Chapter 5

Financial Statements and Ratio Analysis

THE LETTER TO STOCKHOLDERS
 The primary communication from management in the annual report. It describes the
events that managers believe had the greatest effect on the firm during the year.

THE FOUR KEY FINANCIAL STATEMENTS

 The income statement provides a financial summary of the firm’s operating results during
a specified period, usually one quarter or one year.
 The balance sheet presents a summary statement of the firm’s financial position at a
given time
 The statement of retained earnings is an abbreviated form of the statement
of stockholders’ equity. Unlike the statement of stockholders’ equity, which shows all
equity account transactions that occurred during a given year, the statement of retained
earnings reconciles the net income earned during a given year, and any cash dividends
paid, with the change in retained earnings between the start and the end of that year.
 The statement of cash flows is a summary of the cash flows over the period.

NOTES TO THE FINANCIAL STATEMENTS

 Included with published financial statements are explanatory notes keyed to the relevant
accounts in the statements. These notes to the financial statements provide detailed
information on the accounting policies, procedures, calculations, and transactions
underlying entries in the financial statements.
Ratio analysis
 involves methods of calculating and interpreting financial ratios to analyze and monitor
the firm’s performance. The basic inputs required to conduct ratio analysis are the firm’s
income statement and balance sheet.
TYPES OF RATIO COMPARISONS
 Cross-sectional analysis involves the comparison of different firms’ financial ratios at the
same point in time.
 Time-series analysis evaluates performance over time.
 Combined Analysis, The most informative approach to ratio analysis combines cross-
sectional and time-series analyses.