Topic2 Financial Ratios

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Net working capital is the difference between current assets and current
liabilities. This means that it is the cash that will become available over the
next 12 months exceeds the cash that must be paid over that same period.
Net working capital is usually positive in a healthy company.
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In a typical US annual report, the firm will report the balance sheets for the most recent
two years. The balance sheets, as well as other financial statements, are reported on a
consolidated basis – that is, the firm will aggregate all its subsidiaries in reporting as if they
were part of the same firm.
Assets are investments that are expected to generate payoffs. They are direct result of
management’s investment decisions.
Current assets are listed first because they are the most liquid. Fixed assets can include
both tangible and intangible assets, and they are listed at the bottom because they
generally are not very liquid.
It is important to recognize that the balance sheet does not list some very valuable assets,
such as the people who work for the firm.
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Liabilities are claims to payoffs by claimants other than owners. Shareholders’ equity is the
claim by the owners. So, the balance sheet is a statement of the firm’s investments and the
claims to the payoffs from those investments.
Liabilities can also be divided into interest-bearing and non-interest bearing liabilities,
roughly speaking debt and non-debt.
Shareholders’ equity consists of several components and that total equity includes all of
these components not just the “common stock” item. In particular, retained earnings
belong to the shareholders.
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In a typical annual report, income statements of most recent 3 years are reported.
The income statement reports how shareholders’ equity increased and decreased as a
result of business activities.
The top half, the operations section of the income statement, reports the firm’s revenues
and expenses from principal operations. This is the focus of financial analysis.
The bottom half reports the firm’s other revenues and expenses.
Earnings per share (EPS) is earnings for the common shareholders.

•Basic EPS is net income available to common shareholders divided by the weighted
average of common shares outstanding during the year; a weighted average is used to
accommodate changes in shares outstanding from share issues and repurchases.
•Diluted EPS is based on total common shares that would be outstanding if holders of
contingent claims on shares (like convertible bonds and stock options) were to exercise
their options and hold common shares.
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Operating expenses could be recurring or non-recurring.
Operating income is sometimes called earnings before interest and taxes (EBIT)
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The cash flow statement describes how the firm generated and used cash during the
period.
Three types of cash flow:

Cash flows from operating activities, cash flow from investing activities, and cash flow from
financing activities.
In many countries, cash flow from operating activities is calculated based on indirect
method, i.e. the calculation starts from net income, then adjusted for non-cash charges,
change in working capital, …
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The statement of shareholders’ equity starts with beginning-of-period equity on the
balance sheet and ends with end-of-period equity, thus explaining how the equity changed
over the period.
Notice that there are several major reasons for change in shareholders’ equity:
1. Share issues, including those related to employees’ stock options;
2. Cash dividends and share repurchases;
3. Net income;
4. Net other comprehensive income.
Net Payout to Shareholders = Cash dividends + Share repurchases - Share issues
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Notes:
Receivable turnover measures how quick the company receives payments from customers
after making sales.
Inventory turnover ratio measures how quick the company sell the products to customers
after production.
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Topic2 Financial Ratios

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Earnings per share (EPS) is earnings for the common shareholders.

Three types of cash flow:

Net Payout to Shareholders = Cash dividends + Share repurchases - Share issues

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