Financial Statements: Basic Concepts and Comprehensive Analysis

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Financial Statements Basic Concepts and
Comprehensive Analysis
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Financial Statements

• Balance Sheet
• Assets - economic resources expected to benefit
  future activities
• Liabilities - economic obligations to non owners
• Shareholders' s equity - excess of assets over
  liabilities or owners' interest in the firm
• A L O/E
• Income Statement
• Measures the operating performance of the
  organization by matching revenues and expenses
• Revenues - amounts earned by selling goods or
  services
• Expenses - amounts incurred to earn revenues

Liabilities
Assets
Shareholders Equity
Revenues Expenses Net income
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Dividends and Retained Earnings

• Retained Earnings
• Sum of all net incomes earned less all dividends
  paid to shareholders since the firm began
  operations
• Dividends
• Distribution of net income to shareholders
• Not an expense

Balance Sheet Dec 31 Year 1
Balance Sheet Dec 31 Year 2
Liabilities
Liabilities
Assets
Assets
Shareholders Equity
Shareholders Equity
Beginning Net Dividends Ending Retained inc
ome - Declared Retained Earnings for year
2 in year 2 Earnings
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Ratio Analysis

• Ratio analysis is the basis of most financial
  statement analysis
• Compare ratios in three ways
• Time-series analysis compare with firm's own
  ratios in past
• Cross-sectional analysis compare with other
  companies' ratios
• Benchmarking compare with common rules of thumb

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Four Categories of Ratios

• 1. Liquidity Ratios
• Whether company is able to meet its short-term
  financial obligations
• 2. Profitability Ratios
• Examination of levels of profits earned
• 3. Stability Ratios
• Measure of long-term financial strength
• 4. Growth Ratios
• Show areas where company has increased or
  decreased in size

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Liquidity Ratios
Current Ratio Current assets / Current
liabilities Quick Ratio Cash Accounts
receivable / Current liabilities Working
capital Current assets - Current
liabilities Age of Receivables Accounts
receivable / (Sales / No. of days) Age of
Inventory Inventory / (Cost of goods sold / No.
of days) Age of Payables Accounts payable /
(Purchases / No. of days) Inventory
Turnover Cost of goods sold / Inventory
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Profitability Ratios

• Return on Assets (ROA) Net income / Total
  assets
• Net Income Margin Net income / Sales
• Asset Turnover Sales / Assets
• Return on Shareholders Equity Net income /
• 
  Shareholders equity

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Stability Ratios
Debt to Assets Debt / Assets
Equity to Assets Equity / Assets Times
Interest Earned (Net income before taxes
Interest) / Interest
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Growth Ratios

• Sales (Current years sales - Last
• years sales) /
  Last years sales
• Profit (Current years profit - Last
• years profit)
  / Last years profit
• Assets (Current years assets - Last
• years assets) /
  Last years assets
• Equity (Current years equity - Last
• years equity) /
  Last years equity

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Cash Flow Analysis

• Statement of Cash Flows
• Where cash came from and what cash was used for
• Operating Activities
• Net income 240,000
• Non-cash expenses 130,000
• - Non-cash revenues (20,000)
• /- Working capital changes (100,000)
• Cash from Operations 250,000
• Investing Activities
• Purchase of plant and equipment (200,000)
• Cash used for Investing Activities (200,000)
• Financing Activities
• Sale of stock 200,000
• - Retirement of long-term debt (150,000)
• - Payment of dividends (40,000)
• Cash from Financing Activities 10,000
• Net increase in cash for the year 60,000