Session 3

Financial statements
analysis

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 Key Concepts and Skills
• Know how to standardize financial statements for
comparison purposes.
• Know how to compute and interpret important
financial ratios.
• Be able to develop a financial plan using the
percentage of sales approach.
• Understand how capital structure and dividend
policies affect a firm’s ability to grow.

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 Session Outline

3.1 Financial Statements Analysis

3.2 Ratio Analysis
3.3 The DuPont Identity

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 3.1 Financial Statements Analysis
Standardized statements make it easier to compare financial
information, particularly as the company grows.
They are also useful for comparing companies of different
sizes, particularly within the same industry.
Common-Size Balance Sheets
• Compute all accounts as a percent of total assets.

Common-Size Income Statements

• Compute all line items as a percent of sales.

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 3.2 Ratio Analysis
Ratios also allow for better comparison through time
or between companies.
As we look at each ratio, ask yourself:
• How is the ratio computed?
• What is the ratio trying to measure and why?
• What is the unit of measurement?
• What does the value indicate?
• How can we improve the company’s ratio?

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 Categories of Financial Ratios
• Short-term solvency, or liquidity, ratios.
• Long-term solvency, or financial leverage, ratios.
• Asset management, or turnover, ratios.
• Profitability ratios.
• Market value ratios.

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 Computing Liquidity Ratios
CA
Current Ratio 
CL
$708
 1.31 times
$540
(CA  Inventory)
Quick Ratio 
CL
($708  $422)
 .53 times
$540
Cash
Cash Ratio 
CL
$98
 .18 times
$540
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 Computing Leverage Ratios
(TA  TE )
Total Debt Ratio 
TA
($3,588  2,591)
 .28 times
$3,588
TD
Debt  Equity Ratio 
TE
$.28
 .38 times
$.72
TA
Equity Multiplier   1 D  E
TE
1  .38  1.38 times
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 Computing Coverage Ratios

EBIT
Times Interest Earned 
Interest
$600
 4.26 times
$141

( EBIT  Depreciation and Amortization)

Cash Coverage 
Interest

($600  276)
 6.22 times
$141

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 Computing Inventory Ratios

Cost of GoodsSold
Inventory Turnover 
Inventory

$1, 435
 3.40 times
$422

365
Day'sSales in Inventory 
Inventory Turnover

365
 107.37 days
3.40

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 Computing Receivables Ratios

Sales
Receivables Turnover 
Accounts Receivable

$2,311
 12.29 times
$188

365
Day'sSales in Receivables 
Receivables

365
 29.69 days
12.29

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 Computing Total Asset Turnover
Sales
Total Asset Turnover 
Total Assets

$2,311
 .64 times
$3,588

It is not unusual for TAT < 1, especially if a firm has a large

amount of fixed assets.

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 Computing Profitability Measures
Net Income
Profit Margin 
Sales
$363
 .1569, or15.69%
$2,311
EBITDA
EBITDA Margin 
Sales
$876
 .3791, or 37.91%
$2,311
Net Income
Return on Assets (ROA) 
Total Assets
$363
 .1011, or10.11%
$3,588
Net Income
Return on Equity (ROE) 
Total Equity
$363
 .1399, or13.99%
$2,591
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 Computing Market Value Measures
Price per share
Price–Earnings Ratio 
Earnings per share
$88
 8.01times
$10.99
Market value per share
Market–to–Book Ratio 
Book value per share
$88
 1.12 times
 $2,591 
 
 33 
Market Capitalization  Price per share  Shares outstanding
$88  33million  $2,904 million
Enterprise Value (EV)  Market capitalization  Market value of interest  bearing debt  Cash
(In millions)$2,904  (196  457)  98  $3,459 million
EV
EV Multiple 
EBITDA
$3,459
 3.95 times
$876
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 Using Financial Statements
Ratios are not very helpful by themselves: they need to be
compared to something
Time Trend Analysis
• Used to see how the firm’s performance is changing
through time.

Peer Group Analysis

• Compare to similar companies or within industries.

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 3.3 The DuPont Identity
NI
Return on Equity 
TE
Multiply by 1 and then rearrange:

 NI   TA 
ROE    
 TE   TA 
 NI   TA 
ROE      ROA  EM
 TA   TE 
Multiply by 1 again and then rearrange:
 NI   TA   Sales 
ROE     
 TA   TE   Sales 
 NI   Sales   TA 
ROE     
 Sales   TA   TE 
ROE  PM  TAT  EM
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 Using the DuPont Identity
ROE = P M × T AT × E M
• Profit margin is a measure of the firm’s operating efficiency—
how well it controls costs.
• Total asset turnover is a measure of the firm’s asset use
efficiency—how well it manages its assets.
• Equity multiplier is a measure of the firm’s financial leverage.

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 Calculating the DuPont Identity
ROA = .1011 and EM = 1.38
ROE = .1011 × 1.385 = .1399, or 13.99%
PM = .1569 and TAT = .64
• ROE = .1569 × .64 × 1.38 = .1399, or 13.99%

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