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2.1: Firms͛ Disclosure of Financial Information
are accounting reports issued by a firm periodically (usually quarterly and
annually) that present past information and a snapshot of the firm͛s financial position.
together with International Financial Reporting
Standards (issued by the IASB) provide a common set of rules and a standard format for public
companies to use when they prepare their reports.
Corporations are required to hire a neutral third party, known as an auditor, to check the annual
financial statements, to ensure that the annual financial statements are reliable and prepared
according to GAAP.
Four financial statements:
`p he balance sheet
`p he income statement
`p he statement of cash flows
`p Statement of changes in shareholders͛ (or stockholders͛) equity
2.2: he Balance Sheet
he j or
lists the firm͛s assets and liabilities, providing a
snapshot of the firm͛s financial position at a given point in time. he list the cash, inventory,
property, plant, and equipment, and any other investment the company has made; the j
show the firm͛s obligation to creditors.
is the difference between the firm͛s
assets and liabilities and is an accounting measure of the firm͛s net worth. he assets on the left side
show how the firms uses its capital (its investments), and the right side summarizes the sources of
capital, or how a firm raises the money it needs.
The Balance Sheet Equation Assets = Liabilities + Shareholders͛ Equity
Assets:
-p Current assets: are either cash or assets that could be converted into cash within one year
p Cash and other marketable securities
p Accounts receivable
p inventories
p other current assets
-p Long erm Assets:
p Land
p Property
p èachinery
p -eep in mind: depreciation
p Goodwill
p Intangible assets
p -eep in mind: amortization/impairment charge
, is not an actual cash expense that the firm pays; it is a way of recognizing that buildings
and equipment wear out and thus become less valuable the older they get. he j (or
carrying amount) of an asset is equal to its acquisition cost less accumulated depreciation.
If the firm assesses that the value of these intangible assets declined over time, it will reduce the
amount listed on the balance sheet by an ! or that captures the
change in value of the acquired assets
Liabilities:
-p Current liabilities: liabilities that will be satisfied within one year are known as current
liabilities
p Accounts payable
p Short-term debt
p Accrual items such as salary and taxes
-p Long-term liabilities: liabilities that extend beyond one year
p Long term debt
p Capital leases
p Deferred taxes
he difference between the firm͛s assets and liabilities is the shareholders͛ equity; it is also called the
book value of equity. Ideally, the balance sheet would provide us with an accurate assessment of the
true value of a firm͛s equity. Unfortunately, this is unlikely to be the case:
1.p Assets are value based on their historical costs
2.p èany of the firm͛s valuable assets are not captured on the balance sheet
he total market value of a firm͛s equity equals the market price per share times the number of
shares, referred to as the company͛s market capitalization.
2.3: he Balance Sheet Analysis
Liquidation value: the value that would be left if its assets were sold and liabilities paid
Market-to-Book Ratio = Market Value of Equity / Book Value of Equity
Analysts often classify firms with low market-to-book ratios as value stocks (shares), and those with
high market-to-book ratios as growth stocks (shares)
Another important piece of information that we can learn from a firm͛s balance sheet is the firm͛s
leverage (gearing) or the extent to which it relies on debt as source of financing.
Debt-Equity Ratio = Total Debt / Total Equity
he enterprise value of a firm assesses the value of the underlying business assets, unencumbered by
debt and separate from any cash and marketable securities. It can be interpreted as the cost to take
over the business.
Enterprise Value = Market Value of Equity + Debt ʹ Cash
, Current Ratio = Current Assets / Current Liabilities
Quick Ratio or Liquidity Ratio = Current Assets other than inventory / Current Liabilities
2.4: he Income Statement
he income statement of statement of (comprehensive) income lists the firm͛s revenues and
expenses over a period of time. he last line of the income statement shows the firm͛s net income
(or net profit) which is a measure of its profitability during the period. he net income is also referred
to as the firm͛s earnings. he income statement shows the flows of revenues of expenses generated
by assets and liabilities between two dates.
Net Sales
Cost of Sales
Selling, general and administrative expenses
Research and development
Depreciation and amortization
Other income
"
Share of results of associated companies
# $
%&#$ %
Interest income (expense)
&
axes
'
(
Earnings per share Net Income / Shares Outstanding
Diluted earnings per share
p p Earnings Per Share (EPS) = Net Income / Shares Outstanding
Share (stock) options: give the holder the right to buy a certain number of shares by a specific date at
a specific price.
Convertible bonds: a form of debt that can be converted in shares.
Diluted EPS: represents earning per shares for the company calculated as though share options had
been exercised or convertible debt had been converted.
2.5: he Income Statement Analysis
rross Margin = rross Profit / Sales
A firm͛s gross margin reflects its ability to sell a product for more that the cost of producing it.
Operating Margin = Operating Profit / Sales
he operating margin reveals how much a company earns before interest and taxes from each dollar
of sales.
, EBIT Margin = EBIT / Sales
Net Profit Margin = Net Income / Total Sales
he net profit margin shows the fraction of each dollar in revenues that is available to equity holders
after the firm pays its expenses plus interest and taxes.
Accounts Receivable Days = Accounts Receivable / Average Daily Sales
Accounts Payable Days = Accounts Payable / Average Daily Purchase
Inventory Days = Inventory / Average Daily Cost of roods Sold
Financial analysts often compute a firm͛s earnings before interest, taxes and depreciation and
amortization, or EBIDA. EBIDA reflects the cash a firm has ͚͛earned͛͛ from its operations.
Lenders often assess a firm͛s leverage by comparing its income or earnings with its interest expenses
using an interest coverage ratio.
Return on Equity (ROE) = Net Income / Book Value of Equity
he ROE provides a measure of return that firm has earned on its past investments. Another
common measure is return on assets (ROA)
Return on Assets (ROA) = Net Income / Total Assets
DuPont Identity expresses the ROE as the product of profit margin, asset turn over and a measure of
leverage:
ROE = Return on Assets x Equity Multiplier
Return on Assets = Net Profit Margin x Assets Turnover
= (Net Income/Sales) x (Sales/Total Assets)
Equity Multiplier = Total Assets / Total Equity
Thus: ROE = (Net Income / Sales) x (Sales / Total Assets) x (Total Assets / Total Equity)
Net profit margin: measures its overall profitability
Asset turnover: measures how efficiently the firm is utilizing its assets to generate sales
Equity multiplier: indicates the value of assets held per euro or dollar of shareholder equity
Price-Earnings Ratio (P/E) = Market Capitalization / Net income
= Share Price / Earnings per Share
2.1: Firms͛ Disclosure of Financial Information
are accounting reports issued by a firm periodically (usually quarterly and
annually) that present past information and a snapshot of the firm͛s financial position.
together with International Financial Reporting
Standards (issued by the IASB) provide a common set of rules and a standard format for public
companies to use when they prepare their reports.
Corporations are required to hire a neutral third party, known as an auditor, to check the annual
financial statements, to ensure that the annual financial statements are reliable and prepared
according to GAAP.
Four financial statements:
`p he balance sheet
`p he income statement
`p he statement of cash flows
`p Statement of changes in shareholders͛ (or stockholders͛) equity
2.2: he Balance Sheet
he j or
lists the firm͛s assets and liabilities, providing a
snapshot of the firm͛s financial position at a given point in time. he list the cash, inventory,
property, plant, and equipment, and any other investment the company has made; the j
show the firm͛s obligation to creditors.
is the difference between the firm͛s
assets and liabilities and is an accounting measure of the firm͛s net worth. he assets on the left side
show how the firms uses its capital (its investments), and the right side summarizes the sources of
capital, or how a firm raises the money it needs.
The Balance Sheet Equation Assets = Liabilities + Shareholders͛ Equity
Assets:
-p Current assets: are either cash or assets that could be converted into cash within one year
p Cash and other marketable securities
p Accounts receivable
p inventories
p other current assets
-p Long erm Assets:
p Land
p Property
p èachinery
p -eep in mind: depreciation
p Goodwill
p Intangible assets
p -eep in mind: amortization/impairment charge
, is not an actual cash expense that the firm pays; it is a way of recognizing that buildings
and equipment wear out and thus become less valuable the older they get. he j (or
carrying amount) of an asset is equal to its acquisition cost less accumulated depreciation.
If the firm assesses that the value of these intangible assets declined over time, it will reduce the
amount listed on the balance sheet by an ! or that captures the
change in value of the acquired assets
Liabilities:
-p Current liabilities: liabilities that will be satisfied within one year are known as current
liabilities
p Accounts payable
p Short-term debt
p Accrual items such as salary and taxes
-p Long-term liabilities: liabilities that extend beyond one year
p Long term debt
p Capital leases
p Deferred taxes
he difference between the firm͛s assets and liabilities is the shareholders͛ equity; it is also called the
book value of equity. Ideally, the balance sheet would provide us with an accurate assessment of the
true value of a firm͛s equity. Unfortunately, this is unlikely to be the case:
1.p Assets are value based on their historical costs
2.p èany of the firm͛s valuable assets are not captured on the balance sheet
he total market value of a firm͛s equity equals the market price per share times the number of
shares, referred to as the company͛s market capitalization.
2.3: he Balance Sheet Analysis
Liquidation value: the value that would be left if its assets were sold and liabilities paid
Market-to-Book Ratio = Market Value of Equity / Book Value of Equity
Analysts often classify firms with low market-to-book ratios as value stocks (shares), and those with
high market-to-book ratios as growth stocks (shares)
Another important piece of information that we can learn from a firm͛s balance sheet is the firm͛s
leverage (gearing) or the extent to which it relies on debt as source of financing.
Debt-Equity Ratio = Total Debt / Total Equity
he enterprise value of a firm assesses the value of the underlying business assets, unencumbered by
debt and separate from any cash and marketable securities. It can be interpreted as the cost to take
over the business.
Enterprise Value = Market Value of Equity + Debt ʹ Cash
, Current Ratio = Current Assets / Current Liabilities
Quick Ratio or Liquidity Ratio = Current Assets other than inventory / Current Liabilities
2.4: he Income Statement
he income statement of statement of (comprehensive) income lists the firm͛s revenues and
expenses over a period of time. he last line of the income statement shows the firm͛s net income
(or net profit) which is a measure of its profitability during the period. he net income is also referred
to as the firm͛s earnings. he income statement shows the flows of revenues of expenses generated
by assets and liabilities between two dates.
Net Sales
Cost of Sales
Selling, general and administrative expenses
Research and development
Depreciation and amortization
Other income
"
Share of results of associated companies
# $
%&#$ %
Interest income (expense)
&
axes
'
(
Earnings per share Net Income / Shares Outstanding
Diluted earnings per share
p p Earnings Per Share (EPS) = Net Income / Shares Outstanding
Share (stock) options: give the holder the right to buy a certain number of shares by a specific date at
a specific price.
Convertible bonds: a form of debt that can be converted in shares.
Diluted EPS: represents earning per shares for the company calculated as though share options had
been exercised or convertible debt had been converted.
2.5: he Income Statement Analysis
rross Margin = rross Profit / Sales
A firm͛s gross margin reflects its ability to sell a product for more that the cost of producing it.
Operating Margin = Operating Profit / Sales
he operating margin reveals how much a company earns before interest and taxes from each dollar
of sales.
, EBIT Margin = EBIT / Sales
Net Profit Margin = Net Income / Total Sales
he net profit margin shows the fraction of each dollar in revenues that is available to equity holders
after the firm pays its expenses plus interest and taxes.
Accounts Receivable Days = Accounts Receivable / Average Daily Sales
Accounts Payable Days = Accounts Payable / Average Daily Purchase
Inventory Days = Inventory / Average Daily Cost of roods Sold
Financial analysts often compute a firm͛s earnings before interest, taxes and depreciation and
amortization, or EBIDA. EBIDA reflects the cash a firm has ͚͛earned͛͛ from its operations.
Lenders often assess a firm͛s leverage by comparing its income or earnings with its interest expenses
using an interest coverage ratio.
Return on Equity (ROE) = Net Income / Book Value of Equity
he ROE provides a measure of return that firm has earned on its past investments. Another
common measure is return on assets (ROA)
Return on Assets (ROA) = Net Income / Total Assets
DuPont Identity expresses the ROE as the product of profit margin, asset turn over and a measure of
leverage:
ROE = Return on Assets x Equity Multiplier
Return on Assets = Net Profit Margin x Assets Turnover
= (Net Income/Sales) x (Sales/Total Assets)
Equity Multiplier = Total Assets / Total Equity
Thus: ROE = (Net Income / Sales) x (Sales / Total Assets) x (Total Assets / Total Equity)
Net profit margin: measures its overall profitability
Asset turnover: measures how efficiently the firm is utilizing its assets to generate sales
Equity multiplier: indicates the value of assets held per euro or dollar of shareholder equity
Price-Earnings Ratio (P/E) = Market Capitalization / Net income
= Share Price / Earnings per Share
