Financial Statement Analysis

Financial Statement
Analysis
1
Financial Statement Analysis
(objectives)
 A good working knowledge of financial

statement is desirable because such a
statement and number derived from those
statement are primary means of
communicating financial information both
with the firm and out side the firm.
2
(objectives)
 Financial statement analysis is performance
by:-
 Stockholders : to measure management’s
performance.
 Creditors : to make their investment decisions.
 Management: to plan and control operation.
 And it is also an important tool for accountants and
financial analysts to use to better understand their
company's competitive position.
3
(objectives)
• Financial statements can be analyzed to

identify:-
– Trends in key financial data.
– Compare financial performance across
companies.
– Calculate financial ratios which can be used to
assess a company's current performance as well
as its prospects for the future.
• Financial statement users should be able to
find and interpret information to answer
questions about a company.
4
 Annual reports contain four basic financial

statements:-
• Balance Sheet.
• Statement of Stockholders’ Equity.
• Income Statement or Earnings Statement.
• Statement of Cash Flows.
5
The Financial Statements
The Balance Sheet
• Also called the statement of condition or the

statement of financial position.
• Shows the financial condition or financial position
of a company on a particular date.
– Prepared on a particular date at the end of an
accounting period
– End of accounting period can be the end of a calendar
year, fiscal year, or interim period such as a year, a
quarter, etc.
• Summarizes what the firm owns and what the firm
owes to outsiders and to internal owners.
6
The Balance Sheet
• Assets = Liabilities + Stockholders’ equity
– Assets are what the firm owns.

– Liabilities are what the firm owes to outsiders.
– Stockholders’ equity is what the firm owes to
internal owners.
7
Financial Statement : Balance Sheet
Assets Liabilities
Current
Liabilities
Current
Assets Long-Term
Debt
Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity
8
Assets
A. Current Assets: Include cash and assets
expected to be converted to cash within one
year or one operating cycle. Assets that are
continually
1. Cash
• Cash awaiting deposit
• Cash in a bank account
2. Marketable Securities
• Short-term investments of cash that is not needed.
• Treasury bills, certificates, notes, bonds, commercial
paper
3. Accounts Receivable
• Customer balances outstanding on credit sales.
9
Assets
4. Inventories
 Items held for sale or used in the manufacture of products
that will be sold.
 Manufacturing Company (three types of inventory):-
 Raw materials
 Work-in-process
 Finished goods
5. Prepaid Expenses
 Expenses paid in advance. Included in current assets if they
expire within one year or one operating cycle:-
 insurance
 rent
 utilities
10
Assets
A. Fixed Assets
1)Tangible:
• Have physical substance. long-lived
– Not used up during annual operations.
– Produce economic benefits for more than one year.
• Fixed assets other than land are “depreciated” over the
period of time they benefit the firm.
– Straight-line method allocates an equal amount of expense
to each year of the depreciation period.
• Land refers to property used in business, not
investment property.
11
Assets
2 .Intangible
• Goodwill recognized in business combinations
• Patents
• Trademarks
• Copyrights
• Brand Names
• Franchises
12
Financial Statement (Balance Sheet)
Liabilities
 Represent claims against assets and include

Current Liabilities & Non current liabilities.
A. Current liabilities must be satisfied in one year or one

operating cycle and include.
1. Accounts payable
Short-term obligations that arise from credit extended by suppliers for the
purchase of goods and services .Account is eliminated when bill is
satisfied.
2. Notes payable
Short-term obligations in the form of promissory notes. Lines of credit to
suppliers or financial institutions.
3. Accrued liabilities
Result from recognition of an expense prior to actual payment of cash.
4. Unearned revenue
Result from payments received in advance for services or products.
13
Liabilities
B. Long–term liabilities: Obligations with

maturities beyond one year.
1. Long-term debt :Bonds, Long-Term Notes Payable.
2. Deferred Taxes: Result of temporary differences in

the recognition of revenue and expense for taxable
income relative to reported income.
14
Stockholders’ Equity
 Stockholders’ Equity: Final section of balance

sheet
Also called shareholders’ equity Residual interest
in assets that remains after deducting liabilities
A. Common Stock Shareholders
• Do not ordinarily receive a fixed return.
• Have voting privileges in proportion to ownership interest.
• Can benefit through price appreciation.
• Can suffer through price depreciation.
• Dividends are declared at the discretion of a company’s
board of directors.
15
Stockholders’ Equity
B. Additional paid-in capital : Reflects the amount
by which the original sales price of the stock
shares exceeded par value.
C. Retained Earnings: Funds a company has

elected to reinvest in the operations of the
business rather than pay out in stock.
D. Preferred stock : Carries a fixed annual dividend

payments Carries no voting rights.
16
Current assets:
2007 2006 The assets are listed in2007 order
2006
Current Liabilities:
Cash and equivalents $140 $107 by thepayable
Accounts length of time it$213 would$197
Accounts receivable 294 270 Notes payable 50 53
Inventories 269 280 normally
Accrued expenses take a firm with
223 205
Other 58
$761
50
$707
ongoing operations to convert
Total current liabilities $486 $455
Total current assets
them
Long-term into cash.
liabilities:
Deferred taxes $117 $104
Fixed assets:
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
Clearly, cash is much more
Common stock ($1 per value) 55 32
Capital surplus 347 327
liquid than property, plant, and
Accumulated retained earnings 390 347
Less treasury stock (26) (20)
equipment.
Total equity $805 $725
$1,879 $1,742 Total liabilities and stockholder's equity $1,879 $1,742
Total assets 17
The Income Statement
 Also called the earnings statement

Presents the results of operations for the
accounting period.
• revenues
• expenses
• net income
• earnings per share
 Reveals management’s ability to translate

sales dollars into profits.
18
• Sales (operating revenues) are the major revenue
source for most companies.
• Cost of Goods Sold: Cost to seller of products or

services sold to customers.
• Operating Expenses: Selling and administrative,

Advertising.
• Depreciation Cost of assets other than land that

will benefit a business enterprise for more than a
year is allocated over the asset’s service life.
19
• Operating Profit (Operating income) Also called

earnings before interest and taxes (EBIT)
– Measures overall performance of company’s

operations: sales revenue less expenses associated
with generating sales.
– Provides a basis for assessing success of a firm apart

from financing and investing activities and separate
from tax considerations.
20
• Other Income (Expense)

Revenues and costs other than from operations
such as
• dividend and interest income
• interest expense
• investment gains (losses)
• equity earnings (losses)
• gains (losses) from sale of fixed assets
21
Financial Statement : Income Statement
Total operating revenues $2,262

The operations Cost of goods sold ( 1,655)
section of the Selling, general, and administrative expenses ( 327)
Depreciation ( 90)
income statement Operating income $190
reports the firm’s Other income 29
revenues and Earnings before interest and taxes $219
Interest expense ( 49)
expenses from Pretax income $170
principal Taxes ( 84)
Current: $71
operations.
Deferred: $13
Net income $86
Addition to retained earnings $43
Dividends: $43
22

The non-operating Cost of goods sold 1,655
section of the income Selling, general, and administrative expenses 327
Depreciation 90
statement includes Operating income $190
all financing costs, Other income 29
Earnings before interest and taxes $219
such as interest Interest expense 49
expense. Pretax income $170
Taxes 84
Current: $71
Deferred: $13
Net income $86
Addition to retained earnings: $43
Dividends: $43
23

Cost of goods sold 1,655
Selling, general, and administrative expenses 327
Depreciation 90
Operating income $190
Other income 29
Usually a separate Interest expense 49
section reports the Pretax income $170
Taxes 84
amount of taxes Current: $71
levied on income. Deferred: $13
Net income $86
Addition to retained earnings: $43
Dividends: $43
24

Cost of goods sold 1,655
Selling, general, and administrative expenses 327
Depreciation 90
Operating income $190
Other income 29
Net income is the Interest expense 49
Pretax income $170
“bottom line.” Taxes 84
Current: $71
Deferred: $13
Net income $86
Retained earnings: $43
Dividends: $43
25
Short-Term Asset Management
Current
Liabilities
Current
Assets Net
Working
Long-Term
Capital Debt
Fixed Assets How should

short-term assets
1 Tangible be managed and Shareholders’
financed? Equity
2 Intangible
26
$252m = $707- $455

2007 2006 2007 2006
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: Here we see NWC grow
Deferred taxes $117 to $104
Property, plant, and equipment $1,423 $1,274 Long-term debt 471 458
Less accumulated depreciation (550) (460 $275 million in 2006 from
Total long-term liabilities $588 $562
Net property, plant, and equipment
Intangible assets and other
873
245
814
221
$252 million in 2005.
Stockholder's equity:
Total fixed assets $1,118 $1,035
$23 million
Preferred stock
Common stock ($1 par value)
$39
55
$39
32
$275m = $761m- $486m This increase

Capital surplus of
Accumulated retained earnings
$23 million
347
390
is
327
347
anLessinvestment
treasury stock of the firm.
(26) (20)
Total equity $805 $725
Total assets $1,879 $1,742 Total liabilities and stockholder's equity $1,879 $1,742
27
The Statement of Cash Flows
Provides information about the cash

inflows and outflows during an accounting
period
• Operating activities
• Financing activities
• Investing activities
28
Financial Statement : Financial Cash Flow
Cash Flow of the Firm Operating Cash Flow:

Operating cash flow $238
(Earnings before interest and taxes
plus depreciation minus taxes) EBIT $219
Capital spending -173
(Acquisitions of fixed assets Depreciation $90
minus sales of fixed assets)
Additions to net working capital -23
Total $42
Current Taxes -$71
Cash Flow of Investors in the Firm OCF $238
Debt $36
(Interest plus retirement of debt
minus long-term debt financing)
Equity 6
(Dividends plus repurchase of
equity minus new equity financing)
Total $42
29
Cash Flow of the Firm

plus depreciation minus taxes)
Capital Spending
Capital spending -173 Purchase of fixed assets $198
(Acquisitions of fixed assets
minus sales of fixed assets) Sales of fixed assets -$25
Total $42 Capital Spending $173
Cash Flow of Investors in the Firm
Debt $36
Equity 6
Total $42
30

NWC grew from $275
Capital spending -173 million in 2007 from
minus sales of fixed assets) $252 million in 2006.
Total $42 This increase of $23
Cash Flow of Investors in the Firm million is the addition to
Debt $36
(Interest plus retirement of debt NWC.
Equity 6
Total $42
31

minus sales of fixed assets)
Total $42
Debt $36
Equity 6
Total $42
32

Cash Flow to Creditors
(Earnings before interest and taxes Interest
$49
minus sales of fixed assets) Retirement of debt
Total $42
73
Cash Flow of Investors in the Firm Debt service 122
Debt $36
minus long-term debt financing) Proceeds from new debt
Equity 6
sales -86
Total $42 Total $36
33

plus depreciation minus taxes) Cash Flow to Stockholders
Capital spending -173 Dividends $43
minus sales of fixed assets) Repurchase of stock 6
Total $42 Cash to Stockholders 49
Cash Flow of Investors in the Firm Proceeds from new stock issue
Debt $36 -43
minus long-term debt financing) Total $6
Equity 6
Total $42
34
The cash flow

received from the
Operating cash flow $238 firm’s assets must
plus depreciation minus taxes) equal the cash flows
Capital spending -173 to the firm’s creditors
minus sales of fixed assets) and stockholders:
Total $42
CF ( A) 
Debt $36
(Interest plus retirement of debt CF ( B )  CF ( S )
Equity 6
Total $42
35
(Cash Flow from Operations)
To calculate cash flow Operations

Net Income $86
from operations, start
Depreciation 90
with net income, add Deferred Taxes 13
back non-cash items Changes in Assets and Liabilities
like depreciation and Accounts Receivable -24
adjust for changes in Inventories 11
current assets and Accounts Payable 16

Accrued Expenses 18
liabilities (other than
Notes Payable -3
cash). Other -8
Total Cash Flow from Operations $199
36
(Cash Flow from Investing)
Cash flow from

investing activities Acquisition of fixed assets -$198
involves changes in Sales of fixed assets 25
Total Cash Flow from Investing Activities -$173
capital assets:
acquisition of fixed
assets and sales of fixed
assets (i.e., net capital
expenditures).
37
(Cash Flow from Financing)
Retirement of debt (includes notes) -$73

Cash flows to and from Proceeds from long-term debt sales 86
creditors and owners
Dividends -43
include changes in
Repurchase of stock -6
equity and debt.
Proceeds from new stock issue 43
Total Cash Flow from Financing $7
38
Operations
Net Income $86
Depreciation 90
Deferred Taxes 13
Changes in Assets and Liabilities
The statement of cash Accounts Receivable

Inventories
-24
11
flows is the addition of Accounts Payable
Accrued Expenses
16
18
cash flows from Notes Payable -3
Other -8
operations, investing, Total Cash Flow from Operations $199
Investing Activities
and financing. Acquisition of fixed assets -$198
Sales of fixed assets 25
Total Cash Flow from Investing Activities -$173
Financing Activities
Retirement of debt (includes notes) -$73
Proceeds from long-term debt sales 86
Dividends -43
Repurchase of stock -6
Proceeds from new stock issue 43
Total Cash Flow from Financing $7
39
Change in Cash (on the balance sheet) $33
40

Financial Statement Analysis

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Financial Statement Analysis

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Financial Statement

 A good working knowledge of financial

• Financial statements can be analyzed to

 Annual reports contain four basic financial

• Also called the statement of condition or the

• Assets = Liabilities + Stockholders’ equity

– Assets are what the firm owns.

 Represent claims against assets and include

A. Current liabilities must be satisfied in one year or one

B. Long–term liabilities: Obligations with

1. Long-term debt :Bonds, Long-Term Notes Payable.

2. Deferred Taxes: Result of temporary differences in

 Stockholders’ Equity: Final section of balance

C. Retained Earnings: Funds a company has

D. Preferred stock : Carries a fixed annual dividend

 Also called the earnings statement

 Reveals management’s ability to translate

• Cost of Goods Sold: Cost to seller of products or

• Operating Expenses: Selling and administrative,

• Depreciation Cost of assets other than land that

• Operating Profit (Operating income) Also called

– Measures overall performance of company’s

– Provides a basis for assessing success of a firm apart

• Other Income (Expense)

Total operating revenues $2,262

Total operating revenues $2,262

Total operating revenues $2,262

Total operating revenues $2,262

Fixed Assets How should

$252m = $707- $455

$275m = $761m- $486m This increase

Provides information about the cash

Cash Flow of the Firm Operating Cash Flow:

Cash Flow of the Firm

Cash Flow of the Firm

Cash Flow of the Firm

Cash Flow of the Firm

Cash Flow of the Firm

The cash flow

To calculate cash flow Operations

current assets and Accounts Payable 16

Total Cash Flow from Operations $199

Cash flow from

Retirement of debt (includes notes) -$73

Total Cash Flow from Financing $7

The statement of cash Accounts Receivable

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