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Chapter 03 - Working with Financial Statements
3-1
Chapter 3
WORKING WITH FINANCIAL STATEMENTS
CHAPTER WEB SITES
Section
Web Address
CHAPTER ORGANIZATION
3.1 Cash Flow and Financial Statements: A Closer Look
3.4 The Du Pont Identity
Chapter 03 - Working with Financial Statements
3-2
ANNOTATED CHAPTER OUTLINE
Lecture Tip: Students sometimes get the impression that
3.1. Cash Flow and Financial Statements: A Closer Look
A. Sources and Uses of Cash
Lecture Tip: Students often experience difficulty when
Chapter 03 - Working with Financial Statements
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B. The Statement of Cash Flows
The idea is to group cash flows into one of three categories:
operating activities, investment activities, and financing activities.
Financing Activities
Putting it all together:
3.2. Standardized Financial Statements
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A. Common-Size Statements
B. Common-Base Year Financial Statements: Trend Analysis
C. Combined Common-Size and Base-Year Analysis
3.3. Ratio Analysis
Lecture Tip: Unfortunately, students often make it through an
Chapter 03 - Working with Financial Statements
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Things to consider concerning financial ratios:
Categories of Financial Ratios:
Lecture Tip: Students often fail to see the fiforest” for all the
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A. Short-term Solvency, or Liquidity, Measures
Lecture Tip: When asked to define liquidity, students invariably
Lecture Tip: Students often think that a high current ratio is, in
and of itself, a good thing. This may be true if you are a short-
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Lecture Tip: You may want students to consider the interaction of
1. The company is operating with lower levels of the most
2. This situation also indicates that larger levels of inventory,
Lecture Tip: The mantra of many entrepreneurs is that fiCash is
B. Long-Term Solvency Measures
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Lecture Tip: This group of ratios really measures two different
Lecture Tip: The importance of coverage ratios is sometimes
being computed, not just what it is called.
C. Asset Management, or Turnover, Measures
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Total asset turnover = sales / total assets
Lecture Tip: You may wish to mention that there may be
Lecture Tip: A Wall Street Journal article suggested that
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Lecture Tip: In discussing the nature of financial statement
Lecture Tip: Students should be warned that, just as one must take
care in making generalizations across industries, so intra-industry
generalizations should also be made with great caution. For
D. Profitability Measures
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E. Market Value Measures
Lecture Tip: What is fiEEBS”? Under the heading fiA Wire Story
We’d Like to See,” those rascals at Fortune magazine have
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Lecture Tip: Here’s a tip for teaching about the vagaries and
interpretations of the P-E ratio, either in your discussion of
financial ratios, or in your discussion of stock market history.
Consider the table of year-end P-E ratios for the S&P 500
(courtesy of Barron’s through 1997 and the S&P web site for 1998
through 2004):
Year
P-E
Year
P-E
The average P-E ratio over the 28-year period is 16. But what is
the average over a subset through time?
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Lecture Tip: There are the fiofficial” earnings estimates, compiled
by First Call, and then there are the fiunofficial” estimates or
International Note: While some investors use P-E ratios as if they
are universally comparable, differences in generally accepted
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Lecture Tip: Ask the students to consider how the market-to-book
3.4. The Du Pont Identity
A. A Closer Look at ROE
B. An Expanded Du Pont Analysis
We can take a closer look at operating efficiency by looking at
3.5. Using Financial Statement Information
A. Why Evaluate Financial Statements
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Lecture Tip: The development of financial statement analysis is
B. Choosing a Benchmark
comparison figures
C. Problems with Financial Statement Analysis
-no underlying financial theory
Chapter 03 - Working with Financial Statements
Ethics Note: An interesting example of another problem faced by
Lecture Tip: The explosion of the Internet has placed financial
information in the hands of millions of individuals and increases
3.6. Summary and Conclusions
