Financial analysis

assets = liabilities + equity

assets consists of equipment, cash, inventory
liabilities consist of accounts payable, loans
equity consists of capital, retained earnings
why do your assets increase?
why your assets decrease?
both question have a relation with fundamental financial statements are balance
sheet, income statement, statement of cash flows
balance sheet
assets are a different form with liability and equity.
net income
revenues - expenses = net income
A business by assets generate revenues. in generating revenues, the business
requires a source to produce a product. the cost that is used to produce a product
called expenses.
cash flow contains cash in and out, then both thins have three categories simply are
operating activities, investing activities (investing in buying machine to enhance the
productivity
financing activities such borrowing money, repaying loan, cash from investors,
paying dividends.

ratio in finance
1. ROE return on equity
Equation of ROE = net income / stockholder equity
less than 10% is not good while more than 20% is good
applying the DuPont framework consists of three are profitability, efficiency, and
leverage
leverage ratio is how much money has been borrowed to purchase assets
leverage ratio equation: total assets/stockholder equity
efficiency ratio is measuring how much sales are generated from the company's
assets
equation of efficiency ratio total sales / total assets
profitability ratio measures how much income is generated from sales

ROE Profitability Efficiency Leverage

Net income/sales X Total sales/ assets Total assets /
X stockholders’
equity

DuPon framework
It has three components are leverage ratio, efficiency and profitability
As for leverage ratio : total assets / stockholder equity
Efficiency ratio : total sales / total assets
profitability ratio : net income / sales
return on equity (ROE) tell us how much income did we generate given a fixed
amount of stakeholder equity that has been invested by the owners in firm
common-size financial statements
it converts a company’s raw financial statement numbers into percentage of total
sales or percentage of total assets.
Each category in income statement / total sales
For an example

A firm B firm
8.000 Cost of goods sold 52.000
20.000 Total sales 130.000
40% 40%

Common-size income statement for A and B companies

A Company B company
Sales 100% 100%
Cost of goods sales -40% -40%
Wage expense -27.5% -23.1%
R&D expense -21.0% -12.3%
Advertising expense -8.0% -18.5%
Net Income -3.5% -6.2%

Common-size balance sheet

How to convert each category in balance sheet into percentage by dividing to total
assets
So, each category in balance sheet / total assets
For an example:
 A firm B firm
8.000 Property, plant, and 40.000
equipment
20.000 Total sales 130.000
40% 30.8%

Common-size balance sheet for a and b companies

A Company B company
Cash 3.5% 3.5%
Account receivable 20.0% 11.5%
Inventory 9.0% 13.1%
Property, plant, and 40% 30.8%
equipment
Total assets 72.5% 58.8%

The many ways to define income and profit

We will perceive on the income statement a lot of terms of income, profit, margin,
but they are interchangeable.
For an example of an income statement

Revenue 110.360
Cost of revenue 38.353
Gross margin 72.007
Research and development 14.726
Sales and marketing 17.469
General and administrative 4.754
Operating income 35.058
Other income (expenses), net 1.416
Income before income taxes 36.474
Provision for income taxes 19.903
Net income 16.571

Operating income, also known as operating profit, represents the amount of

income generated from a company's core business operations. For example, in the
case of Microsoft, it includes the income from selling Xboxes, cloud computing
services, and software. It excludes revenues, expenses, gains, and losses that are
not related to the day-to-day operations of the business.
Operating Income is the resource a company generates from doing what it is in
business to do, which in this case is selling floral displays.
Interchangeable
The operating cycle
it depicts operating activity of a firm begins process of production of product then
selling products in market and collecting money from buyers. how long operating
activity takes, it explains operating cycle.
What is purpose to know the operating cycle?
Understanding the operating cycle is crucial for several reasons:
 Inventory Management: It helps businesses manage how long they hold
inventory, which can reduce storage costs and improve cash flow.
 Receivables Management: By knowing the operating cycle, companies can
better manage their receivables, ensuring timely payments from customers.
 Efficiency Measurement: It provides direction on which aspects of the
business to manage and helps measure the effectiveness of those efforts.
two efficiency ratios
1. Number of days’ sales in inventory means how long on average does an
inventory of company stay in the wallet or shop of company before selling?
2. Average collections period means how long on average days of payment for a
product or an inventory in credit contract?
Formula of operating cycle
Operating cycle = number of day’s sales in inventory + average collections period
There are two ratios of the operating cycle are
1. Number of days’ sales in inventory (how long the inventory stays with seller
until it is sold)
2. Average collections period (sales of product with credit contract, how long
buyer pay it back completely)
Both things form the operating cycle formula, like this
Operating cycle = number of days’ sales in inventory + average collection period
Number of days’ sales in inventory describes turnover of inventory starts from
production and selling product, how many times in year so the formula for it is
following
Days’s sales in inventory = cost of goods sold/average inventory for the year
For an example

Walmart target
Beginning inventory 43.783 8.597
Ending inventory 44.269 9.497
Average inventory 44.026 9.047
Cost of goods sold 385.301 53.299
Inventory turnover 8.75/year 5.89/year
Days sales in inventory 42 62
Days sales in inventory formula
Year / 8.75 / 365/ 8.75 = 42 days
business converts the fund into inventory, if the inventory was not sold in market,
their money would not come back to them till the inventory was sold. It means days’
sales in inventory is a significant thing for businesses. If business sells inventories as
fast as possible, business will increase the revenue and profit.
Average collection period
It describes how many days buyer pays back the debt of inventory payment in a
credit contract. Since money is a tool of transaction, a business is not able to
produce inventory again, if the fund of production in previous has not returned
completely.
From this ratio we conclude that there are many types of businesses, business has
Leverage
Leverage is a term used in finance to depict a productive debt. For example, a
business that produces a pair of shoes borrows fund to buy a machine in order to
improve the production of shoes, so the debt called as a leverage. In the finance,
leverage is part of return of equity, it means the increase in leverage meaning
increasing assets, then the increase of assets affects the increase in sales then it
increases revenue.
Debt ratio
Debt to equity is a financial ratio that measures the relative proportion of a
company's debt and equity used to finance its assets. It's used to assess a
company's financial leverage and how much of its operations are funded by
borrowed money compared to owners' equity.
Here’s the formula for the debt-to-equity ratio:

Debt to equity ratio Debt

Equity
Total debt refers to all the money a company owes to external parties, such
as loans and bonds.
Total equity refers to shareholders’ equity, which is the money invested by
the owners and shareholders.
Interpretation:
 A higher ratio means the company is relying more on debt to finance
its operations, which may increase financial risk.
 A lower ratio indicates that the company is primarily financed by
equity, which is typically seen as less risky but might also limit
potential growth opportunities.
For example:
 A ratio of 1.0 means that the company has equal amounts of debt and
equity.
 A ratio of 2.0 means that the company has twice as much debt as
equity.
Debt ratio consists of three ratios are long-term debt to assets, debt to
equity, and asset to equity.

An example of question
TechSales is a profitable tech company. Compared to other tech companies, it
has lower assets to equity and debt-to-equity ratio. What does this mean?
Assets = liabilities (leverage) + equity (owner’s equities + external
investments)
a. Techsales has high leverages compared to similar companies (the
techsale use debt to finance the company’s financial so that techsale
can increase revenue)
b. TechSales has higher debt than similar companies (higher debt does
not mean that debt is not used to finance the asset, that it might debt
be utilized to finance utilities of company)
c. Techsales purchases more assets with owners’ equity than similar
companies (it purchases more assets means the equity more than
liabilities or debt or companies is lower risk because it does not have
much debt)
d. Techsales has low leverage compared to similar companies (low debt to
equity ratio, in which the company does not rely on debt to finance its
operations, assets and growth.
Payroll refers to the total amount of money that a company pays to its
employees. It includes salries, wages, bonuses, and deductions. In the
context of the video, the payroll of a baseball team like the Yankees or red
sox represents the total salaries paid to their players and staff.