Financial Statement Analysis & Key Formulas
Financial Statement Analysis
Key Statements
Income Statement: List all revenues and expenses (cost of goods sold included).
Balance Sheet: List all assets (in order of liquidity). List all liabilities (in order of liquidity) and Stockholders’ Equity (SHE) (preferred stock, common stock, additional paid-in capital, retained earnings, treasury stock).
Statement of Cash Flows: Cash flow from operating activities (cash received, accounts receivable/payable, cash paid, income/salaries). Cash flow from investing activities (physical assets, long-term assets, e.g., equipment). Cash flow from financing activities (common stock, notes payable, dividends).
Retained Earnings Statement: Prepared before the balance sheet; add net income, less dividends.
Balance Sheet Details
Asset Order of Liquidity:
- Cash
- Marketable Securities (stocks/bonds)
- Accounts Receivable
- Supplies
- Inventory
- Equipment
- Fixed Assets
- Goodwill
Liability Order of Liquidity:
- Short-term Notes Payable
- Current Portion of Long-Term Debt
- Accounts Payable
- Payroll Liabilities
- Other Accrued Expenses
- Income Taxes Payable
Classified Balance Sheet:
- Current Assets: Cash, debt investments, accounts receivable, inventory.
- Property, Plant, and Equipment (PP&E): Equipment, buildings, land.
- Intangible Assets: Brand, goodwill, intellectual property.
- Current Liabilities: Notes payable, accounts payable, income tax payable.
- Long-Term Liabilities: Mortgage payable, notes payable.
Analysis Techniques
Tabular Analysis: Pay attention to which account a transaction affects. Retained earnings have a positive balance.
Bank Reconciliation:
- Cash balance per bank statement: Add deposits in transit, less outstanding checks. Adjust bank balance.
- Cash balance per books: Add electronic funds transfers (EFTs) and interest. Less non-sufficient funds (NSF) checks, rent/service charges. Adjust cash balance per books. (Only use cash balance in tabular analysis and watch for errors in checks.)
Cash Budget: Use beginning cash balance, add cash receipts, less cash disbursements. Financing: Add borrowings, less repayments. (Calculate totals for each section).
Horizontal Analysis: Calculate the amount and percentage change.
Vertical Analysis: Percentage = individual value / total value.
Inventory Methods
FIFO (First-In, First-Out): Oldest inventory is sold first; newest remains.
LIFO (Last-In, First-Out): Newest inventory is sold first; oldest remains.
Average-Cost: Average cost of all units, regardless of purchase date.
Multi-Step Income Statement
- Sales: Sales revenue less sales deductions.
- Net Sales
- Cost of Goods Sold (COGS)
- Gross Profit
- Operating Expenses: (No interest expense; include freight out, loss on disposal of plant assets, and all other operating expenses if provided).
- Income from Operations
- Other Revenues and Gains: (Interest revenue, etc.)
- Other Expenses and Losses: (Interest expense)
- Income Before Income Taxes
- Income Tax Expense
- Net Income
Inventory Considerations
- Held in Consignment: Do not include in inventory.
- Shipped FOB Destination: Do not include in inventory until received.
- Shipped FOB Shipping Point: Include in inventory once shipped.
- Stored in a warehouse for the coming year: Include in inventory.
- Not in use/made: Do not include in inventory.
Key Formulas
Assets = Liabilities + SHE
Working Capital = Current Assets – Current Liabilities
Current Ratio = Current Assets / Current Liabilities
Debt-to-Asset Ratio = Total Debt / Total Assets
Profit Margin = Net Income / Net Sales
Gross Profit Rate = (Net Sales – COGS) / Net Sales
Return on Assets = Net Income / Average Total Assets
Asset Turnover = Net Sales / Average Total Assets
Return on Common Stockholders’ Equity = (Net Income – Preferred Dividends) / Average Common Stockholders’ Equity
Times Interest Earned = (Earnings Before Interest & Taxes + Interest Expense) / Interest Expense
Gross Profit = Net Sales – COGS
Inventory Turnover = Cost of Goods Sold / Average Inventory
Days in Inventory = Length of Time Provided (e.g., 365 days) / Inventory Turnover
Straight-Line Depreciation = (Cost of Asset – Estimated Salvage Value) / Estimated Useful Life
Percentage Change = (New Value – Old Value) / Old Value
Cost of Land/Equipment = Cash paid + Accrued/Sales Taxes + Net cost of removals + Attorney’s fees + Real estate broker’s fees + Painting and lettering.
Interest = Face Value of Note * Annual Interest Rate * Time (in terms of one year)
Outstanding Shares = Issued Shares – Treasury Shares
Stated Value per Share = Total Common Stock / Issued Shares
Par Value per Share = Total Preferred Stock / Issued Shares
Dividend Rate = (Annual Dividend / Total Par Value of Preferred Stock) * 100
Amortization Expense = Cost / Useful Life