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Chapter 2:Financial Statement and

Cash Flow Analysis

Corporate Finance, 3eGraham, Smart, and Megginson

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Financial Statements Company managers, investors, and outside

analysts use financial statements to conduct… Cash flow analysis Performance (ratio) analysis

The SEC requires U.S. companies to produce financial statements conforming to Generally Accepted Accounting Principles (GAAP), developed by the Financial Accounting Standards Board (FASB).

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Four Key Financial Statements

1. Balance sheet

2. Income statement

3. Statement of retained earnings

4. Statement of cash flows

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Key Measures of Cash Flow

Net operating profit after taxes (NOPAT)

= EBIT (1 – T)

Operating cash flow

(OCF)= NOPAT + Depreciation = EBIT (1 – T) + Depreciation

Free cash flow (FCF) = OCF – FA – (CA – AP – Accruals)

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Table 2.4 The Inflows and Outflows of Corporate Cash

Decrease in any asset Increase in any liability Net profits after taxes Depreciation and other

non-cash charges Sale of stock

Increase in any asset Decrease in any

liability Net loss Dividends paid Repurchase or

retirement of stock

Inflows Outflows

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Liquidity Ratios

Current ratio =

Current assetsCurrent

liabilities

Quick ratio

= Current assets

InventoryCurrent liabilities

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Activity Ratios

Inventory turnover =

Cost of goods sold

InventoryAverage collection

period=

Accounts receivable

Average daily salesAverage

payment period

= Accounts payable

Average daily purchases

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Activity Ratios

Fixed asset turnover =

SalesNet fixed

assetsTotal asset

turnover = SalesTotal

assets

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Debt Ratios

Debt ratio =Total

liabilitiesTotal assets

Equity multiplier =

Total assetsCommon stock

equityDebt-to-equity

ratio = Long-term debtStockholders’

equity

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Debt Ratios

Times interest earned

= EBIT

Interest expense

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Profitability Ratios

Gross profit margin =

Gross profitSales

Operating profit

margin=

Operating profitSales

Net profit margin =

Earnings available for common shareholders

Sales

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Profitability Ratios

Earnings per share (EPS) =

Earnings available for common stockholders

Number of common shares outstanding

Return on total assets

(ROA)=

Earnings available for common stockholdersTotal assets

Return on common

equity (ROE)=

Earnings available for common stockholders

Common stock equity

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DuPont System of Analysis

ROA = Net profit margin

Total asset turnover

ROE = ROA A/E

ROE = Net profit margin

Total asset turnover

A/E

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Market Ratios

Price/earnings (P/E) ratio =

Market price per share of common stock

Earnings per share (EPS)

Book value per share =

Common stock equityNumber of common shares

outstanding

Market/book (M/B) ratio =

Market price per share of common stock

Book value per share of common stock