Financial statements and ratios

Financial statements and ratios

1. 1. Which equation must hold by construction on every balance sheet?

   Revenue − Expenses = Net IncomeAssets = Liabilities + Stockholders' EquityCash from Operations + Investing + Financing = Net IncomeCurrent Assets = Current Liabilities

2. 2. Which of these are reasons net income can differ substantially from cash flow in a given year?

   Depreciation and amortization are non-cash expensesAccounts receivable grew (revenue booked but cash not yet collected)Capital expenditures hit cash this year but income statement over depreciation lifeThe firm changed its dividend policy

3. 3. A firm reports Revenue = $2,000M, Net Income = $200M, Total Assets = $1,500M, Equity = $500M. What is its Return on Equity (ROE)? Answer as a decimal (e.g. 0.20 for 20%).

4. 4. Using the same firm in question 3, decompose ROE via DuPont (net margin × asset turnover × equity multiplier). What is the equity multiplier?

   1.52.03.04.0

5. 5. Bank A and a typical retailer both report ROE of about 12%. What is the most likely reason they look the same on this single ratio despite being very different businesses?

   Banks and retailers have identical profit marginsThe bank has high leverage (high equity multiplier) compensating for lower margins; the retailer has higher margins with low leverageCoincidence — the ratios are unrelatedBanks have negligible assets