Income Statement rather have been utilized to finance the firm’s

The income statement provides a financial summary assets.

of the firm’s
operating results during a specific period.
The most common are income statements
covering a 1-year period
period ending at a specific date, ordinarily
December 31 of the
calendar year.
Many large firms, however, operate on a 12-
month financial cycle,
or fiscal year, that ends at a time other than Statement of Retained Earnings
December 31. The statement of retained earnings is abbreviated
Operating profit is often called earnings before form of the
interest and taxes statement of stockholders equity.
or EBIT. Unlike the statement of stockholders’ equity,
Any preferred stock dividend must be subtracted which shows all equity
from net profits accounts transactions that occurred during a given
after taxes to arrive at earnings available for year, the
common stockholders. statement of retained earnings reconciles the net
The actual cash dividend per share (DPS), which is income earned
the peso during a given year and any cash dividend paid,
amount of cash distributed during the period on with the change in
behalf of each retained earnings between the start and the end
outstanding share of common stock. of that year.

Statement of cash flows

The statement of cash flows is a summary of the
Balance Sheet cash flows over the
The balance sheet presents a summary period of concern.
statement of the firm’s The statement provides insight into the firm’s
financial position at a given time. operating, investment,
The statement balances then firm’s assets (what and financing cash flows and reconciles them with
it owns) against its changes in its cash
financing, which can be either debt (what it owes) and marketable securities during the period.
or equity (what Indirect Method
was provided by owners). The indirect method for the preparation of the
statement of cash
Retained earnings represent the cumulative total flows involves the adjustment of net income with
of all earnings, net changes in balance
of dividends, that have been retained and sheet accounts to arrive at the amount of cash
reinvested in the firm generated by operating
since its inception. activities.
It is important to recognize that retained earnings
are not cash but
 Ratio analysis involves methods of calculating and
interpreting
financial ratios to analyze and monitor the firm’s
performance.
The basic inputs to ratio analysis are the firm’s
income statement and
balance sheet.
Ratio analysis of a firm’s financial statements is of
interest to
stockholders, creditors, and the firm’s own
management.
Notes to the Financial Statements
Both current and prospective shareholders are
Included with published financial statements are
interested in the firm’s
explanatory notes
current and future level of risk and return, which
keyed to the relevant accounts in the statements.
directly affect share
These notes to the financial statements provide
prices. The firm’s creditors are interested primarily
detailed information
in the short-term
on the accounting policies, procedures,
liquidity of the company and its ability to make
calculations, and transactions
interest and principal
underlying entries in the financial statements.
payments. A secondary concern of creditors is the
Common issues addressed by these notes include
firm’s profitability;
revenue
they want assurance that the business is heathy.
recognition, income taxes, breakdowns of fixed
Management uses ratios to monitor the firm’s
asset accounts, debt
performance from
and lease terms and contingencies.
period to period.
Using Financial Ratios

The information contained in the four basic TYPES OF RATIO COMPARISON

financial statements is Ratio analysis is not merely the calculation of a
of major significant to a variety of interested given ratio.
parties who regularly More important is the interpretation of the ratio
need to have relative measures of the company’s value.
performance. A meaningful basis for comparison is needed to
Relative is the key word here, because the analysis answer such
of financial questions as “ Is it too high or to low?” and “ Is it
statements is based on the use of ratios or good or bad.
relative values. Two types of ratio comparisons can be made,
Relative value is a method of determining an cross-sectional and
asset's worth that takes time – series.
into account the value of similar assets. Cross-sectional analysis involves the comparison of
This is in contrast with absolute value, which looks different firms’
only at an asset's financial ratios at the same point in time.
intrinsic value and does not compare it to other Analysis are often interested in how well a firm has
assets. performed in
Financial ratios offer entrepreneurs a way to relation other firms in its industry.
evaluate their company's Frequently, a firm will compare its ratio values to
performance and compare it other similar those of a key
businesses in their industry. competitor or group of competitors that it wishes
Ratios measure the relationship between two or to emulate.
more components of This type of cross-sectional analysis, called
financial statements. They are used most benchmarking
effectively when results over has become very popular.
several periods are compared.
Benchmarking
 Any significant year-to-year changes may be
A type of cross-sectional analysis in which the symptomatic of a
firm’s ratio values are problem, specially if the same trend is not an
compared to those of a key competitor or group of industry-wide
competitors that it phenomenon.
wishes to emulate. Combined Analysis
Benchmarking is a process where you measure The most informative approach to ratio analysis
your company’s combines cross-
success against other similar companies to discover sectional and time-series analyses.
if there is a gap in A combine view makes it possible to assess the
performance that can be closed by improving your trend in the behavior
performance. of the ratio in relation to the trend for the industry.
Studying other companies can highlight what it
takes to enhance your
company’s efficiency and become a bigger player in
your industry.

Comparison to industry averages is also popular.

Cautions About Using Ratio Analysis

1. Ratios that reveal large deviations from the
norm merely indicate
the possibility of a problem.
2. A single ratio does not generally provide
Analyst have to be very careful when drawing sufficient information
conclusions from ratio from which to judge the overall performance of
comparisons. the firm.
It’s tempting to assume that if one ratio for a 3. The ratios being compared should be calculated
particular firm is above using financial
the industry norm, this is a sign that the firm is statements dated at the same point in time
performing well, during the year.
at least along the dimension measured by the ratio. 4. It is preferably to use audited financial
However, ratios may be above or below the statements for ratio
industry norm for both analysis.
positive and negative reasons, and it is necessary to 5. The financial data being compared should have
determine why been developed
a firm’s performance differs from its industry peers. in the same way.
Thus, ratio analysis on its own is probably most 6. Results can be distorted by inflation, which can
useful in lighting cause the book
areas for further investigation. value of inventory and depreciable assets to
differ greatly from
Time-Series Analysis their replacement values.
Time-series analysis evaluates performance over Cautions About Using Ratio Analysis
time. 1. Ratios that reveal large deviations from the
Comparison of current to past performance, using norm merely indicate
ratios, enables the possibility of a problem.
analysts to assess the firm’s progress. 2. A single ratio does not generally provide
Developing trends can be seen by using multiyear sufficient information
comparisons. from which to judge the overall performance of
the firm.
 3. The ratios being compared should be calculated including the firm’s size, its access to short-term
using financial financing sources
statements dated at the same point in time like bank credit lines, and the volatility of its
during the year. business.
4. It is preferably to use audited financial The more predictable a firm’s cash flows the lower
statements for ratio the acceptable
analysis. current ratio.
5. The financial data being compared should have QUICK (ACID-TEST) RATIO
been developed The quick (acid-test) ratio is similar to the current
in the same way. ratio except that
6. Results can be distorted by inflation, which can it excludes inventory, which is generally the least
cause the book liquid current
value of inventory and depreciable assets to assets. The quick ratio is calculated as follows:
differ greatly from
their replacement values. Current assets – Inventory
Categories of Financial Ratios Quick ratio =
Financial ratios can be divided for convenience
into five basic Current liabilities
categories : As with the current ratio, the quick ratio level that
1. Liquidity ratios a firm should
2. Activity ratios strive to achieve depends largely on the nature of
3. Debt ratios the business in
4. Profitability ratios which it operates.
5. Market ratios The quick ratio provides a better measure of
Liquidity ratios overall liquidity only
The liquidity of a firm is measured by its ability to when a firm’s inventory cannot be easily be
satisfy its short- converted into cash.
term obligations as they come due. If inventory is liquid, the current ratio is a
Liquidity refers to the solvency of the firm’s overall preferred measure of
financial overall liquidity.
position.- the ease with which it can pay its bills. Activity Ratios
Because a common precursor to financial distress Activity ratios measure the speed with which
and bankruptcy is various accounts are
low or declining liquidity, these ratios can provide converted into sales or cash-inflows or outflows.
early signs of cash Activity ratios measures how efficiently the
flow problems and impending business failure. business is running.
The two basic measures of liquidity are the current We often call this as “Assets Management Ratio”
ratio and the quick i.e. how efficiently
(acid-test) ratio. the assets of the company is being used by the
CURRENT RATIO management to generate
The current ratio, one of the most commonly cited maximum possible revenue.
ratios, measures (Activity ratio continuation)
the firm’s ability to meet its short-term obligations. In a sense, activity ratios measure how efficiently a
It is express as firm’s operate
follows: along a variety of dimensions such as inventory
Current ratio = Current assets ÷ Current management,
liabilities disbursement, and collections.
A number of ratios are available for measuring the
A higher current ratio indicates a greater degree activity of the most
of liquidity. important current accounts, which, include
How much liquidity a firm needs depends on a inventory, accounts
variety of factors, receivable, and accounts payable.
 The efficiency with which total assets are used can Accounts
also be assessed. receivable
INVENTORY TURNOVER =
Inventory turn over commonly measures the
activity or liquidity, of Annual sales
a firm’s inventory. It is calculated as follows: 365
Inventory = Cost of goods sold ÷ Inventory
(Inventory turnover continuation)
The resulting turnover is meaningful only when it
is compared with The average collection is meaningful only in
that of other firms in the same industry or to the relation to the firm’s
firm’s past inventory credit terms.
turnover. AVERGE PAYMENT PERIOD
An inventory turnover of 20 would not be unusual The average payment period or average age of
for a grocery accounts payable
store, whose goods are highly perishable and must is the average amount of time needed to pay
be sold quickly, accounts payable.
whereas an aircraft manufacturer might turn its It is calculated in the same manner as the average
inventory just four collection period:
times per year.
The difficulty in calculation the
Another inventory activity ratio measures how average payment not available in
many days of published financial statements.
inventory the firm has on hand. Ordinarily, purchases are estimated as a given
Inventory turnover can be easily converted into an percentage of cost of
average age goods sold.
of inventory by dividing in into 365 days. The ratio is meaningful only in relation to the
The value can also be viewed as the average average credit terms
number of days’ sales in extended to the firm.
inventory. TOTAL ASSET TURNOVER
The total asset turnover indicates the efficiency
with which the firm
(Activity ratio continuation)
uses its assets to generate sales. Total asset
turnover is calculated as
AVERAGE COLLECTION PERIOD
follows:
The average collection period, or average age of
Total asset turnover = Sales ÷ Total
accounts receivable,
assets
is useful in evaluating credit and collection policies.
Generally, the higher a firm’s total asset turnover,
Simply put, the average amount of time needed to
the efficient its
collect accounts
assets have been used. This measure is probably
receivable.
of greatest interest
It is arrived at by dividing the average daily sales
to management because it indicates whether the
into the accounts
firm’s operations
receivable balance:
have been financially efficient.

Accounts
Debt Ratios
receivable
The debt position of a firm indicates the amount
Average collection period =
of other people’s
Average sales
money being used to generate profits.
per day
In general, the financial analyst is most
concerned with long-term
debts because these commit the firm to a stream
of contractual
 payments over the long run.
The more debt a firm has, the greater its risk of
being unable to
meet its contractual debt payments.
In general, the more debt a firm uses in relation
to its total assets,
the greater, the greater its financial leverage.
Financial leverage is the magnification of risk
and return through
the use of fixed-cost financing, such as debt and
preferred stock.
The more fixed-cost debt a firm uses, the greater
will be its
expected risk and return
Financial leverage is the use of borrowed money
(debt) to finance the
purchase of assets with the expectation that the
income or capital gain
from the new asset will exceed the cost of
borrowing.
Financial leverage is the use of debt to buy more
assets.
Leverage is employed to increase the return on
equity.
However, an excessive amount of financial
leverage increases the
risk of failure, since it becomes more difficult to
repay debt.
With increase debt comes greater risk as well as
larger potential
return.
There are two general types of debt measures:
1. Measures of the degree of indebtedness
2. Measures of the ability to service debts
The degree of indebtedness measures the amount
debt relative to other
significant balance sheet amounts.
A popular measure of the degree of indebtedness
is the debt ratio.
The second type debt measure, the ability to
service debts, reflects a
firm’s ability to make the payments required on a
schedule basis
over the life of a debt.
The term to service debts means to pay debts on
time.
The firm’s ability to pay certain fixed charges is
measure using
coverage ratios.
Typically, higher coverage ratios are preferred
(especially by the
firm’s lenders), but a very high ratio might indicate
that the firm's
management is too conservative and might be able
to earn higher
returns by borrowing more.
In general, the lower the firm’s coverage rations,
the less certain it is
to be able to pay fixed obligations.
If a firm is unable to pay these obligations, its
creditors may seek
immediate repayment which in most instances
would force a firm
into bankruptcy.
Two popular coverage ratios are the times interest
earned ratio and
the fixed-payment coverage ratio.
DEBT RATIO
The debt ratio measures the proportion of total
assets finance by the
firm’s creditors.
The higher this ratio, the greater the amount of
other people’s money
being used to generate profits.
A debt ratio measures the amount of leverage
used by a company in
terms of total debt to total assets.
This ratio varies widely across industries, such that
capital-intensive
businesses tend to have much higher debt ratios
than others.
From a pure risk perspective, debt ratios of 0.4 or
lower are
considered better, while a debt ratio of 0.6 or
higher makes it more
difficult to borrow money.
While a low debt ratio suggests greater
creditworthiness, there is also
risk associated with a company carrying too little
debt.
 While a low debt ratio suggests greater where T is the corporate tax applicable to the
creditworthiness, there is also firm’s income.
risk associated with a company carrying too little The term 1/(1-T) is included to adjust the after tax
debt. principal and
The ratio is calculated as follows: preferred stock dividend payment back to before-
Debt ratio = Total liabilities ÷ total assets tax equivalent that
The higher the debt ratio, the greater the firm’ s is consistent with the before-tax values of all
degree of other terms.
indebtedness and the more financial leverage it
has. Like the times interest earned ratio, the fixed-
payment coverage ratio
TIMES INTEREST EARNED RATIO measures risk. The lower the ratio , the greater the
The times interest earned ratio, sometimes called risk to both
the interest lenders and owners, and the greater the ratio, the
coverage ratio measures the firm’s ability to make lower the risk.
contractual This ratio allows interested parties to assess the
interest payments. firm’s ability to meet
The higher its value, the better able the firm is to additional fixed-payment obligations without being
fulfill its interest driven into
obligations. bankruptcy.
The Times Interest Earned (TIE) ratio measures a Profitability Ratios
company's ability There are many of measures of profitability. As a
to meet its debt obligations on a periodic basis. group, these
This ratio can be calculated by dividing a measures enable analysts to evaluate the firm’s
company's EBIT by its profits with respect
periodic interest expense. to a given level of sales , a certain level of assets,
Times interest earned ratio = Earnings before or the owners’
interest and taxes ÷ investment. Without profits, a firm could not
Interest expense attract outside capital.
Earnings before interest and taxes (EBIT) is the Owners, creditors, and management pay close
same as operating attention to boosting
profit. profits because of the great importance the
market places on earnings.
FIXED-PAYMENT COVERAGE RATIO
Profitability ratios are a class of financial metrics
The fixed payment coverage ratio measures the
that are used to
firm’s ability to
assess a business's ability to generate earnings
meet all fixed- payment obligations, such as loan
relative to its revenue,
interest and
operating costs, balance sheet assets, or
principal, lease payments and preferred stock
shareholders' equity over
dividends.
time, using data from a specific point in time.
As is true of the times interest earned ratio, the
COMMON – SIZE INCOME STSTAMENTS
higher this value the
A useful tool for evaluating profitability in relation
better. The formula for the fixed-payment coverage
to sales is the
ratio is
common-size income statement.
Fixed-payment
Each item on this statement is expressed as a
coverage ratio = Earnings before interest and taxes
percentage of sales.
+ Lease payments
Common –size income statements are especially
Interest + Lease payments
useful in comparing
+ { ( Principal payments + Preferred
performance across years because it is easy to see
stock dividends)
if certain
x [ 1/(1 – T)]}
categories of expenses are trending up or down as
a percentage of the
 total volume of business that then company a 20% margin is considered high (or “good”), and
transacts. a 5% margin is
low.
How do you interpret gross margin?
The ratio indicates the percentage of each peso of
revenue that the
company retains as gross profit.
For example, if the ratio is calculated to be 20%,
that means for every
peso of revenue generated, P0.20 is retained while
P0.80 is attributed
to the cost of goods sold.

OPERATING PROFIT MARGIN

Three frequently cited ratios of profitability
Operating Profit Margin is a profitability or
that come directly from
performance ratio that
the common-size income statements are
reflects the percentage of profit a company
1. the gross profit margin
produces from its
2. the operating profit margin
operations before subtracting taxes and interest
3. the net profit margin
charges.
GROSS PROFIT MARGING
Operating profit margin measures the percentage
Gross profit margin, also referred to as gross
of each sales peso
margin, is a measure of
remaining after all costs and expenses other than
a company's profitability.
interest, taxes, and
Gross profit margin indicates the amount of
and preferred stock dividend are deducted.
revenue remaining in a
It represents the “pure profits” earned on each
given accounting period after a company pays for
sales peso.
labor and materials,
Operating profits are “pure” because they
otherwise known as cost of goods sold (COGS).
measure only the profits
Gross profit margin is good yardstick for measuring
earned on operations and ignore interest, taxes
how efficiently
and preferred stock
companies make money from products and
dividends. A high operating profit margin is
services, because it
preferred.
measures profit as a percentage of sales revenue.
The operating profit margin is calculated as
The gross profit margin measures the percentage
follows:
of each sales peso
Operating profit margin = Operating profit ÷
remaining after the firm has paid for its goods.
Sales
The higher the gross profit margin, the better (that
is, the lower the
relative cost of merchandise sold).
What is good operating profit margin?
The gross profit margin is calculated as follows:
What constitutes a good profit margin depends on
Gross profit margin = Sales – Cost of goods sold =
the industry in
Gross profit
which a company operates.
Sales
As a general rule, a 10% operating profit margin is
Sales
considered an
What is a good gross profit margin?
average performance, and a 20% margin is
You may be asking yourself, “what is a good profit excellent.
margin?” It's also important to pay attention to the level of
A good margin will vary considerably by industry, interest payments
but as a general from a company's debt.
rule of thumb, a 10% net profit margin is What does low operating profit margin mean?
considered average, A low profit margin means that your business isn't
efficiently
 converting revenue into profit. Sales
This scenario could result from, prices that are too What is a Good Profit Margin?
low, or excessively You may be asking yourself, “what is a good profit
high costs of goods sold or operating expenses. margin?”
Low margins are determined relative to your A good margin will vary considerably by industry,
industry and historical but as a general
context within your company. rule of thumb, a 10% net profit margin is considered
average,
What is good operating profit margin? a 20% margin is considered high (or “good”), and a
What constitutes a good profit margin depends on 5% margin is low.
the industry in The net profit margin is a common cited measure of
which a company operates. the firm’s success
As a general rule, a 10% operating profit margin is with respect to earnings on sales.
considered an “Good” net profit margins differ considerably across
average performance, and a 20% margin is industries.
excellent. A net profit margin of 1% or less would not be
It's also important to pay attention to the level of unusual for a grocery
interest payments store, whereas a net profit margin of 10% would be
from a company's debt. low for a retail
What does low operating profit margin mean? jewelry store.
A low profit margin means that your business isn't EARNINGS PER SHARE (EPS)
efficiently Earnings per share or EPS is a common metric used
converting revenue into profit. to carry out
This scenario could result from, prices that are too corporate value.
low, or excessively It can be defined as the value of earnings per
high costs of goods sold or operating expenses. outstanding share of
Low margins are determined relative to your common stock of the company.
industry and historical EPS indicates the company's profitability by
context within your company. showing how much
money a business makes for each share of its stock.
NET PROFIT MARGIN EPS is generally of interest to present or prospective
Net profit margin measures the percentage of each stockholders and
sales peso management.
remaining after all costs and expenses, including It represents the number of peso earned during the
interest, taxes and period on behalf of
preferred stock dividends, has been deducted. each outstanding share of common stock.
Net profit margin, or simply net margin, measures Earning per share is calculated as follows:
how much net Earning per share = Earnings available for common
income or profit is generated as a percentage of stockholders
revenue. Number of shares of common
It is the ratio of net profits to revenues for a stock outstanding
company or business
segment. The higher the earnings per share of a company,
Net profit margin is typically expressed as a the better is its
percentage but can also profitability.
be represented in decimal form. While calculating the EPS, it is advisable to use the
The higher the firm’s net profit margin, the better. weighted ratio,
A higher net profit margin means that a company is as the number of shares outstanding can change
more efficient at over time.
converting sales into actual profit. RETURN ON TOTA ASSETS (ROA)
The net profit margin is calculated as follows: This profitability indicator helps you determine
Net profit margin = Earnings available for common how your company
stockholder ÷
 generates its earnings and how you compare to A higher ROE signals that a company efficiently
your competitors. uses its shareholder's
The return on total assets ratio compares a equity to generate income.
company's total assets with Low ROE means that the company earns relatively
its earnings after tax and interest. Calculation is as little compared to
follows: its shareholder's equity.
ROA = Earnings available for common stockholders An ROE of 15-20% is considered good.
÷ Total assets A value above 20% can indicate very strong
performance, but it can
also be an indication that company management has
The higher the earnings per share of a company, increased the
the better is its business's exposure to risk by borrowing against
profitability. company assets.
While calculating the EPS, it is advisable to use the
weighted ratio,
as the number of shares outstanding can change Market Ratios
over time. Market ratios relate the firm’s market value, as
RETURN ON TOTA ASSETS (ROA) measure by its
This profitability indicator helps you determine current share price, to certain accounting values.
how your company These ratios give insight into how investors in the
generates its earnings and how you compare to marketplace feel
your competitors. the firm is doing in terms of risk and return.
The return on total assets ratio compares a they tend to reflect, on a relative basis, the
company's total assets with common stockholders’
its earnings after tax and interest. Calculation is as assessment of all aspects of the firm’s past and
follows: expected future
ROA = Earnings available for common stockholders performance.
÷ Total assets Here we consider two widely quoted market
ratios, one that focuses
How do you interpret return on assets? on earnings and another that considers book
value.
A ROA that rises over time indicates the company
is doing well at
PRICE / EARNINGS (P/E) RATIO
increasing its profits with each investment peso it
The price/earning ratio is commonly used to
spends.
assess the owner’s
A falling ROA indicates the company might have
appraisal of share value.
over-invested in
The P/E ratio measures the amount that investors
assets that have failed to produce revenue growth,
are willing to pay
a sign the company
for each peso of a firm earnings.
may be in some trouble.
The level of this ratio indicates the degree of
RETURN ON COMMON EQUITY (ROE/ ROCE)
confidence hat
The return on common equity measures the
investors have in the firm’s future performance.
returned on the common
The higher the P/E ratio, the greater the investors
stockholder’s investment in the firm.
confidence.
Generally, the owners are better off the higher in
How to calculate a company's P/E ratio.
this return.
This ratio is calculated by dividing a company's
Return on common equity is calculated as follows:
stock price by the
ROE = Earnings available for common stockholders
company's earnings-per-share (EPS.) 
÷ Common
P/E ratio = Market price per share of common
sto
(Stock price) ÷
ck equity
Earnings per share

Examples:
 For example, if a company's share price is currently It relates the market value of the firm’s shares to
P30 and the EPS their book --
is currently P10, the P/E ratio would be 3. strict accounting – value.
For example, if a company has earnings of P10 The book-to-market ratio identifies undervalued
billion and has 2 or overvalued
billion shares outstanding, its EPS is P5. If its stock securities by taking the book value and dividing it
price is by the market
currently P120, its PE ratio would be 120 divided value. The ratio determines the market value of a
by 5, which company relative
comes out to 24. to its actual worth.
What is a good price earning ratios? To calculate the firm’s M/B ratio, we first need to
A “good” P/E ratio isn't necessarily a high ratio or a find the book
low ratio on its value per share of common stock.
own. Book value per share (BVPS) is the ratio of equity
The market average P/E ratio currently ranges available to
from 20-25, so a higher common shareholders divided by the number of
PE above that could be considered bad, while a outstanding shares.
lower PE ratio could This figure represents the minimum value of a
be considered better. company's equity
P/E ratio, or price-to-earnings ratio, is a quick way and measures the book value of a firm on a per-
to see if a stock share basis.
is undervalued or overvalued. And so generally
speaking, the lower Formula for book value share c/s:
the P/E ratio is, the better it is for both the Book value per share Common stock
business and potential equity
investors. The metric is the stock price of a =
company divided by its of common stock Number of shares of
earnings per share. common stock
                                                   out standing
What is a good price earning ratios? Formula for M/B ratio:
Market price per share
A “good” P/E ratio isn't necessarily a high ratio or a
of common stock
low ratio on its
own.
Market/book (M/B) ratio =
The market average P/E ratio currently ranges
from 20-25, so a higher
Book value per share of
PE above that could be considered bad, while a
common stock
lower PE ratio could
be considered better.
The stocks of firms that are expected to perform
P/E ratio, or price-to-earnings ratio, is a quick way
well– improve profits,
to see if a stock
increase their market share, or launch successful
is undervalued or overvalued. And so generally
products – typically
speaking, the lower
sell at higher M/B ratios than the stocks of rims
the P/E ratio is, the better it is for both the
with less attractive
business and potential
outlooks. Simply stated, firms expect to earn high
investors. The metric is the stock price of a
returns relative to
company divided by its
their risk typically sell at higher M/B multiples.
earnings per share.
Like P/E ratios are typically assessed cross -
                                                  
sectionally to get a fell
MARKET /BOOK (M/B) RATIO
for the firm’s return and risk compared to peer
M/B ratio provides an assessment of how
firms.
investors view the firm’s
performance .

DUPONT SYSTEMOF ANALYSIS
One of the more interesting measures of a
company's financial
performance is the DuPont Equation.
This model allows stock analysts and investors to
examine the
profitability of a company using information from
both the income
statement as well as the balance sheet.
The DuPont system of analysis is used to dissect
the firm’s financial
statements and to assess its financial condition.
It merges the income statement and balance sheet
into two summary
measures of profitability, return on total
assets(ROA) and return on
common equity (ROE)
DUPONT SYSTEMOF ANALYSIS
One of the more interesting measures of a
company's financial
performance is the DuPont Equation.
This model allows stock analysts and investors to
examine the
profitability of a company using information from
both the income
statement as well as the balance sheet.
The DuPont system of analysis is used to dissect
the firm’s financial
statements and to assess its financial condition.
It merges the income statement and balance sheet
into two summary
measures of profitability, return on total
assets(ROA) and return on
common equity (ROE)
The basic DuPont Analysis model is a method of
breaking down the
original equation for ROE into three components:
1. operating efficiency,
2. asset efficiency, and
3. leverage.
Operating efficiency is measured by Net Profit
Margin and indicates
the amount of net income generated per peso of
sales.
What does the DuPont identity tell you?
What Is the DuPont Identity? The DuPont identity is
an expression
that shows a company's return on equity (ROE) can
be represented
as a product of three other ratios: the profit
margin, the total asset
turnover, and the equity multiplier.
DuPont Analysis
The DuPont analysis, named after a financial
model created by the
chemical manufacturer, DuPont Corporation, is a
financial framework
driven by the return on equity (ROE) ratio.
The ROE is used to assess a company’s ability to
boost returns for its
investors.
 The DuPont analysis is an expanded return on common stockholders Total assets
equity formula, stockholders
calculated by multiplying the net profit margin by ROE = x =
the asset turnover Total sales Common stock
by the equity multiplier. equity Common
The DuPont analysis is also known as the DuPont
identity or DuPont stock
model.
DuPont Formula equity
The DuPont system first brings together the net
profit margin,
which measures the firm’s profitability on sales, Use of the financial leverage multiplier(FLM) to
with its total asset convert the ROA
turnover, which indicates how efficiently the firm into the ROE reflects the impact of financial
has used its assets leverage on owners’
to generate sales. return.
In the DuPont formula, the product of these two
ratios results in the
return on total assets (ROA): Applying the DuPont System
ROA = Net profit margin x Total asset The advantage DuPont system is tat it allows the
turnover firm to break its
Substituting the appropriate formulas into the return on equity into profit-on-sales component
equation and simplify (net profit margin),
results in the formula given earlier, an efficiency-of asset-use component (total asset
turnover), and a
Earnings available for use- of-financial-leverage component (financial
Earnings available for leverage multiplier).
common stockholders x Sales The total return to owners therefore can be
common stockholders analyzed in these
ROA = = important dimension.
Sales Total assets
Total assets

Modified DuPont Formula

The second step in the DuPont system employs
modified DuPont
formula.
This formula relates the firm’s return on total
assets (ROA) to its
return on common equity (ROE).
The latter is calculated by multiplying the return
on total assets
(ROA) by the financial leverage multiplier (FLM),
which is the
ratio of total assets to common stock equity:
ROE = ROA x FLM
Substituting the appropriate formulas into the
equation and
simplifying results in the formula given earlier,

Earnings
Earnings available for
for common