Financial Statements

Income Statement

Sales
– Cost of Goods Sold
Step 1 = Gross Profit
– Operating Expenses
Step 2 = Operating Profit
– Interest Expense
Step 3 = Earnings Before Taxes
– Income Taxes
Step 4 = Earnings After taxes
Income Statement (Cont)

Earnings After taxes

– Preferred Shares Dividends
Step 5 = Earnings available to common shareholders
÷ Outstanding common shares
Step 6 = Earnings per share
P/E Ratio = Market Share Price
Earnings per share (EPS)

• P/E TTM – Trailing Twelve Months

• P/E 10, P/E 20
• 20x, 90x
The Balance Sheet

Assets = Liabilities + Owners’ Equity

• Book Value of Shares

• Market Value of Share
Statement of Cash Flow
Operations: cash paid and received from buying and
selling of goods and services

Investments: cash paid and received from investment

activities (bonds, stocks, property, equipment)

Financing: cash paid and received from financing activities

(dividends, borrowing or issuing stocks, repayment of
borrowings)
Amortization as Tax Shield
Corporation A Corporation B
Earnings before
amortization and taxes . 400,000 400,000
Amortization (capital cost
allowance) . . . . . . 100,000 0

Earnings before taxes . 300,000 400,000

Taxes (30%) . . . . . 90,000 120,000
Earnings aftertaxes . . 210,000 280,000

+ amortization charged
without cash outlay . . . 100,000 0
Cash flow . . . . . . . 310,000 280,000

Difference - $30,000
Financial Analysis
What is financial analysis?
• Evaluating a firm’s financial performance
• Ratios are calculated by dividing one value on
financial statements by another related value
• A long-run trend analysis over a number of years
shows changes over time
• Ratios, trends and other calculations are used to
interpret and compare the financial performance of
a company to its industry and to its past results
• Financial analysis may not answer questions, but
leads to further inquiry
Tools of Financial Analysis
• Comparative financial statements
• Trend analysis
• Common-size statements
• Financial ratios
 •Profitability Ratios

•Asset Utilization Ratios

4 Categories of Ratios
•Liquidity Ratios

•Debt Utilization Ratios

Importance of Ratios
It depends on your perspective
• Suppliers and banks (lenders) are most interested in liquidity ratios
• Shareholders are most interested in profitability ratios
• Long-term creditors concentrate on debt utilization ratios
• The effective utilization of assets is management’s responsibility
A. Profitability Ratios
1. Profit margin
2. Return on assets (ROA) (investment)
3. Return on equity (ROE) (common
shareholders)
 Profitability Ratios
Return on Sales Return on Assets
Net Income Net Income
Sales Total Assets
Net Income
Total Owner’s Equity

Return on Equity
• Measure overall company profitability for potential
investors (income to investment base)
• The higher the ratio, the more profitable the firm
Statements for Ratio Analysis
SAXTON COMPANY
Income Statement
For the Year 2019

Sales (all on credit) . . . . . . . . . . . . . . . . . . P 4,000,000

Cost of goods sold . . . . . . . . . . . . . . . . . . 3,000,000
Gross profit . . . . . . . . . . . . . . . . . . . . . 1,000,000
Selling and administrative expense* . . . . . . . . . . . 450,000
Operating profit . . . . . . . . . . . . . . . . . . . 550,000
Interest expense . . . . . . . . . . . . . . . . . . 50,000
Extraordinary loss . . . . . . . . . . . . . . . . . . 100,000
Net income before taxes . . . . . . . . . . . . . . . . 400,000
Taxes (50%) . . . . . . . . . . . . . . . 200,000

Net income . . . . . . . . . . . . . . . . . . . . . P 200,000

* Includes $50,000 in lease payments.
Statements for Ratio Analysis
Balance Sheet
As of December 31, 2019
Assets
Cash P 30,000
Marketable securities50,000
Accounts receivable 350,000
Inventory 370,000
Total current assets 800,000
Net plant and equipment 800,000
Total assetsP1,600,000
Liabilities and Shareholders' Equity
Accounts payable P 50,000
Notes payable 250,000
Total current liabilities 300,000
Long-term liabilities 300,000
Total liabilities 600,000
Common stock 400,000
Retained earnings 600,000
Total liabilities and shareholders' equity P1,600,000
Profitability ratios

Saxton Company Industry Average

Profit margin
= 5%
Net income P200,000
6.5%
Sales P4,000,000
Return on assets (ROA) (investment)

a Net income
= 12.5% P200,000
10%
Total assets P1,600,000

b Net income
5% 2.5 = 12.5% Sales
6.5%  1.5 = 10%
Sales  Total assets
Profitability Ratios

Saxton Company Industry Average

Return on equity (ROE)
Net income P200,000
a. Shareholders’
= 20% equity
0 15% P1,000,000

Total assets P1,600,000 1

b. Equity multiplier = Equity
= 1.6 P1,000,000=1.5 0.6667

c. ROA × Equity multiplier = 0.125 × 1.60 = 20% 0.10 × 1.50 = 15%

 Du Pont analysis

Net income
 Profit margin

Return on
Sales assets
 Asset
turnover
Total assets Return on
 = Equity
Total assets
Financing plan
 (Equity multiplier)
Equity
Current Liability 168,000 Sales 2.5 times compared to asset

Bonds Payable 200,000 Cost of Goods Sold 1,400,000

Preference Shares 98,500 Interest 20% of the Bonds

Ordinary Shares 175,600 Selling Expenses 250,000

Administrative
Share Premium 80,000 Expenses 322,000

Retained Earnings 148,400

Compute for the following:

• Income Statement
• Profit Margin
• Return on Asset
• Return on Equity
Income Statement
Sales P 2,176,250
COGS (1,400,000)
Gross Profit 776,250
Selling Expenses (250,000)
Administrative Expenses (322,000)
EBIT 204,250
Interest expense (40,000)
EBT 164,250
Tax (30%) (49,275)
EAT P 114,975
 P204,250
Operating Profit Margin = = 9.39%
P2,176,250

P114,975
Net Profit Margin = = 5.28%
P2,176,250
 P114,975
ROA = = 13.21%
P870,500

P114,975
ROE = = 22.28%
P502,500
B. Asset Utilization Ratios
4a. Receivable turnover
4b. Average collection period (days sales
outstanding)
5a. Inventory turnover
5b. Inventory holding period
6a. Accounts payable turnover
6b. Accounts payable period
7. Capital asset turnover
8. Total asset turnover
Asset Utilization Ratios
• Measure how efficiently the company uses its assets to generate sales
• The higher the ratio, the greater the company’s efficiency

Sales
Capital Asset
Accounts Receivable
Receivable Inventory Turnover
Turnover Sales
Turnover Capital Assets

Cost of Goods Sold

Inventory
 Asset utilization ratios(a)

Saxton Company Industry Average

4a. Receivables turnover =

Sales (credit) P4,000,000
= 11.4 10 times
Receivables P350,000

4b. Average collection period =

Accounts receivable
= 32 36 days P350,000
Average daily credit sales P10,959
5a. Inventory turnover =
Cost of Goods Sold = 8.1
P3,000,000 7 times
Inventory P370,000
 Asset utilization ratios(b)
Saxton Company Industry Average

5b. Inventory holding period =

Inventory P370,000
= 45 52 days
Average daily COGS P8,219

6a. Accounts payable turnover =

Cost of = 60 sold 12 times P3,000,000
goods
Accounts payable P50,000
6b. Accounts payable period =
Accounts payable = 6 P50,000
30 days
Average daily purchases P8,219
(COGS)
 Asset utilization ratios(c)
Saxton Company Industry Average

7. Capital asset turnover =

Sales P4,000,000
= 5.0 5.4 times
Capital assets P800,000

8. Total asset turnover =

Sales
= 2.5 1.5 times P4,000,000
Total assets P1,600,000
C. Liquidity Ratios
9. Current Ratio
10. Quick Ratio
Liquidity Ratios
• Measure the company’s liquidity (its ability to pay
short-term debts)
• The higher the ratio, the lower the risk of inability to
pay

Current Ratio Quick Ratio

Current Assets “Quick” Assets
Current Liabilities Current Liabilities
 Liquidity ratios
Saxton Company Industry Average

9. Current ratio =
Current assets P800,000
= 2.67 2.1
Current liabilities P300,000

10. Quick ratio =

Current assets
= 1.43– Inventory
1.0 P430,000
Current liabilities P300,000
D. Debt Utilization Ratios
11. Debt to total assets
12. Times interest earned
13. Fixed charge coverage
 Debt Utilization Ratios
• Measure the company’s ability to pay long-term debts
• The higher the ratio, the less risk of insolvency

Fixed Charge Times Interest

Coverage Earned
Operating Income Operating Income
“Fixed” Charges Debt
Interest Expense
Total Assets

Debt-to-Total Assets Ratio

 Debt Utilization Ratios
Saxton Company Industry Average
3-11. Debt to total assets =
Total debt = 37.5% 33% P600,000
Total assets P1,600,000
3-12. Times interest earned =

Income before
interest=and
11 taxes 7 times P550,000
Interest P50,000
3-13. Fixed charge coverage =
Income before
fixed charges
= 6 and taxes
5.5 times P600,000
Fixed charges P100,000
Trend analysis

A. Profit Margin
Percent

Industry
7
Saxton
5

1
2014 2015 2016 2017 2018 2019 2020
Trend Analysis

B. Total asset turnover

3.5X
3.0X
2.5X Saxton
2.0X
1.5X
1.0X Industry
.5X
2014 2015 2016 2017 2018 2019 2020
Gates Appliances has a return-on-assets
(investment) ratio of 8 percent
a. If the debt-to-total-assets ratio is 40
percent, what is the return on equity?
b. If the firm had no debt, what would the
return-on-equity ratio be?
Evaluate the effects of the following relationships
for the Butters Corporation:
a. Butters Corporation has a profit margin of 7
percent and its return on assets (investment) is 25.2
percent. What is its assets turnover?
b. If the Butters Corporation has a debt-to-total-
assets ratio of 50 percent, what would the firm’s
return on equity be?
c. What would happen to return on equity if the
debt-to-total-assets ratio decreased to 35 percent?