Financial Statement PDF

FINANCIAL STATEMENT ANNUAL REPORT The annual report is a financial document to report on company's activities throughout the past year Annual reports are intended to give shareholders and other interested people (suppliers, banks) information about the company's activities and financial perform...

FINANCIAL STATEMENT ANNUAL REPORT The annual report is a financial document to report on company's activities throughout the past year Annual reports are intended to give shareholders and other interested people (suppliers, banks) information about the company's activities and financial performance Most jurisdictions require companies to prepare and disclose annual reports, and many require the annual report to be filed at the company's registry The minimum content of the financial report depends on the legal status of the company and it’s disciplined by the regulations in place where the legal entity is located The voluntary disclosure of financial information in listed companies mainly is determined by financial communication choices or tactics For listed companies the annual report includes specification of: The EXTERNAL USERS of financial information include: Lenders (of Money) Suppliers (of Goods) Shareholders Government Agencies Security Exchange Commission – SEC Customers Employees (potential and current) The INTERNAL USERS of financial information include: Board of Directors Managers - Purchasing Department - Finance Department - Production Department - Shipping & Receiving Department - Marketing Department - Human Resources Department Investor Relations (IR) is a strategic management responsibility that is capable of integrating finance, communication, marketing and securities law compliance to enable the most effective two-way communication between a company, the financial community, and other constituencies, which ultimately contributes to a company's securities achieving fair valuation. The investor relator is the officer in charge of investor relations. The annual report content is set by local regulatory bodies à The annual report content is different from country to country. Financial Statements are prepared according to General Accepted Accounting Principles – GAAPs à GAAPs are different from country to country. International Accounting Standards (IAS now International Financial Reporting Standards (IFRS) exist in the attempt to harmonize the rules About the IASB The International Accounting Standards Board (IASB) is an independent, private-sector body that develops and approves International Financial Reporting Standards (IFRSs). The IASB operates under the oversight of the IFRS Foundation. The IASB was formed in 2001 to replace the International Accounting Standards Committee. Currently, the IASB has 14 members. The security exchange commissions and other regulators in each jurisdiction set the level of details that the annual report of listed companies need to include. THE AUDITORS The auditors are individuals who inspect and verify the accuracy of a company's financial records. Public companies are required to use a public accounting firm for the conduct of an audit of their financial statements. At the end of the auditing process the auditing firm (or the independent auditor) issues an auditing report an opinion on the quality of financial measurement. The Management too takes responsibility for preparation of financial statements: The CFO (Chief Financial Officer) is the senior-most executive responsible for financial control and planning of a firm. He or she is in charge of all accounting functions including: (1) credit control (2) preparing budgets and financial statements (3) coordinating financing and fund raising (4) monitoring expenditure and liquidity (5) managing investment and taxation issues (6) reporting financial performance to the board (7) providing timely financial data to the CEO. Also called chief finance officer, comptroller, controller, or finance controller. THE THREE FUNDAMENTAL FINANCIAL STATEMENTS THE BALANCE SHEET Before investing in any company, an investor can use the balance sheet to examine the following: Can the firm meet its financial obligations? How much money has already been invested in this company? Is the company overly indebted? What kind of assets has the company purchased with its financing? Elements of the balance sheet: Assets - economic resources of the firm that can be turned into cash Liabilities - economic obligations of the firm which will use cash Owners’ Equity - the residual interest in, or remaining claims against, the firm’s assets after deducting liabilities (rights of the owners). Generally it reflects the amount of capital the owners invested plus any profit that the company generates that is subsequently reinvested in the company BALANCE SHEET EQUATION à EQUITY = ASSETS – LIABILITIES EXAMPLES OF ASSETS EXAMPLES OF LIABILITIES Cash and Cash Equivalents Accounts Payable Accounts Receivable Loans Inventories Dividends Payable Land Unearned revenues (obligation to do something) Buildings Wages payable Intangibles Warranties Goodwill (purchased) ASSETS = LIABILITIES + EQUITY USES OF FUNDS = SOURCE OF FUNDS The balance sheet presentation CURRENT/NON CURRENT THE INCOME STATEMENT Before investing in any company, an investor can use the Income Statement to examine the following: How much are sales? What kind of expenses the company pays? How is interesting the economic result compared with competitors? Is the operating income positive? ELEMENTS OF THE INCOME STATEMENT Revenues: gross increases in Equity Expenses: gross decreases in Equity Net Income = Revenues – Expenses or net increase or decrease in the Equity If Net Income > 0 à Profit If Net Income < 0 à Loss EXAMPLES OF REVENUES EXAMPLES OF EXPENSES Sales Wages and salaries Rent Revenues Raw material consumption Interest Revenues Rent expenses Gains on Sales of Equipment Depreciation expenses Tax expenses Interest expenses The income statement presentation CONSOLIDATED INCOME STATEMENT HOW DOES THE INCOME STATEMENT CONNECT TO THE BALANCE SHEET STATEMENT OF RETAINED EARNINGS The Statement of Retained Earnings lists the beginning balance in Retained Earnings, followed by a description of any major changes that occurred during the period (usually net income and dividends), and the ending balance  BE AWARE: DIVIDENDS ARE NOT EXPENSES THE CASHFLOW STATEMENT Before investing in any company, an investor can use the Cash Flow Statement to examine the following: Is that company able to pay interest, debts, dividends? Is this company able to generate cash for financing new investments? How Management have used the cash generated by the company? CASH INFLOWS: correspond to cash receipts (+) // CASH OUTFLOWS: correspond to cash payments (-) Cash inflows and outflows are clustered according to the type of activity which generated them: Cash Flow from Operations (Normal/Core business): cash inflows and outflows concerned with ordinary activity of the organization + Cash Flow from Investing: cash inflows and outflows concerned with transactions to acquire or to dispose of long-lived assets + Cash Flow from Financing: cash inflows and outflows concerned with transactions to get cash or to repay debts = Net Cash Flow: sum of previous three Examples of Cash Flow from Operations à Nature (raw mat/wages ecc) and Function (logistic/mgmt) -Variable/Fixed costs Collections from customers (+) Cash payments to suppliers (-) Cash payments to employees (-) Tax payments (-) Examples of Cash Flow from Investing Payments on purchases of property, plant and equipment (-) or any longterm assets Collections from sales of property, plant and equipment (+) or any long-term assets Examples of Cash Flow from Financing  Borrowings of cash from creditors (+) Issuance of debt securities (+) Issuance of equity (+) Repayments of loans (-) Payments of dividends (-) Accounting for transactions and preparation of financial statements - How daily routine of business impacts on the three fundamental statements: a framework of analysis - Analyze the changes in equity, earnings and cash flows when conducting business - Preparation of the three fundamentals financial statements from transaction data HOW THE DAILY ROUTINE OF BUSINESS IMPACTS ON THE THREE FUNDAMENTAL STATEMENTS: A FRAMEWORK OF ANALYSIS - The three fundamental statements are the results of an accounting process that entails activity performed to analyze, to record, to quantify, to accumulate, to summarize, to classify, to report, to prepare the financial statements, and to interpret economic events and their effects on the organization financial performance - Entity: is the unity of measurement - Event: any occurrence having an impact on the financial performance of the entity - Transaction: is an event that affects the financial position of an entity and that can reliably be recorded in money terms The first step in the accounting process entails to analyze and to record the economic events and their effects on the organization financial performance To do that the balance sheet equation provides an extremely useful general framework  !"# %!&'(" EPS (BASIC) = ')#*#+!,%!- *.+/"* !"# %!&'(" EPS (DILUTED) = ')#*#+!,%!- *.+/"*01'#"!#%+2 *.+/"* POTENTIAL SOURCES OF DILUTION - Convertible bonds: at the end of the life of the bond you can decide to change your position from bond holder to shareholder - Stock option: the company offers the CEO the possibility to buy shares for a given price instead of receiving a salary KEY MONEY This intangible asset consists of amounts paid by the Group to assume leases for commercial property in prestigious locations. The amounts also include the initial direct costs incurred for the negotiation and stipulation of lease agreements. Such costs are capitalized by virtue of expected incremental revenues deriving from the possibility of operating in prestigious locations. Key money is amortized over the scheduled lease term (for retail channel stores) or over the scheduled term of the affiliation agreement (for wholesale monobrand channel stores) HISTORICAL COLLECTION For each of its collections the Company keeps one example of every article considered important and sellable. The design department uses these products as a source of inspiration when creating new collections. These assets are classified as PPE, recognized at historical cost of production and are not depreciated because they have an indefinite useful life. The value increases of such assets are recognized in profit or loss as own work CAPITALIZED. CAPITALIZATION PPE INVENTORY If cost > selling price à IMPAIRED à report at lower of cost or net realizable value It’s a loss so it affects the PNL We don’t record inventory at price but at cost à COST OF MANUFACTURING (MANUFACTURERS) or COST OF ACQUISITION (RETAILERS). PHYSICAL FLOW and ACCOUNTING FLOW usually have to match à you don’t sell the most recent one first, old and new are sold together. FIFO/LIFO/WA à The weighted average is the most frequently used FIFO allows to discard the units produced in the earlier stages LIFO is not allowed by the IFRS because u value the inventory at an historical cost TRADE RECEIVABLES They represent amounts due for the supply of goods and services and are collectible in the short term, which means that their carrying amount is effectively their fair value at the date of preparation of these financial statements. The amount by which receivables in the financial statements have been written down is a reasonable estimate of the impairment arising from the specific non collectability risk identified in these receivables. ALLOWANCE FOR BAD AND DOUBTFUL DEBTS An allowance for bad debt is a valuation account used to estimate the amount of a firm's receivables that may ultimately be uncollectible. It is also known as an allowance for doubtful accounts. ALLOCATION à adding value to the allowance when its not enough Non-performing loans (NPLs) are exposures to debtors who are no longer able to meet all or part of their contractual obligations because their economic and financial circumstances have deteriorated. CONSOLIDATION When an investor has control over an investee company (over 50% ownership), it must prepare consolidated financial statements. INVESTOR = PARENT à INVESTEE = SUBSIDIARY Although both companies remain separate legal entities, the financial position and earnings reports of the parent are combined with those of the subsidiary CONSOLIDATION AND GOODWILL A parent company who wants to expand geographically will have to set up a new enthity In the new geographical location. Goodwill is an intangible asset that is associated with the purchase of one company by another. When an investor has control over an investee company (over 50% ownership), it must prepare consolidated financial statements CONSOLIDATION happens because we have intercorporate investment such as an acquisition, so for example when a parent company purchases a subsidiary. Although both companies remain separate legal entities, the financial position and earnings reports of the parent are combined with those of the subsidiary ACQUISITION Assume two separate companies: àCompany A: Assets of $650 million àCompany B: Assets of $400 million A purchases all of the outstanding stock of B for $213 million in cash, giving cash to the shareholders of B (the owner). The journal entry on the books of A (in millions) will report an increase in Investment in B and a decrease in Cash for the same amount of 213. The shareholders of B are liquidated so we only have the shareholders of A owning B, so we have to consolidate the report. The balance sheets of each company appear as follows before and after the purchase: 87= 300-213 CONSOLIDATED FINANCIAL STATEMENT In combining the amounts on the balance sheet, A must eliminate its investment account and the stockholders’ equity of B, which eliminates double-counting of the investment in B After the acquisition A continues to use the equity method during the period. To prepare consolidated statements, P must eliminate: à Its investment account and the Shareholder’s Equity of the subsidiary on the consolidated balance sheet à Intercompany revenues and expenses on the income statement à Other intercompany transactions MINORITY INTEREST A parent company may own less than 100% of the outstanding stock (51% - 99%). Claims by non-majority stockholders on assets and earnings in the consolidated statements are called minority interests. Minority interest must be shown on both the consolidated income statement and consolidated balance sheet. PRICE NOT EQUAL TO THE BOOK VALUE PRICE covers TANGIBLE and INTANGIBLE assets à GOODWILL When the acquiring company pays more than the book value of the acquired company’s net assets, consolidation requires a two-step adjustment: 1. All acquired assets and liabilities are shown at their fair market value (FMV) 2. If the purchase price > FMV of the net assets, goodwill must be shown on the consolidated balance sheet Goodwill is the excess of the cost of an acquired company over the sum of the FMV of its identifiable assets less the liabilities In the previous example, assume that: à A acquired a 100% interest in B for $253 million rather than $213 million à A building with a book value of $20 million had a FMV of $35 million Goodwill = Price paid - Equity book value – FMV adjustments à $253 million - $213 million- ($35 million-$20 million) = $25 million $15 million  FINANCIAL COMPANY (PARENT) WHEN YOU CONSOLIDATE YOUR DEBT RATIO IS BIGGER (WORST) * * INVESTMENT MADE BY ROSE = MOUNTAIN’S EQUITY SHARE INVESTMENT Company A purchases the shares of Company B (investee) Categories of Financial Asset Investments Financial Assets: Short-term or long-term – Trading – Held-to-maturity – Available-for-sale Investment in associates (and joint ventures) Investment in subsidiaries – Typically more than 50% ownership – Long-term investments EQUITY METHOD FOR INVESTMENTS Buying a large stake in another company Equity method used when investor owns between 20 – 50% of the investee’s voting share – Investor may significantly influence the business Referred to as affiliates Recorded initially at cost Investor records its share of investee net income and dividends EXAMPLE Equity Method. January 6, 20X6, Vivendi pays €400 million for 20% of the ownership of YY Entertainment. Vivendi’s entry to record the purchase of this investment follows (in millions): Income from Associates. YY Entertainment reports net income of €250 million for the year, Vivendi records 20% of this amount as follows (in millions): Receiving Dividends Under the Equity Method. YY Entertainment declares and pays a cash dividend of €100 million, Vivendi receives 20% of this dividend and records this entry (in millions): Vivendi selling all of its 20% holding in YY Entertainment for €425 million would be recorded as follows: AVAILABLE FOR SALE INVESTMENTS Vivendi purchases 1,000 Siemens shares at the market price of €44 per share. Vivendi intends to hold this for longer than a year and, therefore, treats it as a long-term available-for- sale investment. Assume that Vivendi receives a €0.20 cash dividend per share on the Siemens share. Assume that the market value for Siemens ordinary share is €46,500 on December 31, 20X6. Vivendi bought €44,000 on October 23, 20X6. Vivendi makes the following entry: LIABILITIES The Conceptual Framework defines liability as: Obligations settled through outflow of resources embodying economic benefit. There are two kinds of liabilities: -SHORT TERM à CURRENT LIABILITIES -LONG TERM à NON CURRENT LIABILITIES CURRENT LIABILITIES OF KNOWN AMOUNTS Accounts payable Accrued liabilities (or accrued expenses) Deposits Unearned revenues Payroll-related liabilities Sales tax payable Tax payable Provisions Notes payable – Short term  Debt – Current portion of long term debts PROVISIONS (fondi rischi e spese future) Provisions of uncertain time and amount Liabilities of uncertain timing and amount Covered under IAS 37—Provisions, Contingent Assets and Contingent Liabilities Examples include Warranty: companies may guarantee their products under a warranty Matching principle demands the company records the warranty expense in the same period the business records sales revenue EXAMPLE SOLD 1 APPLE PC (paid in cash) = 1000€ 6/10/2021 cost= 600 A = L + E Cash Inv Provision Revenues COGS Warranty Exp +1000 -600 +1000 -600 +10 -10 CONTINGENT LIABILITIES A potential liability that depends on the future outcome of past events –Possible obligation to be confirmed by a future event –Present obligation that may/may not require outflow of resources –Reliable estimate of amount of present obligation cannot be made Examples: future liabilities that may arise due to lawsuits, tax disputes, or alleged violations of environmental protection laws Either: accrue, disclose, or neither. Can be overlooked when creating a Balance Sheet as they aren’t actual debts Net income will be overstated if the company fails to accrue interest on liability VALUING AND REPORTING LONG TERM LIABILITIES Reporting bonds Time value of money Coupon rate < Market rate à DISCOUNT Affects the pricing of bonds (valuation of bonds) Coupon rate > Market rate à PREMIUM Bond interest rates determine bond prices –Always sold at market price (bond’s present value) –Stated interest rate (coupon rate) –Market interest rate (effective interest rate) à Discount rate= market rate at issuance Bonds may be issues at par, at discount, at premium Issuing Bonds Payable at Par. Suppose Jardine has $50,000 of 9% bonds payable that mature in five years. Jardine issued these bonds at par on January 1, 20X1. Issuing Bonds Payable at Par. Interest payments occur each January 1 and July 1. Jardine’s entry to record the first semiannual interest payment is as follows: Issuing Bonds Payable at Par. At year-end, Jardine accrues interest expense and interest payable for six months (July through December), as follows: Issuing Bonds Payable at Par. At maturity, January 1, 20X6, Jardine pays off the bonds as follows: Issuing Bonds Payable at a Discount. Jardine issued $100,000 of 9%, five-year bonds when the market interest rate is 10%. The market price of the bonds drops, and Jardine receives $96,139 at issuance. JARDINE’S BALANCE SHEET: Each semi-annual cash interest payment is set by the bond contract and remains constant over the life of the bond: Issuing Bonds Payable at a Discount. Jardine’s journal entry to record interest expense and the interest payment for the first 6 months follows: Issuing Bonds Payable at a Discount. At December 31, 20X1, Jardine accrues interest and amortizes the bond discount for July through December as follows: Issuing Bonds Payable at a Premium. On January 1, 20X1, Jardine issued $100,000 of 9%, five-year bonds when the market interest rate is 8%. The issue price is $104,055. The issuance of the bonds is recorded as follows: Jardine’s balance sheet EXERCISES P 8-57B P9-81B The board of directors of Portraits Plus authorizes the issue of €4,000,000 of 8%, 15-year bonds payable. The semi-annual interest dates are May 31 and November 30. The bonds are issued on May 31, 20X0, at par. a. Issuance of half of the bonds on May 31, 20X0. b. Payment of interest on November 30, 20X0. c. Accrual of interest on December 31, 20X0. d. Payment of interest on May 31, 20X1. P9-82B On February 28, 20X0, Dory Corp. issues 6%, 20-year bonds payable with a face value of €1,500,000. The bonds pay interest on February 28 and August 31. Dory Corp. amortizes bonds by the effective interest method. (PV of 1$ = 0.372; PV Annuity of 1$ = 25.103) 1,500,000 x 0,372 = 558,000 45 x 25.103 = 1,129,635 558,000 + 1,129,635 = 1,687,635 Payment of interest and amortization of the bonds on February 28, 20X1. CASH FLOW STATEMENT The statement of cash flows provides a thorough explanation of the change occurred in a firm’s cash(*) balance during the entire accounting period. *“Cash” includes cash and cash equivalents Cash inflows and outflows are grouped according to the type of activity which generate them: 1.Operations: cash inflows and outflows concerned with ordinary functioning of the enterprise 2.Investing: cash inflows and outflows concerned with transactions to acquire or to dispose of long-lived assets 3.Financing: cash inflows and outflows concerned with getting cash or repaying debt. DIRECT METHOD  INDIRECT METHOD INDIRECT METHOD Balance Sheet equation à A = L + E The continuation: the re-classification of the balance sheet equation Cash + Non-cash Current Assets + Long-lived Assets = Current Liabilities + Long Term Liabilities + Capital + Retained Earnings Net income - Dividends The focus on cash: the “arrangement” of balance sheet equation Cash = Net Income – Non-cash Current Assets + Current Liabilities - Long-lived Assets + Long Term Liabilities + Capital – Dividends The changes in cash: from a static to a dynamic balance sheet equation Δ +/- Cash = Net Income* – Δ +/- Non-cash Current Assets + Δ +/- Current Liabilities *Δ Retained Earnings = Net Income -Dividends CASH FLOW FROM OPERATIONS - Δ +/- Long-lived Assets CASH FLOW FROM INVESTING + Δ+/- Long Term Liabilities + Δ +/- Capital –Dividends  CASH FLOW FROM FINANCING NET CASH FLOW CFS +/- OPERATIONS CFO > 0 Always Positive CFS CFS +/- INVESTING CFI < 0 Always Negative CFS +/- FINANCING CFF (DEPENDS) Example Beginning Period End Period CASH FLOW Revenues 100 A/R = 10 A/R = 30 10 +100 - 30 = 80 Wages exp (70) W/P = 0 W/P = 50 0 + 70 – 50 = (20) Net income 30 60 P/L B/S CFS NET INCOME 30 OPERATING WORKING CAPITAL = Δ +/- Acc Rec + Δ +/- Inv + Δ +/- Acc Payable – Δ +/- NCCA (20) + Δ +/- CL 50 CFO 60 Example 2 Beginning Period End Period CASH FLOW Revenues 100 A/R = 10 A/R = 30 10 +100 - 30 = 80 Wages exp (70) W/P = 0 W/P = 50 0 + 70 – 50 = (20) Depr (10) PPE = 80 PPE = 70 Net income 20 60 P/L B/S CFS NET INCOME 20 - (Δ +/- LLA + Depr) = -(-10 + 10) = 0 Depreciation 10 CFI = 0 Potential CF 30 – Δ +/- NCCA (20) + Δ +/- CL 50 CFO 60 MAGISTRETTI CASE  SPONGE (-) Long Lived Assets (+) Long Term Liabilities BRUNELLO CUCCINELLI HORIZONTAL ANALYSIS The study of percentages from year to year Two steps to compute: - Compute amount of change from one period (base period) to the next - Divide the amount of change by the base-period amount Nestlé EXAMPLE Nestlé’s sales increased by 0.77% during 2016, and operating profit increased by 6.08%, in 2016, computed as follows: Step 1: Compute amount change Step 2: Divide change by base-period amount TREND PERCENTAGES Form of horizontal analysis that indicates the direction a business is taking. Select a base year and set it equal to 100% à Amount of each following year stated as a percentage of the base amount VERTICAL ANALYSIS Shows the relationship of financial statement item to its base All items reported as a percentage of the base Income statement usually use net revenue as base Balance sheet usually use total assets as base COMMON SIZE FINANCIAL STATEMENTS Report only percentages, no dollar amounts Assists in comparison of different companies using a common denominator BENCHMARKING Compares a company to some standard set by others -Goal is improvement -Convert companies’ financials to common size for easy, more meaningful comparisons Types of Finance Ratios Efficiency ratios Financial strength ratios Profitability ratios Investment ratios Compare ratios to: Industry averages Prior year ratios Competitors’ ratios Measuring Turnover and the Cash Conversion Cycle Inventory Turnover à We are selling fast à we are receiving money fast Accounts Receivable Turnover à How long it takes to transform AR into cash Days’ Sales Outstanding Accounts Payable Turnover Cash Conversion Cycle Inventory Turnover Measures number of times a company sells its average level of inventory during a year Varies widely by industry Compare to prior years and industry averages Days Inventory Outstanding or Inventory Resident Period Converts inventory turnover ratio into days 𝟑𝟔𝟓 Days' inventory outstanding(DIO) = 𝑻𝒖𝒓𝒏𝒐𝒗𝒆𝒓 Accounts Receivable Turnover Measures ability to collect cash from credit customers àIn general, the higher the better. Tells how many times during the year average receivables were turned into cash 𝑵𝒆𝒕 𝐜𝐫𝐞𝐝𝐢𝐭 𝒔𝒂𝒍𝒆𝒔 Accounts receivable turnover = 𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐧𝐞𝐭 𝐀𝐜𝐜 𝐑𝐞𝐜 Days’ Sales Outstanding or receivable collection period How many days’ sales remain in accounts receivable Can be calculated two ways: 𝟑𝟔𝟓 1) Days' sales outstanding (DSO) (or days'-sales-in receivables) = 𝑻𝒖𝒓𝒏𝒐𝒗𝒆𝒓 Or 𝑵𝒆𝒕 𝒔𝒂𝒍𝒆𝒔 2) Average daily sales = 𝟑𝟔𝟓 𝒅𝒂𝒚𝒔 𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒏𝒆𝒕 𝒂𝒄𝒄𝒐𝒖𝒕𝒔 𝒓𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆 Convert average daily sales to DSO = 𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐝𝐚𝐢𝐥𝐲 𝐬𝐚𝐥𝐞𝐬 Accounts Payable Turnover Measures number of times per year the entity pays off its accounts payable Cost of goods sold 𝑪𝑶𝑮𝑺 Accounts payable turnover = 𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑨𝒄𝒄 𝑷𝒂𝒚𝒂𝒃𝒍𝒆 Payable Outstanding Period Also known as Days’ Payable Outstanding. How many days it takes a company to pay off accounts payable 365 𝟑𝟔𝟓 Days' payable outstanding (DPO) = 𝑻𝒖𝒓𝒏𝒐𝒗𝒆𝒓 CASH CONVERSIO CYCLE Shows overall liquidity Computes total days it takes to convert inventory to receivables and back to cash, less the days to pay off suppliers Cash conversion cycle = DIO + DSO − DPO where DIO = Days’ inventory outstanding DSO = Days’ sales outstanding DPO = Days’ payable outstanding Asset Turnover Measures amount of net sales generated per dollar invested in assets Measures how efficiently management is operating the company Net sales 𝑵𝒆𝒕 𝒔𝒂𝒍𝒆𝒔 Asset turnover ratio = 𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐭𝐨𝐭𝐚𝐥 𝐚𝐬𝐬𝐞𝐭𝐬 Rate of Return on Total Assets (ROA) Measures how profitably the company uses its assets Rate of return of sales x Asset turnover ratio = ROA Measures a company’s success in using assets to earn a profit -The numerator is the net profit -The denominator is the average total assets, the sum of beginning and ending balances divided by 2 Financial Strength Ratios: Working Capital Measures ability to pay current liabilities with current assets In general, the larger the better ability to pay debts Working capital = Current assets - Current liabilities Current Ratio Measures ability to pay current liabilities with current assets In general, a higher current ratio indicates a stronger financial position MNOOPQR STTPRT Current Ratio = MNOOPQR UVWXVYVRVPT Quick (Acid-test) Ratio Tells whether the entity could pay all current liabilities if they came due immediately Uses narrower base than current ratio Rate of.90 to 1.00 is acceptable in most industries MWTZ WQ[ P\NV]WYPQRT^TZ_OR RPO` VQ]^aPR bNOOPQR OPbPV]WXYPT Quick ratio = MNOOPQR UVWXVYVRVPT Debt Ratio Expresses the relationship between total liabilities and total assets Ratio of 1 indicates that debt financed all assets − higher ratio = greater pressure to pay interest and principal c_RWY UVWXVYVRVPT Debt Ratio = c_RWY STTPRT Time-Interest-Earned Ratio Measures number of times operating income can cover interest expense Higher ratio indicates ease in paying interest Low ratio indicates difficulty in paying interest dQb_`P eO_` _fPOWRV_QT Times-interest-earned ratio = dQRPOPTR PgfPQTP Profitability Ratios Gross Profit (Margin) Percentage; Operating Profit (Income) Percentage; Net Profit Margin Return on Total Assets (ROA) Return on Equity Gross Profit Margin Percentage Amount of profit entity makes from merely selling its products, before other operating costs are subtracted Operating Profit Margin Percentage Measures percentage of profit earned from sales in a company’s core business operations Earnings per Ordinary Share (EPS) Shows the amount of net income earned for each outstanding ordinary share Most widely used ratio Net income available divided by the weighted-average number of ordinary shares outstanding during the year. You trade voting right for cash flow rights à You don’t have the right to vote but you receive dividends before everybody else Price/Earnings Ratio Shows market price for each unit of earnings Appears in financial newspapers’ stock listings Abbreviated P/E Dividend Yield Measures percentage of a share’s market value returned annually to shareholders as dividends Book Value per Ordinary Indicates recorded accounting amount for each share of ordinary shares Return on Equity