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Balance Sheets

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Balance Sheets
A balance sheet is a snapshot of a business financial condition at a specific moment in time, usually at
the close of an accounting period. A balance sheet comprises assets, liabilities, and owners or
stockholders equity. Assets and liabilities are divided into short- and long-term obligations including
cash accounts such as checking, money market, or government securities. At any given time, assets
must equal liabilities plus owners equity. An asset is anything the business owns that has monetary
value. Liabilities are the claims of creditors against the assets of the business.

What is a balance sheet used for?

A balance sheet helps a small business owner quickly get a handle on the financial strength and
capabilities of the business. Is the business in a position to expand? Can the business easily handle
the normal financial ebbs and flows of revenues and expenses? Or should the business take
immediate steps to bolster cash reserves?
Balance sheets can identify and analyze trends, particularly in the area of receivables and payables. Is
the receivables cycle lengthening? Can receivables be collected more aggressively? Is some debt
uncollectable? Has the business been slowing down payables to forestall an inevitable cash shortage?
Balance sheets, along with income statements, are the most basic elements in providing financial
reporting to potential lenders such as banks, investors, and vendors who are considering how much
credit to grant the firm.

1. Assets
Assets are subdivided into current and long-term assets to reflect the ease of liquidating each asset.
Cash, for obvious reasons, is considered the most liquid of all assets. Long-term assets, such as real
estate or machinery, are less likely to sell overnight or have the capability of being quickly converted
into a current asset such as cash.

2. Current assets
Current assets are any assets that can be easily converted into cash within one calendar year.
Examples of current assets would be checking or money market accounts, accounts receivable, and
notes receivable that are due within one years time.

Cash
Money available immediately, such as in checking accounts, is the most liquid of all short-term assets.

Accounts receivables
This is money owed to the business for purchases made by customers, suppliers, and other vendors.

Notes receivables
Notes receivables that are due within one year are current assets. Notes that cannot be collected on
within one year should be considered long-term assets.

3. Fixed assets
Fixed assets include land, buildings, machinery, and vehicles that are used in connection with the
business.

Land
Land is considered a fixed asset but, unlike other fixed assets, is not depreciated, because land is
considered an asset that never wears out.

Buildings
Buildings are categorized as fixed assets and are depreciated over time.

Office equipment
This includes office equipment such as copiers, fax machines, printers, and computers used in your
business.

Machinery
This figure represents machines and equipment used in your plant to produce your product. Examples
of machinery might include lathes, conveyor belts, or a printing press.

Vehicles
This would include any vehicles used in your business.

Total fixed assets

This is the total dollar value of all fixed assets in your business, less any accumulated depreciation.

4. Total assets
This figure represents the total dollar value of both the short-term and long-term assets of your
business.

5. Liabilities and owners equity

This includes all debts and obligations owed by the business to outside creditors, vendors, or banks
that are payable within one year, plus the owners equity. Often, this side of the balance sheet is simply
referred to as Liabilities.

Accounts payable
This is comprised of all short-term obligations owed by your business to creditors, suppliers, and other
vendors. Accounts payable can include supplies and materials acquired on credit.

Notes payable
This represents money owed on a short-term collection cycle of one year or less. It may include bank
notes, mortgage obligations, or vehicle payments.

Accrued payroll and withholding

This includes any earned wages or withholdings that are owed to or for employees but have not yet
been paid.

Total current liabilities

This is the sum total of all current liabilities owed to creditors that must be paid within a one-year time
frame.

Long-term liabilities
These are any debts or obligations owed by the business that are due more than one year out from the
current date.

Mortgage note payable

This is the balance of a mortgage that extends out beyond the current year. For example, you may
have paid off three years of a fifteen-year mortgage note, of which the remaining eleven years, not
counting the current year, are considered long-term.

Owners equity
Sometimes this is referred to as stockholders equity. Owners equity is made up of the initial
investment in the business as well as any retained earnings that are reinvested in the business.

Common stock
This is stock issued as part of the initial or later-stage investment in the business.

Retained earnings
These are earnings reinvested in the business after the deduction of any distributions to shareholders,
such as dividend payments.

6. Total liabilities and owners equity

This comprises all debts and monies that are owed to outside creditors, vendors, or banks and the
remaining monies that are owed to shareholders, including retained earnings reinvested in the
business.

Financial Statement Basics

by Angie Mohr
Author of Numbers 101 For Small Business

You hear about financial statements all the time. Your accountant prepares them. Your banker wants
to see them. You know that they tell some kind of story about your business. But what are the
"financial statements" everyone refers to? If you have access to your statements, go get them now
and follow along.

The Balance Sheet

This is usually the first statement in your package. The purpose of the balance sheet is to give a
snapshot of what your business owes and owns at a certain point in time. At the top of the statement
will be an "As of" date. This is the date (usually your businesss year end) that the balance sheet
reflects.

There are three main sections of your balance sheet. "Assets" (as you might suspect) list the types of
assets that your company owns. "Liabilities" show you what your business owes- to the bank, to the
government and to others. The last section is called "Equity". This section shows you what your net
interest is in the business.

Youll notice that the total equity equals the assets minus the liabilities. Another way to view equity is
that it is what would be left if you wound up the company and paid out all the liabilities with the
assets.

One important note is how your balance sheet is valued. All of your financial statements are (with few
exceptions) valued at the cost that you made the original transaction at. For example, if your
company purchased the building that you operate in for $50,000 ten years ago and it is now worth
$150,000, it will appear on your balance sheet at its original $50,000 cost minus depreciation. Your
balance sheet is not a good indicator of the value of your business, only the historical transactions.
There is great debate in the accounting community about whether historical cost is the correct
valuation method (proponents suggest that it is, at least, the most objective method), but for our
purposes here, it is sufficient to note that it is historical cost that appears on your financials.

The assets and liabilities on your balance sheet are divided into "Current" and "Long Term". This is
an important distinction and one that your banker will look at closely. Well talk about ratio analysis in
future columns but for now, just note that it is important to have at least enough current assets to
cover current liabilities.

The Income Statement

The second statement in your package is usually the income statement. At the top of this statement
will be wording to the effect of "For the period ended". Where the balance sheet shows you a pointin-time snapshot, the income statement shows you your business activities for a period of time,
usually a year.

The first line or grouping of lines on the income statement shows you the revenues for the year. They
may be called "Revenue" or "Sales" or "Gross Income", depending on the style of your statements.
The revenue is the gross amount of income earned from your business activities, less the sales
taxes. It is important to note that your sales will appear here even if you havent collected the money
yet. Financial statements are generally prepared using the accrual method, which places revenue and
expenses into the period in which they are earned, not collected.

Following the revenue section is a listing of the expenses. You may find this list in alphabetical, size
or no particular order. My personal preference is to list them in alphabetical order to make it easier to
locate a particular expense, but you may prefer another method, which is just fine.

Your revenue minus your expenses is called the "Net Income". This is the amount that the business
will keep and add to the equity. At the bottom of the income statement, you may find a reconciliation
of the equity. It will start with the income earned in the current year, add the opening equity, and
subtract any dividends paid out to the shareholders in the year. The ending equity will be the same
equity number found on your balance sheet.

Cash Flow Statement

This is probably the least understood but most useful of all the financial statements. The purpose of
the cash flow statement is to show you where the money went during the year.

There are two main classifications on the cash flow statement; sources of cash and uses of cash.
Every transaction the business has entered into in the year has either been a source or use of cash.
The main source of cash, of course, is your net income. Other common sources are; collection of
accounts receivable, loan proceeds, and incurring payables instead of paying cash. Common uses of
cash are; paying payables, paying down debt and buying equipment or inventory.

At the end of your cash flow statement, your current cash balance shows. The statement has
reconciled your opening cash to your closing cash.

Many small business owners ask me "Where did all the money go?" This statement shows them.

In future articles, we will look at how to read the story of your financial statements and predict the
path on which your business is headed.

Angie Mohr

What Banks Look for in Your Financial Statements

Small business loans are on the rise. Between 1996 and 2003, banks with more than $10 billion
in assets upped their share of business loans under $100,000 to 40% from 18%, reports the
Office of Advocacy of the U.S. Small Business Administration. What should business owners be
representing in their financial statements to meet the needs of lenders and quicker turn around on
a loan request?
The financial statements of a small business are the foundation for any financing, venture funding
or business transactions. No matter how small the business may be, accurate and reliable
balance sheets and income statements go a long way toward instilling confidence with your
bank's loan officer.
'Understanding the components of an income statement and balance sheet can really streamline
the loan application process,' says David Prather, Fiducial's accounting and financial reporting
product manager. 'That's why it's so important to have a firm handle on business finances before
you seek financing or funding to seek expert advice when preparing monthly, quarterly and
annual statements. One incorrect filing or lack of supporting documentation can put your business
under scrutiny with both your bank and the IRS.'
Primary financial statements are represented in the balance sheet and income statement and will
be requested by the lending institution at your initial loan meeting. These are important since they
demonstrate a roadmap for success for the business. Banks will use financial statements to spot
trends and anomalies and then follow up with further investigation. If the company's accounts
receivables (A/R) have trended significantly downward over the last few years it could mean that
you're collecting the accounts more aggressively (a positive) or it could mean that you're writing
off the losses sooner (a negative) rather than pursuing collection. Either way, it will provide insight
to the bank on how you operate your business and what type of risk you might be.
Here's a breakdown of the most important components of both the income statement and balance
sheet. See how your business' financial statements measure up:
Income statement
Profit and loss statement-The income statement shows all income receipts and expense
payments over a period of time. It also shows the profitability of the business. The income
statement does not reveal hidden problems like insufficient cash flow concerns and for that
reason, steps can be taken to adjust the statement and create a slightly healthier outlook. Be sure
to provide ample documentation for what you report. When in doubt seek expert advice.
The statement also includes sales, cost of goods sold, gross profit, operating expenses,
depreciation, operating profit, other income and expenses, net profit before taxes, income taxes
and net profit after taxes.
Typically, banks are looking for three years' worth of income statement data to make comparisons
and business trending reports.
Balance sheet

The balance sheet shows a snapshot of the company's financial statements at a single moment in
time. It shows the company's financial position (assets = liabilities + equity) and outlines liabilities
and net worth. The balance sheet has to balance-if it does not, it can cause much angst to a
small business owner who is already struggling with monthly accounting.
Analyzing how the balance sheet changes over time reveals important information about the
company's business trends. It can depict how you manage the business' inventory, reveal your
ability to satisfy creditors and stockholders, and ultimately demonstrate the net worth of the
business.
Other items in the balance sheet include liabilities and net worth as well as assets. Liabilities
represent company's sources of funds. Those who provide cash or its equivalent to the company
and the company's obligations to its creditors (what you owe) are liabilities. Net worth represents
the owner's investment in the company. Assets are anything of value that is owned by the
business. There are many different kinds of assets including cash, accounts receivable, inventory,
machinery, vehicles, buildings and property. The value of those assets reflect a dollar amount in
your asset column but not cash in your checking account.
After you've polished your financial statements, it's time to gather your courage and walk into the
bank. When sitting with the bank's loan officer, small business owners should know which
principles will guarantee the loan and should include a personal financial statement and at least
one year of tax returns with the loan application. Do your own due diligence with the bank and the
loan officer. There should be an open and frank dialogue to determine if the bank is a good fit for
you and your business. Remember that the loan officer is your advocate to the lending
committee. If you don't feel that the loan officer is fully engaged and will advocate to the loan
committee on your behalf, then move on to another bank.
Unless the bank needs to see them more frequently, quarterly should be sufficient.
'Remember that the bank will also consider what software applications were used to record the
transactions and compile the financial statements,' says Prather. 'The easier it is to alter the
financial statements, the less reliable they become. Having a system of checks and balances and
a solid paper trail will provide additional assurance that what is represented is accurate and
reliable.'
To learn more about financial statements and how they can impact your business' future, contact
a Fiducial representative today at 888-FIDUCIAL or visit the web site at www.fiducial.com.
Fiducial Investment Advisors, Inc. is a member of the NASD and SIPC. Some investments may
not be suitable for all investors. Please consult with one of our professionals. Fiducial Investment
Advisors, Inc. is licensed to transact business in all states and the District of Columbia as a
broker/dealer.

Financial Statement Basics

by Angie Mohr
Author of Numbers 101 For Small Business

You hear about financial statements all the time. Your accountant prepares them. Your banker wants

to see them. You know that they tell some kind of story about your business. But what are the
"financial statements" everyone refers to? If you have access to your statements, go get them now
and follow along.

The Balance Sheet

This is usually the first statement in your package. The purpose of the balance sheet is to give a
snapshot of what your business owes and owns at a certain point in time. At the top of the statement
will be an "As of" date. This is the date (usually your businesss year end) that the balance sheet
reflects.

There are three main sections of your balance sheet. "Assets" (as you might suspect) list the types of
assets that your company owns. "Liabilities" show you what your business owes- to the bank, to the
government and to others. The last section is called "Equity". This section shows you what your net
interest is in the business.

Youll notice that the total equity equals the assets minus the liabilities. Another way to view equity is
that it is what would be left if you wound up the company and paid out all the liabilities with the
assets.

One important note is how your balance sheet is valued. All of your financial statements are (with few
exceptions) valued at the cost that you made the original transaction at. For example, if your
company purchased the building that you operate in for $50,000 ten years ago and it is now worth
$150,000, it will appear on your balance sheet at its original $50,000 cost minus depreciation. Your
balance sheet is not a good indicator of the value of your business, only the historical transactions.
There is great debate in the accounting community about whether historical cost is the correct
valuation method (proponents suggest that it is, at least, the most objective method), but for our
purposes here, it is sufficient to note that it is historical cost that appears on your financials.

The assets and liabilities on your balance sheet are divided into "Current" and "Long Term". This is
an important distinction and one that your banker will look at closely. Well talk about ratio analysis in
future columns but for now, just note that it is important to have at least enough current assets to
cover current liabilities.

The Income Statement

The second statement in your package is usually the income statement. At the top of this statement
will be wording to the effect of "For the period ended". Where the balance sheet shows you a pointin-time snapshot, the income statement shows you your business activities for a period of time,
usually a year.

The first line or grouping of lines on the income statement shows you the revenues for the year. They
may be called "Revenue" or "Sales" or "Gross Income", depending on the style of your statements.
The revenue is the gross amount of income earned from your business activities, less the sales
taxes. It is important to note that your sales will appear here even if you havent collected the money
yet. Financial statements are generally prepared using the accrual method, which places revenue and
expenses into the period in which they are earned, not collected.

Following the revenue section is a listing of the expenses. You may find this list in alphabetical, size
or no particular order. My personal preference is to list them in alphabetical order to make it easier to
locate a particular expense, but you may prefer another method, which is just fine.

Your revenue minus your expenses is called the "Net Income". This is the amount that the business
will keep and add to the equity. At the bottom of the income statement, you may find a reconciliation
of the equity. It will start with the income earned in the current year, add the opening equity, and
subtract any dividends paid out to the shareholders in the year. The ending equity will be the same
equity number found on your balance sheet.

Cash Flow Statement

This is probably the least understood but most useful of all the financial statements. The purpose of
the cash flow statement is to show you where the money went during the year.

There are two main classifications on the cash flow statement; sources of cash and uses of cash.
Every transaction the business has entered into in the year has either been a source or use of cash.
The main source of cash, of course, is your net income. Other common sources are; collection of
accounts receivable, loan proceeds, and incurring payables instead of paying cash. Common uses of

cash are; paying payables, paying down debt and buying equipment or inventory.

At the end of your cash flow statement, your current cash balance shows. The statement has
reconciled your opening cash to your closing cash.

Many small business owners ask me "Where did all the money go?" This statement shows them.

In future articles, we will look at how to read the story of your financial statements and predict the
path on which your business is headed.

Angie Mohr

Reading and understanding your statement of income or

profit and loss statement
Ask About This Article
12th January 2009
Author: Victorino Q. Abrugar
Views: 162
Among the four basic components of financial statements (the balance
sheet, statement of changes in equity, income statement and cash flow statement), the
statement of income is the most interesting and exciting to read by its common users. This is
true, since it indicates if an entity is having a profit or a loss, and that every business owners,
investors, creditors and even the tax authorities may primarily want to see and know first if an
entity is earning or making money out of running its business and utilizing its resources.
An income statement also called profit and loss statement (P&L) or sometimes prepared as
statement of operation, is a formal statement showing the performance of an entity for a
given period of time. The performance of the entity is primarily measured in terms of the level
of income earned by the entity through the effective and efficient utilization of its resources.
Income statement indicates how revenue (money received or receivable earned from the sale
of products and services before costs and expenses are taken out) is transformed into net
income or net profit (the result after all revenues, costs and expenses have been accounted
for). This income performance is used to be known as the results of operations of the entity.
Different from common entities, a non-profit organization does not prepare an income
statement or a profit and loss statement since it is established not to earn money but to carry
out its purpose like charity, environment care, cultural development and other activities to
help the society. Thats why they are usually exempted from income tax. The formal statement
prepared by these organizations to show their performance is called statement of supports,
revenues and expenses. A fund accounting method is usually used on these types of entities.
Actually the statement of revenues, support and expenses are the same with the statement of
income
although
the
term
income
or
profit
is
not
used.

The information about the performance and profitability of an entity is useful in predicting the
capacity of the entity to generate cash flows from its existing resources. It is also useful in
forming judgment about the effectiveness of employing additional resources. Owners and
investors of the entity use the income statement to determine if the entity made or lost money
for a given period of time. In others words it is used to know if the entity is earning or losing.
It also tells us if production and employment of products or services for sell will give us
additional
profit
or
loss.
The income statement is prepared for a given period of time. In other words, a period must
expire before the performance of an entity can be properly measured. The income statement
covers a period, unlike a balance sheet which is prepared as of given date or particular
moment in time. For example a company that prepares financial statements on a calendar
year December 31, 2007, its balance sheet should be dated as of December 31, 2007 and its
income statements should be dated for the year ended December 31, 2007. If financial
statement is prepared only for a six-month from June 1, 2007 to December 31, 2007, its
balance sheet should still be dated as of December 31, 2007 since it is for the point of time,
while its income statement will be dated for the six-month period ended December 31, 2007
which means the statement is a report for the six month period time from June 1, 2007 to
December
31,
2007.
The components of income statement are revenues, expenses and net income (the income
after deducting all of cost and expenses during the accounting period). Revenues include sales
of products or services. It may also be deducted by sales discounts or sales refunds. Revenues
are recognized whether they are already collected or not. This is called the accrual basis of
accounting. Revenue is recognized as it is earned regardless of being received or not. For
example, a company that sells canned goods, the sales from canned goods to customers is
recognized as revenue once the ownership of the goods is transferred to the customer
regardless of whether the price money is already collected in the form of cash or cash in bank
or not collected in the form of an accounts receivable. Revenue or income is defined as
increase in economic benefit during the accounting period in the form of inflow or increase in
asset or decrease in liability that results in increase in equity, other than contribution from
equity participants. In other words, it is an inflow of future economic benefit that increases
equity or capital, other than contributions by owners, proprietor (single proprietorship),
partners (partnership) or stockholders (corporation).

Other sources of revenue includes income from rendering of service (accountants fees,
lawyers fees, insurance agent commissions, talent fees, etc.); use of the companys resources
(interest, rents, royalties and dividend income); and disposals of resources other than
products (gains on sale of investments, property and equipment and intangible assets).
An expense is defined as decrease in economic benefit during the accounting period in the
form of outflow or decrease in asset and increase in liability that results in decrease in equity,
other than distribution to equity participants. In simple words, it is an outflow of future
economic benefit that decreases equity, other than drawing paid to proprietors and partners or
dividend
paid
to
stockholders.
Generally, expenses include cost of sales, selling expenses, administrative expenses, other
expenses and income tax expense (if an entity is subject to income tax).The cost of sales is
the direct costs attributable to the cost of products or services sold. In an analytical view, it is

the sales after deducting your mark-up on the goods or services sold. Cost of sales is used to
determine the gross profit amount and ratio of a certain entity. Gross profit is what you get
after deducting cost of sales from your total revenues. Gross profit is computed by dividing
your
gross
profit
to
your
total
revenues.
The cost of sales of a merchandising company is composed of goods available for sale
(beginning inventory plus net purchases) minus ending inventory. While the cost of sales of a
manufacturing company consists of raw materials used (beginning raw materials plus net
purchases less ending raw materials), plus direct labor, plus factory overhead, plus beginning
goods in process, less ending goods in process, plus beginning finish goods, less ending finish
goods.
Selling expenses constitute costs which are directly related to selling, advertising and delivery
of goods to customers. These include sales commissions, salesman salaries and traveling
expenses, marketing expenses, advertising expenses, freight-out, depreciation of delivery
equipment and store equipment, and other expenses related directly to selling activities.
Administrative expenses represent cost of administering the business. This includes all
operating expenses not related to selling and cost of goods sold. Examples of administrative
expenses include salaries of general officers and of administrative staff or employees, office
supplies, taxes and licenses, depreciation of administrative building and equipment, insurance,
amortization
of
intangible
assets
and
doubtful
account
expense.
Other expenses or charges are those expenses which are not directly related to the expenses
discussed in the preceding paragraphs. These include charges to income such as loss on sale
of property and equipment, loss on sale of long-term investments and other losses.
After recognizing and understanding an entitys revenues and all its expenses including income
tax, we realize that what is left after deducting all expenses from all income is the net income
or net profit if the entity is performing efficiently and effectively, and net loss if the entity is
ineffectively and inefficiently employing its resources. However a certain entity having net loss
for a certain period of time cannot be absolutely judged that it is performing poorly in doing
business. A particular company may incur losses because of the fact that it is only in its early
years of operations since its establishment. Therefore, it is always a wise move if we read and
analyze income statement for a series of years instead of reading it for only a year or two year
periods of time. There are also some qualitative factors that we might need to consider like its
participation
to
our
society
and
protection
of
our
environment.

The author is a Certified Public Accountant. He has been in the public practice of accounting
and business professional services for more than four years. You can visit his site for more
business
articles
and
insights
at
www.BusinessAccent.Com
/
www.BusinessPull.Com
A balance sheet differs from an income statement in terms of what it describes. An income statement covers a
range or period of time such as a month or a year. An income statement describes how much money came into an
organization during a period of time, how much went out as expenses, and what was left at the end of the period. A
balance sheet is usually generated to show a snapshot of what an organization owns or owes on the last day of
the period covered by the income statement. The balance sheet describes what the organization owns or owes to
keep making or paying money during the next period of time covered by the next income statement.

As an analogy, say that two individuals tracked

how much salary each brought in during the
year and what expenses each had during that
year. At the end of the year, these individuals
find that they started with exactly the same
salary, had exactly the same amount of money
go out as expenses, and had exactly the same
amount of money left as a net profit or loss at
the end of the year. If you were to examine
their balance sheets, however, you
would find two very different
pictures. Much more of the first persons
expenses went toward buying stocks, bonds,
and real estate. The second persons
expenses went to into buying the latest
fashions and taking lavish vacations. At the
end of the year, the first persons investments
paid off, consequently, he or she has much
more in personal assets than in debts. The
second person has less in assets and much
more in debt.
The types of things that each person owns and
owes are very different. Likewise, the
proportion (or balance) of the amount each
owns versus the amount each owes is very
different. Finally, the first person is in a better
position to make even more money in the next
time period because his or her investments
should help generate even more revenue. The
second person is not in as good a position to
bring in as much money next year. If the first person becomes unemployed, there is a cushion (some assets) to fall
back on at least for a little while! The second person would be in a tough spot if he or she were laid off because
there is no asset cushion to weather a period of unemployment.
In essence, the income statement tells you how much money came in and how much went out. The balance sheet
tells you what the money turned into. The statements are related but different. A good manager or a good WLP
professional must understand both.

Dissecting a Balance Sheet

On a balance sheet, the total amount of assets must always equal the total amount of liabilities and owners equity.
The balance sheet changes constantly. Money flows in and out of an organization as it receives payments,
purchases goods, and makes other daily transactions. For this reason, the balance sheet is considered a snapshot
of the mix of assets, liabilities, and owners equity on a single specified date.
In reality, there can be many unique types of assets and liabilities that an organization can use to produce income.
Senior managers must manage the relative proportion of each type of asset, liability, and owners equity within the
balance sheet and between the balance sheet and the income statement. Whether the organization is maintaining
the appropriate proportions, or balance, is tracked by calculating ratios of how big one item is relative to another.
When communicating value, it is important to know that every item on a balance sheet has an optimal range for its
size. What that optimum is varies depending on the organization and its industry norms. It will be important for you
to discover the appropriate proportions for your target organization because anything that is out of proportion may
signal a financial problem. If you can offer interventions that create better proportions, you will get the attention of
your audience.
On a balance sheet, assets that will be converted into cash within a year are known as current assets.

A common example of a long-term asset is a manufacturing plant. ABC MediCompanys manufacturing plants are
included under the item known as property, plant, and equipment. Liabilities that will be paid within a year are
known as current liabilities. Liabilities that will not be paid within a year are known as long-term liabilities.
The items on a balance sheet can be listed in
any order. For assets, cash is often at the top
of the list. Some accountants list items in order
of their size. Others list assets in the order in
which they can be most easily converted to
cash, with cash being at the top of the list.
Converting an asset into cash is called making
the asset liquid. The easier it is to turn
something into cash, the more liquidity the item
has. Liabilities can be listed in the same way,
with the items needing the most immediate use
of cash listed first. Other liabilities and then the
owners equity may follow in descending order
of their need for cash.
Checking the Balance: Ratios
Now that you have a basic understanding of
the items contained in the income statement
and contained in the balance sheet, it is time to
compare the size or proportion of different
items to each other. This comparison is known
as checking the balance, or the ratios, of an organization. Ratios tell Senior managers and savvy WLP
professionals where problems exist and can hint at what interventions might create the most value by bringing the
items back into balance.

COPYRIGHT 2006 Euromoney Institutional Investor PLC. Internal use only 10 copy limit. No
further use w/o permission. Publisher@euromoneyplc.com.
Financial statements are prepared to help investors and creditors understand the financial
history of a company and use that knowledge to predict the amount, timing and uncertainty of
both future cash flows (interest, principal payments and dividends) and price appreciation.
While investment and credit decision models vary widely, most financial statement analyses
rely on a common set of techniques. The purpose of this article is to introduce and illustrate
those techniques. (1) We provide an overview of financial statement analysis, introducing the
major dimensions of financial performance and common analytical techniques. Subsequent
sections discuss popular financial ratios and their implications for management. We conclude
by introducing the DuPont analysis approach.
Overview of Financial Statement Analysis
The terminology of financial statement analysis varies from source to source in much the same
way that financial statement captions differ across companies. The differences, however, are
mostly unimportant. Whatever names and categories are applied, financial statement analysis
is an attempt to answer four broad questions. These questions define the major dimensions of
financial performance, referred to throughout the remainder of this article: profitability and
market performance, liquidity, efficiency and capital structure.
* Profitability and market performance. Is the company generating sufficient profits to provide
satisfactory returns to investors and attract financial capital?
* Liquidity. Is the company likely to meet its financial obligations on a timely basis?
* Efficiency. Are the financial resources invested in the company being used efficiently?
* Capital structure. Does the company's financial structure provide a foundation for long-term
growth and profitability?

Each of these financial performance dimensions may be assessed using a variety of measures.
While a single number extracted from the financial statements (such as net income or cash
flow from operating activities) can provide significant information, most analytical techniques
involve combining multiple items to produce metrics that can be compared across companies
and over time.
Exhibit 1 presents five-year comparative income statements and balance sheets for a
hypothetical company. These statements provide the raw data for many of the analyses that
follow.
Horizontal Analysis
Horizontal analyses track changes in financial statement line items over time and may take
two forms. The first is a simple percentage change that compares the current-year amount to
the prior-year amount. Exhibit 2 shows the percentage changes for individual income
statement items from 2000 to 2004. Our hypothetical company has experienced growth in
every income statement category in each of the last four years. However, because the growth
in expenses has outpaced sales, net income has lagged. The discussion of ratio analysis
(below) explores this issue in greater detail.
Some analysts prefer to compute trend percentages, expressing every year as a percentage of
a base (100 percent) year. Exhibit 3 illustrates trend percentages on the income statement
over the same five-year period for the same hypothetical company. While the same patterns of
sales and expense growth are evident in Exhibit 3 as in Exhibit 2, the use of trend percentages
brings the entire five-year period into sharper focus. Note that 2004 sales have grown to
149.1 percent of the 2000 level. However, cost of goods sold and operating expenses are
152.8 percent and 162.7 percent of the 2000 amounts, respectively.
Percentage changes and trend percentages help readers assess the importance of dollar
changes. They also facilitate comparisons across companies of varying sizes. While Exhibits 2
and 3 illustrate these computations using income statement numbers, they may be computed
for any financial statement item.
Vertical Analysis
Vertical analysis highlights the relationships that exist among financial statement items within
the same year and identifies changes in those relationships over time. A vertical analysis of
the income statement expresses each line item as a percentage of sales (Exhibit 4), while the
same technique applied to a balance sheet results in each line item expressed as a percentage
of total assets (Exhibit 5). The product of a vertical analysis is generally referred to as a
common-size statement. Common-size balance sheets bring the composition of assets and
liabilities into focus, while common-size income statements highlight the relationship between
expense items and sales. Exhibit 4 provides another perspective on the expense factors that
have kept our hypothetical company's net income from keeping pace with growth in sales.
Note that cost of goods sold has grown from 58 percent of sales in 2000 to 59.5 percent of
sales in 2004. Operating expenses have grown from 24.1 percent of sales to 26.3 percent of
sales during the same period. While the changes in percentage amounts appear relatively
small, their effect on net income can be relatively large, given that net income ranges from 11
percent to 8.5 percent of sales over the five-year period.
Preliminary Observations About Financial Statement Ratios
Financial statement analysis also involves constructing ratios using multiple financial
statement amounts. We will discuss some of the most common ratios and their
interpretations. The ratios are organized according to the dimension of financial performance
assessed. A few caveats are in order before proceeding to the individual ratio definitions.
First, financial statements--and the ratios derived from them--are based on financial
statement data that reflect many choices, estimates and assumptions. Estimated useful lives

and salvage values, inventory cost flow assumptions, revenue recognition methods and
estimates of uncollectible receivables are examples of management judgments that influence
reported results and financial position. Accordingly, financial statement analysts should resist
the "illusion of precision" that is a natural by-product of neatly aligned, double-underlined
columns of figures and ratios carried to three decimal places. Financial ratios are signals,
indicators and pieces of a larger puzzle--not precise tests and cutoffs.
Second, a complete ratio analysis incorporates significant redundancies. The return on assets
and return on stockholders' equity, for example, convey much of the same information about a
company's profitability. The current ratio and quick ratio both zero in on a company's ability to
meet its financial obligations on a timely basis. A set of efficiency ratios presents a
constellation of evidence about efficiency, with differences between individual ratios isolating
particular aspects of the company's performance. In short, there is no universally accepted
system for combining multiple ratios to arrive at an answer. Interpreting the results of a ratio
analysis is as much art as science.
Third, the names and definitions of financial ratios vary from source to source. The variations
are generally minor but can impair comparability. Likewise, the organization and detail in
financial statements may vary from company to company, making it difficult to construct a
particular ratio or to construct it in the same way for two companies. Thus, financial statement
analysts must compare the definitions used to construct ratios before direct comparisons are
made. Exhibit 6 shows how to compute the ratios.
Common Financial Statement Ratios
Profitability and Market Performance
The primary objective of every business is to use the assets provided by investors and
creditors to generate profits. These profits may be reinvested to grow the business or returned
to investors and creditors as dividends and interest. The company's net income is the most
obvious indicator of success. Computing the percentage change in net income, or a series of
trend percentages for net income, highlights the trajectory of the bottom line. Exhibit 7
presents an array of additional profitability measures related to net income and dividends.
The gross profit margin, operating profit margin and net profit margin are all computed by
expressing the corresponding income statement item as a percentage of sales. The gross
profit margin indicates success in assembling, combining and/or transforming materials into
salable products. The viability of a company's core business model is reflected in the gross
profit margin. Changes in the gross profit margin reflect management's success in response to
competitive pressures. The gradual decline in gross profit margin, from 42 percent to 40.5
percent, indicates that our hypothetical company's profits are being squeezed by the cost of
inputs and/or competitive pricing.
Subtracting operating expenses from the gross profit yields the operating profit. While input
costs and selling prices are heavily market driven, operating expenses reflect management
priorities and choices. Thus, the operating profit margin is an indicator of management's
ability to operate the business efficiently and preserve the profits generated by delivering
goods and services. Over the five-year period in our example, operating expenses have grown
as a percentage of sales. The resulting decline in operating profit margin, from 17.9 percent to
14.2 percent, means that a larger portion of gross profit is being consumed by operating
expenses.
The net profit margin reflects the impact of interest and income tax expense. While financing
decisions and tax avoidance strategies influence these expenses, both are essentially outside
the control of management in the short run. Nonetheless, the net profit margin is the bottomline measure of a company's profitability.
Among publicly traded companies, net income is most commonly reported on a per-share
basis, allowing individual investors to evaluate performance in the context of their own

holdings. Basic earnings per share (EPS) is computed by reducing net income by any amounts
designated for preferred dividends and dividing the result by the average number of
outstanding common shares. For our hypothetical company, EPS has grown from $5.38 to
$6.31. This translates to an annual growth rate of slightly over four percent.
Dividing the stock price by EPS produces one of the most popular financial metrics, the priceearnings (P/E) ratio. In our hypothetical company, the P/E has varied slightly from 9.5. The
P/E ratio can be thought of as the price investors are willing to pay for one dollar of earnings.
Because the investor is really buying the future cash flow the company will provide to the
investor, the P/E ratio is an indicator of expected growth and perceived risk. If the company is
expected to grow rapidly, the P/E ratio is likely to be higher. Lower growth expectations are
reflected in lower P/E ratios. The P/E ratio is also influenced by perceived risk. If the stock is
perceived by investors to be risky, the P/E ratio will be lower.
P/E ratios vary widely from company to company and from industry to industry. For example,
at the time this article is being written, IBM's P/E ratio is reported at Moneycentral.com to be
17.7. The average for the companies in the industry is 25.1, while the average for the
Standard & Poor's (S&P) 500 is 18.1. The P/E ratio for IBM has varied substantially over the
past five years, from a low of 16.6 to a high of 61.4. The P/E ratio for our hypothetical
company is 9.5, suggesting a relatively low past growth rate with little, if any, indication of
superior growth projected for the future.
EPS and the P/E ratio focus on the company's reported earnings but do not directly address
returns to investors. The dividend payout ratio and dividend yield measure cash returns to
investors. The dividend payout ratio compares cash dividends to net income, while the
dividend yield compares the dividends per share for the period to market price per share at
the beginning of the period. Companies pursuing aggressive growth strategies typically retain
a large percentage of net income, resulting in relatively low dividend payout ratios. More
mature companies tend to pay out more in dividends. For example, Yahoo pays no dividends,
while General Electric pays out approximately 50 percent of earnings. For the S&P 500, the
dividend payout is approximately 28.4 percent. For our hypothetical company, the payout is 40
percent for each year. The combination of relatively high (40 percent) payout and a history of
low (less than four percent) growth in EPS and dividends per share is consistent with the
relatively low P/E (9.5).
Liquidity
The key to attracting financial capital on favorable terms is to sustain long-term profitability
and provide attractive returns to investors. Thus, profitability measures are foremost in the
minds of most investors and managers. However, in order to pursue the goal of long-term
profitability, companies must survive the short term by meeting financial obligations on a
timely basis. Liquidity means that the company either has sufficient cash to meet its shortterm obligations or is capable of raising funds on short notice when necessary. Maintaining
sufficient liquidity is an important issue for all companies. However, the challenge is more
pronounced for small companies, because their access to capital and money markets is more
limited than that enjoyed by larger companies.
Exhibit 8 illustrates the three most common liquidity measures: working capital, the current
ratio and the quick ratio (sometimes called the "acid-test ratio"). "Working capital" is defined
as the difference between current assets and current liabilities. Recall that current as sets
include cash, receivables, inventories and prepaid expenses. In theory, current assets are
those assets that will be converted to cash (or consumed) within one operating cycle--typically
a year. "Current liabilities" are defined as obligations that will consume current assets. Thus,
working capital is essentially the difference between assets that are likely to be converted to
cash in the coming year and liabilities that must be satisfied in the same time frame. The
dollar amount of our hypothetical company's working capital has grown from $24,069 to
$35,091, nearly 46 percent. However, current liabilities have nearly tripled in the same time
period. The current and quick ratios help bring these changes into perspective.

Dividing current assets by current liabilities yields the most common liquidity ratio, the current
ratio. While current assets in our hypothetical company remain larger than current liabilities,
the current ratio has declined from 2.36 in 2000 to 1.68 in 2004. This downward trend
indicates that our hypothetical company's buffer has declined, making it less able to withstand
short-term financial stress.
Both the concept of working capital and the current ratio implicitly assume that receivables
and inventories will be converted to cash within one operating cycle. The collection period and
inventory turnover statistics discussed in the following section can help analysts assess the
extent to which the company can rely on these key assets to satisfy current obligations. A
third liquidity indicator, the quick ratio, excludes inventory from the numerator, because
inventories may not be quickly sold and converted into cash. The quick ratio is currently 1.15
for our company, its lowest level in five years. The quick ratio confirms the impression that,
while our hypothetical company has sufficient assets to meet its current obligations, its
liquidity buffer is shrinking over time.
Efficiency
In addition to achieving profitability and maintaining liquidity, management is responsible for
using company assets efficiently. Exhibit 9 presents four popular efficiency measures for our
hypothetical company. These ratios measure the company's success in using total assets, fixed
assets and inventory and in collecting receivables promptly. The values of these ratios suggest
that our hypothetical company is struggling with efficiency.
Total asset turnover has declined steadily from 1.56 in 2000 to 1.43 in 2004. The company's
sales are growing, but it is using more assets to generate the sales than in earlier years. The
other three ratios identify more specifically the individual asset accounts that have increased
faster than sales. A longer average collection period indicates our customers are delaying
payment. At the same time, lower inventory and fixed-asset turnover ratios mean we have
increased our investment in both inventories and fixed assets relative to sales. All three trends
impair financial performance. In many cases, inventories tend to decline as a percentage as
sales increase. That has not been the case for our hypothetical company and should be an
area of interest for management.
Capital Structure
Most companies use debt to finance a portion of their assets. Debt is the least costly individual
source of funds for the company. Interest is deductible for tax purposes, while dividends on
preferred and common stock are not deductible as expenses for tax purposes. The
deductibility of interest makes the use of debt highly advantageous. However, it does increase
the risk to investors in all securities of the company. Thus, the company must achieve a
balance between the tax benefits and the added costs associated with the use of debt. Exhibit
10 shows the capital structure ratios for our hypothetical company for the five-year period. For
our company, debt has declined slightly as a percentage of both assets and equity. However,
the long-term debt to equity ratio has declined substantially as the company has increased its
use of short-term debt to finance its asset expansion. From the point of view of the borrower,
short-term debt is more risky than long-term debt because it must be repaid more quickly,
and the company may be forced to borrow at higher rates should interest rates rise in the
short term. On the other hand, short-term interest rates are generally lower than long-term
rates. Thus, the company is faced with another risk/return trade-off. In our company's case, it
has increased its risk by borrowing short term, even though total debt has only increased
slightly as a percentage of the total funds raised.
Standards
To this point we have looked at the various trends exhibited by our company. While trends are
important, it is also important that we analyze the current level of the ratios. Are the numbers
better or worse than we should expect? To answer this question, we must have some standard
against which to compare our numbers. Typically, analysts make comparisons to data from

companies in the same industry. Comparisons to key competitors are of particular interest to
management. There are numerous potential sources for comparative data. Among these, both
Reuters. com and MSN's Moneycentral.com provide company and industry data for a large
number of companies. These sources also provide for comparisons to the data for the S&P 500
Index. Among commercial lenders, the Risk Management Association (RMA) is a popular
source of financial data available on a subscription basis.
DuPont Analysis
The statistics and ratios presented in the preceding sections assess many individual
components of financial performance. Moreover, the individual ratios often provide overlapping
information, raising questions about how to combine results to gain a comprehensive view of
financial performance and position. While there is no universally accepted model for
summarizing the results of a financial statement analysis, the DuPont analysis is a popular
approach for focusing on the factors that determine profitability.
DuPont analysis decomposes the return on equity (ROE) into three factors:
ROE = net profit margin x asset turnover x equity multiplier
where: net profit margin = net income/sales; asset turnover = sales/assets; and equity
multiplier = assets/equity.
Exhibit 11 decomposes the ROE for our hypothetical company into the three factors for each of
the five years. As we can see, the ROE has declined substantially over the four-year period,
from 24.8 percent in 2001 to 18.9 percent in 2004. The DuPont analysis allows us to
determine quickly the major factors responsible for the decline. In our company, the equity
multiplier has remained 1.5 over the four years. Thus, capital structure factors are not
responsible for the decline in ROE. However, both the profit margin and asset turnover have
declined over time. While the profit margin has declined only 1.8 percentage points (from 10.4
percent to 8.6 percent) over the four years, the decline reduces ROE by approximately 17.3
percent. The reduction in the profit margin can be traced to a higher cost of goods sold and
higher operating expenses. Management should ascertain why the goods that are currently
being sold cost more relative to their selling prices than in the past. Declining profit margins
may reflect increased competition in the marketplace, production inefficiencies or both.
Regardless of its cause, this trend must be arrested and (hopefully) reversed to ensure future
profitability.
These results also suggest the need for management action. Reducing operating expenses,
while holding other factors constant, will always increase the ROE. However, wanting to reduce
costs does not necessarily mean that the company can do so without affecting sales. In our
hypothetical case, the fact that costs, relative to selling prices, have risen over the past five
years suggests that there is room for improvement and that a cost-reduction initiative may
prove beneficial.
Concluding Remarks
This article describes common methods of financial statement analysis and connects the
results to management actions that may improve performance. Management is ultimately
responsible for maximizing returns to investors. Lenders can assist management in meeting
that objective while protecting the interests of creditors. Financial statement analysis can be a
powerful tool in the effort to pinpoint areas in which financial performance can be improved-the first step toward implementing effective policy. Thus, the results of careful financial
statement analysis should provide a road map for managers striving to use their time
effectively and efficiently to improve performance.
Financial statement analysis can also be useful to commercial lenders, who serve as both
evaluators and advisors. The value of financial statement analysis in assessing the
creditworthiness of potential borrowers is self-evident. Ongoing analysis also provides an

opportunity for lenders to protect the value of existing loans and enhance client relationships.
Providing informed guidance that leads to improved profitability is a promising strategy for
growing existing clients and increasing profit potential.
Endnotes
(1) For background information, see R. David Mautz, Building a Better Understanding of
Financial Reports, COMMERCIAL LENDING REV., Sept.-Oct. 2005, at 11-18, 45-46.
R. David Mautz, Jr. is an Associate Professor of Accounting at North Carolina A and T State
University, Greensboro, North Carolina. Contact him at mautz@ncat.edu.
Robert J. Angell is a Professor of Finance at North Carolina A and T State University. Contact
him at angellr@ncat.edu.

Exhibit 1. Hypothetical Financial Statements

Income Statements
(for the year ended December 31)

Sales
Cost of goods sold
Gross profit on sales
Depreciation
Other operating expenses
Operating income
Interest expense
Income before taxes
Income taxes
Net income
Beginning retained earnings
Dividends
Ending retained earnings

2004

2003

2002

$365,000
217,000
$148,000
16,790
79,210
$52,000
4,200
$47,800
16,252
$31,548
$57,631
$12,619
$76,560

$335,800
199,000
$136,800
15,279
71,721
$49,800
3,800
$46,000
15,640
$30,360
$39,415
$12,144
$57,631

$305,578
181,000
$124,578
13,597
64,402
$46,579
3,500
$43,079
14,647
$28,432
$22,356
$11,373
$39,415

Balance Sheets
(as of December 31)
2004

2003

2002

Cash
Receivables
Inventories
Net fixed assets
Total assets

$14,600
45,000
27,125
182,500
$269,225

$13,432
36,800
22,111
167,900
$240,243

$12,223
28,465
18,100
152,789
$211,577

Payables
Short-term loans
Long-term loans
Total debt
Common stock
Retained earnings
Total equity
Total debt and equity

$21,700
29,934
41,031
$92,665
$100,000
76,560
$176,560
$269,225

$17,689
23,892
41,031
$82,612
$100,000
57,631
$157,631
$240,243

$14,480
16,651
41,031
$72,162
$100,000
39,415
$139,415
$211,577

2004

2003

2002

Number of common shares

Earnings per share
Market price per share

5000
$6.31
$59.65

5000
$6.07
$57.36

Income Statements
(for the year ended December 31)

Sales
Cost of goods sold
Gross profit on sales
Depreciation
Other operating expenses
Operating income
Interest expense
Income before taxes
Income taxes
Net income
Beginning retained earnings
Dividends
Ending retained earnings

2001

2000

$271,964
160,000
$111,964
12,238
53,762
$45,964
3,200
$42,764
14,540
$28,224
$5,422
$11,290
$22,356

$244,768
142,000
$102,768
11,014
47,986
$43,768
3,000
$40,768
13,861
$26,907
$(10,722)
$10,763
$5,422

Balance Sheets
(as of December 31)
2001

2000

Cash
Receivables
Inventories
Net fixed assets
Total assets

$10,879
23,843
14,545
135,982
$185,249

$9,791
20,118
11,833
122,384
$164,126

Payables
Short-term loans
Long-term loans
Total debt
Common stock
Retained earnings
Total equity
Total debt and equity

$11,636
10,226
41,031
$62,893
$100,000
22,356
$122,356
$185,249

$9,467
8,206
41,031
$58,704
$100,000
5,422
$105,422
$164,126

2001

2000

5000
$5.64
$51.69

5000
$5.38
$51.32

Number of common shares

Earnings per share
Market price per share
Exhibit 2. Horizontal Analysis:
Year-to-Year Percentage Change

Percentage Changes by Item by Year

2004

2003

2002

2001

5000
$5.69
$55.20

Sales
Cost of goods sold
Gross profit on sales
Operating expenses
Operating income
Interest expense
Income before taxes
Income taxes
Net income

8.7%
9.0%
8.2%
10.3%
4.4%
10.5%
3.9%
3.9%
3.9%

9.9%
9.9%
9.8%
11.5%
6.9%
8.6%
6.8%
6.8%
6.8%

12.4%
13.1%
11.3%
18.1%
1.3%
9.4%
0.7%
0.7%
0.7%

11.1%
12.7%
8.9%
11.9%
5.0%
6.7%
4.9%
4.9%
4.9%

Exhibit 3. Horizontal Analysis: Comparison to Base Year

Item vs. Base Year-(2000)

Sales
Cost of goods sold
Gross profit on sales
Operating expenses
Operating income
Interest expense
Income before taxes
Income taxes
Net income

2004

2003

2002

2001

2000

149.1%
152.8%
144.0%
162.7%
118.8%
140.0%
117.2%
117.2%
117.2%

137.2%
140.1%
133.1%
147.5%
113.8%
126.7%
112.8%
112.8%
112.8%

124.8%
127.5%
121.2%
132.2%
106.4%
116.7%
105.7%
105.7%
105.7%

111.1%
112.7%
108.9%
111.9%
105.0%
106.7%
104.9%
104.9%
104.9%

100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%

Exhibit 4. Common-Size Income Statements

Sales
Cost of goods sold
Gross profit on sales
Operating expenses
Operating income
Interest expense
Income before taxes
Income taxes
Net income

2004

2003

2002

2001

2000

100.0%
59.5%
40.5%
26.3%
14.2%
1.2%
13.0%
4.5%
8.5%

100.0%
59.3%
40.7%
25.9%
14.8%
1.1%
13.7%
4.7%
9.0%

100.0%
59.2%
40.8%
25.5%
15.3%
1.1%
14.2%
4.8%
9.4%

100.0%
58.8%
41.2%
24.3%
16.9%
1.2%
15.7%
5.3%
10.4%

100.0%
58.0%
42.0%
24.1%
17.9%
1.2%
16.7%
5.7%
11.0%

Exhibit 5. Common-Size Balance Sheets

2004

2003

2002

2001

2000

Cash
Receivables
Inventories
Net fixed assets
Total assets

5.4%
16.7%
10.1%
67.8%
100%

5.6%
15.3%
9.2%
69.9%
100%

5.8%
13.5%
8.6%
72.2%
100%

5.9%
12.9%
7.9%
73.4%
100%

6.0%
12.3%
7.2%
74.6%
100%

Payables
Short-term loans
Long-term loans
Total debt
Common stock
Retained earnings
Total equity

8.1%
11.1%
15.2%
34.4%
37.1%
28.4%
65.5%

7.4%
9.9%
17.1%
34.4%
41.6%
24.0%
65.6%

6.8%
7.9%
19.4%
34.1%
47.3%
18.6%
65.9%

6.3%
5.5%
22.1%
33.9%
54.0%
12.1%
66.1%

5.8%
5.0%
25.0%
35.8%
60.9%
3.3%
64.2%

Total debt and equity

100%

100%

100%

100%

100%

Exhibit 6. Summary of Common Ratios

Measure

Calculation

Gross profit margin

Gross profit on sales/sales

Operating profit margin

Operating income /sales

Net profit margin

Net income/sales

Earnings per share

(Net income -- preferred dividends)/

Average outstanding common shares

Dividends per share

Dividends/outstanding shares of stock

Dividend yield

Dividends per share/beginning stock price

Price-earnings ratio

Price of common stock/earnings per share

Dividend payout ratio

Dividends/(net income--preferred dividends)

Return on assets

Net income/average total assets

Return on equity

Net income/average equity

Working capital

Current assets--current liabilities

Current ratio

Current assets/current liabilities

Quick ratio

(Current assets--inventory)/current
liabilities

Total asset turnover

Sales/average total assets

Inventory turnover

Cost of goods sold/average inventory

Collection period

Average receivables/(sales/365)

Fixed-asset turnover

Sales/fixed assets (average)

Times interest earned

Operating income/interest expense

Equity multiplier

Average total assets/average equity

Exhibit 7. Profitability Measures

Gross profit margin

Operating profit margin
Net profit margin
Earnings per share
Dividends per share
Dividend yield
Price-earnings ratio

2004

2003

2002

2001

2000

40.5%
14.2%
8.6%
$6.31
$2.52
4.4%
9.5

40.7%
14.8%
9.0%
$6.07
$2.43
4.4%
9.4

40.8%
15.2%
9.3%
$5.69
$2.27
4.4%
9.7

41.2%
16.9%
10.4%
$5.64
$2.26
4.4%
9.2

42.0%
17.9%
11.0%
$5.38
$2.15
4.4%
9.5

Dividend payout ratio

Return on assets
Return on equity

0.4
12.4%
18.9%

0.4
13.4%
20.4%

0.4
14.3%
21.7%

0.4
16.2%
24.8%

0.4
N/A *
N/A *

* Computation of returns on assets and equity requires average total

assets and average equity, which are not available.
Exhibit 8. Liquidity Measures

Working capital
Current ratio
Quick ratio

2004

2003

2002

2001

2000

$35,091
1.68
1.15

$30,763
1.74
1.21

$27,658
1.89
1.31

$27,405
2.25
1.59

$24,069
2.36
1.69

Exhibit 9. Efficiency Measures

Total asset turnover

Inventory turnover
Collection period
Fixed-asset turnover

2004

2003

2002

2001

1.43
8.8
40.9
2.08

1.49
9.9
35.5
2.09

1.54
11.1
31.2
2.12

1.56
12.1
29.5
2.11

Exhibit 10. Capital Structure Measures

Debt/assets
Debt/equity
Long-term debt/equity
Times interest earned

2004

2003

2002

2001

2000

34.4%
52.5%
23.2%
12.4

34.4%
52.4%
26.0%
13.1

34.1%
51.8%
29.4%
13.3

34.0%
51.4%
33.5%
14.4

35.8%
55.7%
38.9%
14.6

Exhibit 11. DuPont Analysis

Net profit margin

Total asset turnover
Equity multiplier
Return on equity

2004

2003

2002

2001

8.6%
1.43
1.5
18.9%

9.0%
1.49
1.5
20.4%

9.3%
1.54
1.5
21.7%

10.4%
1.56
1.5
24.8%

Ops Risk Survival Guide: Three Lessons Bankers Need to Learn from
Oil & Gas Risk Management

Posted by Brian Barnier

Ill spare you the photo of the camel in the desert from my trips to the oil & gas fields.
For those of you who have been in my CPE classes on risk management and other
presentations, you know that I bring an industrial view to ops risk in financial services.
Youve heard me talk about scenarios for real threats to real operations, not just
compliance record-keeping. Industrial firms have spent decades learning what bankers

have just been encountering in the past few years. In this post, well look at just three of
many valuable lessons to learn from the oil & gas industry.
When I started working in oil & gas, I received my risk management training what to
do when the siren sounds. Then I heard about how to get out of a helicopter that crashes
at sea. With that sense of real threats lets look at just three points:
1. In my teaching, I stress the need for an end-to-end process view of risk management.
Yet, Im told by banking attendees that thats not how our reporting forms are set up.
This is a collision with reality for bankers when they realize what is happening in the
industrial (or telecom, or medical , aerospace or) world. In financial services, there are
loan applications, payments, straight through processing for transactions, ATMs and such.
In oil & gas, there are pipelines. In pipeline safety, they look at factors such as third-party
damage, corrosion, equipment failures, and human unsafe acts. They look at frequency
and impact (although they use terms like cause and consequence). With an industrial
heritage, they are also focused on thoughts like high cause areas and the ability to
detect potential problems (such as corrosion). The pipeline analysis is end to end, but is
not restricted to just the pipes. It also looks at the facilities through which the pipes run
(like data centers in banks) and the environment through which the pipes pass
(environmentally sensitive wilderness or high population areas).
Action: Make your risk scenario analysis more end-to-end, not just regulatory snippets.
Look at delivering an actual product to a customer (like gas to a house).
2. Oil & gas firms are far more concerned about the role played by people (internal
people in daily work, not just fraud) whether in detecting, causing, planning or
responding. People can do bad things and good things. Even when they do a good thing
and detect a problem, they can still do a bad thing and respond the wrong way. The oil
& gas industry is concerned about the quality of decision making in all stages of risk
activity. They look at everything from fatigue to quality of training. This is applied
BOTH to people involved in risk management planning and response AND to the actual
operational teams. By contrast, many banks are just starting to learn the importance of the
entire process of risk management (from identification to fixing to preventing). As one
risk officer told me I cant run a risk department with a bunch of compliance retreads.
In banking, if the goal was neat reporting paperwork, then compliance skills were the
answer. However, as weve seen in stories from Bank of America and Countrywide this
week, risk is more than compliance. In banks, the consequence used to be a fine. Now
the world has learned it is about collapsed institutions and massive unemployment. In oil
& gas, theyve long known that failure means world oil price moves when a facility is
down, environmental disaster, displaced people and even death.
Action: Skill up your people, improve your risk governance. Send your people to
training, hire mentoring services, get your people certified. In these cost-constrained
times, mentoring is a highly cost efficient option and a smart decision. As Fred Winegust
posted in his blog entry, you simply must start if you are ever going to reach your
objective.

3. The view of risk is more directly tied to business performance. Weve already noted
that it is not just about compliance. Risk is about risk-return. Risk management is the
ability to take more risk more safely in pursuit of return. If the refinery or pipeline is
down, the costs are not just in fines and repairs. There is also a very direct impact on
revenue. Not only will the oil company lose, but competitors will distinctly benefit. Risk
is deeply tied with quality control. Improved quality reduces cost, improves flexibility
and increases competitive options. (Well talk more about this in future blogs about other
industries.) This business performance focus can carry you forward in spite of the
potential regulatory confusions noted by my colleague, Rod Nelsestuen, in his posting.
Action: Rethink your risk metrics. Sit down with your corporate annual report or internal
scorecard (financial, operational, strategic and customer satisfaction metrics). With paper
and pencil, align current or create new risk measures to each of those business measures.
In summary, everyone knows that operational risk is newer than other types of risk in
financial services. What many financial services people dont know is how far financial
services is behind other industries. Take time to apply just these three lessons from oil &
gas.
What do you think? Are you already applying some of these approaches? If so, good for
you! Why do you think others struggle to get to where you are? If you are not using these
lessons, is it because you were unaware or is there some hurdle you are facing? Share
your thoughts and post a comment. If you would like to reply to me personally or ask a
question, feel free to do so at briangbarnier @ gmail.com (remove the spaces).
Best,
Brian
P.S. Will you be at the World Conference on Disaster Management in Toronto in June? If
so, feel free to look me up. Ill be teaching a session on Business Continuity Governance.
About the author: Brian Barnier, CGEIT, is an advisor, teacher, writer and researcher on
risk-return value management. He teaches CPE classes and speaks at a range of
conferences, writes for business and technology publications, and serves on multiple
industry practices committees regarding risk, business process and IT value. He has
worked in a range of industries and, in doing so, helps cross-pollinate his clients with the
best of the best in risk management.
The postings on this site are the opinions of the individual who is posting and don't
necessarily represent IBM's positions, strategies or opinions.