FINANCIAL

STATEMENTS
Objectives of Financial Statements

The important objectives of financial statements are:

1. Providing Information for Economic Decisions

2. Providing Information about Financial Position
3. Providing Information about Performance of an Enterprise
4. Providing Information about Changes in Financial Position
Demand for Financial Accounting Information

Managers and Investors and Analysts

01 Employees 02

Creditors and Stakeholders and

03 Suppliers 04 Directors

Regulatory and Tax Customers and

05 Agencies 06 Potential Strategic
Partners
07 Other decision makers
Sources of Information about Business Enterprise

1. The audited annual report that includes the four financial

statements with explanatory notes and the management’s discussion
and analysis of financial results.

2. The unaudited quarterly or interim reports that include summary

version of the four financial statements and limited additional
disclosure.
BENEFITS OF DISCLOSURE

The ability of a company to provide reliable (audited)

accounting information about its goods, processes, and
other business operations allows it to compete more
effectively in capital, labor, input, and output markets.
Cost of Disclosure

The preparation and dissemination

costs of supplying accounting
information can be substantial, and
the possibility for information to
produce competitive disadvantages
is high.
CONTRAINTS ON RELEVANT AND RELIABLE
INFORMATION

Timeliness Balance Between

Benefit and Cost

Balance Between True Fair View or

Qualitative Fair Presentation
Characteristics
 Financial
Statements
Financial statements are
written records that disclose
the business activities and the
financial perfromance of a
company.
 Financial Statements
Statement of
Cash Flows

Statement of Statement of
Financial Statement of Financial
Position Stockholders’ Position
Equity

(beginning-of- (end-of-period)
period)

Statement of
Comprehensive
Income
Statement of Financial Position

A Statement of Financial Position reports a company’s

financial position at a point in time, the company’s
resources (assets) namely, what the company owns and
also the sources of asset financing.
Statement of Financial Position
2 ways a company can finance its assets:

Owner Financing Nonowner Financing

Statement of Comprehensive Income

A statement of comprehensive income reports on a

company’s performance over a period of time and lists
amounts for revenues, expenses and other
comprehensive income.
Statement of Stockholders’ Equity

A statement of stockholders’ equity reports on changes in

key types of equity over a period of time.
Statement of Cash Flows

A statement of cash flows report the change (either an

increase or decrease) in a company’s cash balance over a
period of time.
FINANCIAL
STATEMENT
ANALYSIS
Financial Statement Analysis

Financial statement analysis is the process of analyzing a

company’s financial statements for decision-making
purposes.
Broader Business Environment Analysis

Life cycle Inputs Labor

Outputs Competition Governance

Buyers Financing Risk

Basics of Profitability Analysis

The primary goal of financial management is to maximize shareholders’

wealth, not accounting measures such as net income or earnings per share.
However, accounting data influence stock prices and this data can be used
to see why a company is performing the way it is and where it is heading.
Financial Analysis involves

Comparing the firm’s performance to Evaluating trends in the firm’s

that of other firms in the same financial postion over time
industry
Limitations of Financial Statements Analysis
1. Information derived by the analysis are not absolute measures of
performance in any and all of the areas of business operations.

2. Limitations inherent in the accounting data the analyst works with.

3. Limitations of the performance measures or tools and techniques used in the

analysis.

4. Analysts should be alert to the potential for management to influence the

outcome of financial statements in order to appeal to creditors, investors and
others.
Assessing performance
using Financial Ratios
 Comparison to industry average
● Cross-sectional analysis
● Assessing performance of a firm in comparison to the industry
averages.
● Used to find the strengths and weaknesses relative to the industry a firm
is belonging to.
 Benchmarking
● The process of comparing a particular firm with a subset of top
competitors in its industry.
● The companies used for the comparison are called benchmark companies.
 Trend Analysis

● Analysis of a firm’s financial ratios

over time.
● Used to estimate the likelihood of
improvement or deterioration in its
financial condition
Financial Ratio
Analysis
 Ratio Analysis

● Financial Ratios help us evaluate financial statements.

● It help us compare two or more companies which holds a stronger
financial statements.
● Usually expressed as a percent or as times per period.
● Interpretable in comparison with
○ Prior ratios
○ Ratios of competitors
○ Industry ratios
○ Predetermined standards
 Users of financial ratios

● Managers - Use ratios to analyze, control, and improve the firm’s

operations
● Credit analysts - Includes bank loan officers and bond rating analysts, who
analyze ratios to help judge a firm’s ability to repay its debts.
● Stock analysts - Who are interested in a company’s efficiency, risk, and
growth prospects.
 5 Categories of Financial Ratios

● Liquidity Ratios
● Asset Management Ratios / Efficiency Ratios
● Debt Management Ratios / Leverage Ratios
● Profitability Ratios
● Market Ratios
 Liquidity Ratios

● Show relationship of a firm’s cash and

other current assets to its current
liabilities.
● It should help answer the question: Will
the firm be able to pay off its debts as they
come due and thus remain a viable
organization?
● Types:
○ Current ratio
○ Quick or acid test ratio
 Current Ratio

● Primary liquidity ratio.

● Measures how much current assets a firm
has to pay off its current liabilities.
● Expressed as times (X)
● Formula:
 Quick (Acid Test) Ratio

● Measures firm’s ability to pay its current

liabilities with its most liquid assets.
● Expressed as times (X)
● Formula:
 Asset Management Ratios

● Measure how effectively the firm is in managing

its assets.
● It answer the question: Does the amount of each
type of asset seem reasonable, too high, or too
low in view of current and projected sales?
○ Inventory turnover ratio
○ Days Sales Outstanding
○ Fixed assets turnover ratio
○ Total assets turnover ratio
 Inventory Turnover Ratio

● Shows how many times the inventory is turned

over during the year.
● Measures how well a firm is in generating
sales from its inventories
● Expressed as times (X)
● Formula:
 Days Sales Outstanding (DSO)

● Average number of days that receivables remain

outstanding before they are collected.
● Determine the effectiveness of a firm’s credit and
collection efforts in allowing credit to customers, as well
as its ability to collect from them.
● Expressed as days
● Formula:
 Fixed Assets Turnover Ratio

● Indicates how well or efficient a firm is in

using fixed assets to generate sales.
● Expressed in times (X)
● Formula:
 Total Assets Turnover Ratio

● Indicates how well or efficient a firm is in

using its assets to generate sales.
● Expressed in times (X)
● Formula:
 Debt Management Ratios

● Measure how effectively a firm manages its

debt
● Illustrates the potential benefits and risks
associated with debt.
● Can be used as a measure of a firm’s risk and
likelihood of default
○ Total debt to total capital
○ Times interest earned (TIE) ratio
 Total debt to total capital

● Measures the percentage of the firm’s capital

provided by the creditors.
● Company’s debt ratio
● Formula:
 Times-Interest-Earned (TIE) Ratio

● Measure of the firm’s ability to meet its

annual interest payments
● Formula:
 Profitability Ratios

● Show the combined effects of liquidity, asset

management, and debt on operating results.
● Reflect the net result of all of the firm’s
financing policies and operating decisions.
 Operating Margin

● Measures operating income per amount of

sales.
● Formula:
 Profit margin

● Also called as Net Profit Margin

● Measures net income per amount of sales.
 Return on Total Assets

● Measures the rate of return on the firm’s

assets.
● Expressed as percentage (%)
● Formula:
 Return on Common Equity

● Measures the rate of return on common

stockholders’ investment
● Expressed as percentage (%)
● Formula:
 Market Value Ratios

● Relate the firm’s stock price to its earnings and book value per share
○ Market value ratios are used in three primary ways:
■ Investors - when they are deciding to buy or sell a stock
■ Investment bankers - when they are setting the share price for a
new stock issue (IPO)
■ Firms - when they are deciding how much to offer for another
firm in a potential merger.
 Price/Earnings Ratio

● Shows how much investors are willing to pay

per currency of reported profits.
● Expressed as times (X)
● Formula:
 Market/Book Ratio

● Give indication of how investors regard the

firm.
● Expressed as times (X)
● Formula:
THE DUPONT DISAGGREGATION
ANALYSIS

DuPont Equation is the formula that shows that the rate of return on equity
can be found as the product margin, total assets turnover and the equity
multiplier. It shows the relationships among asset management, financial
leverage management and profitability ratios.
THE DUPONT DISAGGREGATION
ANALYSIS

Total assets
Net Income Net Income Sales _________
_________ _________ _________
ROE = Stockholders
= Sales
x Total assets
x Stockholders
’ equity
’ equity

Profit Asset Financial

Margin Turnover Leverage
THE DUPONT DISAGGREGATION
ANALYSIS
Profit Margin
The amount of profit that the
company earns from each
peso of sales.
Asset Turnover
A productivity measure that
reflects the volume of sales
that a company generates
from each peso invested in
assets.
Financial Leverage
Measures the degree to
which the company finances
its assets with debt rather
than equity.
THANK YOU!