CHAPTER 2

FINANCIAL STATEMENT ANALYSIS

(12 hours)

Nguyen Thu Hang

 Chapter Outline
1. Financial Statement
- Financial Reporting Mechanics
- Accruals
- Balance sheet
- Income statement
- Statement of cash flows: calculation of CFO, CFI, CFF
2. Financial Statement Analysis
- Common-Size Analysis
- Ratio Analysis
 Firms’ Disclosure of Financial Information
• Publicly listed companies around the world are
required to file their financial statements with the
relevant listing authorities.
U.S. companies: Generally Accepted Accounting
Principles (GAAP)
VN firms: Vietnamese Accounting Standards (VAS).
• Investors, financial analysts, managers, and other
interested parties such as creditors rely on
financial statements to obtain reliable information
about a corporation.
 Firms’ Disclosure of Financial Information
• Financial reporting: to satisfy reporting requirements.
• Tax reporting: financial statements for the taxation
authorities.
• For financial reporting:
- The balance sheet
- The income statement
- The statement of cash flows
-Notes to the financial statements
- The statement of changes in shareholders’ equity.
 Reading 1
CFA Financial Reporting and Analysis, Level I,
Reading 23
• The classification of business activities
• Accounting equations
• Financial Reporting Mechanics
• Accruals and Valuation Adjustment
Financial statements and company’s activities
Production-Investment Cycles (Cash flow-Production cycle)

6
Classification of business activities
Operating activities- the company’s day-to-day
activities that create revenues
Investing activities: include purchasing and
selling long-term assets and other
investments.
Financing activities- include obtaining or
repaying capital, such as equity and long-term
debt.
Financial statements and company’s activities

Example: Which of the following is an operating

activities?
A. Borrow money from a bank.
B. Pay tax.
C. Buy shares of other companies.

8
 Accrual Accounting
 Revenue and expenses (and thus profits) do not
coincide with cash flows.
 Cash movement may occur before or after accounting
recognition, in which case accruals are required.
 Accruals are non-cash revenues and expenses.
 If cash flows are so important why do people use
accrual accounting but not cash-basic accounting, i.e.
recognizing revenues and expenses when there are
actual flows of cash?

9
Accrual Accounting vs Cash basis Accounting
• Firm A and firm B have the same revenues (100)
and expenses (90) for each year in the period
from year 1 to year 3. Both firms receive the
whole payment from their customers in actual
cash in year 3. Firm A recognizes its revenue and
expenses when the money is received or paid
out. Firm B records when the revenue is earned
and the expenses are incurred.
• Write income statements of these two firms.
Give your comments on their net income
 Accrual Accounting
Example: NMH Corp. sells VND 100 million stationary to
Phuong Book Store on 30-day credit. Cost of
production is VND 70 million. On the day of delivery
NMH records:
A. Nothing.
B. A 70 mil increase in sales.
C. A 100 mil increase in liabilities.
D. A 70 mil decrease in inventory and 100 mil increase in
receivables.

11
• Suppose your firm receives a $5 million order on the last day of
the year. You fill the order with $2 million worth of inventory. The
customer picks up the entire order the same day and pays $1
million upfront in cash; you also issue a bill for the customer to
pay the remaining balance of $4 million in 30 days. Suppose your
firm’s tax rate is 0% (i.e., ignore taxes). Determine the
consequences of this transaction for each of the following:
a. Revenues tăng 5
b. Earnings tăng 3
c. Receivables tăng 4
d. Inventory giảm 2
e. Cash tăng 1
 Some accounting equations
• Assets= Liabilities + Owners’ Equity
• Owners’ Equity= Contributed capital +
Retained Earnings
• Ending retained earnings= Beginning retained
earnings +Net Income- Dividends
• Revenues-Expenses= Net Income (Loss)
 Financial statements
• Balance sheet
• Income statement
• Cash flow statement
 Reading 2
Berk DeMarzo, Corporate Finance
• Chapter 2: Balance sheet, Income statement,
Cash flow statement.
 CFA, Financial Reporting and Analysis, Level 1
• Reading 25, Understanding Income Statement
 Alternative Inventory Costing Methods
 Depreciation and Amortization
 Balance Sheet
 A statement of financial condition/position at
a point in time.
 Used to assess a firm’s liquidity, solvency, and
ability to make distributions to shareholders.
 Three elements: assets, liabilities, equity.
 Assets and liabilities are classified as current
and non-current.
 Working capital.
 Capital employed.
Balance Sheet

17
 CÔNG TY CP PXL 31/12/2016 31/12/2015
A. Tài sản
1. Tài sản ngắn hạn 949252 1366089
a. Tiền và các khoản tương đương tiền 272585 473657
b. Các khoản đầu tư tài chính ngắn hạn 58799 210
c. Các khoản phải thu ngắn hạn 268541 238048
d. Hàng tồn kho 338117 624434
e. Tài sản ngắn hạn khác 11210 29739
2. Tài sản dài hạn 1660188 1301532
a. Các khoản phải thu dài hạn 0 0
b. Tài sản cố định 507121 242580
c. Bất động sản đầu tư 10098 10098
d. Các khoản đầu tư tài chính dài hạn 979155 932716
e. Tài sản dài hạn khác 163814 116137
Tổng cộng tài sản 2609439 2667619
19
 CÔNG TY CP PXL 31/12/2016 31/12/2015
B. Nguồn vốn
3. Nợ phải trả 169572 194368
a. Nợ ngắn hạn 169128 194091
b. Nợ dài hạn 443 276
4. Vốn chủ sở hữu 2425979 2461868
a. Vốn chủ sở hữu 2425979 2461868
- Vốn góp 2225580 2225607
- Cổ phiếu quỹ -31083 -34537
- Lợi nhuận giữ lại 231482 270798
b. Nguồn kinh phí, quỹ khác 0 0
Lợi ích của cổ đông thiểu số 13889 11383
Tổng cộng nguồn vốn 2609439 2667619
20
 Some Notes
 Working capital= Current assets– Current liabilities.
 Strictly speaking, WC does not include current financial
assets and liabilities (for instance, excess cash, short-
term debts,…).
 Operating (current) liabilities should not be viewed as
parts of firm’s financial activities.
 Cash is usually viewed as negative debt

21
 Deferred taxes
• Firm A has two sets of financial statements:
one for financial reporting and one for tax
purposes.
• In IS for tax purposes income before taxes
=100, tax=25. In IS for financial reporting,
income before taxes=120, tax=30. How to
record the difference in tax?
 Deferred taxes
• Deferred taxes are taxes that are owed but have not
yet been paid.
• Firms generally keep two sets of financial
statements: one for financial reporting and one for
tax purposes. The rules for the two types of
statements differ.
• Deferred tax liabilities generally arise when the
firm’s financial income exceeds its income for tax
purposes. Because deferred taxes will eventually be
paid, they appear as a liability on the balance sheet.
 Market Value Versus Book Value
• The book value of equity is distinct from the
market value of equity, or stock market
capitalization.
Market value of equity = Shares outstanding
X market price per share
Market-to-Book Ratio or price-to-book (P/B) ratio

• The market-to-book ratio for most successful firms

substantially exceeds 1  The value of the firm’s
assets exceeds their historical cost.
• Analysts often classify firms with low market-to-
book ratios as value stocks, and those with high
market-to-book ratios as growth stocks.
 Debt-equity ratio

• A firm’s debt-equity ratio has important

consequences for the risk and return of its shares
• Probability of financial distress.
 Income Statement
• The income statement reports a firm’s
revenues and expenses over a period of time
and has the following general form:
EBIT = Net income + Interest expense + Tax
expense

Operating expenses?
Operating income?
Income Statement
 Income Statement
CÔNG TY CP PXL 2016 2015
1. Doanh thu bán hàng và cung cấp dịch vụ 804358 426411
2. Các khoản giảm trừ doanh thu 698 0
3. Doanh thu thuần về bán hàng và cung cấp dịch vụ 803660 426411
4. Giá vốn hàng bán 666623 391192
5. Lợi nhuận gộp về bán hàng và cung cấp dịch vụ 137037 35219
6. Doanh thu hoạt động tài chính 61923 135849
7. Chi phí tài chính 1743 -130698
-Trong đó: Chi phí lãi vay 375 965
8. Chi phí bán hàng 25866 15639
9. Chi phí quản lý doanh nghiệp 24682 29223
10.Lợi nhuận thuần từ hoạt động kinh doanh 146669 256905
29
 Income Statement
CÔNG TY CP PXL 2016 2015
10. Lợi nhuận thuần từ hoạt động kinh doanh 146669 256905
11. Thu nhập khác 274 1172
12. Chi phí khác 0 481
13. Lợi nhuận khác 274 691
14. Lợi nhuận từ công ty liên doanh, liên kết -13876 2739
15. Tổng lợi nhuận kế toán trước thuế 133068 260335
16. Chi phí thuế TNDN hiện hành 19601 28080
17. Lợi nhuận sau thuế TNDN 113467 232254
- Lợi ích cổ đông thiểu số 2297 602
Lợi nhuận công ty mẹ 111170 231653
Lãi cơ bản trên cổ phiếu 0,00173 0,00365

30
 Cost of (good) sales
• Cost of (good) sales shows costs directly
related to producing the goods or services
being sold, such as manufacturing costs.
• Other costs such as administrative expenses,
research and development, and interest
expenses are not included in the cost of sales.
• COGS = Beginning Inventory + Purchases-
Ending Inventory
• Revenues- Cost of good sales= Gross Profit
Operating Expenses and operating income
• Operating Expenses: These are expenses from the
ordinary course of running the business that are not
directly related to producing the goods or services
being sold.
• Operating expenses include administrative expenses
and overhead, salaries, marketing costs, and research
and development expenses. The third type of
operating expense, depreciation and amortization, is
not an actual cash expense but represents an estimate
of the costs that arise from wear and tear or
obsolescence of the firm’s assets.
• Gross profit – Operating expenses= Operating income
 Income Statement
General Format
Revenue
- Cost of goods sold
Gross profit
+ Other recurring income
- Other recurring expense
Income from continuing operations
+/- Other non-recurring income/expense
Income before tax
- Taxes
Net income
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 Example
NMH Company:
Revenue 4 bil
CoGS 3 bil
Other operating expense 0.5 bil
Interest expense 0.1 bil
Provision for income tax 0.12 bil
 Gross profit = ?

34
 Depreciation
• Straight-line method
• Accelerated methods: the allocation of is greater in
earlier years.
• Units-of-production method: the allocation of cost
corresponds to the actual use of an asset in a
particular period. Ex: Double- declining balance
method; double- declining method and then change
to straight-line method.
Affect a variety of financial ratios (fixed asset
turnover, asset turnover, operating profit margin,
operating return on assets, return on assets.
See more: CFA, L1, Financial Reporting and Analysis, p.469
 Problem
1. Suppose Global had an additional $1 million
depreciation expense in 2012. If Global’s tax
rate on pretax income is 26%, what would be
the impact of this expense on Global’s
earnings? How would it impact Global’s cash
balance at the end of the year?
 Example
Biophar purchases a medicine processing machinery for
550 mil đồng, estimated useful life 5 years. Effective
tax rate 30%. Revenue expected to be 600 mil per year,
expenses other than depreciation are 300 mil.
Calculate Biophar net income and cash if the company
depreciates the machinery using (1) the straight-line
method or (2) double declining balance method

37
 Earnings per Share
 Simple capital structure: no potentially dilutive
securities  Basic EPS
 Complex capital structure: contains potentially dilutive
securities  Diluted EPS

38
 Basic EPS
For the year ended 31 December 2016, NMH Corp. had net income
of $2,500,000. The company declared and paid $200,000 of
dividends on preferred stock. The company also had the following
common stock share information:
Shares outstanding on 1 January 2016 : 1,000,000
Shares issued on 1 April 2016: 200,000
Shares repurchased (treasury shares) on 1 October 2016: (100.000)
Shares outstanding on 31 December 2016: 1,100,000
1. What is the company’s weighted average number of shares
outstanding?
2. What is the company’s basic EPS?
 Inventory
 Recorded at the lower of either cost or fair value.
 COGS = Beginning Inventory + Purchases- Ending
Inventory

40
 Inventory
Inventory Systems
 Periodic inventory system.
 Perpetual inventory system (more common).
Valuation Methods
 FIFO.
 LIFO.
 Weighted Average Cost.
 Specific Identification.

41
 Inventory
Example: Use the data in the figure below to calculate
the CoGS in January and ending inventory on January
31 under FIFO, LIFO, and weighted average cost
methods in periodic and perpetual system.

Unit Price Value

Jan 1 (Beginning inventory) 5 $5 $25
Jan 7 purchase 10 $6 $60
Jan 15 sell 8 $9 $72
Jan 22 purchase 6 $7 $42

42
 The Relationship between BS and IS

 Assets = Liabilities + Equity

 Equity = Assets – Liabilities

 Equity = Contributed Capital + Retained Earnings

 Revenue – Expenses = Income/Loss

 Ending retained earnings = Beginning retained earnings

+ Net Income – Dividend
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 The Relationship between BS and IS

Balance Sheet Income Statement Balance sheet

(at a point in time) (for a period of time) (at a point in time)
(billion đồng) (billion đồng) (billion đồng)

REE 31/12/2009 REE 31/12/2010 REE 31/12/2010

Assets 3345 Revenue 1828 Assets 4911

Liabilities 853 Expenses 1482 Liabilities 2000

Contributed Capital 2156 Net Income 346 Contributed Capital 2413

Retained Earnings 336 Dividends 184 Retained Earnings 498

44
 The Relationship between BS and IS
The Relationship between BS and IS

Changes (VND billion)

Assets 1566
Liabilities 1147
Contributed Capital 257
Retained Earnings 162

(Re: CFAI 2013, Volume 3, SS. 7)

45
 The Relationship between BS and IS

1566 = 1147 + 257 + 162

∆Assets = ∆Liabilities + ∆Con. Capital+ ∆Ret. Earn.
Or:
∆Assets = ∆Sources of Capital
And:
346 = 184+ 162
Net Income= Dividends + ∆ Ret. Earnings.

(Re: CFAI 2013, Volume 3, SS. 7)

46
 The Relationship between BS and IS

The Relationship between BS and IS

Example: To reduce tax expense, Phương Xuân Corp.
reports a fake cost that wasn’t actually incurred. How
does this action affect the balance sheet?
A. Increases assets.
B. Decreases liabilities.
C. Increases equity.

47
 The Relationship between BS and IS
Income Statement and Balance Sheet

48
 Statement of Cash flows
• The income statement provides a measure of the firm’s
profit over a given time period. However, it does not
indicate the amount of cash the firm has generated.
 There are non-cash entries on the income statement, such
as depreciation and amortization.
 Certain uses of cash, such as the purchase of a building or
expenditures on inventory, are not reported on the income
statement.
• The statement of cash flows utilizes the information from
the income statement and balance sheet to determine how
much cash the firm has generated, and how that cash has
been allocated, during a set period.
• Net Cash Flow = Ending Cash – Beginning Cash
 Statement of Cash flows
• The cash flow statement provides information
about a company’s cash receipts and cash
payments during an accounting period.
• In addition to information about cash
generated (or, alternatively, cash used) in
operating activities, the cash flow statement
provides information about cash provided (or
used) in a company’s investing and financing
activities.
 Reading 3
CFA, Financial Reporting and Analysis, Level 1
• Reading 27, Understanding Cash flow statement
Financial statements and company’s activities

Types of Company’s Activities

 Operating activities.
 Investing activities.
 Financing activities.
Example: Which of the following is an operating
activities?
A. Borrow money from a bank.
B. Pay tax.
C. Buy shares of other companies.
52
 Statement of Cash flows
 CFO calculation: direct methods
o Add/Subtract cash receipts and cash payments from
operation, or
o Readjust revenue and cost for:
 Non-cash charges or income.
 Non-operation cash-flow.

53
 Statement of Cash flows
Cash Flow Statement
 CFO indirect calculation: adjust net income (or income
before tax) for
o Non-cash income (-), non-cash charges (+).
o Non-operation income or charges.

54
 Statement of Cash flows
Example: PXL Company
Income Statement 2016
1.Sales 100.0
2.Cost of Good Sold 52.0
3.Gross Profit (1)-(2) 48.0
4.Interest Expense 0.5
5.Operating Profit 47.5
6.Other income (sales of land) 10.0
7.Earnings before Tax 57.5
8.Tax 20.0
9.Net Income 37.5

55
 Statement of Cash flows
Balance Sheet
Assets 2016 2015 Liabilities and Equity 2016 2015
1.Cash 33 9 6. Trade payables 9 5
2.Receivables 10 9 7. Staff payables 4.5 8
3.Inventories 5 7 8. Interest payables 3.5 3
4.Fixed assets 79 61 9.Tax payables 5 4
4.1.Cost 95 70 10.Long-term debts 21 11
4.2.Accum. Depr. (16) (9) 11.Deffered tax liabilities 20 15
5.Real Estates 35 40 12.Contributed Capital 40 50
13.Retained earnings 59 30
Total 162 126 Total 1162 126
56
 The Statement of Cash flows
Direct Method
CFO = Cash revenue – Cash cost
Cash revenue = Revenue- non-cash revenue= Revenue – change in
receivables = 100 – 1 = 99
- Cash cost= - CoGS+ depreciation - change in inventory
+ change in trade payables + change in staff payables
+ change in interest payables – interest expenses
+ change in DTL + change in tax payables– tax
= -52 + 7 + 2 + 4 – 3.5 + 0.5 – 0.5 + 5 + 1 – 20
= -56.5
Hence: CFO = 99 – 56.5 = 42.5 (VND billion) 57
 The Statement of Cash flows
Indirect Method
CFO = Net income+ Non-cash charges– non-cash revenue
–/+ Income / expenses from investment activities
Non-cash revenue = change in receivables= 1
Non-cash charges = + depreciation – change in in inventory + change in trade
payables + change in interest payables + change
in staff payables + change in DTL + change in tax
payables
= + 7 + 2 + 4 + 0.5 – 3.5 + 1 + 5 = 16
Income from investment activities = 10
58
CFO = 37.5 -1 + 16 – 10 = 42.5 (VND billion)
• CFO= Net income (after adjusting for Income / expenses from
investment activities) + depreciation– change in inventory-
change in receivables + change in payables= NI + depreciation–
Change in Net WC.

• NI= CFO + (Change in Net WC – depreciation)

NI = CFO+ Accruals

Net WC= Current assets- Current liabilities

Net WC= Inventories+ Receivables- Payables
Change WC= change in inventories+ change in receivables –
change in payables
Accruals-based earnings management
 Statement of Cash flows

Example: PXL Company (con’t)

CFI = - increase in non-current assets + income/expense from sales
of non-current assets
= - (95 – 70) + ( 40– 35) + 10 = -10 (VND billion)
CFF = + increase in debts – decrease in equity – dividend
= 10 – 10 – (net income – increase retained earnings)
= - 8.5 (VND billion)
Total cash flows
= CFO + CFI + CFF = 42.5 – 10 – 8.5 = 24 (VND billion) 60
 Evaluation of the sources and uses of Cash
• Evaluate where the major sources and uses of cash
flows are between operating, investing and financing
activities  Vary with the stage of firm growth
• Evaluate the primary determinants of operating cash
flow
• Evaluate the primary determinants of investing cash
flow.
• Evaluate the primary determinants of financing cash
flow.
 Determinants of operating cash flow
• What are the major determinants of operating
cash flow? Increases/decreases in receivables,
inventory, payables.
• The relationship between net income and
operating cash flow. Is operating cash flow
higher or lower than net income? Why?
Conservative or aggressive accounting
choices?
 Example
• Blue Bayou, a fictitious advertising company,
reported revenues of $50 million, total
expenses of $35 million, and net income of $15
million in the most recent year. If accounts
receivable decreased by $12 million, how much
cash did the company receive from customers?
A. $38 million.
B. $50 million.
C. $62 million.
 Example
• Orange Beverages Plc., a trading company of tropical
drinks, reported cost of goods sold for the year of
$100 million. Total assets increased by $55 million,
but inventory declined by $6 million. Total liabilities
increased by $45 million, but accounts payable
decreased by $2 million. How much cash did the
company pay to its suppliers during the year?
A. $96 million.
B. $104 million.
C. $108 million.
 Example
CML Textile Company.

Income Statement 2012 (forecast) 2011

Revenue 300 250
CoGS 170 140
Gross profit 130 110
SG&A 35 30
EBIT 95 80
Interest 15 10
EBT 80 70
Tax (at 30%) 24 21
Net income 56 49
65
 Example
Balance Sheet
2012 2011 2012 2011
Cash 10 5 Payables 20 20
Receivables 30 15 Short-term debts 20 10
Inventory 40 30 Current liabilities 40 30
Current assets 80 50 Long-term debts 114 100
Non-current assets 400 300 Common stock 50 50

Accumulated Dep. (190) (140) Retained earnings 86 30

Total liabilities and
Total Assets 290 210 290 210
equity
66
 Example
CFO = 56 + 50 – 25 = 81 VND billion
WCInv = (30 + 40 – 20) – (15 + 30 – 20) = 25 billion
FCInv = 400 – 300 = 100 billion
FCFF = 56 + 50 + 15(1 – 0.3) – 100 – 25 = -8.5 bil
Net Borrowings= (114 + 20) – (100 + 10) = 24
FCFE = -8.5 – 15(1 – 0.3) + 24 = 5 (VND billion)

67
 Problem 1
• On 31 December 2009, a company issued a £30,000
180-day note at 8 percent and used the cash received
to pay for inventory and issued £110,000 long-term
debt at 11 percent annually and used the cash
received to pay for new equipment. Which of the
following most accurately reflects the combined effect
of both transactions on the company’s cash flows for
the year ended 31 December 2009 under IFRS? Cash
flows from:
A. operations are unchanged.
B. financing increase £110,000.
C. operations decrease £30,000.
 Problem 2
• A company recorded the following in Year 1:
• Proceeds from issuance of long-term debt: €300,000
• Purchase of equipment: €200,000
• Loss on sale of equipment: €70,000
• Proceeds from sale of equipment: €120,000
• Equity in earnings of affiliate€10,000
On the Year 1 statement of cash flows, the company would
report net cash flow from investing activities closest to:
A. (€150,000).
B. (€80,000).
C. €200,000.
 Problem 3
• Copper, Inc., a fictitious brewery and
restaurant chain, reported a gain on the sale
of equipment of $12 million. In addition, the
company’s income statement shows
depreciation expense of $8 million and the
cash flow statement shows capital
expenditure of $15 million, all of which was
for the purchase of new equipment.
 Problem 3
• Using the above information from the
comparative balance sheets, how much cash
did the company receive from the equipment
sale?
Balance sheet item 12/31/2009 12/31/2010 Change
Equipment (Hist. cost) $100 million $109 million $9 million
Accumulated $30 million $36 million $6 million
depreciation-equipment
 Further reading
• Inventory: CFA L1, Vol3, p.170-174
• Depreciation: CFA L1, Vol3, p.175-178
• EPS: CFA L1, Vol3, p.186-194
• Cash flow statement: CFA L1, Vol3, p.266-312
 Financial Statement Analysis
• Compare the firm with itself by analyzing how
the firm has changed over time.
• Compare the firm to other similar firms using
a common set of financial ratios.
 Evaluate a firm’s ability to meet obligations.

 Evaluate a firm’s ability to growth.

 Assess management’s performance.

 Reading 3
Berk, Chapter2
• 2.6. Financial Statement Analysis
 CFA, Financial Reporting and Analysis, Level 1
 Reading 28  Common ratios in financial
analysis
 Financial Statement Analysis
 Common-Size Analysis
 Ratio Analysis
 Profitability Ratios
 Liquidity Ratios
 Working Capital Ratios
Interest Coverage Ratios
 Leverage Ratios
 Valuation Ratios
 III. RACommon-Size Analysis

 On the Balance sheet:

%Current assets= Current assets/ Total assets

 On the Income statement:

%CoGS = CoGS / Sales
Ví dụ
 Profitability Ratios
Measure the company’s ability to generate profits from
its resources (assets).
Income Statement
 Liquidity Ratios
• Measure the company’s ability to meet its
short-term obligations.
 Working
capital
Ratios
To gauge how
efficiently the
firm is utilizing
its net working
capital.
 Quiz
Assuming inflation and stable or increasing quantities of
inventory, compare LIFO to FIFO with regard to:
 Inventory turnover

84
 QUIZ
Example: Compared to FIFO, a firm that uses LIFO methods will
have (assume inflation environment):
A. Higher tax expense and lower net income because NI = EBT –
T.
B. Lower tax expense and higher net income because NI = EBT –
T.
C. Lower current ratio, higher debt-to-equity due to lower
inventory.
D. Higher inventory turnover, lower profit margins, cash flows
unchanged.
E. C and D are both correct.
85
 III. RATIO ANALYSIS
Liquidity: Cash Conversion Cycle

Cash Conversion Cycle

= days of inventory on hand
+ days of sales outstanding
- days of payables
 Cash Conversion Cycle

• Ref: Berk, Ch26, p.888

 Discussion
Please list industries (strategies) which tend to
have (lead to):
• High/low inventory days
• High/low receivable days
• High/low payable days
 Some industries
• Telecommunications
• Computer Hardware
• Beverages
• Airlines
• Internet Retail
• Restaurants
• Software
• Pharmaceuticals
• Grocery Stores
• Superstores
• Footwear
• Homebuilding
• Luxury Goods
• Constructions (bridge-building, road construction)
 Liquidity
 The level of liquidity needed differs from one
industry to another.
 To judge whether a company has adequate
liquidity:
 Historical funding requirements
 Current liquidity position
 Anticipated future funding needs, and options
for reducing funding needs or attracting
additional funds.
Interest Coverage Ratios
 Problem
 Please discuss the impact of an additional
depreciation expense on EBIT interest
coverage.
Leverage Ratios
 Valuation Ratios
Analysts use a number of ratios to gauge the market value of
the firm.
Operating Ratios
 III. RATIO ANALYSIS
Dupont Analysis
Net income
Return on equity =
Equity
Net income Sales Assets
= X X
Sales Assets Equity
III. RATIO ANALYSIS
ROE

Net Profit Margin Assets Turnover Financial Leverage

Gross profit Inventory

turnover D/E
margin

Receivables
Tax turnover Interest
coverage

Fixed-assets
Common-size
turnover Debt payment
income statement
coverage…

Common-size
balance sheet
Cash Flow Ratios- Performance ratios
Cash flow to revenue: CFO/Net Revenue
Cash return on assets: CFO/ Average total assets
Cash return on equity: CFO/ Average
shareholders’ equity
Cash to income: CFO/ Operating Income
Cash flow per share: (CFO- Preferred dividends)/
number of common shares outstanding
Ref: CFA, L1, Financial Reporting and Analysis,
P.304
Cash Flow Ratios- Coverage Ratios
Debt coverage: CFO/Total Debt
Interest coverage: (CFO+ Interest Paid + Taxes
Paid)/Interest Paid
Reinvestment: CFO/Cash for long-term assets
Debt Payment: CFO/ Cash paid for long-term debt
repayment.
Dividend payment: CFO/dividends paid
Investing and financing: CFO/(Cash outflows for
investing and financing activities)
Ref: CFA, L1, Financial Reporting and Analysis, P.304
• End of Chapter 2