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Chapter 3 - Fundamental interpretations made from financial statement data. After reading this chapter, you should be able to answer the following questions: Why are financial statement ratios important? How is return on investment calculated and why is it important? What is the DuPont model and what do margin and turnover mean? What is the significance of return on equity and how is it calculated? . | 2008 The McGraw Hill Companies Inc. All Rights Reserved. McGraw Hill Irwin Copyright 2014 by The McGraw Hill Companies Inc. All rights reserved. Chapter 3 Fundamental Interpretations Made from Financial Statement Data PowerPoint Authors Susan Coomer Galbreath Ph.D. CPA Charles W. Caldwell D.B.A. CMA Jon A. Booker Ph.D. CPA CIA Cynthia J. Rooney Ph.D. CPA McGraw Hill Irwin Copyright 2014 by The McGraw Hill Companies Inc. All rights reserved. 23 LO 1 Financial Ratios and Trend Analysis A ratio is simply the relationship between The large dollar amounts two numbers. reported on the financial statements of many companies and the varying size of companies make ratio analysis the only sensible method of evaluating various financial characteristics. McGraw Hill Irwin 3 3 2008 The McGraw Hill Companies Inc. All Rights Reserved. 24 LO 1 Trend Analysis Trend analysis compares a single observation over several years. McGraw Hill Irwin 3 4 2008 The McGraw Hill Companies Inc. All Rights Reserved. 25 LO 2 Rate of Return Rate of Amount of return return Amount of investment This ratio provides the return on a given investment alternative. All other things being equal the higher the rate of return the more profitable the alternative. The rate of return calculation is derived from the interest calculation. Interest Principal Rate Time Higher rates of return are associated with greater risk McGraw Hill Irwin 3 5 2008 The McGraw Hill Companies Inc. All Rights Reserved. 26 LO 2 Return on Investment R.O.I. Return on Net income investment Average total assets This ratio describes the rate of return management was able to earn on the assets that it had available during the year. An informed judgment about the firm s profitability requires relating net income to the assets used to generate that net income. McGraw Hill Irwin 3 6 2008 The McGraw Hill Companies Inc. All Rights Reserved. 27 LO 3 The DuPont Model Return on Net income Sales investment Sales Average total assets Margin Turnover
