CHAPTER 8

FINANCIAL ANALYSIS

Topics Covered

 Financial Statements
 Lowe’s Financial Statements
 Measuring Lowe’s Performance
 Measuring Efficiency
 Analyzing the ROA: The DuPont System
 Measuring Leverage
 Measuring Liquidity
 Interpreting Financial Ratios
2/19/2020 702021 - Financial Analysis 2

1
 FINANCIAL STATEMENT

1. WHAT IS FINANCIAL STATEMENT?

2. COMPONENTS OF FINANCIAL
STATEMENT
3. THE PURPOSES OF FINANCIAL
STATEMENT

4. HOW TO READ FINANCIAL STATEMENT

5. KEY TERM

702021 - 3 2/19/2020
Financial
3

WHAT IS
FINANCIAL
STATEMENT?

702021 - 4 2/19/2020
Financial
4

2
 WHAT IS FINANCIAL
STATEMENT?

 It is standard practice for businesses to present

financial statements that adhere to generally
accepted accounting principles to maintain
continuity of information and presentation across
international borders.

 Financial statements are often audited by

government agencies, accountants, firms, etc. to
ensure accuracy and for tax, financing or
investing purposes.

702021 - 5 2/19/2020
Financial
5

2. COMPONENTS OF FINANCIAL
STATEMENT
Balance sheet /Statement of financial
position
Income Statement /Statement of
comprehensive income/Statement of
revenue & expense/ P&L or Profit and Loss
report
Cash Flow Statement

Statement of change in equity /Equity

statement/Statement of retained earnings

702021 - 6 2/19/2020
Financial
6

3
 3. THE PURPOSES OF FINANCIAL
STATEMENT
 The balance sheet provides an overview of
assets, liabilities and stockholders' equity as
a snapshot in time.
 The date at the top of the balance sheet tells
you when the snapshot was taken, which is
generally the end of the fiscal year.

702021 - 7 2/19/2020
Financial
7

4. HOW TO READ FINANCIAL

STATEMENT
Balance sheet
Current assets are balance sheet accounts
that represent the value of all assets that can
reasonably expect to be converted into cash
within one;

Noncurrent assets are company long-term

investments where the full value will not be
realized within the accounting year.
702021 - 8 2/19/2020
Financial
8

4
 Example - Balance Sheet of
Dynamic Mattress Company

2/19/2020 702021 - Financial Analysis 9

4. HOW TO READ FINANCIAL

STATEMENT

Balance sheet
Current liabilities are a company's debts or obligations that
are due within one year, appearing on the company's
balance sheet and include short term debt, accounts
payable, accrued liabilities and other debts.

Noncurrent liabilities are long-term financial obligations

listed on a company’s balance sheet that are not due within
the present accounting year, such as long-term borrowing,
bonds payable and long-term lease obligations.

702021 - 10 2/19/2020
Financial
10

5
 Example - Balance Sheet of
Dynamic Mattress Company

2/19/2020 702021 - Financial Analysis 11

11

INCOME STATEMENT

 The income statement covers a range of time, which is a

year for annual financial statements and a quarter for
quarterly financial statements.
 The income statement provides an overview of revenues,
expenses, net income and earnings per share. It usually
provides two to three years of data for comparison.

702021 - 12 2/19/2020
Financial
12

6
 INCOME STATEMENT
No. Income Statement
(1) Revenues/Sales
(2) - COGS
(3) - Selling, administrative expense
(4) - Depreciation
(5) = (1) – (2) – (3) – (4) Earning before interest and taxes
(EBIT)
(6) - Interest Expense
(7) = (5) – (6) Earning before taxes (EBT)
(8) - Taxes
(9) = (7) – (8) Earning after tax (EAT) or Net
Income
2/19/2020 702021 - Financial Analysis 13

13

3. THE PURPOSES OF FINANCIAL

STATEMENT
 The cash flow statement shows the
sources and uses of cash for a fixed
period of time.
 The cash flow statement informs
investors and creditors about the
solvency of your business, where the
business is receiving its cash from, and
on what it is spending its cash.

702021 - 14 2/19/2020
Financial
14

7
 3. THE PURPOSES OF FINANCIAL
STATEMENT
 The statement of retained earnings is a measure of the
assets of your operation that have been generated through
profitable activity, retained in your business and not paid
out to shareholders as dividends.

 Generally, a large amount of retained earnings is regarded

as a sign that the company has done well and is
reinvesting its profits in itself.

 That said, a startup or early-stage business often faces

reporting negative retained earnings as it takes time to
build a business and become profitable.

702021 - 15 2/19/2020
Financial
15

4. HOW TO READ FINANCIAL

STATEMENT

2/19/2020 702021 - Financial Analysis 16

16

8
 4. HOW TO READ FINANCIAL
STATEMENT

2/19/2020 702021 - Financial Analysis 17

17

Lowe’s Companies

2/19/2020 702021 - Financial Analysis 18

18

9
 Lowe’s Companies

2/19/2020 702021 - Financial Analysis 19

19

Lowe’s Companies

2/19/2020 702021 - Financial Analysis 20

20

10
 Lowe’s Companies

Measuring Performance: Market-to-Book Ratio

Ratio of market value of equity to book value of equity.

2/19/2020 702021 - Financial Analysis 21

21

Lowe’s Companies

 Market Capitalization
 Total market value of equity, equal to share price times
number of shares outstanding.
Market Capitalization = Total outstanding shares x Price per share

Market Capitalization = $18.19 × 1,470 = $26,739 mil

 Market Value Added
 Market capitalization minus book value of equity.

MVA = Market value of Equity – Book value of Equity

MVA = $26,739 - $18,055 = $8,684 million

2/19/2020 702021 - Financial Analysis 22

22

11
 Financial Ratio Analysis of a
Customer’s Financial Statements

1. Profitability

2. Efficiency

3. Financial Leverage

4. Coverage Ratios

5. Liquidity

2/19/2020 702021 - Financial Analysis 23

23

17-24
Financial Ratio Analysis of a
Customer’s Financial Statements
1. Profitability
 How much net income remains for the owners of a
business firm after all expenses (except dividends) are
charged against revenue?
• After-tax net income / total assets (or ROA)
• After-tax net income / total equity (or ROE)
• After-tax net income / total sales (or ROS) or profit
margin

2/19/2020 Copyright
702021 © 2013 The McGraw-Hill
- Financial AnalysisCompanies, Inc. Permission required24for reproduction or display.

24

12
 17-25

PROFITABILITY

Return on Asset After-tax net income

=
(ROA) Total assets

Return on Equity After-tax net income

=
(ROE) Total Equity

Return on Sales After-tax net income

=
(ROS) Total sales

2/19/2020 Copyright
702021 © 2013 The McGraw-Hill
- Financial AnalysisCompanies, Inc. Permission required25for reproduction or display.

25

2. EFFICIENCY

2. Efficiency: Measure of a Business Firm’s

Performance Effectiveness

Asset turnover Sales

=
ratio Average Total Asset

2/19/2020 Copyright
702021 © 2013 The McGraw-Hill
- Financial AnalysisCompanies, Inc. Permission required26for reproduction or display.

26

13
 2. EFFICIENCY

Inventory Cost of Goods Sold

turnover ratio =
Average Inventory

Average Days 365

in Inventory =
Inventory turnover ratio

2/19/2020 Copyright
702021 © 2013 The McGraw-Hill
- Financial AnalysisCompanies, Inc. Permission required27for reproduction or display.

27

2. EFFICIENCY

Receivable Sales
turnover ratio =
Average Account Receivables

Average 365
collection = Receivable turnover ratio
period

2/19/2020 Copyright
702021 © 2013 The McGraw-Hill
- Financial AnalysisCompanies, Inc. Permission required28for reproduction or display.

28

14
 2. EFFICIENCY

Payable COGS
turnover ratio =
Average Account Payables

Average 365
payment period = Payable turnover ratio

2/19/2020 Copyright
702021 © 2013 The McGraw-Hill
- Financial AnalysisCompanies, Inc. Permission required29for reproduction or display.

29

17-30

3. LEVERAGE

Long term Debt Long term debt

=
Ratio Long term debt + Equity

Total liabilities
Debt Equity Ratio =
Total Shareholders’Equity

Total liabilities
Debt Ratio =
Total assets

2/19/2020 Copyright
702021 © 2013 The McGraw-Hill
- Financial AnalysisCompanies, Inc. Permission required30for reproduction or display.

30

15
 17-31

4. LIQUIDITY

Net working =
Current Assets - Current Liabilities
capital

Net working capital Net working capital

=
to Total Asset Ratio Total assets

2/19/2020 Copyright
702021 © 2013 The McGraw-Hill
- Financial AnalysisCompanies, Inc. Permission required31for reproduction or display.

31

17-32

4. LIQUIDITY

Current assets
Current Ratio =
Current Liabilities

Current assets - Inventory

Quick Ratio =
Current Liabilities

Cash + Marketable Securities + Receivables

Quick Ratio =
Current Liabilities

Cash + Marketable Securities

Cash Ratio =
Current Liabilities

2/19/2020 Copyright
702021 © 2013 The McGraw-Hill
- Financial AnalysisCompanies, Inc. Permission required32for reproduction or display.

32

16
 17-33

5. COVERAGE

Time Interest Earned EBIT

=
(Interest Coverage) Interest Payment

2/19/2020 Copyright
702021 © 2013 The McGraw-Hill
- Financial AnalysisCompanies, Inc. Permission required33for reproduction or display.

33

FOUNDATION OF FINANCE

THANK YOU!

34

17