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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
Financial Statement Analysis
(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
Financial Statement Analysis
(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
Financial Statement Analysis
 Annual reports contain four basic financial
statements:•
•
•
•
Balance Sheet.
Statement of Stockholders’ Equity.
Income Statement or Earnings Statement.
Statement of Cash Flows.
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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.
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The Financial Statements
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.
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Financial Statement : Balance Sheet
Assets
Current
Assets
Liabilities
Current
Liabilities
Long-Term
Debt
Fixed Assets
1 Tangible
2 Intangible
Shareholders’
Equity
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Financial Statement : Balance Sheet
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
•
•
2.
Marketable Securities
•
•
3.
Cash awaiting deposit
Cash in a bank account
Short-term investments of cash that is not needed.
Treasury bills, certificates, notes, bonds, commercial
paper
Accounts Receivable
•
Customer balances outstanding on credit sales.
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Financial Statement : Balance Sheet
Assets
4.
Inventories


5.
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
Prepaid Expenses

Expenses paid in advance. Included in current assets if they
expire within one year or one operating cycle: insurance
 rent
 utilities
10
Financial Statement : Balance Sheet
Assets
A. Fixed Assets
1)Tangible:
•
Have physical substance. long-lived
–
–
•
Fixed assets other than land are “depreciated” over the
period of time they benefit the firm.
–
•
Not used up during annual operations.
Produce economic benefits for more than one year.
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.
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Financial Statement : Balance Sheet
Assets
2 .Intangible
•
•
•
•
•
•
Goodwill recognized in business combinations
Patents
Trademarks
Copyrights
Brand Names
Franchises
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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
4.
Result from recognition of an expense prior to actual payment of cash.
Unearned revenue
Result from payments received in advance for services or products.
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Financial Statement (Balance Sheet)
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.
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Financial Statement (Balance Sheet)
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.
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Financial Statement (Balance Sheet)
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.
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Financial Statement : Balance Sheet
Current assets:
Cash and equivalents
Accounts receivable
Inventories
Other
Total current assets
Fixed assets:
Property, plant, and equipment
Less accumulated depreciation
Net property, plant, and equipment
Intangible assets and other
Total fixed assets
Total assets
2007
$140
294
269
58
$761
2006
$107
270
280
50
$707
$1,423 $1,274
(550)
(460)
873
814
245
221
$1,118 $1,035
$1,879
$1,742
The assets are listed in2007
order
2006
Current Liabilities:
by
thepayable
length of time it$213
would
Accounts
$197
Notes payable
50
53
normally
take
a
firm
with
Accrued expenses
223
205
Total current liabilities
$486
$455
ongoing
operations to convert
Long-term
liabilities:
them
into
cash.
Deferred taxes
$117
$104
Long-term debt
Total long-term liabilities
Stockholder's equity:
Preferred stock
Common stock ($1 per value)
Capital surplus
Accumulated retained earnings
Less treasury stock
Total equity
Total liabilities and stockholder's equity
471
$588
458
$562
$39
$39
55
32
347
327
390
347
(26)
(20)
$805
$725
$1,879 $1,742
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Clearly, cash is much more
liquid than property, plant, and
equipment.
The Financial Statements
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.
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The Financial Statements
The Income Statement
• 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
The Financial Statements
The Income Statement
• 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
The Financial Statements
The Income Statement
• 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
The operations
section of the
income statement
reports the firm’s
revenues and
expenses from
principal
operations.
Total operating revenues
Cost of goods sold
Selling, general, and administrative expenses
Depreciation
Operating income
Other income
Earnings before interest and taxes
Interest expense
Pretax income
Taxes
Current: $71
Deferred: $13
Net income
Addition to retained earnings
Dividends:
$2,262
( 1,655)
( 327)
( 90)
$190
29
$219
( 49)
$170
( 84)
$86
$43
$43
22
Financial Statement : Income Statement
The non-operating
section of the income
statement includes
all financing costs,
such as interest
expense.
Total operating revenues
Cost of goods sold
Selling, general, and administrative expenses
Depreciation
Operating income
Other income
Earnings before interest and taxes
Interest expense
Pretax income
Taxes
Current: $71
Deferred: $13
Net income
Addition to retained earnings:
Dividends:
$2,262
1,655
327
90
$190
29
$219
49
$170
84
$86
$43
$43
23
Financial Statement : Income Statement
Usually a separate
section reports the
amount of taxes
levied on income.
Total operating revenues
Cost of goods sold
Selling, general, and administrative expenses
Depreciation
Operating income
Other income
Earnings before interest and taxes
Interest expense
Pretax income
Taxes
Current: $71
Deferred: $13
Net income
Addition to retained earnings:
Dividends:
$2,262
1,655
327
90
$190
29
$219
49
$170
84
$86
$43
$43
24
Financial Statement : Income Statement
Net income is the
“bottom line.”
Total operating revenues
Cost of goods sold
Selling, general, and administrative expenses
Depreciation
Operating income
Other income
Earnings before interest and taxes
Interest expense
Pretax income
Taxes
Current: $71
Deferred: $13
Net income
Retained earnings:
Dividends:
$2,262
1,655
327
90
$190
29
$219
49
$170
84
$86
$43
$43
25
Short-Term Asset Management
Current
Assets
Fixed Assets
1 Tangible
2 Intangible
Current
Liabilities
Net
Working
Capital
How should
short-term assets
be managed and
financed?
Long-Term
Debt
Shareholders’
Equity
26
Financial Statement : Balance Sheet
$252m = $707- $455
2007
Current assets:
Cash and equivalents
Accounts receivable
Inventories
Other
Total current assets
$140
294
269
58
$761
2006
$107
270
280
50
$707
Fixed assets:
Property, plant, and equipment
$1,423 $1,274
Less accumulated depreciation
(550)
(460
Net property, plant, and equipment
873
814
Intangible assets and other
245
221
Total fixed assets
$1,118 $1,035
$275m = $761m- $486m
2007
Current Liabilities:
Accounts payable
Notes payable
Accrued expenses
Total current liabilities
$1,879
$1,742
$213
50
223
$486
$197
53
205
$455
Long-term liabilities:
Deferred taxes
Long-term debt
Total long-term liabilities
Here we see NWC grow
$117 to $104
471
458
$275 million in 2006 from
$588
$562
$252 million in 2005.
Stockholder's equity:
Preferred stock
$39
$39
$23
million
Common stock ($1 par value)
55
32
Capital surplus
347
327
This
increase
of
$23
million
is
Accumulated retained earnings
390
347
Lessinvestment
treasury stock
(26)
(20)
an
of the firm.
Total equity
Total assets
2006
$805
$725
Total liabilities and stockholder's equity $1,879
$1,742
27
The Financial Statements
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
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
$238
Operating Cash Flow:
EBIT
-173
-23
$42
$36
Depreciation
$219
$90
Current Taxes -$71
OCF
$238
6
$42
29
Financial Statement : Financial Cash Flow
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
$238
Capital Spending
-173
-23
$42
Purchase of fixed assets
$198
Sales of fixed assets
-$25
Capital Spending
$173
$36
6
$42
30
Financial Statement : Financial Cash Flow
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
$238
-173
-23
$42
$36
NWC grew from $275
million in 2007 from
$252 million in 2006.
This increase of $23
million is the addition to
NWC.
6
$42
31
Financial Statement : Financial Cash Flow
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
$238
-173
-23
$42
$36
6
$42
32
Financial Statement : Financial Cash Flow
Cash Flow to Creditors
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
$238
-173
Retirement of debt
-23
$42
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
Interest
$49
$36
6
73
Debt service 122
Proceeds from new debt
sales
-86
Total
$36
$42
33
Financial Statement : Financial Cash Flow
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
$238
Cash Flow to Stockholders
-173
$43
Repurchase of stock
-23
$42
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
Dividends
6
Cash to Stockholders 49
Proceeds from new stock issue
$36
-43
Total
$6
6
$42
34
Financial Statement : Financial Cash Flow
Cash Flow of the Firm
Operating cash flow
(Earnings before interest and taxes
plus depreciation minus taxes)
Capital spending
(Acquisitions of fixed assets
minus sales of fixed assets)
Additions to net working capital
Total
$238
-173
-23
$42
Cash Flow of Investors in the Firm
Debt
(Interest plus retirement of debt
minus long-term debt financing)
Equity
(Dividends plus repurchase of
equity minus new equity financing)
Total
$36
The cash flow
received from the
firm’s assets must
equal the cash flows
to the firm’s creditors
and stockholders:
CF ( A) 
CF ( B )  CF ( S )
6
$42
35
Financial Statement : Financial Cash Flow
(Cash Flow from Operations)
To calculate cash flow
from operations, start
with net income, add
back non-cash items
like depreciation and
adjust for changes in
current assets and
liabilities (other than
cash).
Operations
Net Income
$86
Depreciation
90
Deferred Taxes
13
Changes in Assets and Liabilities
Accounts Receivable
-24
Inventories
11
Accounts Payable
16
Accrued Expenses
18
Notes Payable
-3
Other
-8
Total Cash Flow from Operations
$199
36
Financial Statement : Financial Cash Flow
(Cash Flow from Investing)
Cash flow from
investing activities
involves changes in
capital assets:
acquisition of fixed
assets and sales of fixed
assets (i.e., net capital
expenditures).
Acquisition of fixed assets
Sales of fixed assets
Total Cash Flow from Investing Activities
-$198
25
-$173
37
Financial Statement : Financial Cash Flow
(Cash Flow from Financing)
Cash flows to and from
creditors and owners
include changes in
equity and debt.
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
38
Financial Statement : Financial Cash Flow
Operations
Net Income
Depreciation
Deferred Taxes
Changes in Assets and Liabilities
Accounts Receivable
Inventories
Accounts Payable
Accrued Expenses
Notes Payable
Other
The statement of cash
flows is the addition of
cash flows from
operations, investing, Total Cash Flow from Operations
Investing Activities
Acquisition of fixed assets
and financing.
Sales of fixed assets
Total Cash Flow from Investing Activities
Financing Activities
Retirement of debt (includes notes)
Proceeds from long-term debt sales
Dividends
Repurchase of stock
Proceeds from new stock issue
Total Cash Flow from Financing
Change in Cash (on the balance sheet)
$86
90
13
-24
11
16
18
-3
-8
$199
-$198
25
-$173
-$73
86
-43
-6
43
$7
$33
39
40