Week 6 - Chapter 5

Week 6 –
Chapter 5
ACCT 6301
FALL 2019
9/24/2019 COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 1

Chapter 5 Lecture
Tonight’s
Topics SUA Part 3 Walkthrough
SUA Part 2 Grading

Analyzing and
Interpreting
Financial
Statements
ACCT 6301 – FINANCIAL ACCOUNTING – FALL 2019
9/24/2019 COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 1-3

Assessing the Business Environment
Meaningful interpretation of financial information requires an understanding of the
broader business context
◦ The business
◦ Operations
◦ Environment in which a business operates
Analysts
 Life cycle  Customers  Labor
 Competition  Outputs  Technology
 Politics  Inputs  Capital
COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 4

Prepare and
Learning Objective analyze
LEARNING
OBJECTIVE 1 common-size
financial
statements.
COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS

Vertical Analysis
Converts financial statement information to ratio form
◦ Income statement items as a percentage of net sales
◦ Balance sheet items as a percent of total assets
Facilitates comparison
◦ Across companies of different sizes, and
◦ Between accounts within a set of financial statements
Also called common-size financial statements.

Vertical Analysis of Income
Statements
Lowe’s Companies’ common-size income statements for years
ending February 1, 2019 and February 2, 2018:
Percentages
Fiscal years ended on Feb. 1, 2019 Feb. 2, 2018 Feb. 1, 2019 Feb. 2, 2018
Net sales $71,309 $68,619 100.00% 100.00%
Cost of sales 48,401 46,185 67.88% 67.31%
Gross margin 22,908 22,434 32.12% 32.69%
Selling, general and administrative 17,413 14,444 24.42% 21.05%
Depreciation and amortization 1,477 1,404 2.07% 2.05%
Operating income 4,018 6,586 5.63% 9.60%
Interest - net 624 633 0.88% 0.92%
Loss on extinguishment of debt - 464 - 0.68%
Pre-tax earnings 3,394 5,489 4.76% 8.00%
Income tax provision 1,080 2,042 1.51% 2.98%
Net earnings $2,314 $3,447 3.25% 5.02%
48,401 / 71,309 = 0.6788

Vertical Analysis of Balance Sheets
Lowe’s Companies’ ASSETS
Feb. 1, 2019 Feb. 2, 2018 Feb. 1, 2019 Feb. 2, 2018
common-size balance Current assets:

Cash and cash equivalents $511 $588 1.48% 1.67%
Short-term investments 218 102 0.63% 0.29%
sheets at February 1, Merchandise inventory - net
Other current assets
12,561
938
11,393
689
36.40%
2.72%
32.28%
1.95%
2019 and Total current assets

Property, less accumulated depreciation
14,228
18,432
12,772
19,721
41.23%
53.41%
36.19%
55.88%
Long-term investments 256 408 0.74% 1.16%
February 2, 2018: Other assets
Total assets
1,592
$34,508
2,390
$35,291
4.61%
100.00%
6.77%
100.00%
LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Short-term borrowings $722 $1,137 2.09% 3.22%
Current maturities of long-term debt 1,110 294 3.22% 0.83%
Accounts payable 8,279 6,590 23.99% 18.67%
Accrued compensation and employee benefits 662 747 1.92% 2.12%
Other current liabilities 3,724 3,328 10.79% 9.43%
Total current liabilities 14,497 12,096 42.01% 34.28%
Long-term debt, excluding current maturities 14,391 15,564 41.70% 44.10%
Other liabilities 1,976 1,758 5.73% 4.98%
Total liabilities 30,864 29,418 89.44% 83.36%
Each account balance is Shareholders' equity:

Common stock - $.50 par value; 401 415 1.16% 1.18%
expressed as a percentage of Capital in excess of par value - 22 ̶ 0.06%
Retained earnings 3,452 5,425 10.00% 15.37%
total assets. Accumulated other comprehensive income/(loss) (209) 11 -0.61% 0.03%
Total shareholders' equity 3,644 5,873 10.56% 16.64%
Total liabilities and shareholders' equity $34,508 $35,291 100.00% 100.00%

Horizontal Analysis
Examines changes in data across time
Assists in analyzing company performance and in predicting future performance
Percent Change =
[Second year amount – Base year amount]

Base year amount

Horizontal Analysis
of Income Statements
Lowe’s Companies’ income statements for years ending February 1,
2019 and February 2, 2018:
Fiscal years ended on February 1, 2019 February 2, 2018 % Change
Net sales $71,309 $68,619 3.92%
Cost of sales 48,401 46,185 4.80%
Gross margin 22,908 22,434 2.11%
Selling, general and administrative 17,413 14,444 20.56%
Depreciation and amortization 1,477 1,404 5.20% ($71,309 - $68,619)
Operating income 4,018 6,586 -38.99%
Interest - net 624 633 -1.42% $68,619
Loss on extinguishment of debt - 464 -100.00%
Pre-tax earnings 3,394 5,489 -38.17%
Income tax provision 1,080 2,042 -47.11%
Net earnings $2,314 $3,447 -32.87%
Net income is 33% lower in the year ending February 1, 2019 compared to the prior year,
principally due to a significant increase in selling, general and administrative expenses.

Compute and
interpret
measures of return
Learning Objective on investment,
LEARNING including return on
OBJECTIVE 2 equity (ROE),
return on assets
(ROA), and return
on financial
leverage (ROFL).
Return on Investment Metrics
Ratios that divide some measure of performance (typically income statement measures) by
the average amount of investment as reported in the balance sheet
Three important return metrics
Return Return Return

On On On
Equity
(ROE)
= Assets
(ROA)
+ Financial
Leverage
(ROFL)

Return on Equity (ROE)
Average investment by shareholders is measured by total stockholders’ equity from the
balance sheet
Net income is measured by the performance of a firm for a specific period of time
Net income
ROE = Average stockholders’ equity
ROE is the primary summary measure

of company performance

Return on Equity (ROE)
Example
Lowe’s Companies reported the following amounts in its fiscal 2018
annual report:
Net income for 2018 $ 2,698 million
Total equity, February 1, 2019 3,644 million
Total equity, February 2, 2018 5,873 million
Net income
ROE = Average stockholders’ equity
$2,698 M
ROE = [($3,644 M + $5,873 M) / 2] = 56.70%
Lowe’s generated a profit of about 57 cents for every dollar in its

average equity throughout the year

Return on Assets (ROA)
Measures the return earned on each dollar the firm invests in assets
Captures the returns generated by the firm’s operating and
investing activities, ignoring how those assets are financed
ROA = Earnings without interest expense (EWI)

Average total assets
Net income + [Interest expense x (1–Statutory tax rate)]
=
(Beginning total assets + Ending total assets) / 2
EWI measures the income generated by the firm
before taking into account any of its financing costs.

Return on Assets (ROA) Example
Lowe’s Companies reported the following amounts in its fiscal 2018
annual report:
Net income $ 2,314 million
Interest expense 652 million
Total assets, February 1, 2019 34,508 million
Total assets, February 2, 2018 35,291 million
Earnings without interest expense (EWI)

ROA = Average total assets
$2,314 + [$652 x (1 – 0.25)] M

ROA = [($34,508 M + $35,291 M) / 2] = 8.03%
Lowe’s generated about 8 cents of profit for every dollar in its average
assets throughout the year

Return on Financial Leverage (ROFL)
Gauges the effect of financial leverage on a firm
Captures the amount of ROE that can be attributed to financial leverage
Financial leverage
◦ The effect that debt financing has on ROE
ROFL = ROE ‒ ROA

Contribution of Financial Leverage to PepsiCo’s ROE

Return on Financial Leverage
(ROFL)
Example
Lowe’s Companies has the following ROE and ROA amounts for 2018:
ROE, 2018 56.7%

ROA, 2018 8.0%
ROFL = ROE ‒ ROA

= 56.7% ‒ 8.0% = 48.7%
Over 80% of Lowe’s ROE is attributable to
financial leverage throughout the current year.
Managers can increase ROE

by using financial leverage effectively.

Disaggregate
ROA into
Learning Objective profitability
LEARNING (profit margin)
OBJECTIVE 3 and efficiency
(asset turnover)
components.

Components of ROA
Disaggregated into profit margin (PM) and asset turnover (AT)
ROA = Earnings without interest expense

Average total assets
PM AT
= Earnings without interest x Sales revenue

Sales revenue Average total assets
Captures both profitability and efficiency.

Profit Margin (PM)
Captures profitability
Measures profit before interest expense, that is generated from each dollar of sales
revenue
Affected by
◦ Level of gross profit
◦ Level of operating expenses required to support sales of products and services
◦ Level of competition and the company’s ability to manage pricing and control costs

Asset Turnover (AT)
Reveals insights into a company’s productivity and efficiency
Measures the level of sales generated by each dollar that a company invests in assets
Affected by
◦ Level of sales
◦ Level of assets
Can be improved by
◦ Increasing sales revenue
◦ Decreasing assets

PepsiCo’s Profit Margin
and Asset Turnover Ratios
PepsiCo’s Profit Margin and Asset Turnover Ratios, 2013-2017

Profit Margin and Turnover Across Industries
Profit Margin and Turnover Across Industries

Trade-Off Between
Profit Margin and Asset Turnover
ROA can be increased by
◦ Targeting higher profit margins
◦ Increasing asset turnover
Results from strategic decisions made by management

Mix of margin and turnover is often dictated by a company’s industry
Managers often further disaggregate profit margin and asset turnover further to get insight
into factors driving company performance

Disaggregation of Profit Margin (PM)
Using Gross Profit Margin (GPM)
Gross Profit Margin (GPM)
GPM = Sales revenue – Cost of goods sold

Sales revenue
 Measures the percentage of each sales dollar that is left over after
product costs are subtracted
Lowe’s $71,309-$48,401
2018 GPM = $71,309 = 32.1%
Lowe’s has 32.1% of each sales dollar left over

after product costs are subtracted.

Disaggregation of Profit Margin (PM)
Using Expense-to-Sales (ETS)
Expense-to-Sales (ETS)
ETS = Expense
Sales revenue
Measures the percentage of each sales dollar that goes to cover a
specific expense item
Can be applied to any category of expenses
2018 ETS for Lowe’s $17,413

SG&A expense = $71,309 = 24.42%
In 2018, Lowe’s spent over 24% of each sales dollar for selling, general, and
administrative costs, compared to 21.05% in 2017.

Disaggregation of Asset Turnover
(AT) Using Accounts Receivable
Turnover
Accounts Receivable Turnover (ART)
ART = Sales revenue

Average accounts receivable
Measures how many times receivables have been collected during

the period
Since the majority of Lowes’ sales are credit card transactions, Lowe’s carries a
very low balance for receivables.
An analysis of ART is not applicable for Lowe’s and similar companies.

Disaggregation Asset Turnover (AT)
Using Inventory Turnover
Inventory Turnover (INVT)
Inventory Turnover = Cost of goods sold

(INVT) Average inventory
Measures the flow of goods out of inventory relative to the

balance that is held in inventory
2018 INVT $48,401

for Lowe’s = ($12,561 + $11,393) / 2 = 4.04
Lowe’s sold 4.04 times its inventory during 2018.

Disaggregation Asset Turnover (AT)
Using Property, Plant & Equipment
(PP&E) Turnover
PP&E Turnover (PPET)
PPET = Sales revenue Net of accumulated

Average PP&E depreciation
Provides insights into asset utilization and a company’s operating

efficiency given its productive technology.
2018 PPET $71,309

for Lowe’s = ($18,432 + $19,721) / 2 = 3.74 times
Lowe’s generated 3.74 times its average PP&E through sales

revenue during 2018.

ROE Disaggregation
ROE Disaggregation

Compute and
Learning Objective interpret
LEARNING
OBJECTIVE 4 measures of
liquidity and
solvency.

Effect of Financing on ROE
When ROA > Interest Rate
Company A Company B Company A is financed with
100% equity.
Assets (average) $1,000 $1,000
Company B is financed 50%
EWI $100 $100
with debt.
ROA (EWI/Assets) 10% 10%
Equity (average) $1,000 $500 Company B made effective
Debt $0 $500 use of its financing to
Interest expense (4% of debt) $0 $20
improve its ROE.
Net income (EWI ‒ Interest) $100 $80
ROE (Net income/equity) 10% 16%
ROFL (ROE - ROA) 0% 6%
In the best of times, financial leverage increases ROE.

Effect of Financing on ROE
When ROA < Interest Rate
Company A Company B Company A is financed with
100% equity.
Assets (average) $1,000 $1,000
Company B is financed 50%
EWI $30 $30
with debt.
ROA (EWI/Assets) 3% 3%
Equity (average) $1,000 $500 Debt financing caused
Debt $0 $500 Company B to decrease its
Interest expense (4% of debt) $0 $20
ROE.
Net income (EWI ‒ Interest) $30 $10
ROE (Net income/equity) 3% 2%
ROFL (ROE - ROA) 0% -1%
Too much debt is risky. It causes interest expense which decreases profit.
When earnings are depressed, financial leverage makes a bad year worse.

Other Issues of Using Debt Financing
Operating activities may be restricted by covenants
◦ Covenants are restrictions on operating activities imposed by creditors
◦ Help safeguard debt holders
Debt increases default risk

◦ The risk that company’s may not be able to pay debt as it becomes due
◦ Ability to service the debt may be impaired

Median Ratio of Liabilities to
Equity
for Selected Industries
Median Ratio of Liabilities to Equity for Selected Industries

Liquidity and Solvency Analysis
LIQUIDITY ANALYSIS SOLVENCY ANALYSIS
The analysis of available cash The ability to generate sufficient cash in the
future
Ratios used to assess the degree of liquidity
◦ Current ratio Ratios used to assess the degree of solvency
◦ Quick ratio ◦ Debt-to-equity
◦ Operating cash flow to current liabilities ◦ Times interest earned
◦ Cash burn rate

Current Ratio
 The relative magnitude of current assets and current
liabilities
CURRENT ASSETS CURRENT LIABILITIES

Those assets that the company Those liabilities that come due within
expects to convert into cash within the next year
the next accounting cycle
Current assets
Current ratio = Current liabilities

Working Capital
An excess of current assets over current liabilities
◦ Positive working capital implies more expected cash inflows than outflows in the short run
Based on current balance sheet amounts

◦ Ignores cash inflows from future sales
A company can efficiently manage its working capital

by minimizing receivables and inventories and
maximizing payables, and still be liquid.

Quick Ratio
Similar to the current ratio
Reflects a company’s ability to meet its current liabilities without liquidating inventories
that could include markdowns
◦ Excludes inventories and prepaid assets
Quick assets
Quick ratio =
Cash + Short-term securities + Accounts receivable

Current liabilities

Operating Cash Flow
to Current Liabilities (OCFCL)
Relates the net amount of cash from operating activities to the amount of current payment
obligations
A key factor in the ultimate ability of a company to pay its debts
Operating Cash Flow

Cash flow from operations
to Current Liabilities =
Average current liabilities

Cash Burn Rate (CBR)
Measures the rate at which a company is using up its cash resources
in its operations and capital expenditures.
Used only when Free Cash Flow is negative, usually for companies
that are young or are experiencing financial difficulties.
Can be compared to a company’s levels of cash and marketable
securities.
Free cash flow over the period

Cash Burn Rate =
Number of days in the period

Liquidity Analysis for Lowe’s
= $14,228M
Current Ratio = 0.981
$14,497M
= $511M + $218M
Quick Ratio = 0.050
$14,497M
Working capital = $14,228M – $14,497M = ($269M)
Operating Cash Flow to = $6,193M

= 0.47
Current Liabilities ($14,497M + $12,096M) / 2
An analysis of Lowe’s at February 1, 2019 shows it will likely be able to pay its current obligations as
they come due over the next year, however much of its current assets is tied up in inventory.
It’s free cash flow is high enough that the Cash Burn Rate is not relevant.

Solvency Analysis
A company’s ability to meet its debt obligations
◦ Including both periodic interest payments and repayment of the principal borrowed
Two measurement approaches

◦ Use balance sheet data to assess the proportion of capital raised from creditors
◦ Use income statement data to assess the profit generated relative to debt payment obligations

Debt-to-Equity
Conveys how reliant a company is on creditor financing compared
with equity financing
◦ Higher ratios imply less solvency, more risk
Total liabilities
Debt-to-equity =
Stockholders’ equity
ratio
Debt-to-equity levels are affected by many factors including the mix

of assets used and the stability of business operations, so
comparisons to similar companies are very important.

Times Interest Earned (TIE)
How much operating profit is available to pay interest
Sometimes abbreviated as EBIT / I
Times Earnings before interest and

=
interest taxes Interest expense
earned
Lenders prefer this ratio to be sufficiently high

which implies a smaller risk of default.

Solvency Analysis
Example
Lowe’s key solvency indicators for the year ending February 1, 2019:
= $30,864
Debt-to-equity ratio = 8.47
$3,644
Lowe’s debt-to-equity ratio is much higher than the retail industry average
of 1.38, indicating less solvency.
= $3,394 + $652
Times interest earned = 6.21 times
$652
Over the recent past, Lowe’s times interest earned has dropped from over
9 (above the industry average) to 6.2 (below the industry average).

Appendix 5A
Learning Objective Measure and

LEARNING
OBJECTIVE 5 analyze the
(OPTIONAL) effect of
operating
activities on
ROE.
Operating Activities
Operating activities create the most long-lasting, persistent effects on
future profitability and cash flows of the company.
The core transactions and events of a company

Consist of research and development, establishment of supply
chains, administrative support, production and marketing of
products, follow ups with after-sale customer service
Reported in the income statement

Return on Net Operating Assets
(RNOA)
Measures the effect of net operating assets on the return generated by the company
Average public company derives most of its ROE from RNOA
Net operating profit after taxes

RNOA =
(NOPAT)
Average Net operating assets
RNOA can be disaggregated into:
Net operating profit margin (NOPM) and
Net operating asset turnover (NOAT)

Net Operating Profit After Taxes
(NOPAT)
Nonoperating activities must be separated from operating activities
Marginal tax rate used
Net Nonoperating Nonoperating Marginal
NOPAT = ‒ ‒ x 1‒
income revenues expenses tax rate
Lowe’s NOPAT for year ended February 1, 2019:

$2,314M + [$624M x (1 ‒ 25%)] = $2,782M
Focuses only on the operating performance rather than the overall

performance of the company

Net Operating Assets
Defined as operating assets less operating liabilities
Operating assets are those directly linked to operating activities.
Includes:
◦ Most current assets except short-term investments
◦ Most long-term assets except long-term investments
Operating liabilities also arise from operations. Includes:

◦ Most current liabilities except for short-term notes payable, interest payable,
and current maturities of long-term debt
◦ Pension and other post-employment liabilities
◦ Deferred income tax liabilities

Operating Return (RNOA)
Example
The following amounts were determined from Lowe’s Companies
2018 annual report:
Net operating profit after taxes $2,782 million
Net operating assets, February 1, 2019 19,393 million
Net operating assets, February 2, 2018 22,358 million
Net operating profit after taxes (NOPAT)

RNOA = Average net operating assets
$2,782 M
= = 13.3%
($19,393M+ $22,358M) / 2
Lowe’s generated 13.3% return on its net operating assets.
Disaggregation of RNOA:
Net Operating Asset Turnover
(NOAT)
Sales
NOAT = Average NOA
NOAT for Lowes’ for year ending February 1, 2019:
$71,309
= 3.42
($19,393M+ $22,358M) / 2
For every dollar of net operating assets, Lowe’s realizes $3.42 in sales.
NOAT measures the productivity of the company’s net operating assets.

Disaggregation of RNOA:
Net Operating Profit Margin
(NOPM)
NOPAT
NOPM = Sales
NOPM for Lowes’ for year ending February 1, 2019:
$2,282M
= 3.90
$71,309M
For every dollar of sales at Lowe’s for its year ending February 1, 2019, the
company earns 3.90 cents of profit after all operating expenses and taxes.

Disaggregation of RNOA
Example
RNOA is the product of NOPM and NOAT.
Lowe’s RNOA for year ending February 1, 2019:
RNOA = NOPM × NOAT
= 3.90% × 3.42
= 13.3%

Appendix 5B
Learning Objective
LEANRING
Prepare
OBJECTIVE 6
(OPTIONAL)
forecasts of
future
financial
statements.
Financial Statement Forecasts
Forecast statements are hypothetical statements
◦ Prepared to reflect specific assumptions about the company and its
transactions
Seven steps to prepare these forecasts:
1. Forecast sales revenue
2. Forecast operating expenses (e.g., COGS and SG&A expenses)
3. Forecast operating assets and liabilities
4. Forecast nonoperating assets, liabilities, contributed capital, revenues, and
expenses
5. Forecast net income, dividends, and retained earnings
6. Forecast the amount of cash required to balance the balance sheet
7. Prepare a cash flow forecast based on the forecasted income statement and
balance sheet

Step 1:
Forecast Sales Revenue
Crucial first step
◦ Depended upon by many forecast amounts used in predicting the pro income
statement and balance sheet
Must assume a revenue growth rate

◦ Starting point may be the historical rate of sales growth
◦ Uses data from horizontal analysis
Forecasted revenues =
Current revenues × (1 + Revenue growth rate)

Step 2:
Forecast Operating Expenses
Estimates rely on the common-size income statement as a starting
point to identify relationship between operating expense items and
sales revenue
Historical rates may have to be adjusted up or down based on
observed trends or additional information
Forecasted operating expenses =

Forecasted revenues × ETS ratio

Step 3:
Forecast Operating Assets &
Liabilities
Sales forecast can be the basis to estimate operating assets and
liabilities
Asset turnover analysis provides the relationship between operating
assets and revenues
Forecasted accounts receivable =

Reported accounts receivable
Forecasted revenues x
Reported sales revenue
The same approach can be applied to other operating assets and operating liabilities.

Step 4:
Forecast Nonoperating Assets, Liabilities,
Revenues, and Expenses
Nonoperating revenues such as interest and dividend revenue

◦ Related to investments
Nonoperating expenses such as interest expense

◦ Related to debt financing
Starting point is to assume no change from current amounts

◦ Additional information may appear in notes or MD&A

Step 5:
Forecast Net Income, Dividends,
and Retained Earnings
Income tax expense

◦ Sales revenue (Step 1) less operating expenses (Step 2) plus or minus
nonoperating revenues and expenses (step 4) equals income before taxes
◦ Effective tax rate
◦ Average tax rate applied to pretax earnings
◦ Calculated as
Reported income tax expense / Reported pretax earnings
Forecasted income tax expense =

Forecasted pretax income × Effective tax rate

Step 5:
Forecast Net Income, Dividends,
and Retained Earnings
Forecast dividends
◦ Relies on the dividend payout ratio
◦ Dividend payments / Net income
Forecasted Forecasted Dividend

dividends = net income x Payout ratio
Forecast retained earnings

◦ Relies on forecasts of net income and dividends
Forecasted Beginning Forecasted

net income Forecasted
retained = retained + –
Dividends
earnings earnings
Step 6:
Forecast Cash
A ‘plug’ amount that makes the balance sheet balance
If negative or unreasonably small or large
◦ Adjust forecast of short-term debt and interest expense to reflect increased borrowing
OR
◦ Assume that excess cash is invested in marketable securities and increase the amount of interest income
Any changes may require adjustments of income taxes, net income, dividends and retained
earnings

Step 7:
Prepare the Cash Flow Statement
Forecast
Based upon the income statement and balance sheet
Must forecast depreciation expense if not part of the operating
expenses
◦ Same approach as forecasting other operating expenses

Additional Considerations
Forecasted statements are based on assumptions
◦ Decisions made from statement forecasts will be based on assumptions
Sensitivity analysis is useful

◦ Forecasts are used to examine the effect of alternative assumptions
Forecast errors
◦ Differences between the forecasted and the actual amounts
The goal of a good forecast is accuracy, not precision.

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Week 6 –

9/24/2019 COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 1

SUA Part 2 Grading

9/24/2019 COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 2

9/24/2019 COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 1-3

 Competition  Outputs  Technology

 Politics  Inputs  Capital

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 4

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS

Also called common-size financial statements.

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 6

48,401 / 71,309 = 0.6788

common-size balance Current assets:

2019 and Total current assets

LIABILITIES AND SHAREHOLDERS' EQUITY

Each account balance is Shareholders' equity:

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 8

[Second year amount – Base year amount]

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 9

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 10

Return Return Return

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 12

ROE is the primary summary measure

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 13

Lowe’s generated a profit of about 57 cents for every dollar in its

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 14

ROA = Earnings without interest expense (EWI)

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 15

Earnings without interest expense (EWI)

$2,314 + [$652 x (1 – 0.25)] M

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 16

ROFL = ROE ‒ ROA

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 17

ROE, 2018 56.7%

ROFL = ROE ‒ ROA

Managers can increase ROE

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 18

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS

ROA = Earnings without interest expense

= Earnings without interest x Sales revenue

Captures both profitability and efficiency.

COPYRIGHT JEFFREY R. KROMER & CAMBRIDGE BUSINESS PUBLISHERS 20

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Results from strategic decisions made by management

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GPM = Sales revenue – Cost of goods sold

Lowe’s has 32.1% of each sales dollar left over

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2018 ETS for Lowe’s $17,413

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ART = Sales revenue

Measures how many times receivables have been collected during

An analysis of ART is not applicable for Lowe’s and similar companies.

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Inventory Turnover = Cost of goods sold

Measures the flow of goods out of inventory relative to the

2018 INVT $48,401

Lowe’s sold 4.04 times its inventory during 2018.

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PPET = Sales revenue Net of accumulated