Title: Financial Statements, Taxes and Cash Flow
1Chapter
2
Intro to Financial Statements Analysis
2Key Concepts and Skills
 Know the difference between book value and market
value  Know the difference between accounting income and
cash flow  Know the difference between average and marginal
tax rates  Know how to determine a firms cash flow from its
financial statements
3Key Concepts and Skills
 Know how to standardize financial statements for
comparison purposes  Know how to compute and interpret important
financial ratios  Know the determinants of a firms profitability
and growth  Understand the problems and pitfalls in financial
statement analysis
4Chapter Outline
 The Balance Sheet
 The Income Statement
 Taxes
 Cash Flow
5Balance Sheet
 The balance sheet is a snapshot of the firms
assets and liabilities at a given point in time  Assets are listed in order of liquidity
 Ease of conversion to cash
 Without significant loss of value
 Balance Sheet Identity
 Assets Liabilities Stockholders Equity
6Balance Sheet
 Assets Liabilities Owners
Equity
7Market Vs. Book Value
 The balance sheet provides the book value of the
assets, liabilities and equity.  Market value is the price at which the assets,
liabilities or equity can actually be bought or
sold.  Market value and book value are often very
different. Why?  Which is more important to the decisionmaking
process?
8Income Statement
9Income Statement
 The income statement is more like a video of the
firms operations for a specified period of time.  You generally report revenues first and then
deduct any expenses for the period  Matching principle GAAP say to show revenue
when it accrues and match the expenses required
to generate the revenue
10Ratio Analysis
 Ratios also allow for better comparison through
time or between companies  As we look at each ratio, ask yourself what the
ratio is trying to measure and why is that
information important  Ratios are used both internally and externally
11Standardized Financial Statements
 CommonSize Balance Sheet
 Compute all accts as of Tot. Assets
 CommonSize Income Statements
 Compute all accts as of Sales
 Standardized stmts make it easier to compare
financial info, particularly as firm grows  Also useful for comparing co.s of different
sizes, particularly in same industry
12Categories of Financial Ratios
 Shortterm solvency or liquidity ratios
 Longterm solvency or financial leverage ratios
 Asset management or turnover ratios
 Profitability ratios
 Market value ratios
13Sample Balance Sheet
Cash 6,489 A/P 340,220
A/R 1,052,606 N/P 86,631
Inventory 295,255 Other CL 1,098,602
Other CA 199,375 Total CL 1,525,453
Total CA 1,553,725 LT Debt 871,851
Net FA 2,535,072 C/E 1,691,493
Total Assets 4,088,797 Total Liab. Equity 4,088,797
Numbers in thousands
14Sample Income Statement
Revenues 3,991,997
Cost of Goods Sold 1,738,125
Gross Profit 2,253,872
Expenses 1,269,479
Depreciation 308,355
EBIT 739,987
Interest Expense 42,013
Taxable Income 697,974
Taxes 272,210
Net Income 425,764
Shs outstanding 205,838.594
EPS 2.17
Dividends per share 0.86
Numbers in thousands, except EPS DPS
15Computing Liquidity Ratios
 Current Ratio CA / CL

1.02 times  Quick Ratio (CA Inventory) / CL

.825 times  Cash Ratio Cash / CL

.004 times  Net Working Capital CACL

16Longterm Solvency Measures
 Total Debt Ratio (TA TE) / TA

.5863 times or 58.63  The firm finances almost 59 of their assets with
debt.  Debt/Equity TD / TE

1.417 times  Equity Multiplier TA / TE 1 D/E

2.417
17Computing Coverage Ratios
 Times Interest Earned EBIT / Interest

17.6 times  Cash Coverage (EBIT Depreciation) / Interest

24.95 times
18ASSET MGMT RATIOSComputing Inventory Ratios
 Inventory Turnover Sales / Inventory

13.52 times
 Days Sales in Inventory 365 / Inventory
Turnover 
27 days
19Computing Receivables Ratios
 Receivables Turnover Sales / Accounts
Receivable 
3.79 times  Days Sales in Receivables 365 / Receivables
Turnover 
96 days
20Computing Total Asset Turnover
 Total Asset Turnover Sales / Total Assets

.98 times  Measure of asset use efficiency
 Not unusual for TAT lt 1, especially if a firm has
a large amount of fixed assets
21Computing Profitability Measures
 Profit Margin Net Income / Sales

.1067 times or 10.67  Return on Assets (ROA) Net Income / Total
Assets 
.1041 times or 10.41  Return on Equity (ROE) Net Income / Total
Equity 
.2517 times or 25.17
22Computing Market Value Measures
 Market Price 61.625 per share
 Shares outstanding 205,838,594
 PE Ratio Price per share / Earnings per share

28.4 times  Markettobook ratio market value per share /
book value per share 
7.5 times
23Market Value Measures
 Value Stocks Firms w/ low Mrkt to Book ratios
 Growth Stocks Firms w/ high Mrkt to Book ratios
 Market Capitalization Mrkt Value of Common
Equity  Enterprise Value MV equity MV debt Cash
mrktbl securities. Measures value of firms
underlying business
24Using the Du Pont Identity
 ROE PM TAT EM
 Profit margin is a measure of the firms
operating efficiency how well does it control
costs  Total asset turnover is a measure of the firms
asset use efficiency how well does it manage
its assets  Equity multiplier is a measure of the firms
financial leverage
25Payout and Retention Ratios
 Dividend payout ratio Cash dividends / Net
income 
.3963 or 39.63  Retention ratio Additions to retained earnings
/ Net income 1 payout ratio 
.6037 60.37  Or
.6037 60.37
26The Internal Growth Rate
 The internal growth rate tells us how much the
firm can grow assets using retained earnings as
the only source of financing.
27The Sustainable Growth Rate
 The sustainable growth rate tells us how much the
firm can grow by using internally generated funds
and issuing debt to maintain a constant debt
ratio.
28Determinants of Growth
 Profit margin operating efficiency
 Total asset turnover asset use efficiency
 Financial leverage choice of optimal debt ratio
 Dividend policy choice of how much to pay to
shareholders versus reinvesting in the firm
29Why Evaluate Financial Statements?
 Internal uses
 Performance evaluation compensation and
comparison between divisions  Planning for the future guide in estimating
future cash flows  External uses
 Creditors
 Suppliers
 Customers
 Stockholders
30Benchmarking
 Ratios are not very helpful by themselves they
need to be compared to something  TimeTrend Analysis
 Used to see how the firms performance is
changing through time  Internal and external uses
 Peer Group Analysis
 Compare to similar companies or within industries
 SIC and NAICS codes
31Quick Quiz
 How do you standardize balance sheets and income
statements and why is standardization useful?  What are the major categories of ratios and how
do you compute specific ratios within each
category?  What are the major determinants of a firms
growth potential?  What are some of the problems associated with
financial statement analysis?
32Taxes
 The one thing we can rely on with taxes is that
they are always changing  Marginal vs. average tax rates
 Marginal the percentage paid on the next dollar
earned  Average the tax bill / taxable income
 Other taxes
33Example Marginal Vs. Average Rates
 Suppose your firm earns 4 million in taxable
income.  What is the firms tax liability?
 What is the average tax rate?
 What is the marginal tax rate?
 If you are considering a project that will
increase the firms taxable income by 1 million,
what tax rate should you use in your analysis?
34The Concept of Cash Flow
 Cash flow is one of the most important pieces of
information that a financial manager can derive
from financial statements  The statement of cash flows does not provide us
with the same information that we are looking at
here  We will look at how cash is generated from
utilizing assets and how it is paid to those that
finance the purchase of the assets
35(No Transcript)
36Cash Flow Problem 219
 Belyk Paving has sales of 2,000,000. COGS, SGA,
and depreciation expenses were 1,200,000,
300,000, 400,000 respectively. It also had
interest expense of 150,000, a 35 tax rate.
Ignore any tax loss carry back or forward
provisions,  What is the Net Income?
 What is the Operating Cash Flow?
37(No Transcript)
38Quick Quiz
 What is the difference between book value and
market value? Which should we use for decision
making purposes?  What is the difference between accounting income
and cash flow? Which do we need to use when
making decisions?  What is the difference between average and
marginal tax rates? Which should we use when
making financial decisions?  How do we determine a firms cash flows? What
are the equations and where do we find the
information?