Lecture 02 Introduction To Financial Statement Analysis

Copyright 2012 Pearson Prentice Hall. All rights reserved.
Lecture 2
Introduction to
Financial
Statement
Analysis
2-2
Chapter Outline
2.1 Firms Disclosure of Financial Information
2.2 The Balance Sheet
2.3 Balance Sheet Analysis
2.4 The Income Statement
2.5 Income Statement Analysis
2.6 The Statement of Cash Flows
2-3
Learning Objectives
Know why the disclosure of financial information
through financial statements is critical to
investors
Understand the function of the balance sheet
Use the balance sheet to analyze a firm
Understand how the income statement is used
Analyze a firm through its income statement,
including using the DuPont Identity

2-4
Learning Objectives (contd)
Interpret a statement of cash flows
Know what managements discussion and analysis
and the statement of stockholders equity are
Understand the main purpose and aspects of the
Sarbanes-Oxley reforms following Enron and
other financial scandals.
2-5
2.1 Firms Disclosure of Financial
Information
Financial statements are accounting
reports issued periodically to present past
performance and a snapshot of the firms
assets and the financing of those assets.
Investors, financial analysts, managers,
and other interested parties such as
creditors rely on financial statements to
obtain reliable information about a
corporation.
2-6
Information
Public companies must file financial results
with the Securities and Exchange
Commission (SEC)
on a quarterly basis (10-Q)
and an annual basis (10-K)
The annual report with financial
statements must be sent to their
shareholders every year.

2-7
Information
Generally Accepted Accounting Principles
(GAAP)
Set by the Financial Accounting Standards
Board (FASB) to provide a common set of rules
and a standard format for public companies
reports.
Corporations are required to hire an auditor to
check the annual financial statements
ensure they are prepared according to GAAP
provide evidence that the information is reliable.
2-8
Information
International Financial Reporting
Standards
International Accounting Standards Board
(IASB)
Established in 2001 by representatives from 10
countries, including the U.S.
Since 2005 all publicly traded European Union
companies are required to follow IFRS.
Used by many other countries, including Australia,
several countries in Latin America and Africa.
Accepted by all major stock exchanges around the
world except U.S. and Japan.

2-9
Information
Convergence to IFRS in the United States
is likely in the near future.
In 2008, the SEC eliminated the requirement
for foreign firms trading in the U.S. to reconcile
IFRS to U.S. GAAP.
In 2010, the SEC affirmed its support of a
single standard, with IFRS as the preferred
method.

2-10
Information
The four financial statements required by
the SEC are
The balance sheet,
The income statement,
The statement of cash flows, and the
The statement of stockholders equity
2-11
Also called Statement of Financial
Position
Lists the firms assets and liabilities
Provides a snapshot of the firms financial
position at a given point in time.

2-12
Table 2.1 Global Corporation Balance
Sheet for 2010 and 2009
2-13
The Balance Sheet Identity
The two sides of the balance sheet must
balance
Assets = Liabilities + Stockholders
Equity
(Eq. 2.1)
2-14
Current Assets
Cash and other marketable securities
short-term, low-risk investments
easily sold and converted to cash
Accounts receivable
amounts owed to the firm by customers who have
purchased on credit
Inventories
raw materials, work-in-progress and finished goods;
Other current assets
includes items such as prepaid expenses
2-15
Long-Term Assets
Assets that produce benefits for more than one
year
Reduced through a yearly deduction called
depreciation according to a schedule that
depends on an assets life.
Depreciation is not an actual expense, but a way of
recognizing that fixed assets wear out and become
less valuable as they get older.

2-16
Long-Term Assets
The book value of an asset is its acquisition
cost less its accumulated depreciation.
Other assets can include such items as
property not used in business operations, start-
up costs in connection with a new business,
trademarks and patents, and property held for
sale
2-17
Current Liabilities
Accounts payable
the amounts owed to suppliers purchases made on
credit
Notes payable
loans that must be repaid in the next year
repayment of long-term debt that will occur within the
next year
Accrual items
Items such as salary or taxes that are owed but have
not yet been paid, and deferred or unearned revenue
2-18
Net working capital
The capital available in the short term to run
the business:
Net Working Capital = Current Assets Current
Liabilities
(Eq. 2.2)
2-19
Long-Term Liabilities
Long-term debt
a loan or debt obligation maturing in more than a
year.

2-20
Stockholders Equity
Book value of equity
Net worth from an accounting perspective
Assets Liabilities = Equity
True value of assets may be different from book value
Market capitalization
Market price per share times number of shares
Does not depend on historical cost of assets.
2-21
Example 2.1
Market versus Book Value
Problem:
If Global has 3.6 million shares outstanding, and these
shares are trading for a price of $10 per share, what is
Globals market capitalization?
How does the market capitalization compare to Globals
book value of equity?
2-22
Example 2.1
Market versus Book Value (contd)
Solution:
Plan:
Market capitalization is equal to price per share times
shares outstanding.
We can find Globals book value of equity at the bottom of
the right side of its balance sheet.

2-23
Example 2.1
Execute:
Globals market capitalization is:
(3.6 million shares) ($10/share) = $36 million
This market capitalization is significantly higher than
Globals book value of equity:
$22.2 million
2-24
Example 2.1
Evaluate:
Global must have sources of value that do not appear on
the balance sheet.
These include
opportunities for growth
the quality of the management team
relationships with suppliers and customers, etc.
2-25
Example 2.1a
Market versus Book Value
Problem:
In July, 2010, Campbell Soup Co. (CPB) had 340 million
shares outstanding, trading for a price of $35.90 per share.
What was Campbells market capitalization?
How does the market capitalization compare to Campbells
book value of equity?
2-26
Example 2.1
Solution:
Plan:
Market capitalization is equal to price per share times
shares outstanding.
We can find Campbells book value of equity at the bottom
of the right side of its balance sheet.

2-27
Example 2.1a
Execute:
Campbells market capitalization is:
(340 million shares) ($35.90/share) = $12,206 million
This market capitalization is significantly higher than
Campbells book value of equity:
$926 million
2-28
Example 2.1a
Evaluate:
Campbells must have sources of value that do not appear
on the balance sheet.
These include
opportunities for growth
the quality of the management team
relationships with suppliers and customers, etc.
2-29
Book value of equity is sometimes used to
estimate liquidation value
We can learn a great deal from a firms
balance sheet to assess:
the firms value
its leverage
its short-term cash needs
2-30
Market to Book Ratio
The ratio of a firms market capitalization
to the book value of stockholders equity:

Also called Price-to-Book ratio.
Sometimes used to classify firms as value
(low M/B) or growth (high M/B).
Market Value of Equity
Market-to-Book Ratio
Book Value of Equity
(Eq. 2.3)
2-31
Figure 2.1 Market-to-Book Ratios in
2010
2-32
Debt-Equity Ratio
The debt-equity ratio is a common ratio
used to assess a firms leverage
Total Debt
Debt-Equity Ratio
Total Equity
(Eq. 2.4)
2-33
Enterprise value
Assesses the value of the underlying business
assets, unencumbered by debt and separate
from cash and marketable securities
Enterprise Value = Market Value of Equity + Debt Cash
(Eq. 2.4)
2-34
Example 2.2
Computing Enterprise Value
Problem:
In April 2010, H.J. Heinz Co. (HNZ) had a share price of
$46.15, 316.2 million shares outstanding, a market-to-book
ratio of 7.99, a book debt-equity ratio of 2.64, and cash of
$562.3 million.
What was Heinzs market capitalization?
What was its enterprise value?
2-35
Example 2.2
Computing Enterprise Value (contd)
Solution:
Plan:
We will solve the problem using Eq. 2.5:
Enterprise value = Market capitalization + Debt
Cash

Share Price

$46.15

Shares outstanding

316.2 million

Market-to-book

7.99

Cash

$562 million

Debt-to-equity (book)

2.64
2-36
Example 2.2
Execute:
We can compute the market capitalization by
multiplying the share price by the shares
outstanding.
We are given the amount of cash.
We are not given the debt directly, but we are
given the book debt-to-equity ratio.
Since we can compute the market value of equity
(market capitalization) and we have the market-
to-book ratio, we can compute the book value of
equity.
2-37
Example 2.2
Execute (contd):
Heinz had market capitalization of $46.15
316.2 million shares = $14.59 billion.
Since Heinzs market-to-book = 7.99 = $14.59
billion / book equity, then book equity =
$14.59 billion / 7.99 = $1.83 billion.
Given that book equity is $1.83 billion and
book debt-to-equity ratio is 2.64,
the total value of Heinzs debt is $1.83 billion
2.64 = $4.83 billion.
2-38
Example 2.2
Evaluate:
Thus, Heinzs enterprise value was
14.59 + 4.83 .562 = $18.858 billion.
2-39
Example 2.2a
Computing Enterprise Value
Problem:
As of July, 2010, Campbells Soup Co. (CPB) had a share
price of $35.90 and 340 million shares outstanding.
At that time, the company had $5,350 million in total debt
and $254 million in cash.
What was Campbells enterprise value?
2-40
Example 2.2a
Solution:
Plan:
We will solve the problem using Eq. 2.5:
Enterprise value = Market capitalization + Debt
Cash

Share Price

$35.90

Shares outstanding

340 million

Cash

$254 million

Debt

$5,350 million
2-41
Example 2.2a
Execute:
As computed in Example 2.1a, Campbells had a
market capitalization of (340 million shares)
($35.90/share) = $12,206

Enterprise Value = Market Value of Equity +
Debt Cash
2-42
Example 2.2a
Evaluate:
Campbells Enterprise Value =
$12,206 + $5,350 $254.0 = $17,302 million.
2-43
Current Ratio
The ratio of current assets to current
liabilities
Current Assets
Current Ratio =
Current Liabilities
(Eq. 2.6)
2-44
Current Assets - Inventory
Quick Ratio =
Current Liabilities
Quick Ratio
The ratio of current assets other than
inventory to current liabilities.
(Eq. 2.7)
2-45
Table 2.2 Balance Sheet Ratios
2-46
The income statement lists the firms
revenues and expenses over a period of
time.
Sometimes called the profit and loss
statement, or P&L.
The last or bottom line of the income
statement shows net income,
a measure of its profitability during the period.
also referred to as the firms earnings.
2-47
Table 2.3 Global Corporations Income
Statement Sheet for 2010 and 2009
2-48
Earnings Calculations
Revenues (net sales)
- Cost of Sales = Gross Profit
- Operating Expenses = Operating Income
+/- Other Income = Earnings Before Interest and
Taxes
+/- Interest income (expense) = Pretax Income
- Taxes
= Net Income

2-49
Earnings per share
Net income reported on a per-share basis

Net Income $2.0 million
EPS $0.556 per share
Shares Outstanding 3.6 million shares

(Eq. 2.8)
2-50
Fully diluted EPS increases number of
shares by:
Stock options issued to employees
The right to buy a certain number of shares by a
specific date at a specific price.
Shares issued due to conversion of convertible
bonds
Convertible bonds are corporate bonds with a
provision that gives the bondholder an option to
convert each bond into a fixed number of shares of
common stock.

2-51
The income statement provides useful
information regarding the profitability of a
firms business and how it relates to the
value of the firms shares.
There are several ratios that are often
used to evaluate a firms performance and
value.
2-52
Profitability Ratios
Gross Margin
Operating Margin
Net Profit Margin

2-53
Gross margin
how much a company earns from each dollar of
sales after paying for the items sold.
Gross Profit
Gross Margin
Sales
(Eq. 2.9)
2-54
Operating margin
how much a company earns before interest and
taxes from each dollar of sales
Operating Income
Operating Margin
Sales
(Eq. 2.10)
2-55
Net Income
Net Profit Margin
Sales

(Eq. 2.11)
Net Profit Margin
the fraction of each dollar in revenues that is available to
equity holders after the firm pays interest and taxes
2-56
Sales
Asset Turnover =
Total Assets
(Eq. 2.12)
Asset Efficiency: Asset Turnover
A first broad measure of efficiency is asset turnover
2-57
Asset Efficiency: Fixed Asset Turnover
Since total assets include assets that are not directly
involved in generating sales, a manager might also look at
fixed asset turnover
Sales
Fixed Asset Turnover =
Fixed Assets
(Eq. 2.13)
2-58
Accounts Receivable
Accounts Receivable Days
Average Daily Sales
(Eq. 2.14)
Working Capital Ratios: Accounts Receivable
Days
The firms accounts receivable in terms of the number of
days worth of sales that it represents
2-59
Cost of Goods Sold
Inventory Turnover =
Inventory
(Eq. 2.15)
Working Capital Ratios: Inventory Days and
Inventory Turnover
Inventory Days is the number of days cost of goods sold
represented by inventory.
Inventory Turnover tells how efficiently a company turns its
inventory into sales.

2-60
EBITDA
Financial analysts often compute a firms
earnings before interest, taxes,
depreciation, and amortization, or EBITDA.
Because depreciation and amortization are
not cash flows, this subtotal reflects the
cash a firm has earned from operations.
2-61
Leverage Ratios: Interest Coverage Ratio
Also known as times interest earned (TIE).
TIE = earnings divided by interest
Can define earnings as operating income,
EBIT, or EBITDA.
Assesses how easily a firm is able to cover
its interest payments.
2-62
Net Income
Return on Equity =
Book Value of Equity
(Eq. 2.16)
Investment Returns: Return on Equity
Evaluating the firms return on investment
by comparing its income to its investment
2-63
Net Income
Return on Assets =
Total Assets
Investment Returns: Return on Assets
Evaluating the firms return on investment
by comparing its income to its assets
2-64
Net Income Sales Net Income Sales
ROE =
Total Equity Sales Sales Total Equity

(Eq. 2.17)
DuPont Identity
This expression says that ROE can be
thought of as net income per dollar of
sales (profit margin) times the amount of
sales per dollar of equity
2-65
Net Income Sales Total Assets Net Income Sales Total Assets
ROE =
Sales Total Equity Total Assets Sales Total Assets Total Equity

(Eq. 2.18)
DuPont Analysis
This final expression says that ROE is
equal to
net income per dollar of sales (profit margin) times
sales per dollar of assets (asset turnover) times
assets per dollar of equity (a measure of leverage called
the equity multiplier).
2-66

Profit
Margin

Asset
Turnover

Equity
Multiplier

Wal-Mart
3.6% 2.4 2.6

Nordstrom
7.7% 1.7 2.4

Example 2.3 DuPont Analysis
Problem:
The following table contains information about Wal-Mart
(WMT) and Nordstrom (JWN). Compute their respective
ROEs and then determine how much Wal-Mart would need
to increase its profit margin in order to match Nordstroms
ROE.

2-67
(contd)
Solution:
Plan:
We can compute the ROE of each company by multiplying
together its profit margin, asset turnover, and equity
multiplier.
In order to determine how much Wal-Mart would need to
increase its margin to match Nordstroms ROE, we can set
Wal-Marts ROE equal to Nordstroms, keep its turnover and
equity multiplier fixed, and solve for the profit margin.
2-68
(contd)
Execute:
Using the DuPont Identity, we have:
ROE
WMT
= 3.6% x 2.4 x 2.6 = 22.5%
ROE
JWN
= 7.7% x 1.7 x 2.4 = 31.4%
Now, using Nordstroms ROE, but Wal-Marts asset turnover
and equity multiplier, we can solve for the margin that Wal-
Mart needs to achieve Nordstroms ROE:
31.4% = Margin x 2.4 x 2.6
Margin = 31.4% / 6.24 = 5.0%
2-69
(contd)
Evaluate:
Wal-Mart would have to increase its profit margin from
3.6% to 5% in order to match Nordstroms ROE.
It would be able to achieve Nordstroms ROE even with a
lower margin than Nordstrom (5.0% vs. 7.7%) because of
its higher turnover and slightly higher leverage.
2-70

Profit
Margin

Asset
Turnover

Equity
Multiplier

Campbells
10.8% 1.22 6.78

Heinz
8.22% 1.04 5.33

Example 2.3a DuPont Analysis
Problem:
The following table contains information about
Campbells (CPB) and H.J. Heinz (HNZ). Compute
their respective ROEs and then determine how
much Heinz would need to increase its equity
multiplier in order to match Campbells ROE.
2-71
(contd)
Solution:
Plan:
multiplier.
In order to determine how much Heinz would need to
increase its equity multiplier to match Campbells ROE, we
can set Heinzs ROE equal to Campbells, keep its profit
margin and turnover fixed, and solve for the equity
multiplier.
2-72
(contd)
Execute:
ROE
CPB
= 10.8% x 1.22 x 6.78 = 89.3%
ROE
HNZ
= 8.22% x 1.04 x 5.33 = 45.6%
Now, using Campbells ROE, but Heinzs profit margin and
asset turnover, we can solve for the equity multiplier that
Heinz needs to achieve Campbells ROE:
89.3% = 8.22% x 1.04 x Equity Multiplier
Equity Multiplier = 89.3% / 8.55% = 10.44
2-73
(contd)
Evaluate:
Heinz would have to increase its equity multiplier from 5.33
to 10.44 in order to match Campbells ROE.
This large increase in equity multiplier is required because of
its lower asset turnover (1.04 vs. 1.22) (lower efficiency) and
lower profit margin (8.22% vs. 10.8%).
2-74

Profit
Margin

Asset
Turnover

Equity
Multiplier

Campbells
10.8% 1.22 6.78

Heinz
8.22% 1.04 5.33

Example 2.3b DuPont Analysis
Problem:
The following table contains information about
Campbells (CPB) and H.J. Heinz (HNZ). Compute
their respective ROEs and then determine how
much Heinz would need to increase its asset
turnover in order to match Campbells ROE.
2-75
(contd)
Solution:
Plan:
multiplier.
In order to determine how much Heinz would need to
increase its asset turnover to match Campbells ROE, we
can set Heinzs ROE equal to Campbells, keep its profit
margin and equity multiplier fixed, and solve for the asset
turnover.
2-76
(contd)
Execute:
ROE
CPB
= 10.8% x 1.22 x 6.78 = 89.3%
ROE
HNZ
= 8.22% x 1.04 x 5.33 = 45.6%
Now, using Campbells ROE, but Heinzs profit margin and
equity multiplier, we can solve for the asset turnover that
Heinz needs to achieve Campbells ROE:
89.3% = 8.22% x Asset Turnover x 6.78
Asset Turnover = 89.3% / 43.8% = 1.66
2-77
(contd)
Evaluate:
Heinz would have to increase its asset turnover from 1.04 to
1.66 in order to match Campbells ROE.
This large increase in asset turnover is required because of its
lower equity multiplier (1.04 vs. 1.22) (lower leverage) and
lower profit margin (8.22% vs. 10.8%).
2-78
Valuation Ratio: Price-Earnings Ratio
Analysts and investors use a number of ratios to gauge the
market value of the firm.
The most important is the firms price-earnings ratio (P/E)
The P/E ratio is used to assess whether a stock is over-
or under-valued based on the idea that the value of a
stock should be proportional to the earnings it can
generate.
Market Capitalization Share Price
P/ E Ratio
Net Income Earnings per Share

(Eq. 2.19)
2-79
Valuation Ratio: PEG Ratio
P/E ratios can vary widely across industries and tend to be
higher for industries with higher growth rates.
One way to capture the idea that a higher P/E ratio can be
justified by higher expected earnings growth.
It is the ratio of the firms P/E to its expected earnings
growth rate.
The higher the PEG ratio, the higher the price relative to
growth, so some investors avoid companies with PEG ratios
over 1.
2-80
Example 2.4
Computing Profitability and Valuation
Ratios
Problem:
Consider the following data from 2010 for Wal-Mart Stores
and Target Corporation ($ billions):

Compare Wal-Mart and Targets operating margin, net profit
margin, P/E ratio, and the ratio of enterprise value to
operating income and sales.

Wal-Mart Stores
(WMT)

Target Corporation
(TGT)
Sales 408 65
Operating Income 24 5
Net Income 14 2
Market
Capitalization 203 41
Cash 8 2
Debt 41 17
2-81
Example 2.4
Ratios (contd)
Solution
Plan:
The table contains all of the raw data, but we need to
compute the ratios using the inputs in the table.
Operating Margin = Operating Income / Sales
Net Profit Margin = Net Income / Sales
P/E ratio = Price / Earnings
Enterprise value to operating income = Enterprise Value
/ Operating Income
Enterprise value to sales = Enterprise Value / Sales
2-82
Example 2.4
Ratios (contd)
Execute:
Wal-Mart had
an operating margin of 24/408=5.9%
a net profit margin of 14/408=3.4%
and a P/E ratio of 203/14=14.5.
Its enterprise value was 203 + 41 - 8 billion:
a ratio of 236/24=9.8 to operating income
and
236/408=0.58 to sales.
2-83
Example 2.4
Ratios (contd)
Execute (contd):
Target had
an operating margin of 5/65 = 7.7%
a net profit margin of 2/65=3.1%
and a P/E ratio of 41/2=20.5.
Its enterprise value was 41 + 17 2 = $56
billion:
a ratio of 56/5 = 11.2 to operating income
and 56/65 = 0.86 to sales.

2-84
Example 2.4
Ratios (contd)
Evaluate:
Note that despite their large difference in size, Target and
Wal-Marts P/E and enterprise value to operating income
ratios were very similar.
Targets profitability was somewhat higher than Wal-Marts.
This explains the difference in the ratio of enterprise value
to sales.
2-85
Example 2.4a
Ratios
Problem:
Consider the following data from 2010 for Campbell Soup Co.
and H.J. Heinz Co. ($ millions):

Compare Campbells and Heinzs operating margin, net profit
margin, P/E ratio, and the ratio of enterprise value to
operating income and sales.

Campbells Soup Co. (CPB)

H.J. Heinz Co. (HNZ)
Sales 7,676.0 10,495.0
Operating Income 1,615.0 1,582.0
Net Income 830.0 862.7
Market Capitalization 12,206.0 14,809.0
Cash 254.0 483.3
Debt 5,350.0 8,184.4
2-86
Example 2.4a
Ratios (contd)
Solution
Plan:
The table contains all of the raw data, but we need to
compute the ratios using the inputs in the table.
Operating Margin = Operating Income / Sales
Net Profit Margin = Net Income / Sales
P/E ratio = Price / Earnings
Enterprise value to operating income = Enterprise Value
/ Operating Income
Enterprise value to sales = Enterprise Value / Sales
2-87
Example 2.4a: Computing Profitability
and Valuation Ratios (contd)
Ratio Campbells Heinz
Operating Margin 1,615.0/7,676.0=21.0% 1,582.0/10,495.0 = 15.1%
Net Profit Margin 830.0/7,676.0 = 10.8% 862.7/10,495.0 = 8.2%
P/E Ratio 12,206.0/830.0 = 14.71 14,809.0/862.7 = 17.17
Enterprise Value 12,206.0+5,350.0-254.0 =
17,302.0
14,809.0+8,184.4-483.3 =
22,510.10
Enterprise Value to
Operating Income
17,302.0/1,615.0= 10.71 22,510.0/1,582.0 = 14.23
Enterprise Value to
Sales
17,302.0/7,676.0= 2.25 22,510.0/10,495.0 = 2.14
Execute:
2-88
Example 2.4a
Ratios (contd)
Evaluate:
Note that Campbells operating and net profit margins are
quite a bit larger than Heinzs.
Heinz had a larger P/E ratio, which can be explained in part
by Heinzs greater use of leverage as seen in Example 2.3a.
2-89
Table 2.4
Income
Statement
Ratios
2-90
The firms statement of cash flows uses
the information from the income statement
and balance sheet to determine:
how much cash the firm has generated
how that cash has been allocated during a set
period.
Cash is important because it is needed to
pay bills and maintain operations and is
the source of any return of investment for
investors.
2-91
The statement of cash flows is divided into
three sections which roughly correspond to
the three major jobs of the financial
manager:
Operating activities
Investment activities
Financing activities
2-92
Table 2.5
Global
Corporations
Statement of
Cash Flows for
2007 and 2006
2-93
Operating Activity
Use the following guidelines to adjust for
changes in working capital:
Accounts receivable:
When a sale is recorded as part of net income, but
the cash has not yet been received from the
customer, adjust the cash flows by deducting the
increases in accounts receivable.
This increase represents additional lending by the firm
to its customers and it reduces the cash available to
the firm.
2-94
Operating Activity (contd)
Accounts payable:
Similarly, we add increases in accounts payable.
Accounts payable represents borrowing by the firm
from its suppliers.
This borrowing increases the cash available to the
firm.
2-95
Operating Activity (contd)
Inventory:
Finally, we deduct increases to inventory.
Increases to inventory are not recorded as an
expense and do not contribute to net income
However, the cost of increasing inventory is a cash
expense for the firm and must be deducted.
We also add depreciation to net income, since
it is not a cash outflow
2-96
Investment Activity
Subtract the actual capital expenditure that the
firm made.
Also deduct other assets purchased or
investments made by the firm, such as
acquisitions.
2-97
Financing Activity
The last section of the statement of cash flows
shows the cash flows from financing activities.
Dividends paid
Cash received from sale of stock or spent
repurchasing its own stock.
Changes to short-term and long-term borrowing.

2-98
Dividends
Payout Ratio =
Net Income
(Eq. 2.21)
Retained Earnings = Net Income
Dividends
(Eq. 2.20)
Payout Ratio and Retained Earnings
2-99
The last line of the Statement of Cash Flows
combines the cash flows from these three
activities to calculate the overall change in the
firms cash balance over the time period.

2-100
Chapter Quiz
What is the role of an auditor?
What is depreciation designed to capture?
What does a high debt-to-equity ratio tell
you?
What do a firms earnings tell you?
How do you use the price-earnings (P/E)
ratio to gauge the market value of a firm?
Why does a firms net income not
correspond to cash earned?

Lecture 02 Introduction To Financial Statement Analysis

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2.5 Income Statement Analysis

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