Revenues are recorded at the point of sale and costs when they are incurred, not necessarily when a firm receives or pays out cash. Accrual-based approach • Used by financial professionals to focus attention on current and prospective inflows and outflows of cash. Cash flow approach Financial Statements
Balance Sheet Income Statement Statement of Retained Earnings Statement of Cash Flows Notes to Financial Statements Financial Statements • Financial Statements
Actual Examples of Financial Statements • Devon Energy • http://media.corporate-ir.net/media_files/irol/67/67097/reports/AR2007/08_04.htm • General Electric • http://www.ge.com/ar2007/cfs_fp.jsp
Balance Sheet • A firm’s balance sheet presents a “snapshot” view of the company’s financial position at a specific point in time. assets = liabilities + stockholders’ equity
Balance Sheet Assets and Liabilities are listed in descending order of liquidity
Gross profit • Operating profit • Other income • Earnings before interest and taxes • Pretax income • Net income / net profit after taxes Measures of Income Income Statement • Income is also called profit, earnings, or margin. Income = revenue expenses
Statement of Retained Earnings • The statement of retained earnings reconciles • the net income earned during a given year, and any cash dividends paid, • with the change in retained earnings between the start and end of that year.
Reconciles • the firm’s operating, investment, and financing cash flows • with changes in its cash and marketable securities • during the year. Statement of Cash Flows • Explanatory notes • that provide detailed information on the accounting policies, calculations, and transactions • underlying entries in the financial statements. Notes to Financial Statements Financial Statements
Cash Flow Analysis • Although financial managers are interested in the information contained in the firm’s accrual-based financial statements, their primary focus is on cash flows. • Without adequate cash to pay obligations on time, to fund operations and growth, and to compensate owners, the firm will fail.
Free Cash Flow • Operating cash flow = earnings before interest and taxes taxes + depreciation • Free cash flow = operating cash flow change in gross fixed assets change in current assets + change in account payables + change in accrued liabilities
Liquidity Ratios • Measure a firm’s ability to satisfy its short-term obligations as they come due. Activity Ratios • Measure the speed at which a firm converts various accounts into sales or cash. Debt Ratios • Measure the proportion of total assets financed by a firm’s creditors. Profitability Ratios • Relate a firm’s earnings to its sales, assets, or equity. Market Ratios • Relate a firm’s market value to certain accounting values. Analyzing Financial PerformanceUsing Ratio Analysis
Analysts compare the current year’s financial ratios with previous years’ ratios • to identify trends that help them evaluate the firm’s prospects. Benchmark 1 Benchmark 2 • Analysts compare the ratios of one company with those of other firms in the same industry. Using Financial Ratios
Profitability Ratios DuPont System of Analysis