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Financial Statements according to GAAP Income Statement (Statement of Operations) Shows profitability for a period of time A summary statement of revenues, expenses, gains, and losses Must follow GAAP (financial accounting standards) Subject to much judgment by management and CPAs

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financial statements according to gaap
Financial Statements according to GAAP
  • Income Statement (Statement of Operations)
    • Shows profitability for a period of time
    • A summary statement of revenues, expenses, gains, and losses
    • Must follow GAAP (financial accounting standards)
    • Subject to much judgment by management and CPAs
    • Traditionally, bottom-line earnings from income statements represented primary stock price drivers
    • Currently, the move is on in the accounting profession to distinguish appropriately between earnings and “quality” earnings
the balance sheet financial position
The Balance Sheet (Financial Position)
  • Determines Solvency Position of an organization on a given date
    • Assets (Resources): Future economic value owned or controlled by the organization
      • Current:--Cash and near cash assets
      • Non-current—Relatively permanent assets used to generate revenue
    • Liabilities (Debts): Future claims by outsiders on assets of the organization
      • Current—Due in the near future
      • Long-term—Due at least one year from the balance sheet date
    • Stockholders’ Equity—Owners’ claim to organization resources
statement of cash flows
Statement of Cash Flows
  • Summarizes cash inflows and (outflows) for a period of time
    • Includes all cash inflows (outflows) regardless of source or use
    • Categories of cash flows
      • Operating Activities: Shows cash flows from operating income (from income statement)
      • Investing Activities: Shows cash flows to investments and from sales of investments
      • Financing Activities: Shows cash flows from borrowing and sales of original equity issues and subsequent pay back of loans, equity re-acquisitions, and dividends
sources of financial analysis tools
Sources of Financial Analysis Tools
  • Finance and Accounting Texts
  • Dess-Lumpkin Text pp 98-117
  • Stickney-Brown Text (5th Ed)
  • Handout Link in your tentative schedule (Best Source)
    • Uses averages instead of end-of-year figures where appropriate and cost of goods sold instead of sales in inventory turnover calculations
    • Emphasizes DuPont Model for R.O.I. calculations
    • More cash flow analyses included
financial statement analysis
Financial Statement Analysis
  • Profitability Analysis
    • Return on Investment (ROI)
      • Return / Average Investment
    • DuPont Model
      • Return / Sales X Sales / Average Investment
      • Sales Margin X Asset Turnover
    • Return on Equity (ROE)
      • Return / Average Stockholders’ Equity
    • Others: PE Ratio; Dividend Yield; Dividend Payout
    • Also be sure to compare your company stock price trend with some of the major price indices.
why we use averages in denominators
Why We Use Averages in Denominators
  • Assume Total Assets at Beginning of Year = $500
    • At July 1, we acquire $500 in new plant assets
    • Net income (return on investment) for year is $50
  • If we use asset value at end of year
    • ROI = .05 ($50/ $1,000)
  • If we use average asset value
    • ROI = .067 ($50/ ($500 + 1,000)/2
  • Use of average assets gives a more accurate annual return on your investment (The $50 was earned during the last six months of the year)
advantage of using dupont model
Advantage of Using DuPont Model
  • Identifies cause of change in ROI from year to year
  • Uses the product of two intermediate calculations for sales margin (efficiency measure) and asset turnover (effective utilization of assets to generate revenue)
  • Assume the following information as an example

Year 01: Net Income-$50; Average Assets-$800; Sales-$1,000

Year 02: Net Income-$50; Average Assets-$1,000; Sales-$2,000

calculation of roi both methods
Calculation of ROI Both Methods
  • Year 01Year 02
  • Regular $50/$800 = .0625 $50/$1,000= .05
  • DuPont
  • 50/1,000 * 1,000/800 50/2,000 * 2000/1000
  • .05 * 1.25 = .025 * 2 =
  • .0625 .05
liquidity analysis
Liquidity Analysis
  • Working Capital
    • Working Capital =$Current Assets –$ Current Liabilities
    • Current Ratio = Current Assets / Current Liabilities
    • Acid Test Ratio = Cash, Temporary Investments and Receivables / Current Liabilities
  • Cash and Equivalents
    • Cash Flow Adequacy
    • Debt Coverage (Debt Payback)
    • Operations Index
    • Others include Reinvestment ratio, cash flow to sales, and cash flow return on average assets
activity and efficiency measures
Activity and Efficiency Measures
  • Property-Plant-Equipment Turnover
  • Inventory Turnover (Day’s sales in inventory)
  • Accounts Receivable Turnover (Days sales in accounts receivable)
financial leverage analysis
Financial Leverage Analysis
  • Debt Ratio
  • Debt to Equity Ratio
  • Times Interest Earned
  • Times Interest Covered by Cash Flow from Operating Activities
  • Wisely used outside capital injections greatly improve owners’ return on equity
  • Unwise use of outside capital adds burdensome fixed costs and contribute to increased risk of the organization
why financial analysis
  • Solvency Evaluation (Short-range and Long-range)
  • Changes in Company Value (Owner’s net worth)
  • Earnings and Quality of Earnings Trend
  • Management Efficiency
  • Utilization and Control of Organization Resources (Assets)
  • Cash Generation Efficiency of Organization
  • Risk Assessment