Understanding Financial Statements and Ratios: A Comprehensive Guide

1. Content and format of income statement and balance sheet. • Uses of financial ratios. • Calculate and interpret financial ratios. • DuPont analysis. Ch 2 Learning Goals

2. Income statement: a summary of • __________________ • and __________________ during a specified period. The Income Statement Financial Statements

3. Balance sheet: summary of a firm’s financial position at a given ___________________ in time. • Assets: what the firm ________________ • Liabilities: what the firm ________________ • Assets – liabilities = ______________ ____________________ represents the owners’ investment. The Balance Sheet Financial Statements

4. Using Financial Ratios Interested Parties • Ratio analysis: calculating and ________________ financial ratios to assess a firm’s financial condition and performance. • It is of interest to shareholders, creditors, and the firm’s own management.

5. Using Financial Ratios • Trend or time-series analysis Types of Ratio Comparisons Used to evaluate a firm’s performance over time

6. Using Financial Ratios Types of Ratio Comparisons • cross-sectional analysis Used to compare different firms at the same point in time

7. Using Financial Ratios Cross-sectional analysis To do a cross-sectional analysis, compare the firm’s ratios with: ________________ norms industry _______________

8. There are no ____________________ _____________________ for ratios! • Example: the current ratio should be 2. • Not necessarily! • Ratios should be interpreted in comparison to other similar firms (same industry, similar size, etc) Using Fin’l Ratios

9. Using Financial Ratios Cautions for Doing Ratio Analysis • Ratios must be considered together; a single ratio by itself means little. • Financial statements being compared should be from the same time. • Use audited financial statements if possible. • The financial data being compared should have been developed in the same way. • Inflation distorts the results.

10. Ratio Analysis • Liquidity Ratios • Activity (efficiency) Ratios • Leverage Ratios • Profitability Ratios • Common-size statements • DuPont Analysis

11. The DuPont system is not a method of calculating ROA and ROE, rather it is a technique for _____________________ financial performance. DuPont System of Analysis

12. DuPont analysis merges the income statement and balance sheet into two summary measures of profitability: _________ and ____________. DuPont System of Analysis

13. The DuPont system breaks ROE into: • A ___________________________ component • An __________________________ component • A ___________________________ (financing) component. DuPont System of Analysis

14. ROA = NPM X TATO And ROE = ROA X FLM Where: FLM = Financial Leverage Multiplier = Total Assets / Common Equity DuPont Analysis

15. The two formulas can be combined to get: NPM X TATO X FLM = ROE By putting the values for this formula for both the firm and the industry into a table, we can determine why a firm’s ROA and ROE are higher or lower than its competition. DuPont Analysis