FINANCIAL STATEMENTS

AND RATIO ANALYSIS

FINANCIAL MANAGEMENT
Be inspired…char…

“It is a capital mistake to theorize before one

has data.”
- Sherlock Holmes, my idol

“The goal is to turn data into information, and

information into insight.”
- Carly Florina, former executive, president, and chair of
Hewlett-Packard Co.
LEARNING GOALS
 Review the contents of the stockholders’
report and the procedure for consolidating
international financial statements.

 Understand who uses financial ratios and

how.

 Use ratio to analyze a firm’s liquidity and

activity.
LEARNING GOALS (cont.)

 Discuss the relationship between debt and financial

leverage and the ratios used to analyze a firm’s
debt.

 Use ratios to analyze a firm’s profitability and its

market value.

 Use a summary of financial ratios and the DuPont

system of analysis to perform a complete ratio
analysis.
STOCKHOLDERS’ REPORT

 A STOCKHOLDERS’ REPORT is annual

report that publicly owned corporations
must provide to stockholders; it
summarizes and documents the firm’s
financial activities during the past year.
STOCKHOLDERS’ REPORT (cont.)

 GAAP or Generally Accepted Accounting

Principles. The practice and procedure
guidelines used to prepare and maintain
financial records and reports; authorized
by the Financial Accounting Standards
Board (FASB)
STOCKHOLDERS’ REPORT (cont.)

 FINANACIAL ACCOUNTING STANDARDS

BOARD or FASB. The accounting
profession’s rule-setting body, which
authorizes GAAP.
Sarbanes-Oxley Act of 2002

 The Sarbanes-Oxley Act of 2002, passed

to eliminate the many disclosure and
conflict of interest problems of
corporations, established the Public
Company Accounting Oversight Board
(PCAOB), which is a not-for-profit
corporation that oversees auditors.
 TRIVIA:

 IF SOMEONE KNOWS, A REWARD IS WAITING…

THE SARBANES-OXLEY ACT OF 2002 IS NAMED

AFTER… WHO ARE THEY?

Senator Paul Sarbanes and Congressman

Michael Oxley, sponsors of the said act.
PCAOB

 The PCAOB is charged with protecting

the interests of investors and
furthering the public interest in the
preparation of informative, fair, and
independent audit reports.
 Global Focus
 More Countries Adopt International Financial Reporting
Standards
 International Financial Reporting Standards (IFRS) are
established by the International Accounting Standards
Board (IASB).
 More than 80 countries now require listed firms to
comply with IFRS, and dozens more permit or require
firms to follow IFRS to some degree.
 In the United States, public companies are required to
report financial results using GAAP, which requires more
detail than IFRS.
 Focus on Ethics

 Take Earnings Reports at Face Value

 Near the end of each quarter, many companies
unveil their quarterly performance.
 Firms that beat analyst estimates often see
their share prices jump, while those that miss
estimates by even a small amount, tend to
suffer price declines.
 The practice of manipulating earnings in order
to mislead investors is known as earnings
management.
STOCKHOLDERS’ REPORT (cont.)

 The LETTER TO STOCKHOLDERS.

Typically, the first element of the annual
stockholders’ report and the primary
communication from management.
THE FOUR KEY FINANCIAL STATEMENTS

 INCOME STATEMENT

 BALANCE SHEET

 STATEMENT OF STOCKHOLDERS’
EQUITY

 STATEMENT OF CASH FLOWS

Be inspired…char again…

“You can have data without information,

but you cannot have information without
data.”
-Daniel Keys Moran, an American computer programmer
and science fiction writer
INCOME STATEMENT

 Provides a financial summary of the firm’s

operating results during a specified period.
 Although they are prepared quarterly for
reporting purposes, they are generally
computed monthly by management and
quarterly for tax purposes.
 Fiscal
 Calendar
Table 3.1 Bartlett Company Income
Statements ($000)
BALANCE SHEET
 Summary statement of the firm’s
financial position at a given period in
time.

 Composed of:
>Assets: current and noncurrent
>Liabilities: current and noncurrent
>Stockholder’s Equity
HOTEL?.......trivia

 Whatis the most liquid asset

account in the balance sheet?

CASH
Table 3.2 Bartlett Company Balance Sheets
($000)
Table 3.2 Bartlett Company Balance
Sheets ($000) (cont.)
STATEMENT OF RETAINED EARNINGS

The statement of retained earnings

reconciles the net income earned
during a given year, and any cash
dividends paid, with the change in
retained earnings between the start
and the end of that year.
Table 3.3 Bartlett Company Statement of
Retained Earnings ($000) for the Year Ended
December 31, 2015
 STATEMENT OF CASH FLOWS
 The statement of cash flows provides a summary of
the firm’s operating, investment, and financing cash
flows and reconciles them with changes in its cash
and marketable securities during the period.

 This statement not only provides insight into a

company ’ s investment, financing and operating
activities, but also ties together the income
statement and previous and current balance sheets.
Table 3.4 Bartlett Company Statement of Cash Flows
($000) for the Year Ended December 31, 2015
Using Financial Ratios:
Interested Parties
 Ratio analysis involves methods of
calculating and interpreting financial
ratios to analyze and monitor the firm’s
performance.

“The goal is to turn data into information, and

information into insight.”
- Carly Florina, former executive, president, and chair of
Hewlett-Packard Co.
 Interested parties:
• Current and prospective shareholders are interested in
the firm’s current and future level of risk and return,
which directly affect share price.
• Creditors are interested in the short-term liquidity of
the company and its ability to make interest and
principal payments.
• Management is concerned with all aspects of the firm’s
financial situation, and it attempts to produce financial
ratios that will be considered favorable by both owners
and creditors.
Using Financial Ratios:
Types of Ratio Comparisons

 Cross-sectional analysis is the comparison of

different firms ’ financial ratios at the same
point in time; involves comparing the firm’s
ratios to those of other firms in its industry or
to industry averages
 Benchmarking is a type of cross-sectional
analysis in which the firm’s ratio values are
compared to those of a key competitor or
group of competitors that it wishes to
emulate.
Table 3.5 Financial Ratios for Select
Firms and Their Industry Median Values
Using Financial Ratios:
Types of Ratio Comparisons (cont.)

 Time-series analysis is the evaluation of the

firm’s financial performance over time using
financial ratio analysis
 Comparison of current to past performance,
using ratios, enables analysts to assess the
firm’s progress.
 Developing trends can be seen by using
multiyear comparisons.
Ang pangutana!

 What’s the most informative type of

ratio comparison? Is it the cross-
sectional analysis or the time series
analysis?
Using Financial Ratios:
Types of Ratio Comparisons (cont.)

 Themost informative approach to ratio

analysis combines cross-sectional
and time-series analysis.
 Pooled Data.
Pooled data.
LET’S START!!!

 MIGHT WANT TO GET YOUR

CALCULATOR, A PIECE OF PAPER AND
A PEN.
Nevertheless, in some other books and
reference…
There are five categories of Financial Ratios:
>LIQUIDITY AND SOLVENCY RATIOS
>DEBT/FINANCIAL LEVERAGE RATIOS
>ACTIVITY/TURNOVER/EFFICIENCY RATIOS
>PROFITABILITY RATIOS
>MARKET VALUE RATIOS
Nevertheless, in some other books and
reference…

Liquidity Solvency
FOCUS ON A FIRM’S ABILITY
TO PAY ITS SHORT-TERM
OBLIGATIONS
ABILITY OF COMPANY
DATA NEEDED TO CALCULATE RATIOS TO PAY ITS LONG-
CAN BE FOUND IN BALANCE SHEET: TERM OBLIGATIONS
ASSETS, LIABILITIES, AND RETAINED
EARNINGS
Nevertheless, in some other books and
reference…
 FINANCIAL LEVERAGE RATIOS OR DEBT RATIOS

USE THE FIRM’S LONG TERM LIABILITIES

INDICATES HOW MUCH DEBT THE FIRM IS

USING TO PURCHASE ASSETS

SHOWS IF COMPANY USES DEBT OR EQUITY

FINANCING
Nevertheless, in some other books and
reference…

 PROFITABILITY RATIOS

 FREQUENTLY USED DATA ARE THE NET PROFIT

RATIO AND THE CONTRIBUTION RATIO
 THE CONTRIBUTION MARGIN RATIO INDICATES
IF PRODUCTS OR SERVICES ARE GENERATING
PROFIT AFTER VARIABLE EXPENSES
Nevertheless, in some other books and
reference…
 TURNOVER/EFFICIENCY/ACTIVITY RATIOS

USES THE INFORMATION FOUND ON BOTH THE

INCOME STATEMENT AND BALANCE SHEET

DESCRIBE HOW WELL THE BUSINESS IS

BEING MANAGED
INDICATE HOW FAST COMPANY IS SELLING, HOW
LONG CUSTOMERS TAKE TO PAY, OR HOW LONG
IS CAPITAL TIED UP TO INVENTORY
Nevertheless, in some other books and
reference…

 MARKET VALUE RATIOS

 USED TO EVALUATE CURRENT SHARE PRICE

OF A PUBLICLY-HELD COMPANY’S STOCK
 EMPLOYED BY CURRENT AND POTENTIAL
INVESTORS TO DETERMINE WHETHER A
COMPANY’S SHARES ARE OVER- OR UNDER-
PRICED
Chaka na dis…
LIQUIDITY RATIO:
CURRENT RATIO
 Current assets ÷ Current liabilities
The current ratio for Bartlett Company in 2015 is:

$1,223,000 ÷ $620,000 = 1.97

Test of short-term debt-paying ability

LIQUIDITY RATIO:
ACID-TEST (QUICK) RATIO
 (Current assets - inventory) ÷ Current liabilities

The quick ratio for Bartlett Company in 2015 is:

Test of short-term debt-paying ability

without having to rely on inventory
 LIQUIDITY RATIO:
ACID-TEST (QUICK) RATIO
The importance of inventories:
 From Table 3.5:

 All three firms have current ratios of 1.3. However, the

quick ratios for Home Depot and Lowes are dramatically
lower than their current ratios, but for Dell the two
ratios are nearly the same. Why?
ACTIVITY RATIO:
INVENTORY TURNOVER RATIO
 Cost of Goods Sold ÷ Inventory

Applying this relationship to Bartlett Company in 2015

yields:

$2,088,000 ÷ $289,000 = 7.2

Measure of how many times a

company’s inventory has been sold during the
year
ACTIVITY RATIO: AVERAGE SALE
PERIOD/ AVERAGE AGE OF
INVENTORY (turnover in days)
 365 days ÷ Inventory turnover

For Bartlett Company, the average age of inventory in 2015 is:

365 ÷ 7.2 = 50.7 days

Measure of the average number of days

taken to sell the inventory one time
 ACTIVITY RATIO: AVERAGE
COLLECTION PERIOD (AGE OF RECEIVABLES)

Accounts Receivable ÷ Average Sales per Day

Accounts Receivable ÷ Annual Sales/365

Measure of the average number of days taken

to collect an account receivable
ACTIVITY RATIO: AVERAGE COLLECTION
PERIOD (AGE OF RECEIVABLES)

 Theaverage collection period for Bartlett

Company in 2015 is:
ACTIVITY RATIO: AVERAGE
PAYMENT PERIOD

 Accounts Payable ÷ Average Purchases per day

or
Accounts Payable ÷ Annual Purchases/365

Average amount of time needed to

pay accounts payable.
ACTIVITY RATIO: AVERAGE
PAYMENT PERIOD

If we assume that Bartlett Company’s purchases

equaled 70 percent of its cost of goods sold in
2015, its average payment period is:
ACTIVITY RATIO:
TOTAL ASSET TURNOVER
 Sales ÷ Total Assets
The value of Bartlett Company’s total asset turnover in
2015 is:

$3,074,000 ÷ $3,597,000 = 0.85

indicates the efficiency with which the

firm uses its assets to generate sales.
 DEBT RATIOS

 Total Liabilities ÷ Total Assets

The debt ratio for Bartlett Company in 2015 is

$1,643,000 ÷ $3,597,000 = 0.457 = 45.7%

Measures the proportion of total assets

financed by the firm’s creditors.
DEBT RATIO: DEBT-TO-EQUITY
RATIO
 Total liabilities ÷ Stockholders’ equity

The debt-to-equity ratio for Bartlett Company in 2015 is

$1,643,000 ÷ $1,754,000 = 0.937 = 93.7%

Measure of the amount of assets

being provided by creditors for each dollar of
assets being provided by the stockholders
 DEBT RATIO: TIMES INTEREST
EARNED RATIO
= EBIT ÷ interest expense
The figure for earnings before interest and taxes
(EBIT) is the same as that for operating profits
shown in the income statement.
Applying this ratio to Bartlett Company yields the
following
2015 value:
$418,000 ÷ $93,000 = 4.49

Measure of the company’s ability to

make interest payments
 DEBT RATIO: FIXED-PAYMENT
COVERAGE RATIO
 Earnings before interest and taxes + Lease Payments
÷
Interest + Lease Payments + ((Principal payments +
Preferred Stock Dividends) X (1/(1-T)))

Measures the firm’s ability to meet all fixed-

payment obligations.
PROFITABILITY RATIO:
GROSS MARGIN PERCENTAGE

 Gross margin ÷ Sales

Bartlett Company’s gross profit margin for 2015 is:

A broad measure of profitability

 OPERATING PROFIT MARGIN

 Operating Profit ÷ Sales

Bartlett Company’s operating profit margin for 2015 is:

$418,000 ÷ $3,074,000 = 13.6%

Measures the percentage of each sales

dollar remaining after all costs and expenses other
than interest, taxes, and preferred stock dividends
are deducted.
 PROFITABILITY: NET PROFIT MARGIN

 (Net income – Preferred dividends) ÷ Sales

Bartlett Company’s net profit margin for 2015 is:

$221,000 ÷ $3,074,000 = 0.072 = 7.2%

Measures the percentage of each sales dollar

remaining after all cost and expenses including interest,
taxes, and preferred stock dividends, have been
deducted.
PROFITABILITY: EARNINGS PER
SHARE
 (Netincome – Preferred dividends) ÷
Average number of common shares
outstanding

Tends to have an effect on the

market price per share, as reflected in the
price-earnings ratio
Earnings per share

Bartlett Company’s earnings per share (EPS) in

2015 is:

$221,000 ÷ 76,262 = $2.90

PROFITABILITY: DIVIDENDS PER
SHARE
 Dividendspaid to common stockholders ÷
Number of shares of common stock
outstanding

the amount of cash distributed

during the period on behalf of each
outstanding share of common stock.
PROFITABILITY: RETURN ON
TOTAL ASSETS
 NetIncome + [Interest expense X (1 –
Tax Rate)] ÷ Average total assets

Measure of how well assets have

been employed by management
PROFITABILITY: RETURN ON TOTAL
ASSETS
Bartlett Company’s return on total assets in 2015
is:

$221,000 ÷ $3,597,000 = 0.061 = 6.1%

Return on total assets (ROA) = Earnings available

for common stockholders ÷ Total assets
PROFITABILITY: RETURN ON
COMMON STOCKHOLDERS’ EQUITY

 (Net
income – Preferred dividends) ÷
Average common stockholders’ equity

When compared to the return

on total assets, measures the extent to
which financial leverage is working for or
against common stockholders
PROFITABILITY: RETURN ON
COMMON STOCKHOLDERS’ EQUITY
Return on Equity (ROE) = Earnings
available for common stockholders ÷
Common stock equity

This ratio for Bartlett Company in 2015 is:

$221,000 ÷ $1,754,000 = 0.126 = 12.6%

Hala ka bright!!!
MARKET RATIO:
PRICE-EARNINGS RATIO
 Market price per share ÷ Earnings per share

If Bartlett Company’s common stock at the end of

2015 was selling at $32.25, using the EPS of $2.90,
the P/E ratio at
year-end 2015 is:
$32.25 ÷ $2.90 = 11.12

An index of whether a stock is

relatively cheap or relatively expensive in relation
to current earnings
MARKET/BOOK RATIO

 Market Price per share ÷ Book Value per share

$32.25 ÷ $23.00 = 1.40
Provides an assessment of how
investors view the firm’s performance.
 MARKET RATIO: BOOK VALUE
PER SHARE
 Common stock equity ÷ number of shares of common stock
outstanding
Substituting the appropriate values for Bartlett
Company from its 2015 balance sheet, we get:

Measures the amount that would be distributed to holders of

common stock if all assets were sold at their balance sheet
carrying amounts and if all creditors were paid off
DuPONT SYSTEM OF ANALYSIS

 Used to dissect the firm’s financial

statements and to assess its financial
condition.
 Merges the income statement and
balance sheet into two summary
measures of profitability, return on
total assets (ROA) and return on
common equity (ROE).
 DuPONT FORMULA

 Multiplies
the firm’s net profit margin by its
total asset turnover to calculate the firm’s
return on total assets (ROA).

ROA= Net profit margin x Total asset

turnover
 DuPONT FORMULA
To simplify:
ROA= (earnings available for common stockholders/sales)
x (sales/total assets)
(earnings available for common stockholders/total assets)

When the 2015 values of the net profit margin and total asset turnover
for Bartlett Company, calculated earlier, are substituted into the DuPont
formula, the result is:

ROA = 7.2%  0.85 = 6.1%

MODIFIED DuPONT FORMULA

 Relatesthe firm’s return on total

assets (ROA) to its return on equity
(ROE) using the financial leverage
multiplier (FLM).

 Financialleverage multiplier (FLM) is

the ratio of the firm’s total assets to its
common stock equity.
 MODIFIED DuPONT FORMULA
ROE = ROA X FLM
OR to simplify:
ROE= (earnings available for common stockholders/total assets)
X (Total assets/common stock equity)
(earnings available for common stockholders/common
stock equity)

Substituting the values for Bartlett Company’s ROA of 6.1 percent,

calculated earlier, and Bartlett’s FLM of 2.051 ($3,597,000 total assets ÷
$1,754,000 common stock equity) into the modified DuPont formula yields:
ROE = 6.1%  2.051 = 12.5%
STOP!!! CAUTION!!!

 Ratios that reveal large deviations from the

norm merely indicate the possibility of a
problem.
 A single ratio does not generally provide
sufficient information from which to judge the
overall performance of the firm.
 The ratios being compared should be calculated
using financial statements dated at the same
point in time during the year.
STOP!!! CAUTION!!!

 It is preferable to use audited financial

statements.
 The financial data being compared should
have been developed in the same way.
 Results can be distorted by inflation.
What is this?
Be inspired…

“Things get done only if data we gather can

inform and inspire those in a position to make
a difference.”
- Mike Schmoker, English teacher and football coach, author
I hope you’ve learned something. If
none, IBALIK ANG SNACKS!!!