5/6/2023

Fundamentals of
Corporate Finance
Subject code: FIN202

Lecturer: Huyen Nguyen, Ph.D. Faculty of Business – FPT University

CHAPTER 3 REVIEW
1. DEFINE THE BALANCE SHEET.
A balance sheet provides a summary of a firm's financial
position at a particular point in time.
⋆ The balance sheet identity:
Total assets = Total liabilities + Total stockholders' equity.

2. EXPLAIN WHY A BALANCE SHEET MUST BALANCE.

The balance sheet must always balance because the owners get
what is left over after all creditors have been paid.
Total stockholders' equity = Total assets−Total liabilities

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CHAPTER 3 REVIEW
3. DESCRIBE HOW MARKET-VALUE BALANCE SHEETS
DIFFER FROM BOOK-VALUE BALANCE SHEETS.
- Book value is the amount a firm paid for its assets at the
time of purchase.
- Current market value of an asset is the amount that a firm
would receive for the asset if it were sold on the open
market (not in a forced liquidation).
 Most managers and investors are more concerned about
future profit than the cost in the past. Thus, marked-to-
market balance sheets are more helpful in showing a
company's true financial.

CHAPTER 3 REVIEW
4. IDENTIFY THE BASIC EQUATION FOR THE INCOME
STATEMENT AND THE INFORMATION IT PROVIDES.
- An income statement identifies the major sources of
revenues and expenses needed to generate those revenues,
along with a firm's profit or loss for a period of time.
- The equation for the income statement:
Net income = Revenues − Expenses.
 Net profit or net income is the most comprehensive
accounting measure of a firm's performance.

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CHAPTER 3 REVIEW
5. IDENTIFY MAIN OPERATIONS OF A FIRM
PRESENTING IN THE STATEMENT OF CASH FLOWS.
- Net cash flows from Operating activities: related to a firm's
principal business activities. The most important items are
the firm's net income, depreciation and amortization
expense, and working capital accounts.
- Net cash flows from Long-term investing activities relate
to the buying and selling of long-term assets.
- Net cash flows from Financing activities occur when cash
is obtained from or repaid to creditors or owners
(stockholders).

CHAPTER 3 REVIEW
6. EXPLAIN THE ROLE OF STATEMENT OF CASH-FLOW.
HOW IS IT RELATED TO OTHER STATEMENTS?
- The key financial statement that ties together the other
three statements is the statement of cash flows.
- The statement of cash flows summarizes changes in the
balance sheet from the beginning of the year to the end.
- These changes reflect the information in the income
statement and in the statement of retained earnings.

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CHAPTER 3 REVIEW
7. IDENTIFY THE CASH FLOW TO A FIRM'S INVESTORS
USING ITS FINANCIAL STATEMENTS.
- Cash flow to investors is the cash flow that a firm
generates in a given period, excluding cash inflows from
new equity sales or long-term debt issues.
- Calculation formula

CFI = CFOA – CFNWC - CFLTA

• CFI: Cash Flow to Investors
• CFOA: Cash Flow Available to Investors from Operating Activities
• CFNWC: Cash Flow Invested in Net Working Capital
• CFLTA: Cash Flow Invested in Long-term Assets

Fundamentals of Corporate
Finance, 2/e

ROBERT PARRINO, PH.D.

DAVID S. KIDWELL, PH.D.
THOMAS W. BATES, PH.D.

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Chapter 4: Analyzing Financial

Statements

Chapter 4:
Analyzing Financial Statements
Background for financial
statements analysis

Common-size financial statements

Financial ratios & Firm performance

Dupont system: A diagnostic tool

MAIN Selecting a benchmark

CONTENT
Using financial ratios 10

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Learning Objectives
1. EXPLAIN THE THREE PERSPECTIVES FROM
WHICH FINANCIAL STATEMENTS CAN BE
VIEWED.
2. DESCRIBE COMMON-SIZE FINANCIAL
STATEMENTS, EXPLAIN WHY THEY ARE USED,
AND BE ABLE TO PREPARE AND USE THEM TO
ANALYZE THE HISTORICAL PERFORMANCE
OF A FIRM.

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Learning Objectives
3. DISCUSS HOW FINANCIAL RATIOS FACILITATE
FINANCIAL ANALYSIS, AND BE ABLE TO
COMPUTE AND USE THEM TO ANALYZE A
FIRM’S PERFORMANCE.
4. DESCRIBE THE DUPONT SYSTEM OF ANALYSIS
AND BE ABLE TO USE IT TO EVALUATE A
FIRM’S PERFORMANCE AND IDENTIFY
CORRECTIVE ACTIONS THAT MAY BE
NECESSARY.

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Learning Objectives
5. EXPLAIN WHAT BENCHMARKS ARE, DESCRIBE
HOW THEY ARE PREPARED, AND DISCUSS
WHY THEY ARE IMPORTANT IN FINANCIAL
STATEMENT ANALYSIS.
6. IDENTIFY THE MAJOR LIMITATIONS IN USING
FINANCIAL STATEMENT ANALYSIS.

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4.1.
Background for financial
statements analysis
- 3 perspectives to view the financial statements -

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PERSPECTIVES FOR ANALYSIS

Primary concerns: Primary concern: Primary concern:
- Value of their stock Feedback on the - Interest payments
- Cash from short-term impact - Principal payment
dividends their day-to-day
- Capital decisions have on

Managers

Creditors
Stockholders

Focus on:
appreciation the firm. - predictability of
revenues and
Focus on: Focus on: expenses
- Net cash flows - Rate of return - Ability to meet
- Risk - Efficient use of short-term
- Rate of return assets obligations
- Market value of - Controlling costs - Ability to make
firm’s stock - Increasing net loan payments as
cash flows scheduled
- Increasing market - No unanticipated
value of firm’s stock change in risk
- Job security

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IMPORTANT
GUIDELINES FOR
FINANCIAL STATEMENT ANALYSIS
Understand which perspective for:
stockholder, manager or creditor.

Use audited financial statements.

Perform a trend analysis (3-5 years).

Compare a firm’s financial statement with competitors

that are the same size, products, services.

Benchmark: firms compared in a same industry

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4.2.
Common-Size Financial Statements

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Common-Size Financial Statements

(Báo cáo tài chính theo tỉ trọng)

o COMMON-SIZE
. FINANCIAL STATEMENTS
• A financial statement in which each number is
expressed as a percentage of a base number,
such as total assets or net revenues (net sales)
• Meaning of Common-size financial statements:
 Easier to evaluate changes in a firm's performance
and financial condition over time.
 Better comparisons between the financial
statements of two firms that are different in size.

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Common-Size Financial Statements

(Báo cáo tài chính theo tỉ trọng)

o COMMON-SIZE
.
BALANCE SHEET
• Divide each of the asset accounts by total assets.
• Divide each of the liability and equity accounts by
total assets

o COMMON-SIZE INCOME STATEMENTS

• Express each account as a percentage of net sales
• Net sales are defined as total sales less all sales
discounts and sales returns and allowances.

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Common-Size Financial Statements

(Báo cáo tài chính theo tỉ trọng)

o COMMON-SIZE
. FINANCIAL STATEMENTS
• Show the dollar amount of each item as a
percentage of a reference value (total assets or
total revenues)
Common-size balance sheet may use total assets as the
reference value; each item is expressed as a percentage
of total assets.
Common-size income statement may use net sales as
the reference value; each item is expressed as a
percentage of net sales.

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Common-Size Financial Statements

o COMMON-SIZE BALANCE SHEET
• Standardizes the amount in a balance sheet
account by converting the dollar value of each
item to its percentage of total assets
Dollar values on a regular balance sheet provide
information on the number of dollars associated with a
balance sheet account.
Percentage values on a common-size balance sheet
provide information on the relative size or importance
of the dollars associated with a balance sheet account.

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Exhibit 4.1: Common-Size Balance

Sheets for Diaz Manufacturing

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Exhibit 4.2: Common-Size Income

Statements for Diaz Manufacturing

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4.3.
Financial ratios &
Firm performance

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Financial Ratios and Firm Performance

o RATIOS IN FINANCIAL ANALYSIS.
• Ratios establish a common reference point
across firms - even though the numerical value
of the reference point will differ from firm-to-
firm
Ratios make it easier to compare the performance of
large firms to that of small firms.
Ratios make it easier to compare the current and
historical performance of a single firm as the firm
changes over time.

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RATIOS IN FINANCIAL ANALYSIS

COMMON
ACROSS WITHIN
FINANCIAL
FIRMS AN INDUSTRY
RATIOS

Occupancy ratios Liquidity ratios

(hotel)

Efficiency ratios
Sales-per-square
foot (retailing)
Gross Margin Leverage ratios
Loans-to-assets
(banking)
Profitability ratios

Medical cost ratio Market Value

(health insurance) ratios

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CÁC CHỈ SỐ TÀI CHÍNH

SO SÁNH GIỮA SO SÁNH CÁC CHỈ SỐ

CÁC CÔNG TY DN CÙNG NGÀNH CƠ BẢN

Tỷ lệ Chỉ số
sử dụng phòng thanh khoản

Doanh số Chỉ số
bán hàng hiệu suất
trên mét vuông Biên lợi nhuận Chỉ số
gộp đòn bẩy tài chính
Tỷ số tổng nợ trên
tổng tài sản Chỉ số
lợi nhuận
Tỷ lệ chăm sóc y Chỉ số
tế (MRC) giá trị thị trường

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Financial Ratios and Firm Performance

o RATIOS USED VARY ACROSS FIRMS
• occupancy ratios (hotel)
• sales-per-square foot (retailing)
• loans-to-assets (banking)
• medical cost ratio (health insurance)

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Financial Ratios and Firm Performance

o RATIO VALUES VARY WITHIN AN INDUSTRY
• 2010 Gross Margin
Big Lots Target Walmart
40.6% 30.5% 24.9%

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Financial Ratios and Firm Performance

o CATEGORIES OF COMMON FINANCIAL RATIOS
• Liquidity ratios
• Efficiency ratios
• Leverage ratios
• Profitability ratios
• Market Value ratios

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Financial Ratios and Firm Performance

o LIQUIDITY RATIOS (CÁC CHỈ SỐ THANH KHOẢN)
(SHORT-TERM SOLVENCY RATIOS Chỉ số thanh toán ngắn hạn)
• Indicate a firm’s ability to pay short-term
obligations with short-term assets without
endangering the firm. In general, higher ratios
are a favorable indicator.

Tỷ số thanh toán hiện hành

Tỷ số thanh toán nhanh

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Financial Ratios and Firm Performance

o EFFICIENCY RATIOS
• Indicate a firm’s ability to use assets to produce
sales. These are also called asset turnover ratios
(Vòng quay tổng tài sản). In general, higher
numbers are a favorable indicator.
• These ratios also are valuable for a firm’s
investors who use the ratios to find out how
quickly a firm is selling its inventory and
converting receivables into cash flow for
investors.

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Financial Ratios and Firm Performance

o EFFICIENCY RATIOS

Cost of Goods Sold

Inventory Turnover  (4.3)
Inventory

(Vòng quay hàng tôn` kho)

Net Sales
Accounts Receivabl e Turnover  (4.5)
Accounts Receivabl e

(Vòng quay khoản phải thu)

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Financial Ratios and Firm Performance

o EFFICIENCY RATIOS
• For the efficiency ratio below, a lower number is
generally a positive signal

365 Days
Days' Sales in Inventory  (4.4)
Inventory Turnover
(Số ngày tồn kho trung bình)

365 Days
Days' Sales Outstandin g  (4.6)
Accounts Receivable Turnover
(Số ngày phải thu trung bình –
average collection period)

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Financial Ratios and Firm Performance

o EFFICIENCY RATIOS
o Total asset turnover measures the dollar
amount of sales generated with each dollar of
total assets.
o A common asset turnover ratio (fixed asset
turnover) measures sales per dollar invested in
fixed assets (plant or equipment).
Net Sales
Total Asset Turnover  (4.7)
Total Assets
Net Sales
Fixed Asset Turnover  (4.8)
Net Fixed Assets

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Financial Ratios and Firm Performance

o LEVERAGE (DEBT) RATIOS
• Indicate whether a firm is using the appropriate
amount of debt financing. In general, higher
ratios indicate greater potential return and
greater bankruptcy risk.
Total Debt
Total Debt Rati o  (4.9)
Total Assets
Total Debt
Debt - to - Equity  (4.10)
Total Equity
Total Assets
Equity Mul tiplier  (4.11)
Total Equity

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Financial Ratios and Firm Performance

o LEVERAGE (DEBT) RATIOS
• For Coverage ratios (tỷ suất năng lực trả nợ), a
higher number generally indicates less
bankruptcy risk and (possibly) lower potential
return
Times Interest Earned 
Earnings Before Interest & Taxes
(4.12)
Interest Expense
EBITDA
Cash Coverage  (4.13)
Interest Expense

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Financial Ratios and Firm Performance

o PROFITABILITY RATIOS
• Indicate whether a firm is generating adequate
profit from its assets. In general, higher ratios
indicate better performance.

Net Sales - Cost of Goods sold

Gross Profit Margin  (4.14)
Net Sales
EBIT
Operating Profit Margin  (4.15)
Net Sales

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Financial Ratios and Firm Performance

o PROFITABILITY RATIOS
• Indicate whether a firm is generating adequate
profit from its assets. In general, higher ratios
indicate better performance.
Net Income
Net Profit Margin  (4.16)
Net Sales
Net Income
Return on Assets  (4.18)
Total Assets
Net Income
Return on Equity  (4.19)
Total Equity

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Financial Ratios and Firm Performance

o MARKET VALUE RATIOS
• Indicate how the market is valuing the firm’s
equity. Higher ratios indicate greater
shareholder wealth.
Net Income
Earnings Per Share  (4.20)
Shares Outstanding
Price Per Share
Price - Earnings Ratio  (4.21)
Earnings Per Share
Price Per Share
Market - to - Book  (4.22)
Book Value of Equity Per Share

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Diaz Manufacturing Balance Sheets as

of December 31

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Diaz Manufacturing Income

Statements

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Exhibit 4.3: Ratios for Time-Trend

Analysis for Diaz Manufacturing

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4.4.
Dupont system: A diagnostic tool

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The DuPont System

o THE DUPONT SYSTEM
• Diagnostic tool for evaluating a firm’s financial
health
• Uses related ratios that link the balance sheet
and income statement
• Based on two equations that connect a firm’s
ROA and ROE
• Used by management and shareholders to
understand factors that drive ROE

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The DuPont System

• Calculate Dupont ratios: Return on assets (ROA)
and return on equity (ROE)
Step 1 • Assess the company's financial health

• Detect problems
• Find solutions
Step 2

• Monitor the firm's financial performance over time

• Look for benchmarks
Step 3

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The DuPont System

o THE DUPONT EQUATION
• In ratio form (Equation 4.26)
Net Income Net Sales Total Assets
ROE  * *
Net Sales Total Assets Total Equity
 Net Profit Margin * Total Asset Turnover * Equity Multiplier

• Shows that return-on-equity is driven by

profitability, operating efficiency, and amount of
leverage (debt)

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Applying the DuPont System

o THE DUPONT EQUATION TELLS US THAT A FIRM'S ROE IS
DETERMINED BY THREE FACTORS:

(1) Net profit margin:

the firm's operating
efficiency, interest
Net Profit
expense and taxes
Margin
(2) Total asset turnover:
the efficiency of asset Total
utilization Equity
Asset
Multiplier
(3) Equity multiplier: Turnover
the firm's use of
financial leverage.

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Exhibit 4.4: Two Basic Strategies to

Earn a Higher ROA

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Exhibit 4.5: Relations in the

DuPont System of Analysis

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4.5.
Selecting a benchmark

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Selecting a Benchmark
o BENCHMARK: A standard that will be the basis for
meaningful comparisons.

Trend Analysis
• Comparison to the firm’s historical performance
(at least 3-5 years)

Peer Group Analysis

• Comparison to a select group of firms in the
same industry

Industry Analysis
• Comparison to the aggregate of firms in the
same industry

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Selecting a Benchmark
o BENCHMARK RELEVANCE
• A ratio or a ratio analysis is relevant only when
compared to the appropriate benchmark(s).
Benchmarks may be used in combination.
Level and trend should be considered when evaluating
a firm’s performance and its future.

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4.6.
Using financial ratios

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Exhibit 4.6: Peer Group Ratios for

Diaz Manufacturing

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Exhibit 4.7: Peer Group Analysis

for Diaz Manufacturing

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Limitations of Financial Statement

Analysis
o FINANCIAL STATEMENT ANALYSIS
• Weaknesses
1. not an exact science
2. relies on accounting data and historical costs
3. few guidelines or principles for determining
whether a ratio is “high” or “low”, or is a
reason for confidence or for concern

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