1. Financial Statements
Balance Sheet
Income Statement
Managers and Analysts Use Financial Statement to Conduct:
- Cash Flow Analysis
- Performance (Ratio) Analysis

2. The Link Between the Balance Sheets and the Income
Statement.
1999 2000 2000

3. Accounting Profits and
Cash Flows
•Are Accounting Profits and cash Flows same?
• Why Accounting Profits and Cash Flows
Differ
– Revenue Recognition
– The Matching Principle
– Depreciation

4. Translating Accounting Profits into
Cash Flows
• The statement is based on three cash flow
categories:
 Cash flow from operations is net income
adjusted for depreciation and changes in
receivables, payables, and inventories.

5. Translating Accounting Profits into
Cash Flows
 Cash flow from investing activities arise from
the purchase and sale of marketable securities
and productive assets such as machinery.
 Cash flow from financing activities include the
repayment of debt, the payment of dividends,
and the issuance of new securities.

6. Sources And Uses Of Cash
• Sources of cash
– Operations—customers pay invoices
– Investing—firm sells assets
– Financing—firm borrows or issues new shares
• Uses of cash
– Operations—pay its suppliers
– Investing—capital expenditures
– Financing—interest and dividend payments

7. Sources of Cash Inflow and Cash Outflow.

8. The Sources and Uses of Corporate
Cash
Sources Uses
• Decrease in any asset • Increase in any asset
• Increase in any liability • Decrease in any liability
• Net profits after taxes • Net loss
• Depreciation and other • Dividends paid
non-cash charges • Repurchase or retirement
• Sale of stock of stock

9. Key Measures of Cash Flow
Cash Flow
from • Total Cash Generated
Operations
Operating • Cash Flow Before Repaying
Cash Flow Lenders
Free Cash • Cash Flow Firm Could
Flow Distribute to Investors
12

10. FINANCIAL STATEMENT
ANALYSIS

11. Objectives of Analysis
• The adequacy or otherwise of the profits
earned
• The adequacy or otherwise of the financial
strength
• Its ability to generate enough cash and cash
equivalents, their timing and certainty
• The future growth outlook

12. Why Evaluate Financial
Statements?
• Internal uses
– Performance evaluation – compensation and
comparison between divisions
– Planning for the future – guide in estimating future cash
flows
• External uses
– Creditors
– Suppliers
– Customers
– Stockholders, Analysts

13. The Tool Kit
• Multi – Step Income Statement
• Horizontal Analysis
• Common-Sized Analysis
• Trend Analysis
• Analytical Balance Sheet
• Ratio Analysis
• Cash flow Analysis

14. Multi-step Income Statement
• GP
• PBDIT
• OP / PBIT
• PBTEOT
• PBT
• PAT

15. Analytical Balance Sheet

16. Ratio Analysis
• RoI Ratios
• Solvency Ratios
• Liquidity ratios
• Turnover Ratios
• Profitability Ratios
• Market Ratios
• Dupont Analysis

17. RoI Ratios
• RoNW = PAT – Preferred dividend /
Networth (%)
• EPS (Rs)
• CEPS = PAT – Preferred dividend + non-
cash charges / no. of equity shares o/s (Rs)

18. Solvency Ratios
• NAV / NWPS / BVPS (Rs)
• DER
• Interest cover = PAT + Int (LTD) + non-
cash charges / int (LTD) – Times
• DSCR = PAT + Int (LTD) + non-cash
charges / int (LTD) + principal repayment –
Times

19. Liquidity ratios
• CR = CAs, loans and advances + ST Inv / CLs +
provisions + ST debt
• QR
• CP allowed to customers = receivables x 365 /
credit sales
• Supplier’s credit = payables x 365 / credit
purchases
• Inventory holding period = inventory x 365 /
COGS

20. Turnover Ratios
• FATO = Net sales / fixed assets
• NWTO = Net sales / NW
• Debtor turnover
• Inventory turnover

21. Profitability Ratios
• Multi-step profit margins
• Ratios of individual costs and expenses to
sales
• Ratios of other income, extraordinary items
and prior year adjustments to PBT and/or
net sales

22. The DuPont Model
Brings together:
• Profitability
• Efficiency
• Leverage

23. Deriving the Du Pont Identity
• ROE = NI / TE
• Multiply by 1 and then rearrange
– ROE = (NI / TE) (TA / TA)
– ROE = (NI / TA) (TA / TE) = ROA * EM
• Multiply by 1 again and then rearrange
– ROE = (NI / TA) (TA / TE) (Sales / Sales)
– ROE = (NI / Sales) (Sales / TA) (TA / TE)
– ROE = PM * TAT * EM

24. Du Pont Analysis
Net Income Sales Assets
Return on equity =
  
Sales Asset Shareholder’s Equity
Net Total Equity
Profit Asset Multiplier
Margin Turnover

25. Using the Du Pont Identity
• ROE = PM * TAT * EM
– Profit margin is a measure of the firm’s
operating efficiency – how well does it control
costs
– Total asset turnover is a measure of the firm’s
asset use efficiency – how well does it manage
its assets
– Equity multiplier is a measure of the firm’s
financial leverage

26. Potential Problems
• There is no underlying theory, so there is no way
to know which ratios are most relevant
• Benchmarking is difficult for diversified firms
• Globalization and international competition makes
comparison more difficult because of differences
in accounting regulations
• Varying accounting procedures, i.e. FIFO vs.
LIFO
• Different fiscal years
• Extraordinary events

27. • Comparison with industry averages is difficult if
the firm operates many different divisions.
• “Average” performance is not necessarily good.
• Seasonal factors can distort ratios.
(More…)

28. • Window dressing techniques can make
statements and ratios look better.
• Sometimes it is difficult to tell if a ratio value
is “good” or “bad.”
• Often, different ratios give different signals, so
it is difficult to tell, on balance, whether a
company is in a strong or weak financial
condition.

29. What are some qualitative factors
analysts should consider when
evaluating a company’s likely future
financial performance?
• Are the company’s revenues tied to a single
customer?
• To what extent are the company’s revenues tied to
a single product?
• To what extent does the company rely on a single
supplier?
(More…)

30. • What percentage of the company’s
business is generated overseas?
• What is the competitive situation?
• What does the future have in store?
• What is the company’s legal and
regulatory environment?

31. Non-Financial Measures of Operating
Effectiveness
• Innovation
• Customer Service
• Product Quality
• Reputation
• Good Employee Relations

32. Balanced Scorecard
• Organisational Learning and Growth
(Employee Training & Education, Innovation,
Opportunities for Improvement, New Product
Dev. Time)
• Business and Production Process Efficiency
(Quality, Productivity, Cycle time)
• Customer Value (Customer Satisfaction and
Loyalty)
• Financial Performance