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

2. 3-2 Chapter Outline Cash Flows and Financial Statements: A Closer Look Standardized Financial Statements Ratio Analysis The DuPont Identity Using Financial Statement Information

3. 3-3 Chapter Outline Cash Flows and Financial Statements: A Closer Look Standardized Financial Statements Ratio Analysis The DuPont Identity Using Financial Statement Information

4. 3-4 Sample Balance Sheet 2011201020112010 Cash69658A/P307303 A/R956992N/P26119 Inventory301361Other CL1,6621,353 Other CA303264Total CL1,9951,775 Total CA2,2561,675LT Debt8431,091 Net FA3,1383,358C/S2,5562,167 Total Assets 5,3945,033Total Liab. & Equity 5,3945,033 XYZ Corporation December 31, 201X (Figures in millions of dollars)

5. 3-5 Sample Income Statement Revenues$5,000 Cost of Goods Sold(2,006) Expenses(1,740) Depreciation(116) EBIT1,138 Interest Expense(7) Taxable Income1,131 Taxes (442) Net Income$689 EPS$3.61 Dividends per share$1.08 XYZ Corporation January 1 – December 31, 201X ( Figures in millions of dollars)

6. 3-6 Sources and Uses of Cash Sources Cash inflow – occurs when we “sell” something and we add to the cash account Decrease in asset account Accounts receivable, inventory, and net fixed assets Increase in liability or equity account Accounts payable, other current liabilities, and common stock

7. 3-7 Sources and Uses of Cash Uses Cash outflow – occurs when we “buy” something Increase in asset account Cash and other current assets Decrease in liability or equity account Notes payable and long-term debt

8. 3-8 Statement of Cash Flows Statement that summarizes the sources and uses of cash

9. 3-9 Statement of Cash Flows Changes divided into three major categories: 1.Operating Activity – includes net income and changes in most current accounts 2.Investment Activity – includes changes in fixed assets 3.Financing Activity – includes changes in notes payable, long-term debt, and equity accounts, as well as dividends

10. 3-10 Sample Statement of Cash Flows Cash, beginning of year58 Financing Activity Operating Activity Decrease in Notes Payable-93 Net Income689 Decrease in LT Debt-248 Plus: Depreciation116 Decrease in C/S (minus RE)-94 Decrease in A/R36 Dividends Paid-206 Decrease in Inventory60 Net Cash from Financing-641 Increase in A/P4 Increase in Other CL309 Net Increase in Cash638 Less: Increase in other CA-39 Net Cash from Operations1,175 Cash End of Year696 Investment Activity Sale of Fixed Assets104 Net Cash from Investments104 (Numbers in millions of dollars)

11. 3-11 Chapter Outline Cash Flows and Financial Statements: A Closer Look Standardized Financial Statements Ratio Analysis The DuPont Identity Using Financial Statement Information

12. 3-12 Standardized Financial Statements Standardized statements make it easier to compare financial information, particularly as the company grows They are also useful for comparing companies of different sizes, particularly within the same industry

13. 3-13 Standardized Financial Statements Common-Size Balance Sheets: Compute all accounts as a percent of total assets Common-Size Income Statements: Compute all line items as a percent of sales

14. 3-14 Chapter Outline Cash Flows and Financial Statements: A Closer Look Standardized Financial Statements Ratio Analysis The DuPont Identity Using Financial Statement Information

15. 3-15 Ratio Analysis The goal of ratio analysis is to take the numerous lines from both the income statement and balance sheet and to interpret this information in a meaningful way. There is simply too much information to grasp at one time.

16. 3-16

17. 3-17 Ratio Analysis Ratios are simply the construction of a numerator Numerator____________Denominator and a denominator using data from a balance sheet and/or an income statement.

18. 3-18 Ratio Analysis Ratios allow for better comparison through time or between companies As we look at each ratio, ask yourself what the ratio is trying to measure and why that information is important?

19. 3-19 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

20. 3-20 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

21. 3-21 Sample Balance Sheet 2011201020112010 Cash 696 58A/P307303 A/R956992N/P26119 Inventory 301 361Other CL1,6621,353 Other CA303264 Total CL 1,995 1,775 Total CA 2,256 1,675LT Debt8431,091 Net FA3,1383,358C/S2,5562,167 Total Assets 5,3945,033Total Liab. & Equity 5,3945,033 XYZ Corporation December 31, 201X (Figures in millions of dollars)

22. 3-22 Computing Liquidity Ratios Current Ratio = CA / CL 2,256 / 1,995 = 1.13 times Quick Ratio = (CA – Inventory) / CL (2,256 – 301) / 1,995 =.98 times

23. 3-23 Sample Income Statement Revenues$5,000 Cost of Goods Sold (2,006) Expenses (1,740) Depreciation(116) EBIT1,138 Interest Expense(7) Taxable Income1,131 Taxes (442) Net Income$689 EPS$3.61 Dividends per share$1.08 XYZ Corporation January 1 – December 31, 201X ( Figures in millions of dollars)

24. 3-24 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

25. 3-25 Sample Balance Sheet 2011201020112010 Cash69658A/P307303 A/R956992N/P26119 Inventory301361Other CL1,6621,353 Other CA303264Total CL1,9951,775 Total CA2,2561,675 LT Debt 8431,091 Net FA3,1383,358 C/S2,556 2,167 Total Assets 5,394 5,033Total Liab. & Equity 5,3945,033 XYZ Corporation December 31, 201X (Figures in millions of dollars)

26. 3-26 Computing Long-term Solvency Ratios Total Debt Ratio = (TA – TE) / TA (5,394 – 2,556) / 5,394 = 52.61% Debt/Equity = TD / TE (5,394 – 2,556) / 2,556 = 1.11 times

27. 3-27 Sample Balance Sheet 2011201020112010 Cash69658A/P307303 A/R956992N/P26119 Inventory301361Other CL1,6621,353 Other CA303264Total CL1,9951,775 Total CA2,2561,675 LT Debt 843 1,091 Net FA3,1383,358 C/S2,556 2,167 Total Assets 5,394 5,033Total Liab. & Equity 5,3945,033 XYZ Corporation December 31, 201X (Figures in millions of dollars)

28. 3-28 Computing Long-term Solvency Ratios Equity Multiplier = EM = TA / TE = 1 + D/E 1 + 1.11 = 2.11

29. 3-29 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

30. 3-30 Sample Income Statement Revenues$5,000 Cost of Goods Sold(2,006) Expenses(1,740) Depreciation(116) EBIT1,138 Interest Expense(7) Taxable Income1,131 Taxes (442) Net Income$689 XYZ Corporation January 1 – December 31, 201X ( Figures in millions of dollars)

31. 3-31 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

32. 3-32 Computing Profitability Measures Profit Margin = PM = Net Income / Sales 689 / 5,000 = 13.78% Return on Assets (ROA) = Net Income / Total Assets 689 / 5,394 = 12.77% Return on Equity (ROE) = Net Income / Total Equity 689 / 2,556 = 26.96%

33. 3-33 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

34. 3-34 Computing Market Value Measures If the Market Price = $87.65 per share and if the number of shares of common stock outstanding is: 190.9 million, Then the PE Ratio = Price per share / Earnings per share 87.65 / 3.61 = 24.28 times

35. 3-35 Computing Market Value Measures If the Market Price = $87.65 per share and If the number of shares of common stock outstanding is: 190.9 million, and the book value of the equity is $2,556, Then the Market-to-book ratio = Market value per share / book value per share 87.65 / 3.61 = 24.28 times

36. 3-36 Computing Market Value Measures The Price/Earnings (P/E) ratio focuses on the market price of a share of stock and compares it to the Net Earnings of a company.

37. 3-37 Work the Web The Internet makes ratio analysis much easier than it has been in the past Click on the web surfer to go to www.reuters.com www.reuters.com Click on Stocks, then choose a company and enter its ticker symbol Click on Ratios to see what information is available