Methods of Financial Statement Evaluation With Respect To Business Profitability

Methods of Financial Statement Evaluation With
Respect to Business Profitability

October 27th, Dr. Babandi Ibrahim Gumel
2022
PURPOSE OF THE PRESENTATION
The purpose of this presentation is to look at financial

statements and find out their users and why they need
them.
The presentation will look at the Basics of financial
analysis with a view to understanding the various
reasons of conducting financial analysis. The
presentation will look into the analysis made to
determine the profitability of business with particular
emphasis on financial ratio analysis.
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AT THE END OF THE PRESENTATION
Learners are expected to understand:

 Financial Reporting
 Financial Statements
 Users of Financial Statements
 Accounting Cycle and Auditor’s opinions
 Responsibility of Management as it relates to financial
statement analysis
 Basics of Analysis
 Types of Analysis
 Profitability Analysis of Businesses.
INTRODUCTION TO FINANCIAL REPORTING
 The users of financial statements will highlight the importance

of financial reporting in the corporate environment.
 The users of financial statements include Managers,
stockholders, bondholders, security analysts, regulatory
authorities, suppliers, employees, lending institutions, labor
unions, and the general public.
 Looking at the list, they are internal and external stakeholders
of corporations.
 They all require the reports to enable make decisions that will
maximize the wealth of the stakeholders.
USERS OF FINANCIAL STATEMENTS
 Potential investors require financial statements to enable them understand the

wellness of a corporation and make decision of whether to buy the stocks of a
firm.
 Suppliers investigate the financial statements to find out the short-term paying
ability of a firm and decide whether to sell merchandize to a firm on credit.
 Labor unions analyze the statements to understand the nature of free cash
flow coming into the firm and help them press for demands and negotiate on
behalf of employees.
 Management use the statements to understand the profitability of the company.
 Creditors Look at the debt paying ability of firm.
 Government – are interested to determine whether a firm can settle its tax
obligations.
THE FINANCIAL STATEMENTS
 The principal financial statements of corporations are

the balance sheet, income statement, and the
statement of cash flows. There are notes that
accompany these financial statements .
 For a user to understand the financial condition,
profitability, and cash flows of an entity, it is necessary
to understand how to evaluate the financial statements
and the accompanying notes.
BALANCE SHEET
 Balance Sheet (Statement of Financial Position) – it shows the financial
condition of an accounting entity as of a particular date.
 It has three sections:
 The assets, resources of the firm;
 The liabilities, the debts of the firm; and
 The stockholder’s equity, the owner’s interest in the firm.
At any point in time, the total assets amounts must be equal to the total amount
of contributions of the creditors and owners: thus,
Assets = liabilities + stockholders' equity.
The stockholder’s equity of a corporation is the summation of common stock
and retained earnings.
STATEMENT OF STOCKHOLDERS’ EQUITY
 Statement of Stockholders’ Equity (Reconciliation of Stockholders’ Equity
Accounts) – presentation of the beginning and ending period balances of
their stockholders’ equity accounts is a requirement by firms and is
accomplished by presenting the statement of stockholders’ equity.
Retained earnings is one of the accounts of stockholders’ equity.
 Retained Earnings – links income statement with the balance sheet: it is
increased by net income and reduced by dividend paid to stockholders’
and net losses. We describe retained earnings as prior earnings less
prior dividends. While some firms present reconciliation of retained
earnings within statement of stockholders’ equity, others present it at the
bottom of the income statement (combined income statement and
retained earnings).
INCOME STATEMENT (STATEMENT OF EARNINGS)
 Income Statement (Statement of Earnings) – it is the

summary of revenues and expenses; and losses and
gains, ending with net income. Income statement
summarizes the operations results for a particular
period.
 Net income is necessary to be included in retained
earnings in the stockholders’ equity section for balance
sheet to balance.
INCOME STATEMENT (STATEMENT OF EARNINGS)
 Statement of Cash Flows (Statement of Inflows

and Outflows of Cash) – details the inflows and
outflows of cash during a specified period of time
– same period used for income statement. It has
three sections:
 cash flows from operating activities
 cash flows from investing activities, and
 cash flows from financing activities.
NOTES TO FINANCIAL STATEMENTS
 Notes – notes to financial statements present

additional information included in the financial
statements.
 They are integral part of the financial statements.
 Accounting policies are disclosed as the first note or in
a separate summary of significant accounting policies
preceding the first notes.
 Accounting policies includes; inventory valuation
method, depreciation policies, and contingent liabilities.
THE INTERRELATIONSHIP OF FINANCIAL STATEMENTS
Statement of Cash Flows for the Year Ended Dec. 31, 2013
Cash flow from operating activities:
Net Income $ 20,000
+ Decrease in inventory 10,000
- Decrease in accounts Payable (5,000) Balance Sheet December 31, 2013
Net cash flow from operating activities 25,000 Assets
Balance Sheet December 31,
Cash $40,000
2012 Cash flow from investing activities:
Receivables 20,000
Assets - Increase in land (10,000)
Net cash flow from investing activities (10,000) Inventory 20,000
Cash $25,000
Land 20,000
Receivables 20,000
Cash flow from financing activities: Other assets 10,000
Inventory 30,000 + Capital stock 10,000 Total Assets $110,000
Land 10,000 - Dividends (10,000)
Other assets 10,000 Net cash flow from financing activities 0
Liabilities
Total assets $95,000
Net increase in cash 15,000 Accounts payable $20,000
Cash at beginning of year 25,000 Wages payable 5,000
Liabilities
Cash at end of year $40,000 Total liabilities 25,000
Accounts payable $25,000
Wages payable 5,000 Income Statement for the Year Ended Dec. 31, 2013 Stockholders' Equity
Total liabilities 30,000 Revenues $ 120,000
- Expenses (100,000)
Capital stock $50,000
--Net income $ 20,000 Retained earnings 35,000
Stockholders' Equity
Total stockholders' equity 85,000
Capital stock $40,000
Statement of Retained Earnings for the Year Ended Total liabilities and
Retained earnings 25,000 Dec. 31, 2013
Total stockholders' equity 65,000 Beginning balance $ 25,000 stockholders' equity $110,000
Total liabilities and -+ Net income 20,000
stockholders' equity $95,000 - Dividends (10,000)
Ending balance $ 35,000
12
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CONTINGENT LIABILITIES
 Contingent Liabilities – are requiring disclosure in notes. They are dependent on
occurrence and nonoccurrence of one or more future events to confirm liability. An
example of confirmation of contingent liability include settlement of litigation, a ruling of
a tax court, or signing as guarantor of a loan.
 An estimated contingent liability should be charged to income and be established as
liability only if the cost is reasonably determinable and loss is considered probable: such
contingent liability that is recorded is also described as a note.
 A loss contingency that is reasonably estimable and not probable is not charged to
income or established as liability. A loss contingency that is less than reasonably
possible does not need to be disclosed, but where there is unusually large potential
loss, disclosure is desirable.
 There are two varieties of events that occur after the balance sheet date, but before the
statements are issued as follows: first are events that existed at the balance sheet date,
and affect the estimates in the statements, they require adjustments before the
statements are issued.
THE ACCOUNTING CYCLE
 The accounting cycle is the sequence of accounting procedures completed within an accounting period.
There are three broad summary steps of the accounting cycle:
 Recording transactions - as events of transactions happens, they change the firm’s assets,
liabilities, or stockholders’ equity; thus, changing the firm’s financial position. There are basically
two types of transactions, internal and external transactions. While internal transactions are
confined within the company, external transactions happens outside the company.
 Recording adjusting entries - Accrual basis accounting requires that revenue be recognized
when realized (Realization concept) and expenses recognized when incurred (matching
concept). The accrual basis requires numerous adjustments to account balances at the end of
the accounting period. Adjusting entries are recorded in the general journal and then posted to
the general ledger. Once accounts are adjusted to the accrual basis, the financial basis can be
prepared.
 Preparing the financial statements - the accountants uses the accounts after adjustments have
been affected to prepare the financial statements. These statements represent the output of the
accounting system. The balance sheet and the income statement can be prepared directly from
the adjusted accounts, but the preparation of statement of cash flows requires further analysis of
the adjusted accounts.
AUDITOR’S OPINION
 An auditor is a certified public accountant who conducts an independent examination and evaluations of the
accounting information presented by the business (management) and issues a report thereon. The report of
the auditor is a formal report of his opinion of the financial statements after conducting an audit. The following
are the classifications of audit opinions:
 Unqualified opinion – it states that the financial statements present fairly: in all material respects, the
financial position, results of operations, and cash flows of the entity, is in conformity with generally accepted
accounting principles.
 Qualified opinion – states that, except for the effects of the matter(s) to which the qualification relates, the
financial statements present fairly, in all material respects, the financial position, results of operations, and
cash flows of the entity, in conformity with the generally accepted accounting principles.
 Adverse opinion – states that the financial statements do not present fairly the financial position, results of
operations, and cash flows of the entity, in conformity with the generally accepted accounting principles.
 Disclaimer of opinion – states that the auditor does not express an opinion on the financial statements. A
disclaimer of opinion is rendered when the auditor has not performed an audit sufficient in scope to form an
opinion.
 Financial analysts must review the independent auditor’s report during the examination of financial
statements. The audit opinion will be used by financial analysts to advise the users of financial statement
based on whether the financial statements conformed with GAAP or there are explanations of concerns that
will help them make a decision.
MANAGEMENT’S RESPONSIBILITY
FOR FINANCIAL STATEMENTS
 The management are responsible for preparing the financial statements
and ensuring the integrity of the financial statements.
 It is the responsibility of the auditor who are qualified public accountants
to conduct independent examination of the financial statements and
expressing an opinion on the statements based on the audit they
conducted.
 Some companies presented the management statement to shareholders
as part of the annual report to ensure that users of financial statements
are aware of the responsibilities of management.
BASICS OF ANALYSIS
 There are various techniques used in analyzing financial data; the techniques used the data for
comparative analysis to determine the importance of the data presented and evaluate the position of
the firm.
 The followings are the techniques used in financial analysis: ratio analysis, common-size analysis,
study of differences in components of financial statements among industries, review of
descriptive material, and comparisons of results with other types of data.
 The information obtained from the analysis are used to determine the financial position of a firm.
Each of the analysis techniques can be used for a different purpose and by different user of financial
information.
 Being a judgmental process, one of the primary objectives of financial statement analysis is the
identification of major changes in trends, amounts, and relationships. The analyst investigates
the major reasons that caused the major changes to occur.
 A turning point is identified which is the major changes and is a signal of early warning of a
significant shift in the future success or failure of a business.
 The process of analysis is improved with experience and by use of analytical tools
RATIO ANALYSIS
Financial ratios are expressed as a percentage or as a times per period. The following are the different
categories of ratios:
- Liquidity Ratios – measures the ability of a firm to meet its current obligation.
- Borrowing Capacity Ratio – otherwise called leverage ratios, it measure the degree of protection of
suppliers of long-term funds.
- Profitability Ratios – measures the earning ability of a firm.
- Investors special group of ratios – apart of liquidity, debt, and profitability ratios, investors are
interested in certain group of ratios to help them determine the viability of a firm.
- Cash Flow Ratios – they indicate liquidity, borrowing capacity, or profitability.
- Ratios are interpretable by making comparison with 1). Prior ratios, 2). Ratios of competitors, 3).
Industry ratios, and 4). Experts predetermined standards.
- There two important considerations when making the interpretations: trend of a ratio and variability. It
should also be noted that, ratio analysis must be understood based on accounting principles used,
business practice, and the country culture.
COMMON-SIZE ANALYSIS (VERTICAL AND HORIZONTAL)
 A common size financial statement “displays all items as percentages of a common base
figure rather than as absolute numerical figures. This type of financial statement allows for
easy analysis between companies or between time periods for the same company” (Hayes,
R., p. 1, 2019). It is an expression of comparisons in percentages. Comparisons of firms of
different sizes is much more meaningful with common-size analysis.
 Vertical analysis compares each amount in a financial statement with a base amount
selected from the same year. Assuming an advertising expenses were $1,000 in 2011 and
sales were $100,000, thus, advertising expenses were 1% of sales.
 Horizontal Analysis compares amount with the base amount for a selected base year. For
example, if in 2010, sales were $400,000 and $600,000 in 2011, then sales increased by
50% in 2011.
YEAR-TO-YEAR CHANGE ANALYSIS
 Sometimes it is meaningful to compare financial statements over two time periods
using absolute amounts and percentages. The approach aids in keeping absolute
and percentages changes in perspective. For example, a substantial percentage
change may not be relevant due to an immaterial absolute change.
 The following are some of the rules to used when performing a year-to-year change
analysis;
 When an item has a value in the base year and none in the next period, the
decrease is 100%
 A meaningful percent change is not realizable when one number is positive,
and the other number is negative.
 No percentage change is computable when there is no figure for the base year.
FINANCIAL STATEMENT VARIATION BY
TYPE OF INDUSTRY
 Financial statements components especially income statement and balance sheet
vary by type of industry of firms.
 In merchandize industry, major asset is inventory, with large cash sales and low
receivables or opposite. Because of competition, profit ratios are low on income
statement with large cost of sales and operating expenses.
 In service industry, due to the fact service cannot be stored, inventory is low. Where
service is people extensive such as advertising, there is less investment in property
and equipment compared with manufacturing.
 In manufacturing industry, due to raw materials, work in progress, and finished
goods, inventory is large. There is large investment in property and equipment.
Depending on the terms of sales of a company, notes and accounts receivable may
also be material. Cost of sales is the major expense in the manufacturing firm’s
financial statement.
COMPARISONS
 Financial Analyst compares the data of a company with industry average which are
produced by certain regulatory organizations.
 The following are the financial services that provided the industry averages in the united
states:
 The department of commerce financial report.
 Annual Statement Studies.
 The standards & Poor’s Industry Surveys.
 Almanac of Business and Industrial Financial Ratios. and
 Value Line Investment Survey.
 The data provided by these organizations are used by firms to analyze financial statements.
 Note that countries have many sources of industry average data, thus, analysts in different
countries must refer to the sources of the industry data to make meaningful analysis.
ANALYSIS
 Liquidity of Short-Term Assets; Related Debt-Paying Ability - All users of financial statement attached
importance to the abilities of an entity to maintain its short-term debt paying ability. It is only when an entity can be
able to maintain its short-term debt paying ability the entity can be able to maintain its long-term debt paying ability.
Also, it is only when an entity can maintain both short-term and long-term debt paying ability it can satisfy its
stockholders. A profitable business can turn to be bankrupt if it fails to meet its short-term obligations. The ability of
a firm to pay its current obligations is related to the ability of a firm to generate cash.
 Long-Term Debt-Paying Ability - the long-term debt paying ability of an entity will be viewed from two approaches:
from the view of firm’s ability to carry debt as indicated by the income statement, secondly from the view of the
firm’s ability to carry the debt as indicated by the balance sheet. In the long-run, a relationship exist between
income reported from the use of accrual accounting and the firm’s ability to meets its long-term obligations, which
makes the entity’s profitability an important factor when determining long-term debt paying ability of a firm.
 Analysis for the Investor - There are analysis that are meant to serve the interest of investors. Nevertheless, an
investor is also interested in liquidity, debt, and profitability analysis earlier covered in this course.
 Profitability - Analysts investigates profits because it is vital to stockholders as it generate revenues in the form of
dividends; without profits there will be no dividends to stockholders. Further generation of profits will result in an
increase in the price of the stock of a firm, which will result in capital gains. Creditors are also concern with profits
because profits are one source of debt coverage. Profit is been used by management to measure performance.
THIS PRESENTATION IS ON PROFITABILITY ANALYSIS.

PROFITABILITY ANALYSIS
 Profitability Measures – the income statement of an entity contains a number
of items that might be used for the profitability analysis. Primary financial
analysis of profit ratios include only the income arising from the normal
business operations of an entity. Earlier in chapter four, explanation on the
contents of income statement was made.
 Apart from contents of the income statement, there are other items that are
important to the discussions of profit: equity in earnings of nonconsolidated
subsidiaries and the noncontrolling interest share of earnings. Trend analysis
is also use to analyze income arising from the normal operations of the
business.
NET PROFIT MARGIN
Net Profit Margin – is a commonly used profit measure otherwise called return
on sales. If a firm reports a 6% return on sales, it indicated that the firm’s profit
was 6% of sales. It is calculated as:
Net Profit Margin = Net Income Before Noncontrolling Interest, Equity Income and Nonrecurring Items
Net Sales.
It is a measure of net amount generated by the amount of sales. A

high ratio is needed. The factors that cause the ratio to vary include,
competition within an industry, conditions of an economy, use of
debt financing, and operating characteristics such as fixed cost.
Example of Net Profit Margin Computations.
Years Ended May 31, 2011 and 2010
(In millions) 2011 2010
Net income (A) $2,133.0 $1,907.0
Net sales (B) $20,862.0 $19,014.0
Net Profit Margin (A / B) 10.22% 10.03%
TOTAL ASSET TURNOVER
Total Asset Turnover – measures the activity of the assets
and the ability of the firm to generate sales through the use
of the assets. It is computed as follows:
Total Asset Turnover = Net Sales
Average Total Assets
Example of Total assets turnover ratio computations

Net sales (A) $20,862.0 $19,014.0
Average total assets:
Beginning year $14,419.0 $13,249.6
End of year 14,998.0 14,419.0
Total $29,417.0 $27,668.6
Average (B) $14,708.5 $13,834.3
Total Asset turnover (A / B) 1.42 times 1.37
times
RETURN ON ASSETS RATIO
Return on Assets Ratio – measure the ability of a firm to utilize its assets to create profits.
The ratio compares profits with the assets that generate the profits. The ratio is computed as
follows:
Return on Assets = Net income before noncontrolling interest and nonrecurring items
Average total assets
Example of Return on assets computations
Net income (A) $2,133.0 $1,907.0
Average total assets (B) $14,708.5 $13,834.3
Return on assets (A / B) 14.50% 13.78%
DUPONT RETURN ON ASSETS
 DuPont Return on Assets – is a process of reviewing some ratios together; net profit margin, total
asset turnover, and return on assets are reviewed because of the direct influence net profit margin and
total asset turnover have on return on assets. The review together is termed as Dupont return on
assets.
 The rate of return on assets can be broken down into the net profit margin and the total asset turnover.
It allows for the improved analysis of changes in return on assets. The process was developed by E. I.
DuPont de Nemours and company.
The following is the process of reviewing the ratios together:
Example of DuPont Return on Assets Computations
Return on Assets = Net Profit Margin X Total Asset

Turnover
2011 14.50% = 10.22% X 1.42 times
2010 13.78% = 10.03% X 1.37 times
OPERATING INCOME MARGIN
Operating Income Margin – it measures the ability of operating
assets to generate income. It includes only the operating income in
the numerator; and computed as:
Operating Income Margin = Operating Income

Net Sales
Example of Operating income margin computations
Operating income (A) $2,815.0 $2,474.0
Net Sales (B) $20,862.0 $19,014.0
Operating income margin (A / B) 13.49% 13.01%
OPERATING ASSETS TURNOVER
Operating Assets Turnover – measures the ability of operating
assets to generate sales and is computed as:
Operating Assets Turnover = Net Sales .

Average Operating Assets
Example of Operating Assets Turnover Ratio Computation.
Net sales (A) $20,862.0 $19,014.0
Average operating assets:
Beginning of year $12,714.0 $11,527.9
End of year 13,285.0 12,714.0
Total (B) $25,999.0 $24,241.9
Average (B / 2) = (C) $12,999.5 $12,121.0
Operating assets turnover (A / C) 1.6 times 1.57 times

per year per year
OPERATING ASSETS TURNOVER
Return on Operating Assets – it is an adjustment for nonoperating items in
the operating assets turnover computation, measures the ability of operating
assets to generate income, as follows:
Return on Operating Assets = Operating Income

Average Operating Assets
Example of Return on Operating Assets Computations
Operating income (A) $2,815.0 $2,474.0
Average operating assets (B) $12,999.5 $12,121.0
Return on operating assets (A / B) 21.65% 20.41%
DUPONT RETURN ON OPERATING ASSETS
DuPont Return on Operating Assets – review operating

income margin and operating assets turnover and is
computed as:
DuPont Return on Operating Assets = operating income

margin x operating assets turnover.
Example of DuPont Return on Operating Assets Computation
Return on = Operating income X Operating asset

operating assets margin turnover
2011 21.65% = 13.49% X 1.60
2010 20.41% = 13.01% X 1.57
The result support a minor increase in operating income and a moderate

increase in operating assets turnover which resulted in a moderate increase in
return on operating assets
SALES TO FIXED ASSETS
Sales to Fixed Assets – measure the ability of a firm to make productive use of its property, plant, and
equipment through the generation of sales.
Construction in progress should be excluded from net assets because it do not contribute to sales. It is
computed as:
Sales to fixed assets = Net Sales .

Average Net Fixed Assets (Exclude Construction in Progress
Example of Sales to fixed assets ratio computations

Net sales (A) $20,862.0 $19,014.0
Net fixed assets: (exclude construction in progress)
Beginning year $1,755.0 $1,793.9
End of year 1,988.0 1,755.0
Total (B) $3,743.0 $3,548.9
Average (B / 2) = (C) $1,871.5 $1,774.5
Sales to fixed assets (A / C) 11.15 10.72
times per times per
year year
RETURN ON INVESTMENT
(ROI)
Return on Investment (ROI) – applies to ratios measuring the income earned on the invested
capital. The method is widely used to measure the performance of an enterprise. It measure
the firm’s ability to reward long-term providers of funds and attract those to provide future funds
to an entity.
Return on Investment = Net Income before noncontrolling interest and nonrecurring items
+ [(Interest Expense) x (1 – Tax Rate)] .
Average (Long-Term Liabilities + Equity)
The ratio evaluates earning performance, earnings on investment, and indicates how well a
firm utilizes its asset base.
Example of Return on Investment (ROI) ratio computations
Interest expense (A) $34.0 $36.0
Net income $2,133.0 $1,907.0
Tax rate 25.0% 24.2%
1 – Tax rate (B) 75.0% 75.8%
(Interest expense) x (1 – Tax rate) [A X B] $25.5 $27.3

Net income + [(interest expense) x (1 – Tax rate)] (C) $2,158.5 $1,934.3
Long-term liabilities and shareholders’ equity
Beginning of year:
Long-term liabilities $1,301.0 $1,279.2
Total shareholders’ equity 9,754.0 8,693.1
End of year:
Long-term liabilities 1,197.0 1,301.0
Total shareholders’ equity 9,843.0 9,754.0
Total (D) $22,095.0 $21,027.3
Average (D / 2) = (E) $11,047.5 $10,513.7
Return on investment (C / E) 19.54% 18.40%
RETURN ON TOTAL EQUITY
Return on Total Equity – measures the return to both common and preferred stockholders. It
is computes as; Return on Total Equity =Net Income Before Nonrecurring Items –
Dividends on redeemable preferred stock
Average Total Equity
Example of Return on Total Equity Ratio Computation

Net income $2,133.0 $1,907.0
Less Redeemable preferred dividends 0.0 0.0
Adjusted income (A) $2,133.0 $1,907.0
Total equity:
End of year 9,843.0 9,754.0
Total equity (B) $19,597.0 $18,447.1
Average (B / 2) = (C) $9,798.5 $9,223.6
Return on total equity [A / C] 21.77% 20.68%
RETURN ON COMMON EQUITY
Return on Common Equity – it measures the return to the common stockholder, the residual owner. It is
computed as:
Return on Common Equity
= Net Income before nonrecurring items – Preferred Dividends
Average Common Equity
Net income appears on the income statement while the preferred stock dividends appears commonly on
statement of stockholders’ equity. The common equity includes common stock and retained earnings less
treasury stock which is equals to total equity minus the preferred capital and any noncontrolling interest
included in the equity section.
Example of Illustration of Return on Common Equity computation

Net income $2,133.0 $1,907.0
Less: Redeemable preferred dividends 0.0 0.0
Adjusted income (A) $2,133.0 $1,907.0
Total common equity:
End of year 9,843.0 9,754.0
Total (B) $19,597.0 $18,447.0
Average common equity (B / 2) = (C) $9,798.5 $9,223.6
Return on common equity (A / C) 21.77% 20.68%
GROSS PROFIT MARGIN
Gross Profit Margin – gross profit is the difference between net
sales revenue and the cost of goods sold. Gross profit margin is the
comparison of gross profit with net sales and computed as:
Gross Profit Margin = Gross Profit / Net Sales.
The ratio is usually compared with industry average or analyzed by

trend.
Example of Gross profit margin computation
2011 2010 2009
Net sales (B) $5,000,000 $4,500,000 $4,000,000
Less: Cost of goods $3,500,000 $2,925,000 $2,200,000

sold
Gross profit (A) $1,500,000 $1,575,000 $1,800,000
Gross profit margin 30.00% 35.00% 45.00%

(A/B)
QUESTION AND
ANSWERS
SESSION
REFERENCES
Alexandra, D. (2011). Private company financial reporting. Journal of Accounting, 34-36.
American Accounting Association's Financial Accounting Standards Committee. (2007).
The FASB's conceptual framework for financial reporting:
A critical analysis. Accounting Horizons, 229-238.
Ge, W. & Sarah, M. (2005). The disclosure of material weaknesses
internal control after the Sarbanes-Oxley act. Accounting Horizons, 137-158.
Geiger, M. A. & Raghunandan, K. (2002). Going-concern opinions in
the new legal environment. Accounting Horizons, 17-26.
Gibson, C. H. (2013). Financial Statement Analysis. Delhi: Cengage Learning India Private Limited.
Glen, C. (2007). If IFRS offers the answer, they sure raise a lot of questions. Financial Executive, 21-
23.
Hayes, A. (2019). Common-size Analysis. Retrieved December 27, 2019,
from Investopedia: https://www.investopedia.com/terms/c/commonsizefinancialstatement.asp
Ray, B. (2008). What is the actual economic role of financial reporting? Accounting Horizons, 427-
432.

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Methods of Financial Statement Evaluation With Respect To Business Profitability

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Methods of Financial Statement Evaluation With

Respect to Business Profitability

The purpose of this presentation is to look at financial

Learners are expected to understand:

 The users of financial statements will highlight the importance

 Potential investors require financial statements to enable them understand the

 The principal financial statements of corporations are

 Income Statement (Statement of Earnings) – it is the

 Statement of Cash Flows (Statement of Inflows

 Notes – notes to financial statements present

THIS PRESENTATION IS ON PROFITABILITY ANALYSIS.

It is a measure of net amount generated by the amount of sales. A

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Net income (A) $2,133.0 $1,907.0

Net sales (B) $20,862.0 $19,014.0

Net Profit Margin (A / B) 10.22% 10.03%

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Net income (A) $2,133.0 $1,907.0

Average total assets (B) $14,708.5 $13,834.3

Return on assets (A / B) 14.50% 13.78%

Years Ended May 31, 2011 and 2010

Return on Assets = Net Profit Margin X Total Asset

2011 14.50% = 10.22% X 1.42 times

2010 13.78% = 10.03% X 1.37 times

Operating Income Margin = Operating Income

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Operating income (A) $2,815.0 $2,474.0

Net Sales (B) $20,862.0 $19,014.0

Operating income margin (A / B) 13.49% 13.01%

Operating Assets Turnover = Net Sales .

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Net sales (A) $20,862.0 $19,014.0

Average operating assets:

Beginning of year $12,714.0 $11,527.9

End of year 13,285.0 12,714.0

Total (B) $25,999.0 $24,241.9

Average (B / 2) = (C) $12,999.5 $12,121.0

Operating assets turnover (A / C) 1.6 times 1.57 times

Return on Operating Assets = Operating Income

Years Ended May 31, 2011 and 2010

(In millions) 2011 2010

Operating income (A) $2,815.0 $2,474.0

Average operating assets (B) $12,999.5 $12,121.0

Return on operating assets (A / B) 21.65% 20.41%

DuPont Return on Operating Assets – review operating

DuPont Return on Operating Assets = operating income

Years Ended May 31, 2011 and 2010

Return on = Operating income X Operating asset

2011 21.65% = 13.49% X 1.60

2010 20.41% = 13.01% X 1.57

The result support a minor increase in operating income and a moderate