Chapter

3
Financial Statement Analysis

Copyright © 2016 McGraw-Hill Education. All rights reserved.

 Chapter Overview
• The Statement of Financial Position
• The Income Statement
• Taxes
• Net Working Capital
• Cash Flow
• Financial Statement Analysis
• Ratio Analysis
• The DuPont Identity
• Using Financial Statement Information
 Overview
Three Important Accounting Statements

The Statement of The Income

Financial Position Statement

The Cash Flow

Statement
The Statement of
Financial Position
What are the firm’s assets and
how are they funded?
 The Statement of Financial Position

Sky plc 2014 Statement of Financial Position

Liquidity
 The Income Statement

Important Characteristics of Statements of Financial

Position
Current Current
and Non- and Non-
Current Current
Assets Liabilities

Net
Equity Working
Capital
The Income Statement
How has the firm performed over
the previous period?
 The Income Statement

Sky plc 2014 Income Statement

 The Income Statement

Important Characteristics of Income Statements

Variable
Non-Cash
and Fixed
Items
Costs

Operating
Profit and
Tax
Net
Income
Taxes
How to Calculate Tax
 Taxes

Average versus Marginal Tax Rates

Average Tax Marginal Tax

Rate Rate
•Tax Paid/Profit •Tax (%) you
before Taxes pay if you earn
one more unit
of currency
 Taxes

Average versus Marginal Tax Rates

First €200,000 earned by Dutch firms pay 20% tax; extra earnings pay 25% tax.
Suppose Dutch corporation has taxable income of €400,000.

Tax Paid Tax Rates

•20%*€200 + •Average:
25%*€200 = 90/400 = 22.5%
€90 •Marginal: 25%
Net Working Capital
How to Calculate Net Working
Capital
 Net Working Capital

How to Calculate Net Working Capital

Net
Current Current
Working
Assets Liabilities
Capital
 Net Working Capital
Sky plc 2014 Net Working Capital

Current Assets – Current Liabilities =

£2,573m – £2,519m = £54 million
The Cash Flow Statement
Where has the cash come from
and what has the firm spent?
 The Cash Flow Statement

Sky plc 2014 Cash

Flow Statement
Financial Statement
Analysis
How to assess firm performance,
risk and liquidity
 Financial Statement Analysis
Important to compare like for like

Financial Ratios

Common Size
Statements
Ratio Analysis
The Important Financial Ratios
 Ratio Analysis
What do Ratios Measure?
Short-term Solvency or Liquidity

Long-term Solvency or Leverage

Asset Management or Turnover

Profitability

Market Value
 Ratio Analysis
Short-term Solvency Ratios

Current assets
Current ratio =
Current liabilities

Current assets − Inventory

Quick ratio =
Current liabilities

Cash and cash equivalents

Cash ratio =
Current liabilities
 Ratio Analysis
Long-term Solvency Ratios
Total assets − Total equity
Total debt ratio =
Total assets

Debt-equity ratio = Total debt/Total equity

Equity multiplier = Total assets/Total equity

Profit Before Interest and Taxes

Times interest earned ratio =
Interest

EBIT + Depreciation
Cash coverage ratio =
Interest
 Ratio Analysis
Asset Management Ratios
Cost of goods sold
Inventory turnover =
Inventory
Operating Expenses
Inventory turnover =
Inventory

365 days
Days’ sales in inventory =
Inventory turnover
Revenues
Receivables turnover =
Trade receivables
365 days
Days’ sales in receivables =
Receivables turnover

Revenues
Total asset turnover =
Total assets
 Ratio Analysis
Profitability Ratios

Net income
Profit margin =
Revenues

Net income
Return on assets =
Total assets
Net income
Return on equity =
Total equity
 Ratio Analysis
Market Value Ratios

Net income
EPS =
Shares outstanding

Price per share

PE ratio =
Earnings per share

Market value per share

Market-to-book ratio =
Book value per share
The DuPont Identity
Disassembling Return on Equity
 The Du Pont Identity
What drives Performance?
Net income Net income Assets
Return on equity = = x
Total equity Total equity Assets
Net income Assets
= x
Assets Total equity

ROE
= ROA × Equity multiplier
= ROA × (1 + Debt–Equity ratio)
Using Financial Statement
Information
Practical Aspects of Financial
Statement Analysis
 Using Financial Statement Information
Choosing a Benchmark

Time Trend
Analysis

Peer Group
Analysis
 Concept Quiz
How much do you understand?
Identify two circumstances where negative operating cash flow might not

Quiz necessarily be a sign of deteriorating financial health. When can negative operating
cash flow become problematic for a company?

Both ROA and ROE measure profitability. Which one is more useful for comparing
two companies? Why?

A financial ratio by itself tells us little about a company because financial ratios vary
a great deal across industries. There are two basic methods for analysing financial
ratios for a company: time trend analysis and peer group analysis. Why might each
of these analysis methods be useful? What does each tell you about the company’s
financial health?