Chapter 9

The Analysis of the Balance

Sheet and the Income
Statement
The Analysis of the Balance Sheet
and the Income Statement
Link to Previous Chapter

Chapter 8 reformulated the

statement of owners’ equity.

This Chapter

What assets What items in How are taxes What ratios

This chapter continues the
and liabilities the income allocated to the are calculated
reformulation and analysis are classified statement are operating and from
with the balance sheet and as operating ? classified as financing reformulated
income statement. As financing ? operating ? As components of statements ?
The reformulation follows the financing ? the income What do they
design in Chapter 7. statement ? mean ?

Link to Next Chapter

Chapters 10 reformulates the

cash flow statement.

Link to Web Page

More applications and

discussion are on the web page.
 What you will learn from this
chapter

• Why reformulated income statements and

balance sheets are desirable

• How knowledge of the business is

incorporated in reformulated statements

• How operating and financing components

of the two statements are identified

• Which assets and liabilities typically fall

into operating and financing categories

• Why income taxes are allocated to different

parts of the income statement

• What balance sheet and income statement

ratios reveal
Analysis of Balance Sheet and
Income Statement: the Steps

1. Reformulate to distinguish
between operating and
financing activities

2. Carry out common size and

trend analysis

3. Calculate balance sheet and

income statement ratios
 The Standard Balance Sheet
Assets Liabilities and Stockholders’ Equity

Current assets: Current liabilities:

Cash Accounts payable

Cash equivalents Accrued expenses
Short-term investments Deferred (unearned) revenues
Deposits and advances Advances from customers
Accounts receivable (less allowances) Short-term notes payable
Short-term notes receivable Short-term borrowings
Other receivables Deferred taxes (current portion)
Inventories Current maturities of long-term debt
Prepaid expenses
Deferred income taxes (current portion)

Long-term assets: Long-term liabilities:

Long-term marketable debt securities Bank loans

Long-term non-marketable debt investments
Equity investments at market
Equity investments - equity method
Property plant and equipment
(less accumulated depreciation)
Land
Buildings
Equipment
Leased assets
Leasehold improvements
Construction in progress
Bonds payable
Long-term notes payable
Lease obligations
Commitments and contingencies
Deferred taxes
Pension liabilities
Post employment liabilities
Minority Interest

Intangible assets
Patents
Copyrights
Goodwill

Deferred taxes (non-current) Preferred equity

Deferred charges Common equity
Reformulating the Balance Sheet:
The Governing Accounting
Relations

Net Operating Assets (NOA)

= Operating Assets (OA) – Operating
Liabilities (OL)

Net Financial Obligations (NFO)

= Financial Obligations (FO) – Financial
Assets (FA)

Common Shareholders’ Equity (CSE)

= NOA – NFO
 The Typical Reformulated
Balance Sheet
Assets Liabilities and Stockholders’ Equity

Financial assets: Financial liabilities:

- Cash equivalents - Short-term borrowings

- Short-term investments - Current maturities of long-term debt

- Short-term notes receivable (?) - Short-term notes payable (?)

- Long-term non-marketable - Long-term borrowing (bank loans,

debt investments bonds, payable, notes payable)

- Long-term marketable - Lease obligations

debt securities
- Preferred stock

Operating assets: Operating liabilities:

all else all else

Common equity
Issues in Reformulating Balance
Sheets
• Cash: working cash and excess cash
• Short term notes receivable: trade receivables or
investment of cash?
• Finance receivables: an operating asset
• Debt investments: financial assets
• Short-term equity investments: excess cash or trading
securities?
• Short-term notes payable: trade notes or borrowing?
• Lease assets: operating assets
• Lease liabilities: financial obligation
• Deferred tax assets and liabilities: operating
• Deferred revenues and accrued expenses: operating
• Minority interest: not a financial obligation
• For financial firms, many “financial items” are
operating assets and liabilities
Nike, Inc.: GAAP Balance Sheet
(1)

May 31,
2004 2003
(In millions)
ASSETS
Current Assets:
Cash and cash equivalents 828.0 634.0
Short-term investments 400.8 -
Accounts receivables, less allowance for doubtful 2,120.2 2,083.9
accounts of $95.3 and $81.9
Inventories (Note 2) 1,633.6 1,514.9
Deferred income taxes (Note 8) 165.0 221.8
Prepaid expenses and other current assets 364.4 332.5
Total current assets 5,512.0 4,787.1

Property, plant and equipment, net (Note 3) 1,586.9 1620.8

Identifiable intangible assets, net (Note 4) 366.3 118.2
Goodwill (Note 4) 135.4 65.6
Deferred income taxes and other assets (Note 8) 291.0 229.4
Total assets 7,891.6 6,821.1
 Nike, Inc.: GAAP Balance Sheet
(cont.)

May 31,
2004 2003
(In millions)
LIABILITIES AND SHAREHOLDERS EQUITY
Current Liabilities:
Current portion of long-term debt (Note 7) 6.6 205.7
Notes payable (Note 6) 146.0 75.4
Accounts payable (Note 6) 763.8 572.7
Accrued liabilities (Notes 5 and 16) 974.4 1,036.2
Income taxes payable 118.2 130.6

Total current liabilities 2,009.0 2,020.6

Long-term debt (Note 7) 682.4 551.6

Deferred income taxes and other liabilities 418.2 257.9
(Note 8)
Commitments and contingencies (Notes 14 and 16) - -
Redeemable Preferred Stock (Note 9) 0.3 0.3
Shareholders Equity:
Common Stock at stated value (Note 10):
Class A convertible - 77.6 and 97.8 shares outstanding 0.1 0.2
Class B - 185.5 and 165.8 shares outstanding 2.7 2.6
Capital in excess of stated value 887.8 589.0
Unearned stock compensation (5.5) (0.6)
Accumulated other comprehensive loss (Note 13) (86.3) (239.7)
Retained earnings 3,982.9 3,639.2

Total shareholders equity 4,781.7 3,990.7

Total liabilities and shareholders equity 7,891.30 6,820.80
Nike, Inc.:
Reformulated Balance Sheets

2004 2003 2002

Net Operating Assets
Operating Assets:
Operating cash1 61 53 49
Account receivables (less doubtful accounts 2,120 2,084 1,807
of $95, $82, and $77)
Inventories 1,634 1,515 1,384
Prepaid expenses 6 370 333 261
Property, plant and equipment (net) 1,587 1,621 1,615
Goodwill 135 66 174
Trademarks and other intangibles 400 140 283
Accumulated amortization (34) 366 (22) 118 (19) 264
Deferred income taxes and other assets 456 451 374
6,728 6,241 5,928

Operating Liabilities:
Accounts payable-non-interest bearing2 720 523 468
Accrued liabilities 3 921 999 768
Income taxes payable 118 131 83
Deferred income taxes 418 258 142
2,177 - 1,911 1,461
4,551 4,330 4,467
Net Financial Obligations
Cash equivalents 1 (767) (581) (527)
Short-term investments (401)
Current portion of long-term debt 7 206 55
Notes payable4 146 75 425
Accounts payable-interesting bearing2 44 50 36
Long-term debt 682 552 626
Redeemable preferred stock 5 - (289) - 302 - 615
Common Stockholders' Equity6 4,840 4,028 3,852

1
Cash and cash equivalents are split between operating cash and cash investments. Operating cash is estimated
at 1/2 percent of sales
2
Some accounts payable are interst bearing. These are classified as financing obligations.
3
Accured expenses exclude dividends payable (now included in equity)
4
Notes payable are interest bearing
5
Preferred stock is less than $0.5 million
6
Unearned compensation is excluded from equity and included in prepaid expenses.

Some items may not total precisely due to rounding error

 Reebok: GAAP Balance Sheet
(1)

December 31
--------------------------------------
2004 2003
---------------- ----------------
Amounts in thousands,
except per share data
Assets

Current assets:
Cash and cash equivalents $ 565,233 $ 693,599
Accounts receivable, net of allowance for 660,599 532,320
doubtful accounts (2004, $81,280; 2003,
$70.823)
Inventory 458,435 352,692
Deferred income taxes 111,516 100,070
Prepaid expenses and other current assets 61,730 48,169
----------- ------------
Total current assets 1,857,513 1,726,850
----------- ------------
Property and equipment, net 183,799 149,765
Other non-current assets:
Goodwill, net 124,125 24,690
Intangibles, net of amortization 196,138 42,296
Deferred income taxes 44,892 22,478
Other 34,161 23,663
-------------- --------------
Total Assets $ 2,440,628 $ 1,989,742
-------------- --------------
 Reebok: GAAP Balance Sheet
(cont.)
December 31
------------------------------------
2004 2003
---------------- --------------
Amounts in thousands,
except per share data
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable to banks $ 63,179 $ 8,055
Current portion of long-term debt 100,627 163
Accounts payable 183,853 155,904
Accrued expenses 386,725 374,849
Income taxes payable 71,930 27,017
----------- -----------
Total current liabilities 806,314 565,988
----------- -----------
Long-term debt, net of current portion 360,126 353,225
Minority interest 8,514 11,657
Other long-term liabilities 45,718 25,162
Commitments and contingencies

Stockholders' equity:
Common stock, par value $.01; authorized 250,000 shares; 1.018 1.011
issued shares: 101,827 in 2004; 101,081 in 2003
Retained earnings 1,985,324 1,796,321
Less shares in treasury at cost: 42,619 in 2004; 41,473 in 2003 (780,510) (740,189)
Unearned compensation (5,804) (1,225)
Accumulated other comprehensive income (expense) 19,928 (22,208)
------------- -------------
Total Stockholders' Equity 1,219,956 1,033,710
------------- -------------
Total Liabilities and Stockholders' Equity $ 2,440,628 $ 1,989,742
-------------- --------------
Reebok: Reformulated Balance
Sheet
Microsoft Corporation:
Reformulated Balance Sheet
Year ending June 30 2002 2001

Net Operating Assets

Operating assets:
Working cash1 $ 50 $ 50
Account receivable, net 5,129 3,671
Inventories 673 83
Deferred income taxes 2,112 1,522
Property and equipment, net 2,268 2,309
Equity investments 9,151 8,780
Convertible preferred debt2 3,036 3,925
Goodwill 1,426 1,511
Intangible assets, net 243 401
Other assets 2,952 3,372
27,040 25,624
Operating liabilities
Accounts payable 1,208 $ 1,188
Accrued compensation 1,145 742
Income taxes payable 2,022 1,468
Unearned revenue 7,743 5,614
Preferred income taxes 398 409
Other liabilities 2,950 15,466 2,120 11,541
11,574 14,083
Net financial assets
Cash equivalents 2,966 3,872
Short-term investments 35,636 27,678
Long-term debt investments 2,004 40,606 1,656 33,206

Common Stockholders’ Equity 52,180 47,289

1
Cash and cash equivalents split between working cash and financial assets.
2
Convertible debt of AT&T Corp. in connection with investment in broadband.
 The Standard Income
Statement
Net sales (sales minus sales allowances)
+ Other revenue (royalties, rentals, license fees)
- Cost of sales
= Gross margin
- Marketing and advertising expenses
- General expenses
- Administrative expenses
- Pension Expense
- ± Special items and nonrecurring items
o Restructuring charges
o Merger expenses
o Gains and losses on asset sales
o Asset impairments
o Litigation settlements
o Environmental remediation
- Research and development expense

+ Interest revenue
- Interest (expense)
 Realized gains and losses on financial assets
+ Share of income of subsidiary
- Income taxes
= Income before extraordinary items and discontinued operations
 Discontinued operations
 Extraordinary items
 Gains and losses on debt retirement
 Abnormal gains and losses
 Cumulative effect of an accounting change
- Minority interest

= Net income
 The Reformulated Income
Statement (1)
1. Operating items are separated from financing items.
2. Operating income from sales is separated from other operating income.
3. Tax is allocated to components of the statement, with no allocation to items
reported on an after-tax basis

Reformulated Comprehensive Income Statement

Net sales
– Expenses to generate sales
Operating income from sales (before tax)
– Tax on operating income from sales
+ Tax as reported
+ Tax benefit from net financial expenses
– Tax allocated to other operating income
Operating income from sales (after tax)
±Other operating income (expense) requiring tax allocation
Restructuring charges and asset impairments
Merger expenses
Gains and losses on asset sales
Gains and losses on security transactions
− Tax on other operating income
± After-tax operating items
Equity share in subsidiary income
Operating items in extraordinary income
Dirty-surplus operating items in Table 8.1
Hidden-dirty surplus operating items
Operating income (after tax)
 The Reformulated Income
Statement (2)

continued…

- Net financial expenses after tax

+ Interest expense
- Interest revenue
= Net interest expense before tax
+ Tax benefit from net interest expenses
= Net interest expenses after tax
 Gains and losses on debt retirement.
 Realized gains and losses on financial assets
 Dirty surplus financial items in Table 8.1
 Hidden dirty surplus financial items
+ Preferred dividends
 Gains and losses on redemption of preferred stock
- Tax benefit from preferred dividends (if any)
- Minority Interest

= Comprehensive Income to Common

 The Allocation of Taxes
• In the income statement only one tax number is
reported: It must be allocated to the operating and
financial components to put both on an after-tax basis

• First, calculate the tax benefit (tax shield) provided by

deducting interest expense

Tax Benefit  Net Interest Expense  t

where t is the marginal (not effective) tax rate.
(The statutory rate is usually the marginal rate)

• From the operating income deduct both the total tax

and the tax benefit, to capture what the operating
income would have been, after tax, had there been no
financing activities

• To the net financial expense add the tax benefit,

because its net effect is attributable to the financing
activities
 Top-down and Bottom-up Methods
for Tax Allocation: Tax Rate = 35%

GAAP Top-down Bottom-up

Income Statement Tax Allocation Tax Allocation

Revenue $4,000
Operating expenses (3,400)
Interest expense (100)
Income before tax 500
Income tax expense (150)
Net income $ 350

Revenue $4000
Operating expenses (3,400)
Operating income before tax 600
Tax expense:
Tax reported $150
Tax benefit for interest 35 (185)
($100 x 0.35)
Operating income after tax $ 415

Net income $350

Interest expense $100
Tax benefit 35 65
Operating income after tax $415
 Additional Tax Allocation within
Operations

• Allocate taxes between operating

income from sales and other
operating income (not from sales)
so that both are after tax.

• Remember: some other operating

income items are after tax (if they
appear below the tax line on the
GAAP statement)

• Remember: losses draw negative

tax
Starting Point for Income Statement
Reformulation: Identify Comprehensive
Income from Equity Statement

Nike Reebok

Balance May 31, 2003 $4,028 $1,035

Transactions with shareholders:

Shares issued, at market $388 $83

Shares repurchased (416) (88)
Common dividends (179) (207) (18) (23)

Comprehensive income

Net income reported $946 $192

Currency translation gain 28 38
Gains on hedging instruments 126 4
Loss on option exercise $127 $32
Tax benefit (47) (80) 1,019 12 (20) 214

Balance May 31, 2004 $4,840 $1,226

Nike, Inc; GAAP Income
Statement

Year Ended May 31,

2004 2003 2002
(In millions, except per share data)
Revenues $ 12,253.1 $ 10,697.0 $ 9,893.0
Cost of sales 7,001.4 6,313.6 6,004.7
Gross Margin 5,251.7 4,383.4 3,888.3
Selling and administrative 3,702.0 3,154.1 2,835.8
Interest expense, net (Notes 6 and 7) 25.0 28.8 34.0
Other expense, net (Note 16) 74.7 77.5 1.2
1,450.0 1,123.0 1,017.3
Income before income taxes and
cumulative effect of accounting on change
Income taxes (Note 8) 504.4 382.9 349.0

Income before cumulative effect of

accounting change 945.6 740.1 668.3
Cumulative effect of accounting change
net of income taxes of ($-. $- and $3.0)
(Note 4, Note 1) - 266.1 5.0
Net Income $ 945.6 $ 474.0 $ 663.3
Basic earnings per common share -
before accounting change (Notes 1 and
11) $ 3.59 $ 2.80 $ 2.50
Cumulative effect of accounting change - 1.01 0.02
$ 3.59 $ 1.79 $ 2.48

Diluted earnings per common share -

before accounting change (Notes 1 and
11) $ 3.51 $ 2.77 $ 2.46
Cumulative effect of accounting change - 1.00 0.02
$ 3.51 $ 1.77 $ 2.44
Nike Inc.: Reformulated Income
Statement
Reebok: GAAP Income Statements
Reebok: Reformulated Income
Statements
2004 2003 2002

Operating Revenues 3,785 3,485 3,128

Cost of sales 2,287 2,147 1,930
Gross margin 1,498 1,338 1,198
Operating expenses
Administrative expenses 1,067 936 851
Advertising 137 150 131
Other expenses 5 1,209 1 1,087 6 988
Operating income from sales (before tax) 289 251 210
Taxes
Tax as reported 68 72 61
Tax on financial items 5 73 6 78 5 66
Operating income from sales (after tax) 216 173 144
Other operating income (net-of-tax items):
Currency translations gains 38 49 37
Loss on derivative employee stock option (20) (17) (7)
Derivative gains and losses in equity statement 4 (14) (23)
Effect of accounting change 22 18 (5) 2
Operating income (after tax) 237 191 146

Financing expense (Income)

Interest expense 26 26 24
Interest income (13) 13 (8) 18 (9) 15
Tax effect (5) (6) (5)
Net interest expense 8 12 10
Loss on retirement debt (10)
(18) 12 10

Comprehensive income before minority interest 219 179 136

Minority interest 5 5 3
Comprehensive income to common 214 174 133

1
Broken out from selling and administrative expenses in published income statement.
2
Marginal tax rate was 35.9%, 35.9% and 35.5% for 2004, 2003 and 2002, respectively, including both federal and state taxes.
 Track Nike on BYOAP

2002 2001 2000 1999 1998 1997 1996

Sales 9,893 9,489 8,995 8,777 9,553 9,187 6,471
Operating income 620 577 557 449 410 797 549
(after tax)
Comprehensive 599 549 537 430 384 777 535
income
Net operating assets 4,460 4,517 4,402 3,993 4,042 3,674 2,659
Net financial 616 1,022 1,254 658 780 518 228
obligations
Common 3,844 3,495 3,148 3,335 3,262 3,156 2,431
shareholders’ equity
 Microsoft Corporation:
GAAP Income Statements

Year Ended June 30 2002 2001

_________________________________________________________________________________________

Revenue $ 28,365 $ 25,296

Operating expenses:
Cost of revenue 5,191 3,455
Research and development 4,307 4,379
Sales and marketing 5,407 4,885
General and administrative 1,550 857
-------------------------------------------------------- - ------ - - -
Total operating expenses 16,455 13,576
-------------------------------------------------------- - ------ - - -

Operating income 11,910 11,720

Losses on equity investees and other (92) (159)
Investment income(loss) (305) (36)

-------------------------------------------------------- - ------ - - -

Income before income taxes 11,513 11,525

Provision for income taxes 3,684 3,804
-------------------------------------------------------- - ------ - - -

Income before accounting change 7,829 7,721

Cumulative effect of accounting change (net of tax) (375)

-------------------------------------------------------- - ------ - - -

Net income $ 7,829 $ 7,346

__________________________________________________________________________________
 Microsoft Corporation:
Reformulated Income Statements
Year ended June 2002 2001

Revenue $ 28,365 $ 25,296

Operating expenses:
Cost of revenue 5,191 3,455
Research and development 4,307 4,379
Sales and marketing 5,407 4,885
General and administrative 1,550 857
16,455 13,576

Operating income from sales, before tax 11,910 11,720

Tax as reported $ 3,684 $ 3,804

Tax on other operating income 872 756
Tax on financing income (758) 3,798 (743) 3,817

Operating income from sales, after tax 8,112 7,903

Investment income in income statement:1
Dividends 357 377
Realized gains on sales of investments 2,121 3,003
Permanent impairment of investments (4,323) (4,804)
Unrealized losses on derivatives (480) (2,325) (592) (2,016)
Tax on investment income (at 37.5%)2 872 756
(1,453) (1,260)
Investment income in equity statement
(after tax):
Unrealized loss on convertible debt -- (829)
Gains (losses) on derivatives (91) 634
Unrealized losses on equity investments (281) (707)
Total investment income (1,825) (2,162)

Losses in equity subsidiaries (92) (159)

Currency translation and other 82 (39)
Cumulative effect of accounting change -- (450)
Total other income (1,835) (2,810)

Total operating income 6,277 5,093

Net financing income

Interest income3 1,762 1,808
Realized gains on short-term investments 258 172
2,020 1,980
Tax at 37.5%4 758 743
1,262 1,237
Financing income in equity statement
(after tax):
Unrealized gain on financial assets 286 76

Total financing income 1,548 1,313

Comprehensive income 7,825 6,406

1
Included in investment income is the GAAP statement; details from footnotes.
2
Losses on investments draw a tax deduction.
3
Interest income is included in investment income in the GAAP statement.
4
With net financing income, financing activities draw further taxes rather than a tax benefit.
 Common Size Analysis

Comparison to other firms is called cross-

sectional analysis

Common size analysis gives a ready

comparison:

• The Income Statement

– Each item/Total revenues

• The Balance Sheet

– Operating items/Totals
– Financing items/Totals
 Common Size Analysis : Nike
and Reebok Income Statements
Nike Reebok
$ % $ %

Revenue 12,253 100.0 3,785 100.0

Cost of sales 7,001 57.1 2,287 60.4
Gross margin 5,252 42.9 1,498 39.6

Operating expenses
Administrative 2,312 18.9 1,067 28.4
Advertising 1,378 11.2 137 3.6
Amortization and other 87 0.7 5 0.1
Operating income from sales 1,474 12.0 289 7.6
(before tax)

Tax on operating income from sales 513 4.2 73 1.9

Other operating income from sales 961 7.8 216 5.7

(after tax)
Other operating income 74 0.6 22 0.5
Operating income 1,035 8.4 237 6.3
Net financing expense (income) 16 0.1 18 0.5

Comprehensive income to common 1,019 8.3 214 5.7

 Common Size Analysis: Nike
and Reebok Balance Sheets
Nike Reebok
$ % $ %

Operating assets
Cash 61 0.9 19 1.0
Accounts renewable 2,120 31.5 661 34.8
Inventories 1,634 24.3 458 24.1
Prepaid expenses 370 5.5 68 3.6
Property, plant and equipment 1,587 22.6 184 9.7
Goodwill 135 2.0 124 6.5
Trademarks and other intangibles 400 5.9 200 10.5
Accumulated amortization (34) (0.5) (4 (0.2)
Deferred taxes and other assets 456 6.8 190 10.0
6,729 100.0 1,900 100.0

Operating liabilities
Accounts payable 720 33.1 184 26.7
Accrued liabilities 921 42.3 387 56.3
Income taxes payable 118 5.4 72 10.7
Deferred taxes and other 418 19.2 46 6.7
2,177 100.0 688 100.0

Net operating assets 4,551 1,212

 Common Size Analysis: Nike
and Reebok Balance Sheets
Nike Reebok
$ % $ %

Operating assets
Cash 61 0.9 19 1.0
Accounts renewable 2,120 31.5 661 34.8
Inventories 1,634 24.3 458 24.1
Prepaid expenses 370 5.5 68 3.6
Property, plant and equipment 1,587 22.6 184 9.7
Goodwill 135 2.0 124 6.5
Trademarks and other intangibles 400 5.9 200 10.5
Accumulated amortization (34) (0.5) (4 (0.2)
Deferred taxes and other assets 456 6.8 190 10.0
6,729 100.0 1,900 100.0

Operating liabilities
Accounts payable 720 33.1 184 26.7
Accrued liabilities 921 42.3 387 56.3
Income taxes payable 118 5.4 72 10.7
Deferred taxes and other 418 19.2 46 6.7
2,177 100.0 688 100.0

Net operating assets 4,551 1,212

 Trend Analysis: Nike, Inc.
Base in 1999 ($
2004 2003 2002 2001 2000
millions)
Sales 139.6 121.9 112.7 108.1 102.5 8,777
Cost of sales 127.4 114.9 109.3 105.3 98.4 5,494
Gross margin 160.0 133.5 118.4 112.8 109.4 3,283
Operating expenses 153.5 131.3 115.3 111.3 107.4 2,461
Operating income from sales (before tax) 179.3 140.1 127.9 117.5 115.3 822

Operating income from sales (after tax) 193.0 152.2 138.4 124.1 119.9 498

Operating income 202.4 192.4 147.9 128.5 124.1 449

Comprehensive income to common 237.0 94.2 139.3 127.6 124.9 430

Balance Sheet

Accounts receivable 137.7 153.3 117.3 105.3 101.8 1,540

Inventories 139.5 129.4 117.3 121.6 123.5 1.171
Property, plant and equipment 1,266
Operating assets 132.0 122.4 116.1 109.8 111.4 5,094

Accounts payable 151.9 110.3 98.7 91.1 114.8 474

Accrued liabilities 166.5 180.7 138.9 85.4 112.5 553
Operating liabilities 196.7 172.6 132.0 92.9 115.3 1,107

Net operating assets 114.0 108.5 111.7 114.6 110.3 3,992

Net financial obligations -43.9 45.9 93.6 162.5 191.6 658

Common shareholders’ equity 145.1 120.8 115.3 105.1 94.4 3,335

 Income Statement Ratios
• Revenue composition ratios
– Operating Revenue Composition Ratio:

Revenue from an Activity

Total Sales Revenue
– Financial Income Composition Ratio:

Financial Income from a Source

Total Financial Income
• Profit margin ratios

– Operating Profit Margin:

OI (after tax)
Sales
– Sales Profit Margin:

OI (after tax) from Sales

Sales
– Other Items Profit Margin:

OI (after tax) from Other Items

Sales
 Income Statement Ratios
(cont.)

• Profit Margin Ratios (cont.)

– Financial Income Contribution Ratio:

Net Financial Income

Sales

– Net Income Profit Margin

Comprehens ive Net Income
Sales

• Expense Ratios

– Expense Ratio

Expense for an Activity

Sales

– 1 - Sales PM = Sum of Expense Ratios

 Balance Sheet Ratios

• Composition Ratios
– Operating Asset Composition Ratio
Operating Asset
Total Operating Assets

– Operating Liability Composition Ratio

Operating Liability
Total Operating Liabilities

– Financial Asset Composition Ratio

Financial Asset
Total Financial Assets

– Financial Liability Composition Ratio

Financial Obligation
Total Financial Obligation s
Balance Sheet Leverage Ratios

• Financial Leverage Ratios

– Capitalization Ratio:
NOA
CSE
– Financial Leverage Ratio (FLEV)
NFO
CSE

It is always the case that

Capitalization Ratio - Leverage Ratio = 1.0

• Operating Liability Leverage Ratio

Operating Liability Leverage (OLLEV)

Operating Liabilitie s
Net Operating Assets
 Growth Ratios

Change in Sales
Growth Rate in Sales =
Prior Period' s Sales

Change in Operating Income (after Tax)

Growth Rate in Operating Income =
Prior Period' s OI

Change in Net Operating Assets

Growth in NOA =
Beginning NOA

Change in CSE
Growth in CSE = Beginning CSE
 Summary Profitability
Measures
Operating Profitability:
OI t
RNOA t 
1
NOA t  NOA t 1 
2

Financing Profitability:
NFE t
NBC t 
1
NFO t  NFO t 1 
2
or
NFI t
RNFA t 
1
NFA t  NFA t 1 
2

All measures are after tax.

 Financial Statement Analysis
Procedures
1. Reformulate the statement of stockholders’ equity on clean
surplus basis (Chapter 8)

2. Calculate comprehensive rate of return on common equity,

ROCE, from reformulated statement of common
stockholders’ equity (Chapter 8)

3. Reformulate the balance sheet to distinguish operating and

financial assets and obligations

4. Reformulate the income statement on clean surplus basis

and distinguish operating and financing income

5. Compare reformulated balance sheets and income

statements with reformulated statements of comparison
firms and over time through a common size analysis and a
trend analysis

6. Calculate balance sheet and income statement ratios

7. Carry out the analysis of ROCE: Chapter 11

8. Carry out the analysis of growth: Chapter 12

Reebok: Reformulated Income
Statements
2004 2003 2002

Operating Revenues 3,785 3,485 3,128

Cost of sales 2,287 2,147 1,930
Gross margin 1,498 1,338 1,198
Operating expenses
Administrative expenses 1,067 936 851
Advertising 137 150 131
Other expenses 5 1,209 1 1,087 6 988
Operating income from sales (before tax) 289 251 210
Taxes
Tax as reported 68 72 61
Tax on financial items 5 73 6 78 5 66
Operating income from sales (after tax) 216 173 144
Other operating income (net-of-tax items):
Currency translations gains 38 49 37
Loss on derivative employee stock option (20) (17) (7)
Derivative gains and losses in equity statement 4 (14) (23)
Effect of accounting change 22 18 (5) 2
Operating income (after tax) 237 191 146

Financing expense (Income)

Interest expense 26 26 24
Interest income (13) 13 (8) 18 (9) 15
Tax effect (5) (6) (5)
Net interest expense 8 12 10
Loss on retirement debt (10)
(18) 12 10

Comprehensive income before minority interest 219 179 136

Minority interest 5 5 3
Comprehensive income to common 214 174 133

1
Broken out from selling and administrative expenses in published income statement.
2
Marginal tax rate was 35.9%, 35.9% and 35.5% for 2004, 2003 and 2002, respectively, including both federal and state taxes.