Chapter 14
Financial Statement
Analysis
Albrecht, Stice, Stice, Swain
COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
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Why Perform Financial
Statement Analysis?
• Using financial statement analysis
– To predict a company’s future probability and
cash flows from its past performance.
– To evaluate the performance of a company
with an eye toward identifying problem areas.
• Financial statement analysis users
– Investors
– Creditors
– Management
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Financial Ratios
• Financial ratios
– Relationships between financial statement
amounts.
• Information is revealed when companies:
– Compare ratio values with past ratio values.
– Compare ratio values with ratio values for
similar companies in the same industry.
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Widely Used Ratios
• Debt ratio
– Represents the amount of assets financed
through debt.
Total Liabilities
Total Assets
• Current Ratio
– Measures a company’s liquidity or ability to
pay debt obligations in the short run.
Current Assets
Current Liabilities
4
Widely Used Ratios
• Return on Sales
– Measures the amount of profit earned per
dollar of sales.
Net Income
Total Sales
• Asset Turnover
– A measure of the company’s efficiency.
Total Sales
Total Assets
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Widely Used Ratios
• Return on Equity
– Measures the amount of profit earned per
dollar of investment.
Net Income
Total Stockholders’ Equity
• Price-Earnings Ratio
– A measure of growth potential, earnings
stability, and management capabilities.
Market Value of Shares
Price Per Share
OR
Net Income
Earnings Per Share
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Matching Financial Ratios
Debt ratio
Current ratio
Asset turnover
Return on sales
Return on equity
Price-earnings ratio
Sales
Total assets
Market price per share
Earnings per share
Total liabilities
Total assets
Net income
Owners’ equity
Net income
Sales
Current assets
Current liabilities 7
Common-Size
Financial Statements
• Common-size financial statements
– Generated by dividing all financial statement
amounts for a given year by sales for that
year.
• Common-size income statement
– Reveals the number of pennies of each
expense for each dollar of sales.
• Common-size balance sheet
– Asset section reveals the number of pennies
of each asset that are needed to generate
each dollar of sales.
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Common-Size Income
Statement Example
Goodrich Company
Common-Size Income Statement
For the Year Ended 12/31/09
Revenues. . . . . . . . . . . . . . . .
Cost of sales. . . . . . . . . . . .
Selling & admin. exp. . . . . .
Income before taxes. . . . . . . .
Income tax expense. . . . . . . .
Net income. . . . . . . . . . . . . . .
$10,000
5,000
1,500
$ 3,500
1,000
$ 2,500
100%
50
15
35%
10
25%
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The DuPont Framework
• The DuPont Framework
– A systematic approach for breaking down
return on equity into three components.
• Profitability.
• Efficiency.
• Leverage.
– Identifies factors that cause return on equity
to deviate from normal.
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Breaking Down Return on Equity
Return on Equity =
Profitability
x Efficiency
Profit Margin x
Net Income
Revenue
Net Income
Equity
Asset
Turnover
x Revenue
Assets
x
Leverage
x Assets-toEquity Ratio
x
Assets
Equity
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Efficiency Ratios—Receivables
• Accounts Receivable Turnover
– How many times during the year a company
collects its receivables.
Sales Revenue
Average Accounts Receivable
• Average Collection Period
– The average number of days it takes to collect
a credit sale.
365
Accounts Receivable Turnover
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Efficiency Ratios—Inventory
• Inventory Turnover
– How many times during the year a company
sells all of its inventory.
Cost of Goods Sold
Average Inventory
• Number of Days’ Sales in Inventory
– How many days worth of sales the company
has in inventory.
365
Inventory Turnover
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Efficiency Ratios—Fixed Assets
• Fixed Asset Turnover
– The amount of dollars in sales generated by
each dollar of fixed assets.
Sales
Average PP&E
– Standard values for this ratio differ from
industry to industry.
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Leverage Ratios
• Debt-to-equity ratio
– The number of dollars of debt for every dollar
invested by stockholders.
Total Liabilities
Total Stockholders’ Equity
• Times Interest Earned Ratio
– The ratio of income that is available for
interest payments.
Earnings Before Interest and Taxes
Interest Expense
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Cash Flow Ratios
• Why aren’t cash flow ratios standard for
financial statement analysis?
– The statement of cash flows is relatively
recent.
– Cash flow ratios are not included in the
DuPont framework.
• Usefulness of cash flow ratios.
– Large non-cash expenditures.
– Rapid growth.
– Window dressing time.
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Cash Flow Ratios
• Cash flow-to-net income ratio
– Reflects the extent to which accrual accounting
assumptions and adjustments have been included in
computing net income.
Cash Flow from Operations
Net Income
• Cash flow adequacy ratio
– Measures a company’s ability to finance its capital
expansion through cash from operations.
Cash Flow from Operations
Cash Paid for Capital Expenditures
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Potential Pitfalls
• Financial statements don’t contain all the
information about a company.
– All information is not numerical.
• Lack of comparability between companies.
– Different accounting practices.
– Conglomerates.
• Problems are not always readily apparent.
• Financial statement analysis is based off
of past information.
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