Ratios
Average number of days that receivables are outstanding.
(or RT in days)
365
5.61
= 65 days

31. Activity Ratio Comparisons
Average Collection Period
Year
2003
2002
2001
BW Industry
BW has improved the average collection
period to that of the industry average.

32. Activity Ratios Payable Turnover (PT) Income Statement / Balance Sheet
Annual Credit Purchases
Accounts Payable
For Basket Wonders December 31, 2003
Income Statement /
Balance Sheet
Ratios
(Assume annual credit
purchases = $1,551.)
Activity Ratios
Indicates the promptness of payment to suppliers by the firm.
$1551
$94
= 16.5

33. Activity Ratios PT in Days Income Statement / Balance Sheet
Days in the Year
Payable Turnover
For Basket Wonders December 31, 2003
Income Statement /
Balance Sheet
Ratios
Activity Ratios
Average number of days that payables are outstanding.
365
16.5
= 22.1 days

34. Activity Ratio Comparisons
Payable Turnover in Days
Year
2003
2002
2001
BW Industry
BW has improved the PT in Days.
Is this good?

35. For Basket Wonders December 31, 2003
Activity Ratios
Inventory Turnover
Cost of Goods Sold
Inventory
For Basket Wonders December 31, 2003
Income Statement /
Balance Sheet
Ratios
Activity Ratios
Indicates the effectiveness of the inventory management practices of the firm.
$1,599
$696
= 2.30

36. Activity Ratio Comparisons
Inventory Turnover Ratio
Year
2003
2002
2001
BW Industry
BW has a very poor inventory turnover ratio.

37. Inventory Turnover Ratio --Trend Analysis Comparison

38. For Basket Wonders December 31, 2003
Activity Ratios
Total Asset Turnover
Net Sales
Total Assets
For Basket Wonders December 31, 2003
Income Statement /
Balance Sheet
Ratios
Activity Ratios
Indicates the overall effectiveness of the firm in utilizing its assets to generate sales.
$2,211
$2,169
= 1.02

39. Activity Ratio Comparisons
Total Asset Turnover Ratio
Year
2003
2002
2001
BW Industry
BW has a weak total asset turnover ratio.
Why is this ratio considered weak?

40. Profitability Ratios Gross Profit Margin Income Statement /
Net Sales
For Basket Wonders December 31, 2003
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
Indicates the efficiency of operations and firm pricing policies.
$612
$2,211
= .277

41. Profitability Ratio Comparisons
Gross Profit Margin
Year
2003
2002
2001
BW Industry
27.7% 31.1%
BW has a weak Gross Profit Margin.

42. Gross Profit Margin -- Trend Analysis Comparison

43. For Basket Wonders December 31, 2003
Profitability Ratios
Net Profit Margin
Net Profit after Taxes
Net Sales
For Basket Wonders December 31, 2003
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
Indicates the firm’s profitability after taking account of all expenses and income taxes.
$91
$2,211
= .041

44. Profitability Ratio Comparisons
Net Profit Margin
Year
2003
2002
2001
BW Industry
4.1% 8.2%
BW has a poor Net Profit Margin.

45. Net Profit Margin -- Trend Analysis Comparison

46. For Basket Wonders December 31, 2003
Profitability Ratios
Return on Investment
Net Profit after Taxes
Total Assets
For Basket Wonders December 31, 2003
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
Indicates the profitability on the assets of the firm (after all expenses and taxes).
$91
$2,160
= .042

47. Profitability Ratio Comparisons
Return on Investment
Year
2003
2002
2001
BW Industry
4.2% %
BW has a poor Return on Investment.

48. Return on Investment – Trend Analysis Comparison

49. For Basket Wonders December 31, 2003
Profitability Ratios
Return on Equity
Net Profit after Taxes
Shareholders’ Equity
For Basket Wonders December 31, 2003
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
Indicates the profitability to the shareholders of the firm (after all expenses and taxes).
$91
$1,139
= .08

50. Profitability Ratio Comparisons
Return on Equity
Year
2003
2002
2001
BW Industry
8.0% 17.9%
BW has a poor Return on Equity.

51. Return on Equity -- Trend Analysis Comparison