Chapter No.

3
Working With financial Statements

Chapter’s Objectives:
1. How to standardize financial Statement for
comparison purposes
2. How to compute and interpret ratios
3. The determinants of firm’s profitability
Two basic things firms do,
1. Generate cash
a. Selling a product, an asset or a security
b. Securities involved either selling bonds or shares of stock
2. Spend cash
a. Paying for material, labors, creditors, owners etc.

So activities that bring in cash are called sources of cash

while
those activities that involved spending of cash are called
spending of cash
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Standardized Financial Statements
The problem of comparison within Co. and with others
1. Due to size problems
2. Different currencies

Solution
To standardize Financial Statements
 Percentages

Two ways to Standardize Financial statements

1. Common-Size Statements
2. Trend Analysis
1. Common-Size Statement

 For Balance sheet, each item is expressed as a

percentage of assets

 For income statement, each item is expressed as

percentage of sale.

The resulting financial statements are called Standardized

Financial Statements
2. Trend Analysis: Common-base year amount

 A standardized financial statement that presents all

items relative to a certain base year amount.
 Base year acts as the denominator

 Balance sheets of the last 10 years

 Income statements of the last 20 years

3. Combined common size and base year analysis

Other Liquidity Ratio

Cash Ratio = Cash / Current liability = .18?

Interval measure = current assets / average daily operating cost

While ADOC = Total cost / 365 = cost per day on average

LONG TERM SOLVENCY MEASURES
Financial leverage ratios

1. Total Debt Ratio = (Total Assets-Total equity)/ Total Assets

= .28

All debts of all maturities to all creditors

2. Debt to Equity Ratio = Total Debt / Total Equity

.39

3. Equity multiplier = Total Assets / total liability

 Time Interest Earned

= EBIT/interest

=4.31
Interpret it please.
ASSET MANAGEMENT TURNOVE RATIO

How efficiently a firm uses its assets

1. Inventory turnover = Cost of Goods Sold/ Inventory

=3.2 times

Turn over the entire inventory 3.2 times in a period

2. Day’s Sale Inventory = 365/inventory turnover

=365/3.2 = 114 waiting days

This is the period in which inventory waits in warehouses to be sold

 Receivable Turnover ratio

= sale / account receivable

=2311/188 = 12.3 time

Collected and reloaned the money 12.3 time during the year/ any period

Day’s Sale in receivable =

= 354 / receivable turnover
=365/ 12.3 = 30 days A.R stays outstanding

firm collects on its credit sale in 30 days

 PROFITABILITY MEASURES

That a business generates a little less than 16 cents in profit for every 1
dollar in sale.

Higher ratio is desirable, keeping other things equal.

 Return on Assets

Return on equity
 MARKET VALUE MEASURES

 Price-Earning Ratio
 Market to Book Value
 Notice, return on equity is expressed as the product of two
other ratios: ROA and equity multiplier.
Expanded Due Pont
End of Chapter!