Assignment Topic: summary of chapters 7 to 10 from book financial

reporting & analysis by Charles Gibson

Assignment Submitted by: KAINAT KUMARI

Roll no :(18-BBA-026)

SUBJECT: Analysis of Financial Statement

Submitted to: Sir Muhibullah Nahrio

(LECTURER at Shaheed Benazir Bhutto University sanghar campus)

DEPARTMENT OF: BBA (BACHELOR OF BUSINESS ADMINISTRATION)

DATE: 28/JUNE/2020

CONTENTS
CHAPTER7: LONG-TERM DEBT-PAYING ABILITY.........................................................3

IDENTIFY ABILITY TO REPAYING LONG TERM DEBT BY CONSIDERING

INCOME STATEMENT..............................................................................................................3

CALCULATING LONG TERM DEBT PAYING ABILITY BY BALANCE SHEET..........4

CHAPTER8: PROFITABILITY.................................................................................................5

RATIO FOR CALCULATING PROFITABILITY OF FIRM.................................................5

CHAPTER 9: FOR THE INVESTORS......................................................................................8

RATIOS THAT HELP INVESTORS FOR EVALUATION....................................................8

CHAPTER10: STATEMENT OF CASH FLOWS....................................................................9

COMPONENTS OF CASH FLOW STATEMENT.................................................................10

MAIN RATIO FROM THE STATEMENTS OF CASH FLOW...........................................10

REFERENCES............................................................................................................................11
Chapter: Long-Term Debt-Paying Ability
Every firm has three main components, assets, shareholder equity and liability to grow the
business. The liability especially long term liability that is known as the long term debt of a
company is our main concern in this chapter. By the definition we consider that the long term
debt is the obligations or duty of the firm to repay the money in the future that borrowed from
any other person or institution like bank. So to identify how effectively the firm paying its long
term debt is important. Basically there are two main approaches to identify the ability of paying
it. First approach is that one can find the effectiveness for it by viewing the income statement of
the firm. And the other is balance sheet, as we know in the balance sheet there is a specific
calculation for liabilities. So with the help of income statement and balance sheet, the investors
who are interest to know the future condition of the firm can use these approaches [ CITATION
Har \l 1033 ]

Identify ability to repaying long term debt by considering income

statement
Let’s look closure into the approach that use income statement to calculate ability to pay long
term debt. As the income statement is recorded income from accrual base method, there is a
relation between these method and ability to pay long term debt. Moreover, there are two ratios
to find out the conclusion for long-term debt paying ability that use income statement
data[ CITATION fab99 \l 1033 ]

1.Times interest earned ratio

The time interest earned is a ratio that is calculated for many years to find out the performance of
firm for over some time. The science behind using this formula that it provides information from
corresponding years it that it provides enough information for loan provider to trace out
[ CITATION fab99 \l 1033 ]
Times interest earned ratio = EBIT / interest expense

2.Fixed charge coverage

The next ratio that we are going to understand is fixed charge coverage ratio that is the extended
form of previous ratio that is time interest earned ratio.so fixed charge ratio is a ratio that help us
to find that how many times before paying interest or tax, the company have cash or earning that
cover its all fixed charges.
fixed charges cover ratio = (earnings before interest & taxes) + (fixed charges before tax)
Interest + fixed charge before tax (principal amount)

calculating long term debt paying ability by balance sheet.

The balance sheet as we know that it is one of the financial statements of the firm. This statement
given by calculating three things that is asset, equity and liability. so there are many ratios that
calculated when we use these three thing to calculate the ability to repay the long-term debt
[ CITATION min \l 1033 ]

1.Debt ratio

Every firm wants to grow and to grow it need money. The debt financing is a way to borrowing
money but with the expectation to repay over a given period of time. But there is also risk for
borrowing money that the creditors financed the business asset as a security
Debt ratio = Total liabilities (short and long time liabilities)
Total assets

2.Debt to equity ratio

The capital in the firm is generated by two sources one the shareholder of the firm and the other
from outsiders. The debt to equity ratio is the ratio that show that calculate how much the total
assets of the are financed by the creditor as compare with shareholders. It gives view to the
creditors how much they are protected for retake its money[ CITATION Asl98 \l 1033 ],
Debt to equity ratio = totality of liabilities ÷ shareholder equity[ CITATION fab99 \l 1033 ]

3.Debt to tangible net worth ratio

As mainly tangible assets are help to repay the long-term debt of the creditors. So there is a ratio
that is knew as the debt to tangible net ratio, that calculate how much firm has tangle asset worth
to repay. It secures the creditor money in the insolvency condition so this calculate a follow.
Debt/tangible worth ratio = Total liabilities ÷ Shareholder’s equity – intangible asset
Chapter8: Profitability
Firms as a business concept is establish to earn the profit, the act of earn or generate the profit is
known as the profitability. As the profit is the real outcome of the efforts of the firm, it is main to
calculate it. It is not only important for firm but as well for the stockholder’s creditors and for
management to measure the extend of profitability. There are many ways to calculate the
profitability, but the income statements items specially serve more to help in the calculation. So
this chapter is based on the ratio or formulas that calculate or measure the
profitability[ CITATION Jos \l 1033 ]

Ratio for calculating profitability of firm

1.Net profit margin

The company mainly consider the profitability in the term on sales. And there are many to
calculate return on sales like gross profit operating profit and net profit. but the common one is
the net profit margin that calculate the net profit scale. Basically each company has different
items in the income statement so each consider this formula with their prospective but the
common formula is shown below.
net income before noncontrolling income , equity income , non recuring items
Net profit margin¿
net sales

2.Total asset turnover

Some assets are used to make the finised goods that genertaes the sales and that sale is the
profitablity for the firm. So it is important to measure how much assets are used or turnover to
generte that amount of sales . let’s look it formule that make our view for clear[ CITATION
Jos \l 1033 ].
net sales( part of income statement )
Total assets turnove=
Avergae total asset

3.Return on asset(ROA)

The contrast how effecitive assets are used to generate profit , the firm calculate the return on
asset that maybe not show to outsiders , it use the average of the asset how know how much
asset are avaiable in the beginning and how much assets are present at the ending of the monyh
or finacial period.[ CITATION Har \l 1033 ]
ROA =net income before non controlling interest & non recuuring items /average income

4.duPont return on assets.

Noww a day firm wants quick assertment on the caluction for that a new concept emerge that is
know as duPont return that calculate total asset turnover, net profit margin and return on asseet
together. The return on the asset directly increase or decrease by the incrase and decrease of net
profit margin and asset turnover ratio. the merge formula are stated in simple form below.
Return on assets = net profit margin × total asset turnover[ CITATION Gib11 \l 1033 ]

5. Operting income margin

The opertaing income is the income that is generated within operting period of the firm revenue
and expense) of the current month. Like wise net profit it includes net sales but unlike net
inocme it only consider the operting income. As it is a logic that if copmany can survive in the
short run , then it become able to carry in the busniess for future. So to calculte the margin of
operating income is necessay[ CITATION Gib11 \l 1033 ]
Operating income margin = operating income ÷ net sale
6.Operating assets turnover
The operating asset turnover ratio is the measure of much the assets are utlized to generate net
sales. Basically raw materials , inventories , current operting asset are utliized by the comoany to
fulfil the current need of the market. As this formula use two things one is revenue or net sales as
a numertor and the operting income that is EBIT. Sp palce it into the formula[ CITATION Gib11
\l 1033 ]

Operating asset turnover = net sales ÷ avergae operating asset

7.Return on operating asset

The operating asset like equipement, cash machinery are used by the company to make the
profit. It is important for the firm to generte greater profit. let’s look the formula that calculate
it .
Return on operting asset = operating income (EBIT)
Average of operating asset
duPont return on operating is the alternative formula to calcualate the return on operting asset.
Basically is the three step into one step formula.
Like that duPont return on operating asset= operating profit margin ×turnover of operating asset.

8.Sales to fixed asset

Sales are generated with the help of using the firm’s fixed asset , incleed firm builing ,
equipment , machinery that are fixed means it can be used more and more for many years . so to
generate high profit through the fixed asset is the productive art of the firm. To calculate the
formula is like as following[ CITATION Gib11 \l 1033 ]
Sales to fixed assets = net revenue ÷ average but net fixed asset

9.Return on investment

. As the firm takes investment from different resoures tto grow the business.so it is important to
know how much the firm generate sales from these investment. To calcualte it we use formula
that is know as return on investment ratio.
net earningbefore noncontrolling interest , nonrecuring items+interestexpense
× { 1−taxrate )
ROI=
average ( longtermliability+ equity )

10.Return on total equity

Return on total quity means return on common equity plus preferred stock is a financial ratio that
can help you to analyze performance of a company from the prospective of the shareholders and
compare financial performce to others.
Net Income Before Nonrecurring Items
−Dividends on Redeemable Preferred Stock
return on total equity=
averagetotal equity

11. Return on common equity

To calculate return on common euquity shareholder firist we have to find write net income and
then minus preferred income and then divide the value with avergae of common equity.
12.Gross profit margin

When net sales gets minus from the cost of good sold w get the gross profit. Basically the gross
profit margin the margin that tell us how much firm generete sales to the cost that is incured to
sold the good. The formula for it is like as follow[ CITATION the1 \l 1033 ]
Gross profit margin = gross profit ÷ net sales

Chapter 9: For the investors.

The investor is the person who would like to invest his money in the firm. The investor has main
concern on how the firm is going, what is the pros and cons if he invests in this firm. The
investor analyzes the conditions specially the financial condition. This chapter help him to
consider which things he has to analyze, which is moist important for consideration before
investing.[ CITATION Jos \l 1033 ]

Ratios that help investors for evaluation

1.Degress of financial leverage

First of all, the leverage in the finance is a term that is used to know what is the cost structure of
a firm, how much it pays on fixed expenses and how much the outsider helps to leverage the
organizations. Basically the main formula to calculate is the % changes in net income to change

EBIT
in degree of financial leverage=
earning before interst

2. earnings per common share

The earnings per common share is the basic and primary analysis for investors, fortunately the
firm show it the income statements. Earnings per common share can be defined as the how much
the firm earnings with respect its common share. Basically every investor wants to invest in
common stock. so it is the main for company to earn more, it become capable to give dividend to
the common stockholders. Let’s look it formula that how it is calculated.
net income− prefered dividents
earning per share=
avergae number of common shares outstanding
3. price to earnings ratio.

Every company wants to issue its share that at least at market price. The price to earning ration
tells us how much a firm earning per share from common stock in relation with the market value
of share in the marketplace. [ CITATION Asl98 \l 1033 ]

4.Percentage of earning retained

Corporations having savings accounts that is called as retained earnings. Corporations retained
them from year to year to be used for differ net purpose. The main focus of invest to trace out , if
the company become insolvency, should company has retained earning to pay

net income before nonrecurring items−all dividends

% of earnings retained=
net income before nonrecurring items

5.Dividend payout

When the company earns the profits from each common stock it has to pay the dividend which is
the portion of money of common stock holder paid for their portion on the company’s equity. So
how much the company payout dividends are also the concern of the investor.
Dividend payout= dividends per common share ÷ diluted earnings per share before nonrecurring
items[ CITATION Har \l 1033 ]

6.Dividend yield

The dividend yield is a relation between the dividend investors get relative to the price of the
share in market. More specifically when the dividend per common share contrast with the market
price that has to pay to buy it is knew as the dividend yield. So to calculate it we need a proper
formula that is stated below.
dividend per common share
dividend yield=
market price per common share

7.Book value per share

In the stock market when we look to enter any stock then we should research whether the stock is
overvalued or undervalued this known by the book value of share. Basically it is the actual value
of the asset or share. It is the value the shareholders received in the event of company become
insolvent or bankrupt.
total eqity of shareholders−preferred stock equity
book per share value=
no of common sahres outstanding

Chapter10: Statement of cash flows

Cash is king it is critical at every stage of a company’s lifecycle. The cash flow statement is one
of the main three main financial statements. As the cash flow statement explain how much cash
has come in and gone out during a year and what the secures and uses of this cash flow were,
you could see the cash flow statement as an explanation of how the cash that the foundation of
asset has developed between two balance sheet.
Cash flow statements is basically main concern for the managers, analyzers, investors, lenders.
Because it provides the firm work how much company is able to regulate its cash and earns
profit
But as the manager of finance, or student of finance we have to the cash flow statements only for
finance relating view.[ CITATION Gib11 \l 1033 ]

Components of cash flow statement

Mainly or widely the cash flow statement has three elements named as operating, investing and
financing. Before understanding further, we have to understand that not only cash but cash
equivalents are considering as a cash
Cash from operating activities is roughly the cash inflow from customers paying company minus
the cash outflow of the company paying for purchases for purchase from suppliers minus the
cash outflow of salaries paid to employees, and minus the cash outflow of taxes to government
for most companies in good health, the cash flow from operating activities is a net cash
inflowThe next element is called as cash from investing activities. this is where capital
expenditures acquisition and the investments are recorded. And the last is cast from the financing
activities, this the cash that are flow from debt, liability and equity recorded.[ CITATION Har \l
1033 ]
Main ratio from the statements of cash flow

1.Operating cash flow /current maturities of long term debt and current notes
payable.

Operating cash flow to maturities of debt is the ratio that calculate how extend the firm has
strength to meet its current and maturities of debt. The more the ratio the grater the strength of
the firm to meet current and mature obligation. to calculate it the following formula formed.
operating cash flows
current maturities of long term debt∧notes payble currently

2.Operation cash flows to total debt ratio

As the operating cash flow is the flow of cash from current operating activities. The operating
cash is the main way to pay the debt. So this ratio is the ratio is telling us how much operating
cash flow cover the total debt in the firm. Operating cash flows to total debt = operating cash
flow ÷ total debt

3.Operating cash flow per share

Operating cash flow per share is a measure of how much operating cash get in and get out for per
share. Basically this help to make view about to pay the current dividend. The formula for it is as
follows:
operating cshflow− preferred dividents
diluted weighted average common share outstanding

4.Operating cash flow to cash dividends

When operating cash flow get divide with the cash dividend, we can find the ability of firm to
pay its cash dividend and that cash is generating from the operating cash flow. Following the
mathematical expression for it[ CITATION Har \l 1033 ]
operating cash flow
operating cash flow ¿ cash dividends=
cash dividends

References
Abor, J. (n.d.). the effect of capital struture on profitability . journal of Risk finance.
Asli Demirguc, V. M. (1998). institution,financial markets, and firm debt maturity. financial
economics.
fabozzi, p. p. (1999). analysis of finncial statments.
Gibson, C. H. (2011). Financial reporting & analysis. USA: South Westing.
Hart, o. ,. (n.d.). An analsis of hard claims in constraiting management. NBER wrking paper
series.
Hung, m. (n.d.). accounting statdards and value relevance. accounting and economics.
the determination of longterm credit with Financial ratios. (n.d.). jornel of accounting research.