Financial Statement Analysis
Financial statements are
- income statement
- balance sheet
- cashflow statement
In theory, cashflow statement is redundant with (1) income statement and (2) the variation of the balance sheet during the accounting period.
It should be noted that it is customary to divide IS by total sales to create a proforma statement, whereas the BS gets divided by total assets.
Decomposing Return on Equity
In the Dupont analysis, various common ratio are defined to decompose an activity's profitability:
- ROE = net income / equity
- ROA = (net income + interest paid on liability) / asset
- ROE = ROA x Leverage x AdjustFactor
where Leverage = asset / equity, and adjustment factor = 1 + interest paid on liability / net income.
We see that the ROE can be explained by the ROA and the leverage, which is a result of the financing choice of the firm. We now look into the ROA analysis.
Decomposing Return on Asset
Then the return on asset can be further analysed in terms of net margin and revenue / asset ratio:
- net margin = net income / sales
- turnover = sales / asset
- ROA = net margin x turnover
In order to go further one needs to look at common measures of turnover.