Financial Statements according to GAAP

1
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

2
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-currentRelatively permanent assets used to
  generate revenue
• Liabilities (Debts) Future claims by outsiders
  on assets of the organization
• CurrentDue in the near future
• Long-termDue at least one year from the balance
  sheet date
• Stockholders EquityOwners claim to
  organization resources

3
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

4
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

5
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.

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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)

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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
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Calculation of ROI Both Methods

• Year 01 Year
  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

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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

10
Activity and Efficiency Measures

• Property-Plant-Equipment Turnover
• Inventory Turnover (Days sales in inventory)
• Accounts Receivable Turnover (Days sales in
  accounts receivable)

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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

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WHY FINANCIAL ANALYSIS?

• Solvency Evaluation (Short-range and Long-range)
• Changes in Company Value (Owners net worth)
• Earnings and Quality of Earnings Trend
• Management Efficiency
• Utilization and Control of Organization Resources
  (Assets)
• Cash Generation Efficiency of Organization
• Risk Assessment