The document provides an overview of financial statement analysis. It discusses the primary types of financial statements, including the balance sheet and income statement. It then analyzes the balance sheet and income statement of Basket Wonders, a sample company, to calculate and examine different types of ratios including liquidity, leverage, activity, and profitability ratios. These ratios are used to evaluate the financial performance and position of Basket Wonders compared to industry averages.

1. 1
Chapter 6Chapter 6
Financial StatementFinancial Statement
AnalysisAnalysis
© 2001 Prentice-Hall, Inc.
Fundamentals of Financial Management, 11/e
Created by: Gregory A. Kuhlemeyer, Ph.D.
Carroll College, Waukesha, WI

2. 2
Examples of External UsesExamples of External Uses
of Statement Analysisof Statement Analysis
Trade CreditorsTrade Creditors -- Focus on the
liquidity of the firm.
BondholdersBondholders -- Focus on the
long-term cash flow of the firm.
ShareholdersShareholders -- Focus on the
profitability and long-term health of
the firm.

3. 3
Examples of Internal UsesExamples of Internal Uses
of Statement Analysisof Statement Analysis
PlanPlan -- Focus on assessing the current
financial position and evaluating
potential firm opportunities.
ControlControl -- Focus on return on investment
for various assets and asset efficiency.
UnderstandUnderstand -- Focus on understanding
how suppliers of funds analyze the firm.

4. 4
Primary Types ofPrimary Types of
Financial StatementsFinancial Statements
Income StatementIncome Statement
A summary of a firm’s revenues and
expenses over a specified period, ending
with net income or loss for the period.
Balance SheetBalance Sheet
A summary of a firm’s financial position on
a given date that shows total assets = total
liabilities + owners’ equity.

5. 5
Basket Wonders’ BalanceBasket Wonders’ Balance
Sheet (Asset Side)Sheet (Asset Side)
a. How the firm stands on
a specific date.
b. What BW owned.
c. Amounts owed by
customers.
d. Future expense items
already paid.
e. Cash/likely convertible
to cash within 1 year.
f. Original amount paid.
g. Acc. deductions for
wear and tear.
Cash and C.E. $ 90
Acct. Rec.cc
394
Inventories 696
Prepaid Expdd
5
Accum Tax Prepay 10
Current AssetsCurrent Assetsee
$1,195$1,195
Fixed Assets (@Cost)ff
1030
Less: Acc. Depr. gg
(329)
Net Fix. AssetsNet Fix. Assets $ 701$ 701
Investment, LT 50
Other Assets, LT 223
b
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003Basket Wonders Balance Sheet (thousands) Dec. 31, 2003a

6. 6
Basket Wonders’ BalanceBasket Wonders’ Balance
Sheet (Liability Side)Sheet (Liability Side)
a. Note, Assets =
Liabilities + Equity.
b. What BW owed and
ownership position.
c. Owed to suppliers for
goods and services.
d. Unpaid wages,
salaries, etc.
e. Debts payable < 1 year.
f. Debts payable > 1 year.
g. Original investment.
h. Earnings reinvested.
Notes Payable $ 290
Acct. Payablecc
94
Accrued Taxesdd
16
Other Accrued Liab.dd
100
Current Liab.Current Liab.ee
$$
500500 Long-Term Debtff
530 Shareholders’
Equity Com. Stock ($1
par)gg
200 Add Pd in Capitalgg
729 Retained
Earningshh
210 TotalTotal
EquityEquity $$1,1391,139
a,b
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003Basket Wonders Balance Sheet (thousands) Dec. 31, 2003

7. 7
Basket Wonders’Basket Wonders’
Income StatementIncome Statement
a. Measures profitability
over a time period.
b. Received, or receivable,
from customers.
c. Sales comm., adv.,
officers’ salaries, etc.
d. Operating income.
e. Cost of borrowed funds.
f. Taxable income.
g. Amount earned for
shareholders.
Net Sales $ 2,211
Cost of Goods Soldbb
1,599
Gross Profit $ 612
SG&A Expensescc
402
EBITd
$
210 Interest Expensee
59 EBTff
$
151 Income Taxes 60
EATg
$ 91
Cash Dividends 38
Increase in REIncrease in RE $ 53$ 53
Basket Wonders Statement of Earnings (in thousands)Basket Wonders Statement of Earnings (in thousands)
for Year Ending December 31, 2003for Year Ending December 31, 2003a

8. 8
Use of Financial RatiosUse of Financial Ratios
Types ofTypes of
ComparisonsComparisons
InternalInternal
ComparisonsComparisons
ExternalExternal
ComparisonsComparisons
A Financial Ratio is
an index that relates
two accounting
numbers and is
obtained by dividing
one number by the
other.

9. 9
Liquidity RatiosLiquidity Ratios
CurrentCurrent
Current AssetsCurrent Assets
Current LiabilitiesCurrent Liabilities
For Basket Wonders
December 31, 2003
Shows a firm’s
ability to cover its
current liabilities
with its current
assets.
Balance Sheet Ratios
Liquidity Ratios
$1,195$1,195
$500$500
= 2.392.39

10. 10
Liquidity RatioLiquidity Ratio
ComparisonsComparisons
BW Industry
2.39 2.15
2.26 2.09
1.91 2.01
Year
2003
2002
2001
CurrentCurrent RatioRatio
Ratio is stronger than the industry average.

11. 11
Liquidity RatiosLiquidity Ratios
Acid-Test (Quick)Acid-Test (Quick)
Current Assets - InvCurrent Assets - Inv
Current LiabilitiesCurrent Liabilities
For Basket Wonders
December 31, 2003
Shows a firm’s
ability to meet
current liabilities
with its most liquid
assets.
Balance Sheet Ratios
Liquidity Ratios
$1,195 - $696$1,195 - $696
$500$500
= 1.001.00

12. 12
Liquidity RatioLiquidity Ratio
ComparisonsComparisons
BW Industry
1.00 1.25
1.04 1.23
1.11 1.25
Year
2003
2002
2001
Acid-Test RatioAcid-Test Ratio
Ratio is weaker than the industry average.

13. 13
Summary of the LiquiditySummary of the Liquidity
Ratio ComparisonsRatio Comparisons
Strong current ratio and weak acid-test
ratio indicates a potential problem in
the inventories account.
Note that this industry has a relatively
high level of inventories.
RatioRatio BWBW IndustryIndustry
Current 2.39 2.15
Acid-Test 1.00 1.25

14. 14
Financial Leverage RatiosFinancial Leverage Ratios
Debt-to-EquityDebt-to-Equity
Total DebtTotal Debt
Shareholders’ EquityShareholders’ Equity
For Basket Wonders
December 31, 2003
Shows the extent to
which the firm is
financed by debt.
Balance Sheet Ratios
Financial Leverage
Ratios
$1,030$1,030
$1,139$1,139
= .90.90

15. 15
Financial Leverage RatiosFinancial Leverage Ratios
Debt-to-Total-AssetsDebt-to-Total-Assets
Total DebtTotal Debt
Total AssetsTotal Assets
For Basket Wonders
December 31, 2003Shows the
percentage of the
firm’s assets that are
supported by debt
financing.
Balance Sheet Ratios
Financial Leverage
Ratios
$1,030$1,030
$2,169$2,169
= .47.47

16. 16
Coverage RatiosCoverage Ratios
Interest CoverageInterest Coverage
EBITEBIT
Interest ChargesInterest Charges
For Basket Wonders
December 31, 2003Indicates a firm’s
ability to cover
interest charges.
Income Statement
Ratios
Coverage Ratios
$210$210
$59$59
= 3.563.56

17. 17
Summary of the CoverageSummary of the Coverage
Trend AnalysisTrend Analysis
This indicates that low earningslow earnings (EBIT)
may be a potential problem for BWBW.
Note, we know that debt levelsdebt levels are in
line with the industryindustry averages.
The interest coverage ratio for BWBW has
been falling since 2001. It has been
below industryindustry averages for the past
two years.

18. 18
Activity RatiosActivity Ratios
Inventory TurnoverInventory Turnover
Cost of Goods SoldCost of Goods Sold
InventoryInventory
For Basket Wonders
December 31, 2003
Indicates the
effectiveness of the
inventory management
practices of the firm.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
$1,599$1,599
$696$696
= 2.302.30

19. 19
Inventory Turnover RatioInventory Turnover Ratio
--Trend Analysis--Trend Analysis
ComparisonComparison
Trend Analysis of Inventory Turnover Ratio
2.0
2.5
3.0
3.5
4.0
2001 2002 2003
Analysis Year
RatioValue
BW
Industry

20. 20
Activity RatiosActivity Ratios
Total Asset TurnoverTotal Asset Turnover
Net SalesNet Sales
Total AssetsTotal Assets
For Basket Wonders
December 31, 2003
Indicates the overall
effectiveness of the firm
in utilizing its assets to
generate sales.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
$2,211$2,211
$2,169$2,169
= 1.021.02

21. 21
Profitability RatiosProfitability Ratios
Gross Profit MarginGross Profit Margin
Gross ProfitGross Profit
Net SalesNet Sales
For Basket Wonders
December 31, 2003
Indicates the efficiency
of operations and firm
pricing policies.
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
$612$612
$2,211$2,211
= .277277

22. 22
Profitability RatiosProfitability Ratios
Net Profit MarginNet Profit Margin
Net Profit after TaxesNet Profit after Taxes
Net SalesNet Sales
For Basket Wonders
December 31, 2003
Indicates the firm’s
profitability after taking
account of all expenses
and income taxes.
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
$91$91
$2,211$2,211
= .041.041

23. 23
Profitability RatiosProfitability Ratios
Return on InvestmentReturn on Investment
Net Profit after TaxesNet Profit after Taxes
Total AssetsTotal Assets
For Basket Wonders
December 31, 2003Indicates the
profitability on the
assets of the firm (after
all expenses and taxes).
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
$91$91
$2,160$2,160
= .042.042

24. 24
Profitability RatiosProfitability Ratios
Return on EquityReturn on Equity
Net Profit after TaxesNet Profit after Taxes
Shareholders’ EquityShareholders’ Equity
For Basket Wonders
December 31, 2003Indicates the profitability
to the shareholders of
the firm (after all
expenses and taxes).
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
$91$91
$1,139$1,139
= .08.08