CHAPTER 3

Financial Statements
Analysis
FIN 6301: Financial Management
Instructor: Dr. Hiro Nishi

The University of Texas at Dallas

Naveen Jindal School of Management

LEARNING OBJECTIVES

Company A Company B
Net income: $10 million Net income: $10 billion

A common way to analyze the financial

statements is computing a ratio (= a
relationship between two numbers).
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LEARNING OBJECTIVES

1. Be familiar with some of the

commonly used financial ratios.

2. Understand what benchmarking

means.
• A ratio by itself may not mean
anything much!

TYPES OF FINANCIAL RATIOS

1. Liquidity ratios: How liquid is the firm?

2. Asset management ratios: How efficiently

does a firm use its current assets?

3. Financial leverage ratios: How is the firm

financing its assets?

4. Profitability ratios: Is the firm providing a good

return on the capital?

5. Market-value ratios: Is the firm creating

shareholder value?
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1. LIQUIDITY RATIOS

Liquidity measures the firm’s ability to pay its

bills on time.

Recall from Chapter 2

A “liquid” asset is one that can be converted
into cash quickly and routinely at the current
market price.

1. LIQUIDITY RATIOS
Nishi Sushi, Inc. Balance Sheets ($ in millions)
Cash 98 Accounts payable 344
Accounts receivables 188 Notes payable 196
Inventory 422 Total 540
Total $708
Long-term debt 457
Common stock 550
Net fixed assets 2,880 Retained earnings 2,041
Total assets $3,588 Total liabilities & equity $3,588

Total current assets 708

Current Ratio = = = 1.31 times
Total current liabilities 540

Cash + Acount receivables (98 + 188)

Quick Ratio = = = 0.53
Total current liabilities 540

Cash = 98/540 = 0.18

Cash Ratio =
Total current liabilities 5
 2. ASSET MANAGEMENT
Nishi Sushi, Inc. Balance Sheets ($ in millions) Nishi Sushi, Inc. Income
Statement ($ in millions)
Cash 98 Accounts payable 344
Net sales 2,311
Accounts receivables 188 Notes payable 196
Cost of goods sold 1,344
Inventory 422 Total 540
Depreciation 276
Total $708
EBIT $ 691
Long-term debt 457
Interest paid 141
Common stock 550
Taxable Income 550
Net fixed assets 2,880 Retained earnings 2,041
Taxes (34%) 187
Total assets $3,588 Total liabilities & equity $3,588
Net income $ 363

Sales Dividends
2,311 121
Receivables Turnover = =
Addition = 12.3 times 242
to RE
Account Receivables 188
• How many times does a firm collect account receivables per year?

365 days 365

Days’ Sales in Receivables = = = 30 days
Receivables Turnover 12.3
• How many days, on average, does it take a firm to collect account
receivables? 6

2. ASSET MANAGEMENT
Nishi Sushi, Inc. Balance Sheets ($ in millions) Nishi Sushi, Inc. Income
Statement ($ in millions)
Cash 98 Accounts payable 344
Net sales 2,311
Accounts receivables 188 Notes payable 196
Cost of goods sold 1,344
Inventory 422 Total 540
Depreciation 276
Total $708
EBIT $ 691
Long-term debt 457
Interest paid 141
Common stock 550
Taxable Income 550
Net fixed assets 2,880 Retained earnings 2,041
Taxes (34%) 187
Total assets $3,588 Total liabilities & equity $3,588
Net income $ 363

COGD 1,344 Dividends 121

Payable Turnover = = = 3.91 times
Account Payables 344 Addition to RE 242

• How many times does a firm pay its account payables per year?

365 days 365

Days’ Payable Outstanding = = = 93.4 days
Payables Turnover 3.91

• How many days, on average, does it take a firm to pay its account
payables?
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 2. ASSET MANAGEMENT
Nishi Sushi, Inc. Balance Sheets ($ in millions) Nishi Sushi, Inc. Income
Statement ($ in millions)
Cash 98 Accounts payable 344
Net sales 2,311
Accounts receivables 188 Notes payable 196
Cost of goods sold 1,344
Inventory 422 Total 540
Depreciation 276
Total $708
EBIT $ 691
Long-term debt 457
Interest paid 141
Common stock 550
Taxable Income 550
Net fixed assets 2,880 Retained earnings 2,041
Taxes (34%) 187
Total assets $3,588 Total liabilities & equity $3,588
Net income $ 363

Cost of goods sold 1,344Dividends 121

Inventory Turnover = =
Inventory 422 Addition to RE 242

= 3.2 times
• How many times are a firm’s inventories sold per year?

365 days 365

Days’ Sales in Inventory = = = 114 days
Inventory Turnover 3.2
• How many days, on average, does it take a firm to sell its inventories?
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3. FINANCIAL LEVERAGE
Nishi Sushi, Inc. Balance Sheets ($ in millions)
Cash 98 Accounts payable 344
Accounts receivables 188 Notes payable 196
Inventory 422 Total 540
Total $708
Long-term debt 457
Common stock 550
Net fixed assets 2,880 Retained earnings 2,041
Total assets $3,588 Total liabilities & equity $3,588

Total liabilities (540 + 457)

Debt/Value (D/V, debt ratio) = = = 0.28
Total assets 3,588

Total liabilities (540 + 457)

Debt/Equity (D/E) = = = 0.38
Equity 2,591
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 4. PROFITABILITY
Nishi Sushi, Inc. Income
Statement ($ in millions)
Net sales 2,311
Cost of goods sold 1,344
Depreciation 276
EBIT $ 691
Interest paid 141
Taxable Income 550
Taxes (34%) 187
Net income $ 363

NI 363
Profit Margin (PM) = = = 15.70%
Sales 2,311

• PM examines how effectively a firm is managing its expenses.

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4. PROFITABILITY
Nishi Sushi, Inc. Balance Sheets ($ in millions) Nishi Sushi, Inc. Income
Statement ($ in millions)
Cash 98 Accounts payable 344
Net sales 2,311
Accounts receivables 188 Notes payable 196
Cost of goods sold 1,344
Inventory 422 Total 540
Depreciation 276
Total $708
EBIT $ 691
Long-term debt 457
Interest paid 141
Common stock 550
Taxable Income 550
Net fixed assets 2,880 Retained earnings 2,041
Taxes (34%) 187
Total assets $3,588 Total liabilities & equity $3,588
Net income $ 363

NI 363
Dividends 121
Return on Assets (ROA) = = = 10.12%
Addition to RE 242
Total assets 3,588
• This ratio indicates how well a firm’s assets are being utilized to
generate profits.

NI 363
Return on Equity (ROE) = = = 14.01%
Total equity 2,591
• Is a higher ROE always better?
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 5. MARKET VALUE

How are investors assessing the firm’s

future prospects?
• What is the current stock price?

Let’s suppose:
• Current market price = $88/share
• # of shares outstanding = 33 million

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5. MARKET VALUE
Nishi Sushi, Inc. Balance Sheets ($ in millions) Nishi Sushi, Inc. Income
Statement ($ in millions)
Cash 98 Accounts payable 344
Net sales 2,311
Accounts receivables 188 Notes payable 196
Cost of goods sold 1,344
Inventory 422 Total 540
Depreciation 276
Total $708
EBIT $ 691
Long-term debt 457
Interest paid 141
Common stock 550
Taxable Income 550
Net fixed assets 2,880 Retained earnings 2,041
Taxes (34%) 187
Total assets $3,588 Total liabilities & equity $3,588
Net income $ 363

NI $363 million
Earnings per Share (EPS) = = = $11
# of shares 33 million

Current market price 88

Price/Earnings (P/E) Ratio= = = $8.0
Earnings per share 11

• P/E ratio indicates how much investors are willing to pay for
$1 of reported earnings 13
IN-CLASS EXERCISE #1
Calculate the price-earnings (P/E) ratio as of December
2019. Note that 400 million shares were outstanding as of
December 2019. The market stock price was $20.20/share.

2018 2019 2018 2019

Cash 350 370 Accounts payable 750 850
Accounts receivables 650 680 Long-term debt 5,150 5,800
Inventory 2,500 2,800 Common stock 3,500 3,600
Total 3,500 3,850 Retained earnings 600 800
Net fixed assets 6,500 7,200
Total assets $10,000 $11,050 Total liabilities & equity $10,000 $11,050

Net sales 6,500

Cost of goods sold 4,000
Depreciation 700
EBIT 1,800
Interest paid 300
Taxable Income 1,500
Taxes (21%) 315
Net income 1,185 14

5. MARKET VALUE
Nishi Sushi, Inc. Balance Sheets ($ in millions)
Cash 98 Accounts payable 344
Accounts receivables 188 Notes payable 196
Inventory 422 Total 540
Total $708
Long-term debt 457
Common stock 550
Net fixed assets 2,880 Retained earnings 2,041
Total assets $3,588 Total liabilities & equity $3,588

Equity book value / share = 2,591/33 = $78.52

Recall Ch. 2
Current market price
Market-to-Book (M/B) Ratio =
Equity book value per share

$88
= = 1.12
$78.52 15
5. MARKET VALUE

Market-to-book ratio that is greater than 1

indicates that the stock has gained value since
it was issued.
• In other words, the firm’s value has increased.
• Compare the M/B ratios (called the Price/Book
ratio in Yahoo! Finance) of the following firms:

Ford Motor Microsoft Corp Tesla, Inc.

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IN-CLASS EXERCISE #2
Calculate the market-to-book (M/B) as of December 2019.
Note that 400 million shares were outstanding as of December
2019. The market stock price was $20.20/share.
2018 2019 2018 2019
Cash 350 370 Accounts payable 750 850
Accounts receivables 650 680 Long-term debt 5,150 5,800
Inventory 2,500 2,800 Common stock 3,500 3,600
Total 3,500 3,850 Retained earnings 600 800
Net fixed assets 6,500 7,200
Total assets $10,000 $11,050 Total liabilities & equity $10,000 $11,050

Net sales 6,500

Cost of goods sold 4,000
Depreciation 700
EBIT 1,800
Interest paid 300
Taxable Income 1,500
Taxes (21%) 315
Net income 1,185 17
BENCHMARKING
A ratio by itself may have no meaning. Ratios
need to be compared to something.

A. Time-Trend Analysis
- How is the firm’s performance changing
through time?
- Compare ratios to those from previous
years

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BENCHMARKING
B. Peer-Group Analysis
- How is the firm performing compared to
other firms?
- Compare to similar companies or firms
within the same industries
- Standard Industrial Classification (SIC)

6: Finance, insurance & real estate

60: Depository institutions

6021: National commercial banks

See the SIC code by sector

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