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CMA PART2
SECTION (A)
A1. Basic Financial
Statement Analysis
2021
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Part 2: Strategic Financial Management

 Section A Financial Statement Analysis 20%

 Section B Corporate Finance 20%
 Section C Decision Analysis 25%
 Section D Risk Management 10%
 Section E Investment Decisions 10%
 Section F Professional Ethics 15%
Section A Financial Statement Analysis Overview

A1. Basic financial statement analysis

 Introduction
 Comparative Financial Statement Analysis
 Common-Size Financial Statements Vertical
 Trend Analysis Horizontal
Section A Financial Statement Analysis Overview

A2. Financial ratios

 Liquidity Ratios
 Leverage and Coverage Ratios
 Activity Ratios
 Profitability Ratios
 Market Ratios
 General Topics
Section A Financial Statement Analysis Overview

A3. Profitability analysis

 Analyzing Return on Assets
 Analyzing Return on Equity
 Factors in Measuring Income
 Sustainable Growth Rate
Section A Financial Statement Analysis Overview

A4.Special issues
 The Impact of Foreign Exchange Fluctuations
 The Impact of Inflation on Financial Statements and Financial
Ratios
 Adjusting Financial Statements for Accounting Changes and
Error Corrections
 Book/Market Value and Accounting/Economic Profit
 Earnings Quality
A1. Basic financial statement analysis Introduction
Income Statement
Net Sales 10,400
Less Cost of goods sold (3,200)
Gross profit $ 7,200

Less Operating expenses:

Research and development (3,000)
Selling, general and administrative (1,500)
Operating income $ 2,700
Non-operating income and expenses:
Gains (losses) on equity securities (344)
Financial income:
Interest and dividend income 177
Earnings before interest and taxes (EBIT) $ 2,533
Interest expense (400)
Earnings before tax (EBT) $ 2,133
Income tax expense (533)
Net income 1,600
How is EBIT calculated?

Operating income
+ Interest and dividend income
+/−Non-operating gains/(losses)
+/−G/L from operations of discontinued Component X
including G/L on disposal of $XXXX (before tax)
= Earnings Before Interest and Taxes (EBIT)
How is EBT calculated?

Earnings Before Interest and Taxes (EBIT)

− Interest expense
= Earnings Before Taxes (EBT)
Balance Sheet: LIABILITIES
Current Liabilities:
ASSETS Accounts payable 600
Current Assets: Accrued liabilities 500
Cash & cash equivalents Other current liabilities
2,895 1,700
Marketable securities - current Total current liabilities
14,100 Accounts receivable, net 2,800
700
Inventories 400 Noncurrent Liabilities:
Other current assets Long-term debt
300 5,000
Total current assets Other noncurrent liabilities 4,300
18,395 Total liabilities 12,100
Noncurrent Assets: STOCKHOLDERS’ EQUITY
Intangible assets Preferred stock 100
4,500 Common stock
Property, plant & equipment, net 1,685
2,400 Other noncurrent assets Paid-in capital 5,780
1,200
Total assets Retained earnings 6,830
26,495 Total stockholders’ equity 14,395
Total liabilities and equity
Cash and Cash Equivalents

 Usually, cash and cash equivalents presented together

as one line on balance sheet.
What is Included in Cash

1. Cash on hand
2. Savings accounts
3. Checking accounts
Cash Equivalents
1. Highly liquid
2. Short-term investments
3. Three months or less to maturity when acquired by the
company
What is Not Included in Cash

1. Time certificates of deposit

2. Money market funds
3. Legally restricted deposits
Comparative Financial Statement Analysis
 One of the main difficulties in the comparison of financial
statements between companies or between periods of time for the
same company is the difference in size.
 Comparative Financial Statement Analysis
When comparing two companies, one company may have a higher net
income simply because it is bigger and not because it is more efficient,
effective or sells a better product.

1000
 Comparative Financial Statement Analysis
When comparing two companies, one company may have a higher net
income simply because it is bigger and not because it is more efficient,
effective or sells a better product.

1000
 Comparative Financial Statement Analysis
To overcome this obstacle, common-size statements restate financial
statement line items in terms of a percentage of a given amount, such as total
assets for a balance sheet or net sales for an income statement.

1000
 Comparative Financial Statement Analysis
To overcome this obstacle, common-size statements restate financial
statement line items in terms of a percentage of a given amount, such as total
assets for a balance sheet or net sales for an income statement.

1000
What is a vertical common-size
financial statement?

• A simple vertical common-size financial statement covers

one year’s operating results and expresses each
component as a percentage of a total.
• For example, fixed assets will not be stated as a dollar
amount but rather will be stated as a percentage of total
assets. Each expense item will be stated as a percentage
of total revenue.
Simple vertical common-size Income statement
Income Statement 20x3 Common Size
Net Sales 10,400 100%
Less Cost of goods sold (3,200) -30.8%
Gross profit $ 7,200 69.2%
Less Operating expenses:
Research and development (3,000) -28.9%
Selling, general and administrative (1,500) -14.4%
Operating income $ 2,700 25.9%
Non-operating income and expenses:
Gains (losses) on equity securities (344) -3.3%
Financial income:
Interest and dividend income 177 1.7%
Earnings before interest and taxes (EBIT) $ 2,533 24.3%
Interest expense (400) -3.8%
Earnings before tax (EBT) $ 2,133 20.5%
Income tax expense (533) -5.1%
Net income 1,600 15.4%
What is horizontal trend analysis?

• Horizontal trend analysis is used to evaluate trends for a

single business over a period of several years.
• The first year is the base year and amounts for
subsequent years are presented not as dollar amounts but
as percentages of the base year amount, with the base
year assigned a value of 100%, or 100.
Horizontal trend
Income Statement
analysis
20x3 20x2 20x1
Net Sales 10,400 11,100 9,900

Less Cost of goods sold (3,200) (3,400) (3,000)

Gross profit $ 7,200 7,700
6,900
Less Operating expenses
Research and development (3,000) (1,800) (1,200)
Selling, general and administrative (1,500) (1,700) (1,400)
Operating income $ 2,700 4,200
4,300
Non-operating income and expenses:
Gains (losses) on equity securities (344) 388 382
Financial income:
Interest and dividend income 177 129 118
Earnings before interest and taxes $ 2,533 4,667
4,800
Interest expense (400) (400)
(400)
Earnings before tax (EBT) $ 2,133 4,267
4,400
Income tax expense (533) (1.067) (1,100)
Horizontal trend
Income Statement
analysis
20x3 20x2 20x1
Net Sales 10,400 11,100 9,900

Less Cost of goods sold (3,200) 105.1% (3,400) 112.1% (3,000) 100%
Gross profit $ 7,200106.7% 7,700
113.3% 100%
6,900
Less Operating expenses 104.3% 111.6% 100%
Research and development (3,000) (1,800) (1,200)
Selling, general and administrative (1,500) 250.0% (1,700) 150.0% (1,400) 100%
Operating income $ 2,700107.1% 121.4%
4,200 100%
4,300 62.8% 97.7% 100%
Non-operating income and expenses:
Gains (losses) on equity securities (344) N/M * 388 88.5% 382 100%
Financial income:
Interest and dividend income 177 150.0% 129 109.3% 118 100%
Earnings before interest and taxes $ 2,53352.8% 97.2%
4,667 100%
4,800 100.0% 100.0% 100%
Interest expense (400)
48.5% (400)
97.0% 100%
(400)
( 48.5%) ( 97.0%) 100%
Earnings before tax (EBT) $ 2,133 4,267
4,400 48.5% 97.0% 100%
Income tax expense (533) (1.067) (1,100)
AIncome
variation analysis showing
Statement 20x3growth 20x2
rates Growth
Rate
Net Sales 10,400 11,100

Less Cost of goods sold (3,200) (3,400) -6.3%

Gross profit $ 7,200 7,700 -5.9%
-6.5%
Less Operating expenses
Research and development (3,000) (1,800) 66.7%
Selling, general and administrative (1,500) (1,700) -11.8%
Operating income $ 2,700 4,200 -35.7%

Non-operating income and expenses:

N/M
Gains (losses) on equity securities (344) 388
Financial income:
37.2%
Interest and dividend income 177 129
-45.7%
Earnings before interest and taxes $ 2,533 4,667
0.0%
Interest expense (400) (400) -50%
-50%
Earnings before tax (EBT) $ 2,133 4,267 -50%

Income tax expense (533) (1.067)

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