Applied Finance
Summary
Calculations and brief explanations
,Contents
Financial Statements............................................................................................. 3
Income Statement Layout.................................................................................. 4
Balance Sheet Layout......................................................................................... 5
Cash Flow Statement.......................................................................................... 5
Using Financial Ratios............................................................................................ 6
Liquidity Ratios: Current Ratio............................................................................6
Liquidity Ratios: Quick Ratio............................................................................... 7
Liquidity Ratios: Accounts Receivable.................................................................7
Average Collection Period................................................................................... 7
Liquidity Ratios: Accounts Receivable Turnover Ratio.........................................7
Accounts Receivable Turnover............................................................................7
Liquidity Ratios: Inventory Turnover Ratio..........................................................8
Capital Structure Ratios......................................................................................... 8
Debt ratio........................................................................................................... 8
Times Interest Earned Ratio................................................................................9
Asset Management Efficiency Ratios.....................................................................9
Total Asset Turnover Ratio.................................................................................. 9
Fixed asset turnover ratio................................................................................. 10
Profitability Ratios................................................................................................ 10
Gross profit margin........................................................................................... 10
Operating Profit Margin..................................................................................... 11
Net Profit Margin............................................................................................... 11
Operating Return on Assets ratio......................................................................11
Decomposing the OROA ratio:..........................................................................12
Return on Equity............................................................................................... 12
Market Value Ratios.......................................................................................... 12
Price-Earnings (PE) Ratio..................................................................................13
Market-to-Book Ratio........................................................................................ 13
Types of Capital Investment Projects...................................................................14
Net Present Value............................................................................................. 14
Independent Versus Mutually Exclusive Investment Projects...........................14
Choosing Between Mutually Exclusive Investments......................................14
Profitability Index.............................................................................................. 15
1 | Page
, Payback Period................................................................................................. 15
The Cost of Capital: An Overview (WACC)............................................................16
Operating and Cash Conversion Cycles...............................................................17
Calculating the Operating and Cash Conversion Cycle.....................................18
2 | Page
,Financial Statements
Following four types of financial statements are mandated by the accounting and
financial regulatory authorities:
1. Income Statement:
An income statement provides the following information for a specific period of
time (for example, a year or 6 months or 3 months):
• Revenue,
• Expenses, and
• Profit.
2. Balance sheet:
Balance sheet provides a snap shot of the following on a specific date (for
example, as of December 31, 2010)
Assets (value of what the firm owns),
Liabilities (value of firm’s debts), and
Shareholder’s equity (the money invested by the company
owners).
3. . Cash flow statement:
It reports cash received and cash spent by the firm over a period of time (for
example, over the last 6 months).
4. Statement of shareholder’s equity:
It provides a detailed account of the firm’s activities in the following accounts
over a period of time (for example, last six months):
Common stock account,
Preferred stock account,
Retained earnings account, and
Changes to owner’s equity.
3 | Page
,Income Statement Layout
• Sales
– Minus Cost of Goods Sold
• = Gross Profit
• Minus Operating Expenses
– Selling expenses
– General and Administrative expenses
– Depreciation and Amortization Expense
• = Operating income (EBIT)
• Minus Interest Expense
• = Earnings before taxes (EBT)
• Minus Income taxes
• = Net income (EAT)
– EBIT = Earnings before interest and taxes; EBT = Earnings before
taxes; EAT = Earnings after taxes
• Earnings per share (EPS) = Net income÷ Number of shares outstanding
• Dividends per share = Net income ÷ Number of shares
What can the firm do with the net income?:
• Pay dividends to shareholders, and/or
• Reinvest in the firm
How much was retained or reinvested by the firm?
• Amount retained = Net Income – Dividends
4 | Page
, Balance Sheet Layout
Cash Flow Statement
• The format for a traditional cash flow statement is as follows:
Beginning Cash Balance
Plus: Cash Flow from Operating Activities
Plus: Cash Flow from Investing Activities
Plus: Cash Flow from Financing Activities
Equals: Ending Cash Balance
• Operating activities represent the company’s core business including sales
and expenses. Basically any activity that affects net income for the period.
• Investing activities include the cash flows that arise out of the purchase
and sale of long-term assets such as plant and equipment.
• Financing activities represent changes in the firm’s use of debt and equity
such as issue of new shares, payment of dividends
5 | Page
Summary
Calculations and brief explanations
,Contents
Financial Statements............................................................................................. 3
Income Statement Layout.................................................................................. 4
Balance Sheet Layout......................................................................................... 5
Cash Flow Statement.......................................................................................... 5
Using Financial Ratios............................................................................................ 6
Liquidity Ratios: Current Ratio............................................................................6
Liquidity Ratios: Quick Ratio............................................................................... 7
Liquidity Ratios: Accounts Receivable.................................................................7
Average Collection Period................................................................................... 7
Liquidity Ratios: Accounts Receivable Turnover Ratio.........................................7
Accounts Receivable Turnover............................................................................7
Liquidity Ratios: Inventory Turnover Ratio..........................................................8
Capital Structure Ratios......................................................................................... 8
Debt ratio........................................................................................................... 8
Times Interest Earned Ratio................................................................................9
Asset Management Efficiency Ratios.....................................................................9
Total Asset Turnover Ratio.................................................................................. 9
Fixed asset turnover ratio................................................................................. 10
Profitability Ratios................................................................................................ 10
Gross profit margin........................................................................................... 10
Operating Profit Margin..................................................................................... 11
Net Profit Margin............................................................................................... 11
Operating Return on Assets ratio......................................................................11
Decomposing the OROA ratio:..........................................................................12
Return on Equity............................................................................................... 12
Market Value Ratios.......................................................................................... 12
Price-Earnings (PE) Ratio..................................................................................13
Market-to-Book Ratio........................................................................................ 13
Types of Capital Investment Projects...................................................................14
Net Present Value............................................................................................. 14
Independent Versus Mutually Exclusive Investment Projects...........................14
Choosing Between Mutually Exclusive Investments......................................14
Profitability Index.............................................................................................. 15
1 | Page
, Payback Period................................................................................................. 15
The Cost of Capital: An Overview (WACC)............................................................16
Operating and Cash Conversion Cycles...............................................................17
Calculating the Operating and Cash Conversion Cycle.....................................18
2 | Page
,Financial Statements
Following four types of financial statements are mandated by the accounting and
financial regulatory authorities:
1. Income Statement:
An income statement provides the following information for a specific period of
time (for example, a year or 6 months or 3 months):
• Revenue,
• Expenses, and
• Profit.
2. Balance sheet:
Balance sheet provides a snap shot of the following on a specific date (for
example, as of December 31, 2010)
Assets (value of what the firm owns),
Liabilities (value of firm’s debts), and
Shareholder’s equity (the money invested by the company
owners).
3. . Cash flow statement:
It reports cash received and cash spent by the firm over a period of time (for
example, over the last 6 months).
4. Statement of shareholder’s equity:
It provides a detailed account of the firm’s activities in the following accounts
over a period of time (for example, last six months):
Common stock account,
Preferred stock account,
Retained earnings account, and
Changes to owner’s equity.
3 | Page
,Income Statement Layout
• Sales
– Minus Cost of Goods Sold
• = Gross Profit
• Minus Operating Expenses
– Selling expenses
– General and Administrative expenses
– Depreciation and Amortization Expense
• = Operating income (EBIT)
• Minus Interest Expense
• = Earnings before taxes (EBT)
• Minus Income taxes
• = Net income (EAT)
– EBIT = Earnings before interest and taxes; EBT = Earnings before
taxes; EAT = Earnings after taxes
• Earnings per share (EPS) = Net income÷ Number of shares outstanding
• Dividends per share = Net income ÷ Number of shares
What can the firm do with the net income?:
• Pay dividends to shareholders, and/or
• Reinvest in the firm
How much was retained or reinvested by the firm?
• Amount retained = Net Income – Dividends
4 | Page
, Balance Sheet Layout
Cash Flow Statement
• The format for a traditional cash flow statement is as follows:
Beginning Cash Balance
Plus: Cash Flow from Operating Activities
Plus: Cash Flow from Investing Activities
Plus: Cash Flow from Financing Activities
Equals: Ending Cash Balance
• Operating activities represent the company’s core business including sales
and expenses. Basically any activity that affects net income for the period.
• Investing activities include the cash flows that arise out of the purchase
and sale of long-term assets such as plant and equipment.
• Financing activities represent changes in the firm’s use of debt and equity
such as issue of new shares, payment of dividends
5 | Page
