6

Chapter
Earnings and Cash Flow
Analysis
Cash Flow is a Company’s
Lifeblood.
Earnings and Cash Flow
Analysis
Our goal in this chapter is to acquaint you
with the financial accounting concepts
necessary to understand basic financial
Goal statements and perform earnings and cash
flow analysis using these financial
statements.
 Sources of Financial
Information
• Company annual reports
• Internet
– The New York Stock Exchange at
http://www.nyse.com
• Securities and Exchange Commission
(SEC)
– Electronic Data gathering and Retrieval
(EDGAR) archives (including 10Ks and 10Qs)
accessible through the Internet (
http://www.sec.gov)
Financial Statements
Balance sheet
Accounting statement that provides
a snapshot view of a company’s
assets and liabilities on a particular
date.
Income statement
Summary statement of a firm’s
revenues and expenses over a
specific accounting period, usually
a quarter or a year.
Financial Statements
Cash flow statement
Analysis of a firm’s sources and
uses of cash over the accounting
period, summarizing operating,
investing, and financing cash flows.
 The Balance Sheet
• Asset - Anything a company owns that
has value.
• Liability - A firm’s financial obligation.
• Equity - An ownership interest in the
company.
• Fundamental accounting identity:
Assets = Liabilities + Equity
 7-8
The
Balance
Sheet
The Balance Sheet
 The Income Statement
• Income - The difference between a company’s
revenues and expenses, used to pay dividends
to stockholders or kept as retained earnings
within the company to finance future growth.

Net income = Revenues – Expenses

= Dividends + Retained earnings
The Income Statement
 The Cash Flow Statement
• Cash flow - Income realized in cash
form, whether from operations,
investments, or financing activities.
The Cash Flow Statement
 Performance Ratios and Price
Ratios
• Grossmargin= Gross profit
Net sales

• Operatingmargin= Operating income

Net sales

• Returnonassets(ROA)= Net income

Total assets
• Returnonequity(ROE)= Net income .

Stockholder equity
 Performance Ratios and Price
Ratios
• Book value = Stockholder equity
per share (BVPS) Shares outstanding
• Earnings = Net income .

per share (EPS) Shares outstanding

• Cash flow = Operating cash flow

per share (CFPS) Shares outstanding
 Performance Ratios and Price
Ratios
• Price-book (P/B) = Stock price
BVPS

• Price-earnings (P/E) = Stock price

EPS

• Price-cash flow (P/CF) = Stock price

CFPS
 Financial Statement
Forecasting
Pro forma financial statements
Statements prepared using certain
assumptions about future income,
cash flow, and other items. Pro
forma literally means according to
prescribed form.
The Pro Forma Income
Statement
The Pro Forma Cash Flow
Statement
 7 - 20

The Pro Forma Balance

Sheet
Projected Profitability and Price
Ratios
Borg Corporation
Original Optimistic
Pessimistic
Gross margin 22.22% 25% 20%
Operating margin7.78% 10.83% 3%
ROA 3.64% 7.70% .77%
ROE 7.29% 14.43% 1.54%
BVPS $25 $28.63 $24.88
EPS $1.82 $4.13 $.38
CFPS $3.32 $3.98 $.48
Projected Profitability and Price
Ratios
Borg Corporation
Projected
Stock Prices
Optimistic
Pessimistic
BVPS × P/B $45.81 $39.81
EPS × P/E $90.86 $8.36
CFPS × P/CF $47.76 $5.76
Adolph Coors Company
Case Study
Adolph Coors Company
Case Study
 7 - 25

Adolph Coors Company Case

Study
Adolph Coors Company
Case Study
Adolph Coors Company
Case Study
 7 - 28

Adolph Coors Company Case Study

 Adolph Coors Company
Case Study
Original + 10% – 10%
Gross margin 40.88% 40.88% 40.88%
Operating margin6.90% 9.99% 3.13%
ROA 5.97% 8.44% 2.95%
ROE 10.97% 14.95% 4.75%
BVPS $22.91 $26.18 $23.38
EPS $2.51 $3.91 $1.11
CFPS $4.62 $6.27 $3.47
Adolph Coors Company
Case Study

Projected
Stock Prices
+ 10% – 10%
BVPS × P/B $58.27 $52.03
EPS × P/E $79.46 $22.54
CFPS × P/CF $69.19 $38.26
1. Liquidity Measurement Ratios
2. Profitability Indicator Rat

Profitability Indicator Ratios: Profit

Margin Analysis
 ROA

Components:
As of December 31, 2005, with amounts expressed in
millions, Zimmer Holdings had net income of $732.50
(income statement), and average total assets of
$5,708.70 (balance sheet). By dividing, the equation
gives us an ROA of 12.8% for FY 2005.
 ROE

As of December 31, 2005, with amounts expressed in

millions, Zimmer Holdings had net income of $732.5
(income statement), and average shareholders' equity of
$4,312.7 (balance sheet). By dividing, the equation gives us
an ROE of 17% for FY 2005
 ROCE

As of December 31, 2005, with amounts expressed in

millions, Zimmer Holdings had net income of $732.50
(income statement). The company's average short-term
and long-term borrowings were $366.60 and the average
shareholders' equity was $4,312.70 (all the necessary
figures are in the 2004 and 2005 balance sheets), the sum
of which, $4,479.30 is the capital employed. By dividing,
the equation gives us an ROCE of 16.4% for FY 2005.
 Other financial indicators
3) Debt Ratios 5) Cash Flow Indicator Ratios
- Overview Of Debt - Operating Cash Flow/Sales Ratio
- Debt Ratio - Free Cash Flow/Operating Cash Ratio
- Debt-Equity Ratio - Cash Flow Coverage Ratio
- Capitalization Ratio - Dividend Payout Ratio
- Interest Coverage Ratio
- Cash Flow To Debt Ratio
6) Investment Valuation Ratios
4) - Price/Book Value Ratio
Operating Performance Ratios - Price/Cash Flow Ratio
- Price/Earnings Ratio
- Fixed-Asset Turnover - Price/Earnings To Growth Ratio
- Sales/Revenue Per Employee - Price/Sales Ratio
- Operating Cycle - Dividend Yield
- Enterprise Value Multiple
 Chapter Review
• Sources of Financial Information
• Financial Statements
– The Balance Sheet
– The Income Statement
– The Cash Flow Statement
– Performance Ratios and Price Ratios
 Chapter Review
• Financial Statement Forecasting
– The Pro Forma Income Statement
– The Pro Forma Cash Flow Statement
– The Pro Forma Balance Sheet
– Projected Profitability and Price Ratios
• Adolph Coors Company Case Study