CLASS+5

5
FINANCIAL
STATEMENT ANALYSIS
D. STOJANOVIC & C. BARRETTE
RSM219: INTRODUCTION TO FINANCIAL ACCOUNTING
CONTENTS
WELCOME.............................................................................................................................................................................. 2
WARM-UP............................................................................................................................................................................... 3
ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS ................................................................................ 3
#1 | We use financial ratios to help diagnose financial health. ............................................................................................ 4
#2 | We use common-size financial statements to facilitate analysis .................................................................................. 7
#3 | We can use DuPont analysis to understand company performance ............................................................................ 8
Step 1: Evaluate the ability to generate revenues through efficient use of assets ......................................................... 9
Step 2: Evaluate the ability to turn revenues into profits (profitability) .......................................................................... 14
Step 3: Understand the trade-offs between efficiency and profitability ......................................................................... 15
Step 4: Evaluate the use of leverage as a “magnifier” .................................................................................................. 17
Appendix 1: Amazon financial statements & notes ........................................................................................................ 20
Appendix 2: Meta financial statements & notes .............................................................................................................. 22
Appendix 3: Apple financial information (selected) ........................................................................................................ 24
Appendix 4: Ratio formula sheet ....................................................................................................................................... 25
NOTES AND REFLECTIONS ............................................................................................................................................... 26
WELCOME
GROUP
MID-TERM Nov. 15 (2% FINAL
Oct 17 (25%) Nov. 22 (15%) TBA (40%)
FOUNDATIONS ANALYSIS OPERATIONS INVESTING & FINANCING

Class 1 Class 4 Class 6 Class 9
Introducing financial Cash flow analysis Sales & receivables Long-lived operating assets
accounting
Class 5 Class 7 Class 10
Class 2 Financial statement MIDTERM (NO CLASS) Intercorporate investments
Conceptual framework analysis
Class 8 Class 11
Class 3 Inventories and operating Debt and equity
Basic transactions & costs
events Class 12
Advanced topics & review
CLASSWORK (~ 4.5 to 8 hrs) LEARNING OUTCOMES (LOs)

BEFORE CLASS (~ 1.5 hrs): READINGS: Ch. 12 (pp. 545-565)
 (60 min) Read the textbook relating to the learning outcomes  LO1 | Prepare and analyse common-size financial
for this class. Focus on pp. 550-558. statements. (pp. 545-550)
 (30 min) Prepare “rough” point-form answers to the  LO2 | Compute and interpret measures of return on
exercises. Be ready to discuss your ideas (and prepare your investment, including return on equity (ROE), return on
questions). assets (ROA), and return on financial leverage (ROFL).
(pp. 550-553)
CLASS (~ 2hrs):  LO3 | Disaggregate ROA into profitability (profit margin)
and efficiency (asset turnover) components. (pp. 553-558)
 Attend the lecture and ask clarifying questions.
 LO4 | Compute and interpret measures of liquidity and
solvency. (pp. 558-565)
AFTER CLASS (~ 1 to 3 hrs):
 (10-30 min) Debrief the key concepts and workbook notes.
 (30-120 min) Work through the practice questions/problems.
 (30-90 min) Clarify remaining topics by reading the textbook
and posting any remaining questions to discussion board.
TUTORIAL (~1 hr):

 (60 min) Attend the tutorial session and clarify remaining
questions.
ONGOING WORK (~ 0.5-1 hrs)

 (30 min) Submit Class 4: Weekly Assignment due Monday,
October 7th at 5:00pm EST.
DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 2 OF 26

WARM-UP
Business Environment (competitors, regulators, etc.)
1. STRATEGIC
Identify profit Board of Directors
potential &
business risks
CAPITAL $$$
PRODUCTS PRICE
& SERVICES
Suppliers Customers
COST
$$ Operating
Investing
$ VALUE
Financing
2.
ACCOUNTING
Evaluate quality FSs
& adjust to “reality”
Financial
statements
1. Voting
2. Dividends
3. Residual claim
Shareholders | Creditors
3. FINANCIAL
Evaluate
performance, risk,
& sustainability
Past Future
4.
PROSPECTIVE What is today’s “value” of projected future
Forecast & value earnings and cash flows? Consider “time value
of money” and “cost of capital” (in finance).
VALUE & TERMS

ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
#1 | We use financial ratios to help diagnose financial health.
We use financial ratios to help diagnose financial health

 Financial ratios help us relate items on the financial statements in a meaningful and comparable
way
 Definitions of the ratios may vary depending on the purpose of the analysis
 Financial ratios are generally used to identify key questions for further analysis – rather than
providing deep insight by themselves
Conclusions and
Financial statement analysis framework 1:
recommendations must
tie back to the purpose
of the analysis.
1. Purpose 2. Collect 3. Process 4. Analyze &

5. Conclusions 6. Follow-up
and Context input data data interpret
Our focus is on financial Focus on analysis rather than computation. Link the numbers to the
reports including financial company’s strategy and business environment. Go beyond describing and
statements (and notes) explain reasons for performance, risks, and implications for the future.
Adjust financial statements, prepare common-size

and trend analysis, prepare ratios (and graphs).
EXERCISE: Uses and limitations of ratios

REFLECT: Reflect on the benefits and limitations of ratios.
Benefits Limitations
 Identifies key economic relationships (e.g., gross profit to  Difficult to find “comparable” companies (or even clearly
revenues, earnings to assets, etc.) identify an industry/sector for some companies). Consider
 Comparability of financial performance over time (scaled) industry -specific ratios but be aware of ratio definitions!
 Comparability with other companies (or industry  Irregular items can skew ratios and need to be carefully
benchmarks) considered (and, adjusted)
 Easy access through data aggregators (e.g., Capital IQ,  Different companies may use different accounting standards
FactSet, Bloomberg, etc.) – but be careful! and judgments (e.g., IFRS vs. US GAAP), making it more
difficult to compare ratios.
1 Adapted from van Greuning and Bratanovic (2003, p. 300) and Benninga and Sarig (1997, pp. 134-157)

EXERCISE: Amazon (AMZN)
Analyze the selected financial statements of Amazon (see Appendix 1).
REFLECT: What are your insights about Amazon’s performance?
EXERCISE: Meta Platforms (META)

Analyze the selected financial statements of Meta Platforms (see Appendix 2).
REFLECT: What are some of the benefits of additional “segment” disclosures (i.e., breakdown by segment)?

EXERCISE: Ratios to assess performance – Apple (AAPL)
Analyze the selected financial statements of Apple (selected statements provided in the Appendix 3). Consider
also the excerpts from notes below.
REFLECT: What are your insights about Apple’s performance in 2023?

#2 | We use common-size financial statements to facilitate analysis
Chapter 12 | LO 1
Prepare and analyse common-size financial statements. (pp. 545-550)
 Horizontal analysis represents each selected item as percentage change over a base year (e.g.,
prior period).
 Vertical analysis represents each selected item as a percentage of a key metric (e.g., revenues
or total assets).

Analyze the selected financial statements of Apple (selected statements provided in the Appendix 3).

#3 | We can use DuPont analysis to understand company performance
Chapter 12 | LO 2, 3, 4
 Compute and interpret measures of return on investment, including return on equity (ROE), return
on assets (ROA), and return on financial leverage (ROFL). (pp. 550-553)
 Disaggregate ROA into profitability (profit margin) and efficiency (asset turnover) components. (pp.
553-558)
 Compute and interpret measures of liquidity and solvency. (pp. 558-565)
DuPont analysis and integrative ratios
It is critical to understand the relationships between various ratios. DuPont analysis allows us to decompose
an important profitability measure: return on equity (ROE). By breaking it down, we can understand the
drivers of ROE (over time and compared to other companies).
STEP 1:
Ability to generate
revenues through
efficient use of assets
STEP 2:
Ability to keep
revenues as profits
STEP 3:
Recognize the trade-off
as levers of profitability
STEP 4:
Ability to use LEVERAGE
(debt) as a “magnifier”

Step 1: Evaluate the ability to generate revenues through efficient use of assets
EXERCISE: Generating revenues

REFLECT: Evaluate the following ratios for each of the companies below. What are your insights?
Efficiency in using assets to generate revenues COMPANY FY2023 FY2022 FY2021

Total asset turnover AMZN 1.16 1.16 1.27
= sales revenue / average total assets META 0.65 0.66 0.73
AAPL 1.09 1.12 1.08
Sales revenue $383,285

Total asset turnover = = = 1.09
Average total assets ($352,583 + $352,755) ÷2
Avg. total
Avg. total
Apple FY’23 Revenues $383,285 assets
assets
Meta FY’23 Revenues $134,902
Sep. 24, 2022 Sep. 30, 2023 Dec. 31, 2022 Dec. 31, 2023
$352,755 $352,583 $185,727 $229,623
Total Assets Total Assets Total Assets Total Assets
Insights and challenges:
PPE turnover AMZN 2.94 2.96 3.44

= sales revenue / average PPE META 1.53 1.70 2.28
AAPL 8.93 9.67 9.60

PPE turnover = = = 8.93
Average PPE ($43,715 + $42,117) ÷2
FY’23 Revenues $383,285
Avg. PPE
Sep. 24, 2022 Sep. 30, 2023

$42,117 $43,715
PPE PPE

Efficiency in managing inventories COMPANY FY2023 FY2022 FY2021
Inventory turnover AMZN 9.0 8.6 9.7
= cost of goods sold / average inventory META N/A N/A N/A
AAPL 33.6 35.0 36.1
COGS $189,282
Inventory turnover = = = 33.6
Average inventory ($6,331 + $4,946) ÷2
Avg.
FY’23 COGS $189,282 inventory
Sep. 24, 2022 Sep. 30, 2023

$4,946 $6,331
Inventory Inventory
Days of inventory outstanding AMZN 41 42 38

= days in period / inventory turnover META N/A N/A N/A
AAPL 11 10 10
Days in period 365

Days of inventory outstanding = = = 11
Inventory turnover 33.6

Efficiency in managing receivables COMPANY FY2023 FY2022 FY2021
Receivables turnover AMZN 12.2 13.7 16.4
= revenue / average receivable META 9.1 8.5 9.3
AAPL 13.3 14.5 17.3
Net sales $383,285

Receivables turnover= = = 13.3
Average A/R ($29,508 + $28,184) ÷2

Avg. A/R
Sep. 24, 2022 Sep. 30, 2023

$28,184 $29,508
A/R A/R
Days of sales outstanding AMZN 30 27 22

= days in period / receivables turnover META 40 43 39
AAPL 27 25 21
Days in period 365

Days of sales outstanding= = = 27
A/R turnover 13.3
EXERCISE: Business models and sales/collections

REQUIRED: In the calculation of receivables turnover (and therefore, days of sales outstanding), many
aggregator services (e.g., FactSet) include “vendor non-trade receivables”. Analyze Apple’s note describing
this balance and critically evaluate the use of this amount in the calculation of the receivables turnover.
Vendor Non-Trade Receivables

The Company has non-trade receivables from certain of its manufacturing vendors resulting from the sale of components to these vendors
who manufacture subassemblies or assemble final products for the Company. The Company purchases these components directly from
suppliers. As of September 24, 2022, the Company had two vendors that individually represented 10% or more of total vendor non-trade
receivables, which accounted for 54% and 13%. As of September 25, 2021, the Company had three vendors that individually represented
10% or more of total vendor non-trade receivables, which accounted for 52%, 11% and 11%.

Efficiency in managing the cash cycle COMPANY FY2023 FY2022 FY2021
Payables turnover AMZN 3.7 3.6 3.6
(we can use cost of sales as proxy for purchases) META 5.3 5.6 8.4
= cost of sales / average trade payables AAPL 3.4 3.8 4.4
Cost of sales $214,137

Payables turnover = = = 3.4
Average A/P ($62,611 + $64,115) ÷2
Days of payables outstanding AMZN 99 100 101

= days in period / payables turnover META 69 66 44
AAPL 108 97 83
Days in period 365

Days of payables outstanding = = = 108
A/P turnover 3.4

AMZN (28) (31) (41)
CASH CONVERSION CYCLE META (29) (23) (4)
= days in inventory AAPL (70) (61) (52)
+ days sales outstanding
– days of payables
= 11 + 27 – 108 = (70)
EXERCISE: Business models and cash collection cycles

REQUIRED: What are the implications of a negative cash cycle? Compare Apple’s cash cycle relative to the
technology sector. What are your insights?

Step 2: Evaluate the ability to turn revenues into profits (profitability)
EXERCISE: Business models and profitability

REFLECT: Review the “profitability funnels” below. What are your key insights?
Sales 100%
Gross profit margin 47%
Operating profit margin 6%
Net profit margin 5%
Sales 100%
Sales 100%
Profitability analysis FY2023 FY2022 FY2021

AMZN 47.0% 43.8% 39.6%
Gross profit margin META 80.8% 78.3% 80.6%
= (sales revenue – cost of sales) / sales revenue AAPL 44.1% 43.3% 38.2%
= gross profit / sales revenue
= $169,148 / $383,285 = 44.1%
AMZN 6.4% 2.4% 5.9%

Operating profit margin META 34.7% 24.8% 38.0%
= operating income / sales revenue AAPL 29.8% 30.3% 24.1%
= $114,301 / $383,285 = 29.8%
AMZN 5.3% -0.5% 5.5%

Net profit margin META 29.0% 19.9% 33.9%
= net income / sales revenue AAPL 25.3% 25.3% 20.9%
= $96,995 / $383,285 = 25.3%

Step 3: Understand the trade-offs between efficiency and profitability
EXERCISE: Understanding ROA

REFLECT: Critically evaluate the return on asset (ROA) ratio. What are some challenges of using this ratio to
evaluate company performance? Be critical.
Evaluating the trade-offs between efficiency and profitability FY2023 FY2022 FY2021
AAPL 1.09 1.12 1.08
Net profit margin AMZN 5.3% -0.5% 5.5%

= net income / sales revenue META 29.0% 19.9% 33.9%
AAPL 25.3% 25.3% 20.9%
AMZN 6.1% -0.6% 9.0%

Return on assets (ROA) META 18.8% 13.2% 24.2%
= net income / average total assets AAPL 27.5% 28.4% 28.1%
= net profit margin x total asset turnover
Net income $96,995

Return on Assets (ROA)= = = 27.5%

REVIEW: Explaining trade-offs
REFLECT: Review the graph below and write down your main observations/insights.
For those interested in additional research studies on this topic, see the framework in Nissim, D.,
& Penman, S. H. (2001). Ratio analysis and equity valuation: From research to practice. Review of
accounting studies, 6(1), 109-154.Graph below reproduced from Wong et al. 2nd ed.
Key insights:

Step 4: Evaluate the use of leverage as a “magnifier”
EXERCISE: Understanding basic leverage

REFLECT: Critically evaluate the financial leverage ratio. What are some challenges of using this ratio to
Evaluating the returns on investments and the use of leverage FY2023 FY2022 FY2021
AMZN 6.1% -0.6% 9.0%
AMZN 2.8 3.1 3.2

Financial leverage (FL) META 1.5 1.4 1.3
= average total assets / average total equity AAPL 6.3 6.2 5.3

Financial leverage (FL)= = = 6.3
Average total equity (62,146 + 50,672) ÷ 2
AMZN 17.5% -1.9% 28.8%

Return on equity (ROE) META 28.0% 18.5% 31.1%
= net income / average total equity AAPL 171.9% 175.5% 147.4%
= net profit margin x total asset turnover x FL
= ROA x financial leverage
Net income $96,995

Return on Equity (ROE)= = = 171.9%

EXERCISE: Evaluating solvency
Solvency analysis and the use of leverage FY2023 FY2022 FY2021

Debt-to-equity AMZN 1.6 2.2 2.0
= total liabilities / total equity META 0.5 0.5 0.3
AAPL 4.7 6.0 4.6
Total liabilities $290,437

Debt-to-equity= = = 4.7
Total equity $62,146
Interest coverage AMZN 12.8 -1.5 22.1

= EBIT / interest expense META 107.3 156.8 2,057
[interest expense disclosed as $3,933 in FY2023] AAPL 29.9 41.6 42.3
Earnings before interest and taxes $96,995 + 16,741 + 3,933

Interest coverage= = = 29.9
Interest expense $3,933

EXERCISE: Evaluating liquidity
Liquidity analysis FY2023 FY2022 FY2021

Current ratio AMZN 1.0 0.9 1.1
= current assets / current liabilities META 2.7 2.2 3.2
AAPL 1.0 0.9 1.1
current assets $143,566

Current ratio = = = 1.0
current liabilities $145,308
Quick ratio AMZN 0.8 0.7 0.9

= “Quick assets” / current liabilities META 2.6 2.0 2.9
AAPL 0.6 0.5 0.7
cash + short-term securities + accounts receivable $29,965 + 31,590 + 29,508

Quick ratio = = = 0.6

APPENDIX 1: AMAZON FINANCIAL STATEMENTS & NOTES

APPENDIX 2: META FINANCIAL STATEMENTS & NOTES

APPENDIX 3: APPLE FINANCIAL INFORMATION (SELECTED)

APPENDIX 4: RATIO FORMULA SHEET

NOTES AND REFLECTIONS
Most important ideas/points:
All copyrights attributable to owners.

5
FINANCIAL
STATEMENT ANALYSIS
D. STOJANOVIC & C. BARRETTE
RSM219: INTRODUCTION TO FINANCIAL ACCOUNTING
CLASS NOTES
CONTENTS
WELCOME.............................................................................................................................................................................. 2
WARM-UP............................................................................................................................................................................... 3
ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS ................................................................................ 3
#1 | We use financial ratios to help diagnose financial health. ............................................................................................ 4
#2 | We use common-size financial statements to facilitate analysis .................................................................................. 7
#3 | We can use DuPont analysis to understand company performance ............................................................................ 8
Step 1: Evaluate the ability to generate revenues through efficient use of assets ......................................................... 9
Step 2: Evaluate the ability to turn revenues into profits (profitability) .......................................................................... 14
Step 3: Understand the trade-offs between efficiency and profitability ......................................................................... 15
Step 4: Evaluate the use of leverage as a “magnifier” .................................................................................................. 17
Appendix 1: Amazon financial statements & notes ........................................................................................................ 20
Appendix 2: Meta financial statements & notes .............................................................................................................. 22
Appendix 3: Apple financial information (selected) ........................................................................................................ 24
Appendix 4: Ratio formula sheet ....................................................................................................................................... 25
NOTES AND REFLECTIONS ............................................................................................................................................... 26
WELCOME
GROUP
MID-TERM Nov. 15 (2% FINAL
Oct 17 (25%) Nov. 22 (15%) TBA (40%)
FOUNDATIONS ANALYSIS OPERATIONS INVESTING & FINANCING

Class 1 Class 4 Class 6 Class 9
Introducing financial Cash flow analysis Sales & receivables Long-lived operating assets
accounting
Class 5 Class 7 Class 10
Class 2 Financial statement MIDTERM (NO CLASS) Intercorporate investments
Conceptual framework analysis
Class 8 Class 11
Class 3 Inventories and operating Debt and equity
Basic transactions & costs
events Class 12
Advanced topics & review
CLASSWORK (~ 4.5 to 8 hrs) LEARNING OUTCOMES (LOs)

BEFORE CLASS (~ 1.5 hrs): READINGS: Ch. 12 (pp. 545-565)
 (60 min) Read the textbook relating to the learning outcomes  LO1 | Prepare and analyse common-size financial
for this class. Focus on pp. 550-558. statements. (pp. 545-550)
 (30 min) Prepare “rough” point-form answers to the  LO2 | Compute and interpret measures of return on
exercises. Be ready to discuss your ideas (and prepare your investment, including return on equity (ROE), return on
questions). assets (ROA), and return on financial leverage (ROFL).
(pp. 550-553)
CLASS (~ 2hrs):  LO3 | Disaggregate ROA into profitability (profit margin)
and efficiency (asset turnover) components. (pp. 553-558)
 Attend the lecture and ask clarifying questions.
 LO4 | Compute and interpret measures of liquidity and
solvency. (pp. 558-565)
AFTER CLASS (~ 1 to 3 hrs):
 (10-30 min) Debrief the key concepts and workbook notes.
 (30-120 min) Work through the practice questions/problems.
 (30-90 min) Clarify remaining topics by reading the textbook
and posting any remaining questions to discussion board.
TUTORIAL (~1 hr):

 (60 min) Attend the tutorial session and clarify remaining
questions.
ONGOING WORK (~ 0.5-1 hrs)

 (30 min) Submit Class 4: Weekly Assignment due Monday,
October 7th at 5:00pm EST.

WARM-UP
Business Environment (competitors, regulators, etc.)
1. STRATEGIC
Identify profit Board of Directors
potential &
business risks
CAPITAL $$$
PRODUCTS PRICE
& SERVICES
Suppliers Customers
COST
$$ Operating
Investing
$ VALUE
Financing
2.
ACCOUNTING
Evaluate quality FSs
& adjust to “reality”
Financial
statements
1. Voting
2. Dividends
3. Residual claim
Shareholders | Creditors
3. FINANCIAL
Evaluate
performance, risk,
& sustainability
Past Future
4.
PROSPECTIVE What is today’s “value” of projected future
Forecast & value earnings and cash flows? Consider “time value
of money” and “cost of capital” (in finance).
VALUE & TERMS

ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
#1 | We use financial ratios to help diagnose financial health.
We use financial ratios to help diagnose financial health

 Financial ratios help us relate items on the financial statements in a meaningful and comparable
way
 Definitions of the ratios may vary depending on the purpose of the analysis
 Financial ratios are generally used to identify key questions for further analysis – rather than
providing deep insight by themselves
Conclusions and
Financial statement analysis framework 1:
recommendations must
tie back to the purpose
of the analysis.
1. Purpose 2. Collect 3. Process 4. Analyze &

5. Conclusions 6. Follow-up
and Context input data data interpret
Our focus is on financial Focus on analysis rather than computation. Link the numbers to the
reports including financial company’s strategy and business environment. Go beyond describing and
statements (and notes) explain reasons for performance, risks, and implications for the future.
Adjust financial statements, prepare common-size

and trend analysis, prepare ratios (and graphs).
EXERCISE: Uses and limitations of ratios

REFLECT: Reflect on the benefits and limitations of ratios.
Benefits Limitations
 Identifies key economic relationships (e.g., gross profit to  Difficult to find “comparable” companies (or even clearly
revenues, earnings to assets, etc.) identify an industry/sector for some companies). Consider
 Comparability of financial performance over time (scaled) industry -specific ratios but be aware of ratio definitions!
 Comparability with other companies (or industry  Irregular items can skew ratios and need to be carefully
benchmarks) considered (and, adjusted)
 Easy access through data aggregators (e.g., Capital IQ,  Different companies may use different accounting standards
FactSet, Bloomberg, etc.) – but be careful! and judgments (e.g., IFRS vs. US GAAP), making it more
difficult to compare ratios.
1 Adapted from van Greuning and Bratanovic (2003, p. 300) and Benninga and Sarig (1997, pp. 134-157)

EXERCISE: Amazon (AMZN)
Analyze the selected financial statements of Amazon (see Appendix 1).
REFLECT: What are your insights about Amazon’s performance?
 Revenues continue to increase in 2023, especially in services. Operating income increased after improved results in North
America. The main bright spot for the company continues to be the Amazon Web Services (AWS) part of the business.
 Notice the significant swings in “other income (expense). This relates to the investment in Rivian (google "Amazon
investment in Rivian" for more).
 On the balance sheet, we see significant goodwill (evidence of past acquisitions) and note that all earnings have been
retained (as retained earnings increased exactly by the amount of the earnings in 2023).
EXERCISE: Meta Platforms (META)

Analyze the selected financial statements of Meta Platforms (see Appendix 2).
REFLECT: What are some of the benefits of additional “segment” disclosures (i.e., breakdown by segment)?
 Notice the significant increase in revenues, while cost of revenues remained steady (boosting gross margins in 2023).
Research and development continue to increase significantly.
 We can observe that Reality Labs revenues are a small portion of total revenues but are a major source of (increasing)
operating losses. In this case, it is difficult to see this without segment disclosures.
 It is useful to notice that Reality Lab losses are probably related to R&D expenses.
Ultimately, certain issues are difficult to diagnose without segment disclosures. Therefore, we want to be careful how we interpret
the overall performance.

Analyze the selected financial statements of Apple (selected statements provided in the Appendix 3). Consider
also the excerpts from notes below.
Review notes from Class 2. Notice the following:

 Apple’s revenues declined slightly in fiscal 2023 due to lower product sales.
 Despite the lower revenues, gross margin (as a %) continued to increase, and net income as a % of revenues remained
steady.
 Apple distributed majority of its earnings in 2023.
 Notice that Apple’s “segments” have unusual categorizations (e.g., India, Middle East, and Africa are all included in
“Europe”). As a result, we need to be careful when comparing Apple’s performance in “Europe” to other companies (e.g.,
Samsung’s performance in Europe). This is an important point: be careful when making assumptions about what specific
categories actually mean, and confirm by reading the notes.

#2 | We use common-size financial statements to facilitate analysis
Chapter 12 | LO 1
Prepare and analyse common-size financial statements. (pp. 545-550)
 Horizontal analysis represents each selected item as percentage change over a base year (e.g.,
prior period).
 Vertical analysis represents each selected item as a percentage of a key metric (e.g., revenues
or total assets).

Analyze the selected financial statements of Apple (selected statements provided in the Appendix 3).
Review notes from Class 1. Notice the following:

 Apple’s revenues declined slightly in fiscal 2023 due to lower product sales.
 Despite the lower revenues, gross margin (as a %) continued to increase, and net income as a % of revenues remained
steady.
 Apple distributed majority of its earnings.

#3 | We can use DuPont analysis to understand company performance
Chapter 12 | LO 2, 3, 4
 Compute and interpret measures of return on investment, including return on equity (ROE), return
on assets (ROA), and return on financial leverage (ROFL). (pp. 550-553)
 Disaggregate ROA into profitability (profit margin) and efficiency (asset turnover) components. (pp.
553-558)
 Compute and interpret measures of liquidity and solvency. (pp. 558-565)
DuPont analysis and integrative ratios
It is critical to understand the relationships between various ratios. DuPont analysis allows us to decompose
an important profitability measure: return on equity (ROE). By breaking it down, we can understand the
drivers of ROE (over time and compared to other companies).
STEP 1:
Ability to generate
revenues through
efficient use of assets
STEP 2:
Ability to keep
revenues as profits
STEP 3:
Recognize the trade-off
as levers of profitability
STEP 4:
Ability to use LEVERAGE
(debt) as a “magnifier”

Step 1: Evaluate the ability to generate revenues through efficient use of assets
EXERCISE: Generating revenues

Efficiency in using assets to generate revenues COMPANY FY2023 FY2022 FY2021

AAPL 1.09 1.12 1.08

Total asset turnover = = = 1.09
Avg. total
Avg. total
Apple FY’23 Revenues $383,285 assets
assets
Meta FY’23 Revenues $134,902
Sep. 24, 2022 Sep. 30, 2023 Dec. 31, 2022 Dec. 31, 2023
$352,755 $352,583 $185,727 $229,623
Total Assets Total Assets Total Assets Total Assets
 We must be careful when interpreting Apple’s ability to generate revenues relative to total assets. After all, total assets include non-
operating assets such as marketable securities (which are extremely significant for Apple). Therefore, it would be more useful to
consider revenues relative to operating assets (i.e., those that logically and directly contribute to generating core revenues).
 While Meta looks “less efficient”, it is important to note that Meta had major acquisitions (e.g., Instagram, WhatsApp, Oculus, etc.).
This means that assets are valued at acquisition date (more about this in the future), and have higher values compared to internal
growth. Remember, internal spending on R&D generally shows up as an expense, rather than assets.
PPE turnover AMZN 2.94 2.96 3.44

= sales revenue / average PPE META 1.53 1.70 2.28
AAPL 8.93 9.67 9.60

PPE turnover = = = 8.93
Average PPE ($43,715 + $42,117) ÷2
Avg. PPE
Sep. 24, 2022 Sep. 30, 2023

$42,117 $43,715
PPE PPE

Efficiency in managing inventories COMPANY FY2023 FY2022 FY2021
Inventory turnover AMZN 9.0 8.6 9.7
= cost of goods sold / average inventory META N/A N/A N/A
AAPL 33.6 35.0 36.1
COGS $189,282
Inventory turnover = = = 33.6
Average inventory ($6,331 + $4,946) ÷2
Avg.
FY’23 COGS $189,282 inventory
Sep. 24, 2022 Sep. 30, 2023

$4,946 $6,331
Inventory Inventory
Days of inventory outstanding AMZN 41 42 38

= days in period / inventory turnover META N/A N/A N/A
AAPL 11 10 10
Days in period 365

Days of inventory outstanding = = = 11
Inventory turnover 33.6
NOTES:
 When attempting to approximate days of inventory held, it is important to relate inventory to COGS. Therefore, we only use the
“cost of sales: products” and not those for services (as services are not directly related to inventories).
 Of course, we should consider a similar adjustment to Amazon. Specifically, we should exclude the cost of services (e.g., AWS,
Amazon Prime, etc.).
 Notice that days in inventory figures (before adjustments) are also relatively steady over time for each company.
 Another way to calculate days in inventory is to use Average Daily Cost of Goods Sold (COGS) method:
o Calculate Average Daily COGS: Next, divide the total COGS for the period (usually a year) by the number of days in
that period: Average Daily COGS = COGS / number of days in the period (e.g., 365)
o Calculate Days in Inventory: divide the average inventory by the average daily COGS:
o By converting the annual COGS into a daily figure, you can easily compare it against the average inventory on hand
to see how many days, on average, it takes to sell the inventory. This approach gives a more intuitive, time-based
understanding of the inventory turnover process, making it easier to assess how quickly the company is selling
inventory. It also helps identify potential inefficiencies in inventory management.
 Note also that Apple’s fiscal year is longer than 365 days: from Sep. 24, 2022, to Sep. 30, 2023, is 371 days. We use 365 in the
calculation as a simplified estimation.

Efficiency in managing receivables COMPANY FY2023 FY2022 FY2021
Receivables turnover AMZN 12.2 13.7 16.4
= revenue / average receivable META 9.1 8.5 9.3
AAPL 13.3 14.5 17.3
Net sales $383,285

Receivables turnover= = = 13.3
Average A/R ($29,508 + $28,184) ÷2

Avg. A/R
Sep. 24, 2022 Sep. 30, 2023

$28,184 $29,508
A/R A/R
Days of sales outstanding AMZN 30 27 22

= days in period / receivables turnover META 40 43 39
AAPL 27 25 21
Days in period 365

Days of sales outstanding= = = 27
A/R turnover 13.3
 Ideally, we want to consider only “credit revenues” (and not cash sales) when calculating A/R turnover and average age of
receivables. After all, cash sales are not related to receivables and the velocity of their collection.
 Notice that the ranges for average days in accounts receivable are steady and similar.
 Like days in inventories, we can break total sales down into Daily Sale. This approach gives a clear sense of the company's
daily revenue generation. When this is compared to the Average Accounts Receivable, it provides a time-based measure,
showing the typical number of days it takes to collect outstanding receivables. This approach makes it easier to gauge
collection efficiency, as it translates financial data into a simple, time-focused perspective that is easy to understand and apply.
EXERCISE: Business models and sales/collections

REQUIRED: In the calculation of receivables turnover (and therefore, days of sales outstanding), many
aggregator services (e.g., FactSet) include “vendor non-trade receivables”. Analyze Apple’s note describing
this balance and critically evaluate the use of this amount in the calculation of the receivables turnover.
Vendor Non-Trade Receivables

The Company has non-trade receivables from certain of its manufacturing vendors resulting from the sale of components to these vendors
who manufacture subassemblies or assemble final products for the Company. The Company purchases these components directly from
suppliers. As of September 24, 2022, the Company had two vendors that individually represented 10% or more of total vendor non-trade
receivables, which accounted for 54% and 13%. As of September 25, 2021, the Company had three vendors that individually represented
10% or more of total vendor non-trade receivables, which accounted for 52%, 11% and 11%.
 These vendor receivables are indeed “non-trade” and don’t relate to Apple’s core revenues. Therefore, we generally want to
only use trade receivables that relate to core credit revenues.

Payables turnover AMZN 3.7 3.6 3.6
(we can use cost of sales as proxy for purchases) META 5.3 5.6 8.4
= cost of sales / average trade payables AAPL 3.4 3.8 4.4
Cost of sales $214,137

Payables turnover = = = 3.4
Average A/P ($62,611 + $64,115) ÷2
Days of payables outstanding AMZN 99 100 101

= days in period / payables turnover META 69 66 44
AAPL 108 97 83
Days in period 365

Days of payables outstanding = = = 108
A/P turnover 3.4
 Notice the estimated length of time taken by each company to pay suppliers. For Amazon and Apple, it is more than 3 months! We
often associate these as favourable terms from suppliers and want to consider the importance of companies like Amazon and
Apple relative to the number and size of their suppliers (consider the importance of Apple to Foxconn, and the other way around).
 The Days in Payables calculation provides an intuitive way to understand how long, on average, a company takes to pay its
suppliers. By calculating Daily Cost of Goods Sold (COGS), you can determine how much the company spends each day on its
operations. Comparing this daily figure to the Average Accounts Payable gives a time-based measure of the company’s payment
cycle. This shows how many days it typically takes to settle its obligations to suppliers. The daily approach makes it easier to
assess the company’s payment habits and its management of cash flow, providing a clear time-based view of its payables
process.

AMZN (28) (31) (41)
CASH CONVERSION CYCLE META (29) (23) (4)
= days in inventory AAPL (70) (61) (52)
+ days sales outstanding
– days of payables
= 11 + 27 – 108 = (70)
 Notice the significance of negative cash conversion cycle (CCC). This provides significant financial flexibility with respect to
working capital.
 For example, it takes Apple approximately 11 days to sell inventory, and 27 days to collect cash after the sale. This means that
Apple needs to wait for 11 + 27 = 38 days (or just over a month) to collect cash after receiving inventory.
 However, Apple needs to pay its suppliers for that inventory in about 108 days in 2023 (more than 3 months).
 Therefore, Apple can use the cash from the sale of inventory for about 70 days before paying the suppliers for the inventory it
already sold (and collected the cash). This is excellent!
 Not all businesses are structured this way. Consider if you had a winery, you would need to spend lots of cash up front and wait
about 2 years to harvest the grapes and age the wine before selling it and collecting cash. Structurally, such a business requires
significant short-term financing!
EXERCISE: Business models and cash collection cycles

REQUIRED: What are the implications of a negative cash cycle? Compare Apple’s cash cycle relative to the
technology sector. What are your insights?
 Notice the significant difference between Apple’s negative CCC and the rest of its peers in the technology sector (as per FactSet).
 Similarly, notice the significant increase in the CCC in 2022. However, Apple doesn’t follow this trend!
 Ultimately, we can see how not manufacturing its products can have a significant impact on Apple’s days in inventory and working
capital financing needs.

Step 2: Evaluate the ability to turn revenues into profits (profitability)
EXERCISE: Business models and profitability

REFLECT: Review the “profitability funnels” below. What are your key insights?
Sales 100%
Sales 100%
Sales 100%
Profitability analysis FY2023 FY2022 FY2021

AMZN 47.0% 43.8% 39.6%
Gross profit margin META 80.8% 78.3% 80.6%
= (sales revenue – cost of sales) / sales revenue AAPL 44.1% 43.3% 38.2%
= gross profit / sales revenue
= $169,148 / $383,285 = 44.1%
AMZN 6.4% 2.4% 5.9%

Operating profit margin META 34.7% 24.8% 38.0%
= operating income / sales revenue AAPL 29.8% 30.3% 24.1%
= $114,301 / $383,285 = 29.8%
AMZN 5.3% -0.5% 5.5%

Net profit margin META 29.0% 19.9% 33.9%
= net income / sales revenue AAPL 25.3% 25.3% 20.9%
= $96,995 / $383,285 = 25.3%
 Consider the link between the business model and company performance. In addition, consider the industry competitive dynamics
and the company’s strategic choices. These are reflected in the financials.

Step 3: Understand the trade-offs between efficiency and profitability
EXERCISE: Understanding ROA

REFLECT: Critically evaluate the return on asset (ROA) ratio. What are some challenges of using this ratio to
Evaluating the trade-offs between efficiency and profitability FY2023 FY2022 FY2021
AAPL 1.09 1.12 1.08
Net profit margin AMZN 5.3% -0.5% 5.5%

= net income / sales revenue META 29.0% 19.9% 33.9%
AAPL 25.3% 25.3% 20.9%
AMZN 6.1% -0.6% 9.0%

Net income $96,995

Return on Assets (ROA)= = = 27.5%

 Once again, notice the impact of one-time items that can skew these ratios (especially net profit margin) – such as Amazon in
2022. Absent these times, we might expect that ROA metrics start to converge between firms. This would be consistent with the
trade-offs between efficiency and profitability.
 ROA is meant to measure return on “assets” – regardless of how they are financed (i.e., by debt or equity). As a result, it is more
appropriate to use an adjusted ROA, defined as follows:
Adjusted ROA = [net income + interest expense(1 – tax rate)] / average total assets

REVIEW: Explaining trade-offs
REFLECT: Review the graph below and write down your main observations/insights.
For those interested in additional research studies on this topic, see the framework in Nissim, D.,
& Penman, S. H. (2001). Ratio analysis and equity valuation: From research to practice. Review of
accounting studies, 6(1), 109-154.Graph below reproduced from Wong et al. 2nd ed.
Key insights:
 Notice that the space in the top-right corner is very difficult to occupy. Recall that economics and strategy would suggest that, in
general, abnormal profits and efficiency will get competed away.

Step 4: Evaluate the use of leverage as a “magnifier”
EXERCISE: Understanding basic leverage

REFLECT: Critically evaluate the financial leverage ratio. What are some challenges of using this ratio to
Evaluating the returns on investments and the use of leverage FY2023 FY2022 FY2021
AMZN 6.1% -0.6% 9.0%
AMZN 2.8 3.1 3.2

Financial leverage (FL) META 1.5 1.4 1.3
= average total assets / average total equity AAPL 6.3 6.2 5.3

Financial leverage (FL)= = = 6.3
 Leverage can be used to “magnify” returns if those returns exceed the cost of borrowing.
 This idea is related to finance theory and the question of capital structure (how much debt vs. equity).
 Financial leverage refers to the use of borrowed funds to amplify the returns on equity (ROE). When a company borrows money at
an interest rate lower than the return it generates on its investments, it can increase the overall return on equity. This works
because the additional return from the investment (greater than the cost of borrowing) flows to the equity holders, boosting their
earnings. However, leverage also introduces more risk since the company must meet its debt obligations regardless of its
performance. Therefore, while leveraging can significantly improve ROE in favorable conditions, it also increases financial risk
during downturns.
 Notice that Apple’s financial leverage is increasing significantly. This is not a result of adding debt. Instead, it is primarily a result of
significant dividends and aggressive share repurchases. This has pushed Apple’s retained earnings into a retained deficit.
o As equity starts to approach zero, please note that ROE starts to lose meaning and becomes harder to interpret. As
equity approaches zero from the positive side, ROE skyrockets. However, as soon as it crosses over into the negative
territory, ROE skyrockets on the negative side.
o Be careful how to interpret this! Apple’s performance would not suddenly turn from “amazing” to “horrible”.
AMZN 17.5% -1.9% 28.8%

Return on equity (ROE) META 28.0% 18.5% 31.1%
= net income / average total equity AAPL 171.9% 175.5% 147.4%
= net profit margin x total asset turnover x FL
= ROA x financial leverage
Net income $96,995

Return on Equity (ROE)= = = 171.9%

EXERCISE: Evaluating solvency
Solvency analysis and the use of leverage FY2023 FY2022 FY2021

Debt-to-equity AMZN 1.6 2.2 2.0
= total liabilities / total equity META 0.5 0.5 0.3
AAPL 4.7 6.0 4.6
Total liabilities $290,437

Debt-to-equity= = = 4.7
Total equity $62,146
 Apple’s debt-to-equity ratio is increasing due to declining equity (not increasing debt). As noted before, this is driven by dividends
and share repurchases. This trend reversed in 2023 as Apple paid down some debt and tempered its share repurchases.
Interest coverage AMZN 12.8 -1.5 22.1

= EBIT / interest expense META 107.3 156.8 2,057
[interest expense disclosed as $3,933 in FY2023] AAPL 29.9 41.6 42.3
Earnings before interest and taxes $96,995 + 16,741 + 3,933

Interest coverage= = = 29.9
Interest expense $3,933
 Despite the higher leverage (debt relative to equity), Apple is also maintaining significant earnings and is comfortably able to
“cover” interest costs. Of course, this “coverage” has declined as earnings leveled off and interest costs increased significantly in
2023.
 Notice that Amazon’s earnings before taxes are negative in 2022, although this is due to the revaluation of the Rivian investment.
Therefore, we need to contextualize the significant volatility in earnings.

EXERCISE: Evaluating liquidity
Liquidity analysis FY2023 FY2022 FY2021

Current ratio AMZN 1.0 0.9 1.1
= current assets / current liabilities META 2.7 2.2 3.2
AAPL 1.0 0.9 1.1
current assets $143,566

Current ratio = = = 1.0
 Apple’s current ratio reached 0.9 in 2022, declining below 1. This is sometimes framed as a “red flag”. However, we must consider
the context. In Apple’s case, the company also has $132 billion in long-term marketable securities (which can be sold if needed).
Apple doesn’t have a liquidity problem.
 A low current ratio, which measures a company's ability to pay short-term liabilities with its short-term assets, might seem
concerning at first glance. However, when connected to a negative cash conversion cycle (CCC), it isn't necessarily a bad sign. A
negative CCC means the company collects cash from customers before it pays suppliers, which can improve liquidity and reduce
the need for a high current ratio. In this case, the company operates efficiently by managing inventory and receivables quickly,
making a low current ratio less of a concern since cash flow is consistently positive.
Quick ratio AMZN 0.8 0.7 0.9

= “Quick assets” / current liabilities META 2.6 2.0 2.9
AAPL 0.6 0.5 0.7
cash + short-term securities + accounts receivable $29,965 + 31,590 + 29,508

Quick ratio = = = 0.6
 Similarly to the discussion of the current ratio, Apple’s quick ratio can appear “concerning”. However, as noted, we must consider
the context. Apple has significant long-term marketable securities (which can be sold if needed). Again, Apple doesn’t have a
liquidity problem.

APPENDIX 1: AMAZON FINANCIAL STATEMENTS & NOTES

APPENDIX 2: META FINANCIAL STATEMENTS & NOTES

APPENDIX 3: APPLE FINANCIAL INFORMATION (SELECTED)

APPENDIX 4: RATIO FORMULA SHEET

NOTES AND REFLECTIONS
Most important ideas/points:
All copyrights attributable to owners.

Class 5 | Ch. 12 (DuPont Practice Case: Costco Wholesale Corp)
RSM219
Introduction to Financial Accounting
Class 12
Analysing Financial Statements
DuPont Practice Case
(Costco Wholesale Corp)
Costco is a global retail giant known for its membership-only warehouse clubs that offer bulk products at low prices. It has
built a loyal customer base by focusing on cost efficiency, high-quality private label products, and exceptional member
benefits. In the context of the business world, Costco is important because it challenges traditional retail models through
its unique pricing strategy, limited product selection, and efficient inventory turnover, which results in low operating costs
and high sales volume. Costco's approach to delivering value to customers, along with its financial success, makes it a
significant player in the retail industry and an influential example of how scale and efficiency can drive profitability in a
highly competitive market.
Costco's share price increase from $290 to $880 over the last five years is a significant reflection of the company's strong
business model and investor confidence. This growth—more than tripling in value—highlights Costco’s effective strategy
of providing high-quality products at low prices while maintaining operational efficiency. The increase also signals
Costco's resilience during challenging economic conditions, such as the COVID-19 pandemic, where bulk shopping and
the value provided by warehouse clubs attracted more customers. Investors have recognized Costco's consistent
performance, customer loyalty, and ability to adapt to changing consumer behaviors, making it one of the most successful
retail companies in terms of market value and financial health.
Costco’s financial statements are included in the Appendix, and Excel file is posted on Quercus. Below is the stock price
chart over the last 5 years.
TABLE OF CONTENTS
QUESTION 1: Assessing profitability .............................................................................................................................. 2
QUESTION 2: Cash conversion cycle ............................................................................................................................ 3
QUESTION 3: Assessing liquidity ................................................................................................................................... 4
QUESTION 4: Assessing solvency ................................................................................................................................. 4
APPENDIX: Costco Financial Statements ...................................................................................................................... 5
RSM219 – Introduction to Financial Accounting © Dragan Stojanovic and Catherine Barrette Page 1 of 5
QUESTION 1: Assessing profitability

REQUIRED: Calculate the ratios listed in the table below and provide an overall assessment of profitability. Show all calculations and
round to one decimal point.
NOTE: When providing an overall assessment, it is important to include explanations of relevant ratios. Providing an explanation does
not mean simply listing facts about ratio variables (e.g., “gross profit is higher because cost of sales is lower relative to sales”). Rather it
means attempting to identify the reasons for the differences (e.g., what is it that makes the costs of sales lower relative to sales?). In
other words, calculating the ratios is only the first step (please state any and all assumptions you used in making the calculations).
Contextualizing those numbers and explaining them is the real focus.
RATIO 2023 2022 2021

Gross profit margin ($242,290 - $212,586) / ($226,954 - $199,382) / ($195,929 - $170,684) /
= gross profit / net sales $242,290 = 12.3% $226,954 = 12.1% $195,929 = 12.9%
Operating profit margin 8,114 / 242,290 7,793 / 226,954 6,708 / 195,929

= operating profit / sales = 3.3% = 3.4% = 3.4%
Profit margin 6,292 / 242,290 5,915 / 226,954 5,079 / 195,929

= net income / sales = 2.6% = 2.6% = 2.6%
Asset turnover 242,290 / 226,954 / 195,929 /

= sales / average total ((68,994 + 64,166)/2) ((64,166 + 59,268)/2) ((59,268 + 55,556)/2)
assets = 3.64 = 3.68 = 3.41
Return on assets (ROA) 6,292 / 5,915 / 5,079 /

= net income / average ((68,994 + 64,166) / 2) ((64,166 + 59,268)/2) ((59,268 + 55,556)/2)
total assets = 9.5% 9.6% = 8.8%
= profit margin x asset
turnover Or Or Or
2.6% x 3.64 = 9.5% 2.6% x 3.68 = 9.6% 2.6% x 3.41 = 8.9%
Difference due to rounding
Financial leverage (FL) ((68,993 + 64,166)/2) / ((64,166 + 59,268)/2) / ((59,268 + 55,556)/2) /
= average total assets ((25,058 + 20,647)/2) ((20,647 + 18,078)/2) ((18,078 + 18,705)/2)
/ average total equity = 2.91 = 3.19 = 3.12
Return on equity (ROE) 6,292 / 5,915 / 5,079 /

= net income / average ((25,058 + 20,647)/2) ((20,647 + 18,078)/2) ((18,078 + 18,705)/2)
total equity = 27.5% = 30.5% = 27.6%
= ROA x FL
Or Or Or
9.5% x 2.91 = 27.6% 9.6% x 3.19 = 30.6% 27.6% x 3.12 = 27.8%
Difference due to rounding Difference due to rounding Difference due to rounding
Overall assessment of profitability:
QUESTION 2: Cash conversion cycle

REQUIRED: Estimate the cash conversion cycle for Costco and compare it to Walmart. Show all calculations (as required) and state all
necessary assumptions. Provide an overall interpretation and assessment of the cash conversion cycle.
NAME Costco Walmart

= 365 / Inventory turnover = 365 * (Avg Inventory / COGS)
Days of = 365 * [((16,651 + 17,907) / 2) / 212,586] 44.5 days
inventory on = 29.7 days
hand
Or, using 371 days for 53 weeks reported:
2023 = 371 * (Avg Inventory / COGS)
= 371 * [((16,651 + 17,907) / 2) / 212,586]
= 30.2 days
= 365 / AR turnover = 365 * (Avg Net A/R / Sales)
Days of = 365 * [((2,285 + 2,241) / 2] / 242,290] 4.8 days
sales = 3.4 days
outstanding
= 371 * (Avg Net A/R / Sales)
2023 = 371 * [((2,285 + 2,241) / 2] / 242,290]
= 3.5 days
= 365 / Payables turnover = 365 * (Avg A/P / COGS)
Days in = 365 * [((17,483 + 17,848) / 2) / 212,586] 42.9 days
payables = 30.3 days
2023 Or, using 371 days for 53 weeks reported:

= 371 * (Avg A/P / COGS)
= 371 * [((17,483 + 17,848) / 2) / 212,586]
= 30.8 days
Cash DSO + DOH – DPO
conversion = 3.4 + 29.7 – 30.3 6.4 days
cycle = 2.7 days

= 2.8 days
NOTE: Costco reported a 53 week period = 371 days. Using 365 days for Costco was also acceptable.
Overall interpretation and assessment:
QUESTION 3: Assessing liquidity

REQUIRED: Calculate the liquidity ratios listed below and use them to assess Costco’s liquidity relative to Walmart.
NAME Costco Walmart
Current ratio Current assets / current liabilities 0.82

= $35,879 / $33,583 = 1.07
2023
Quick ratio = (cash + receivables + marketable securities) / current liabilities 0.18

= ($13,700 + 1,534) / 33,583 = 0.52
2023
QUESTION 4: Assessing solvency

REQUIRED: Calculate the solvency ratios listed below and use them to assess Costco’s solvency relative to Walmart.
NAME Costco Walmart
Debt-to- = total liabilities / total equity 1.90

equity = $43,936 / $25,058 = 1.75
2023
Interest = Earnings before interest / interest expense 10.52

coverage = ($6,292 + 2,195 + 160) / 160 = 54.04
2023
APPENDIX: Costco Financial Statements
RSM219
Introduction to Financial Accounting
Class 12
Analysing Financial Statements
DuPont Practice Case
(Costco Wholesale Corp)
Costco is a global retail giant known for its membership-only warehouse clubs that offer bulk products at low prices. It has
built a loyal customer base by focusing on cost efficiency, high-quality private label products, and exceptional member
benefits. In the context of the business world, Costco is important because it challenges traditional retail models through
its unique pricing strategy, limited product selection, and efficient inventory turnover, which results in low operating costs
and high sales volume. Costco's approach to delivering value to customers, along with its financial success, makes it a
significant player in the retail industry and an influential example of how scale and efficiency can drive profitability in a
highly competitive market.
Costco's share price increase from $290 to $880 over the last five years is a significant reflection of the company's strong
business model and investor confidence. This growth—more than tripling in value—highlights Costco’s effective strategy
of providing high-quality products at low prices while maintaining operational efficiency. The increase also signals
Costco's resilience during challenging economic conditions, such as the COVID-19 pandemic, where bulk shopping and
the value provided by warehouse clubs attracted more customers. Investors have recognized Costco's consistent
performance, customer loyalty, and ability to adapt to changing consumer behaviors, making it one of the most successful
retail companies in terms of market value and financial health.
Costco’s financial statements are included in the Appendix, and Excel file is posted on Quercus. Below is the stock price
chart over the last 5 years.
TABLE OF CONTENTS
QUESTION 1: Assessing profitability .............................................................................................................................. 2
QUESTION 2: Cash conversion cycle ............................................................................................................................ 3
QUESTION 3: Assessing liquidity ................................................................................................................................... 4
QUESTION 4: Assessing solvency ................................................................................................................................. 4
APPENDIX: Costco Financial Statements ...................................................................................................................... 5
QUESTION 1: Assessing profitability

REQUIRED: Calculate the ratios listed in the table below and provide an overall assessment of profitability. Show all calculations and
round to one decimal point.
NOTE: When providing an overall assessment, it is important to include explanations of relevant ratios. Providing an explanation does
not mean simply listing facts about ratio variables (e.g., “gross profit is higher because cost of sales is lower relative to sales”). Rather it
means attempting to identify the reasons for the differences (e.g., what is it that makes the costs of sales lower relative to sales?). In
other words, calculating the ratios is only the first step (please state any and all assumptions you used in making the calculations).
Contextualizing those numbers and explaining them is the real focus.
RATIO 2023 2022 2021

Gross profit margin ($242,290 - $212,586) / ($226,954 - $199,382) / ($195,929 - $170,684) /
= gross profit / net sales $242,290 = 12.3% $226,954 = 12.1% $195,929 = 12.9%
Operating profit margin 8,114 / 242,290 7,793 / 226,954 6,708 / 195,929

= operating profit / sales = 3.3% = 3.4% = 3.4%
Profit margin 6,292 / 242,290 5,915 / 226,954 5,079 / 195,929

= net income / sales = 2.6% = 2.6% = 2.6%
Asset turnover 242,290 / 226,954 / 195,929 /

= sales / average total ((68,994 + 64,166)/2) ((64,166 + 59,268)/2) ((59,268 + 55,556)/2)
assets = 3.64 = 3.68 = 3.41
Return on assets (ROA) 6,292 / 5,915 / 5,079 /

= net income / average ((68,994 + 64,166) / 2) ((64,166 + 59,268)/2) ((59,268 + 55,556)/2)
total assets = 9.5% 9.6% = 8.8%
= profit margin x asset
turnover Or Or Or
2.6% x 3.64 = 9.5% 2.6% x 3.68 = 9.6% 2.6% x 3.41 = 8.9%
Difference due to rounding
Financial leverage (FL) ((68,993 + 64,166)/2) / ((64,166 + 59,268)/2) / ((59,268 + 55,556)/2) /
= average total assets ((25,058 + 20,647)/2) ((20,647 + 18,078)/2) ((18,078 + 18,705)/2)
/ average total equity = 2.91 = 3.19 = 3.12
Return on equity (ROE) 6,292 / 5,915 / 5,079 /

= net income / average ((25,058 + 20,647)/2) ((20,647 + 18,078)/2) ((18,078 + 18,705)/2)
total equity = 27.5% = 30.5% = 27.6%
= ROA x FL
Or Or Or
9.5% x 2.91 = 27.6% 9.6% x 3.19 = 30.6% 27.6% x 3.12 = 27.8%
Difference due to rounding Difference due to rounding Difference due to rounding
Overall assessment of profitability:
 Gross profit margin: very steady and consistent with minor fluctuations. Costco effectively managed its costs relative to sales.
Gross profit margin is very small relative to the other companies we have considered so far in the course.
 Operating margin: very steady, decreasing slightly due to slight increase in SG&A as percentage of sales.
 Profit margin: very steady with minor fluctuations described above. Profit margin is much lower than most of the other companies
we have considered so far in the course.
 Asset turnover: very steady with minor fluctuations, such as higher holdings of cash offset by lower inventories and lease assets.
In addition, sales were higher in fiscal 2023 in part due to 53 weeks included in the fiscal year (vs. 52 in prior years). Asset turnover
is very high relative to other companies we have considered in the course so far.
 Financial leverage: decreasing leverage with increasing retained earnings.
 Return on equity: decline primarily due to lower leverage. Notice that despite extremely low profit margins, Costo is able to
generate significant ROE.
Costco has demonstrated strong and stable profitability over the past three years. The company maintains consistent profit margins
and effectively utilizes its assets to generate sales and profits. The reduction in financial leverage suggests a strategic move towards
a more conservative capital structure, potentially enhancing long-term financial stability. Overall, Costco's profitability metrics indicate
a healthy financial position with efficient operations and solid returns to shareholders.
NOTE: Full financial statements and notes would help provide additional insights and interpretation.
QUESTION 2: Cash conversion cycle

REQUIRED: Estimate the cash conversion cycle for Costco and compare it to Walmart. Show all calculations (as required) and state all
necessary assumptions. Provide an overall interpretation and assessment of the cash conversion cycle.
NAME Costco Walmart

= 365 / Inventory turnover = 365 * (Avg Inventory / COGS)
Days of = 365 * [((16,651 + 17,907) / 2) / 212,586] 44.5 days
inventory on = 29.7 days
hand
2023 = 371 * (Avg Inventory / COGS)
= 371 * [((16,651 + 17,907) / 2) / 212,586]
= 30.2 days
= 365 / AR turnover = 365 * (Avg Net A/R / Sales)
Days of = 365 * [((2,285 + 2,241) / 2] / 242,290] 4.8 days
sales = 3.4 days
outstanding
= 371 * (Avg Net A/R / Sales)
2023 = 371 * [((2,285 + 2,241) / 2] / 242,290]
= 3.5 days
= 365 / Payables turnover = 365 * (Avg A/P / COGS)
Days in = 365 * [((17,483 + 17,848) / 2) / 212,586] 42.9 days
payables = 30.3 days
2023 Or, using 371 days for 53 weeks reported:

= 371 * (Avg A/P / COGS)
= 371 * [((17,483 + 17,848) / 2) / 212,586]
= 30.8 days
Cash DSO + DOH – DPO
conversion = 3.4 + 29.7 – 30.3 6.4 days
cycle = 2.7 days

= 2.8 days
NOTE: Costco reported a 53 week period = 371 days. Using 365 days for Costco was also acceptable.
Comparing Costco and Walmart's efficiency metrics highlights how their distinct business models and strategies impact operational performance.
 Costco's Days of Inventory on Hand is approximately 30 days, significantly lower than Walmart's 44.5 days, which reflects Costco's
strategy of offering a limited selection of bulk products leading to faster inventory turnover. This efficient inventory management is central to
Costco's warehouse club model, focusing on high-volume sales of a narrower product range, which reduces holding costs and minimizes the
risk of obsolescence. In contrast, Walmart offers a vast variety of products to cater to a broad customer base across its extensive
international footprint, resulting in longer inventory holding periods.
 Costco's Days of Sales Outstanding is slightly lower at 3.4 days compared to Walmart's 4.8 days, indicating that Costco collects cash
from customers marginally faster, which improves its liquidity. Both companies primarily deal in cash or immediate payment methods, but
Costco's membership model may contribute to quicker cash inflows.
 Days in Payables for Costco are 30.3 days, which is shorter than Walmart's 42.9 days, suggesting that Costco pays its suppliers more
promptly. This practice could strengthen supplier relationships and potentially lead to better purchasing terms, supporting Costco's strategy
of offering low prices to its members.
 The Cash Conversion Cycle (CCC) brings these elements together, with Costco at a swift 2.7 days versus Walmart's 6.4 days,
demonstrating Costco's superior efficiency in managing cash. Costco's shorter CCC indicates that it ties up its capital for a shorter duration,
which can be attributed to its streamlined product offerings, efficient inventory management, and quicker payment cycles. Walmart's longer
CCC reflects its strategic choice to offer a wider array of products across global markets, which, while attracting a diverse customer base,
results in longer inventory turnover and payment periods. In essence, these efficiency metrics illustrate how Costco's focused product
assortment and operational efficiency contrast with Walmart's broad product variety and expansive international operations, each aligning
with their respective business strategies and market positions.
QUESTION 3: Assessing liquidity

REQUIRED: Calculate the liquidity ratios listed below and use them to assess Costco’s liquidity relative to Walmart.
NAME Costco Walmart
Current ratio Current assets / current liabilities 0.82

= $35,879 / $33,583 = 1.07
2023
Quick ratio = (cash + receivables + marketable securities) / current liabilities 0.18

= ($13,700 + 1,534) / 33,583 = 0.52
2023
Costco's liquidity ratios indicate a stronger short-term financial position compared to Walmart. In 2023, Costco's current ratio was 1.07, meaning it has $1.07 in
current assets for every $1.00 of current liabilities, while Walmart's current ratio was lower at 0.82. Similarly, Costco's quick ratio was 0.52, showing it has $0.52 in
liquid assets excluding inventory per dollar of current liabilities, whereas Walmart's quick ratio was just 0.18. These figures suggest that Costco is better
positioned to meet its short-term obligations without relying heavily on selling inventory.
The differences in these liquidity ratios are closely tied to each company's business model. Costco operates on a membership-based warehouse model, offering a
limited selection of bulk products. This approach leads to faster inventory turnover and generates upfront cash from membership fees, enhancing liquidity.
Additionally, Costco's streamlined product range means less cash is tied up in inventory and receivables. In contrast, Walmart's strategy involves offering a vast
array of products across numerous international markets. This requires maintaining larger inventories and can result in more cash being tied up in stock and
accounts receivable. Consequently, Walmart's liquidity ratios are lower, reflecting the challenges of managing liquidity in a business model that emphasizes
extensive product variety and global operations.
QUESTION 4: Assessing solvency

REQUIRED: Calculate the solvency ratios listed below and use them to assess Costco’s solvency relative to Walmart.
NAME Costco Walmart
Debt-to- = total liabilities / total equity 1.90

equity = $43,936 / $25,058 = 1.75
2023
Interest = Earnings before interest / interest expense 10.52

coverage = ($6,292 + 2,195 + 160) / 160 = 54.04
2023
Costco and Walmart's solvency ratios highlight differences in their ability to manage long-term debts and financial obligations. In 2023, Costco's debt-to-equity
ratio was 1.75, indicating it has $1.75 in total liabilities for every $1.00 of equity. Walmart's debt-to-equity ratio was slightly higher at 1.90, meaning it relies
marginally more on debt financing relative to its equity. While both companies use debt to finance their operations, the similarity in these ratios suggests they
maintain a comparable balance between debt and equity in their capital structures.
However, a notable difference appears in their interest coverage ratios. Costco's interest coverage ratio was a robust 54.04, showing that its earnings before
interest and taxes (EBIT) are over 54 times greater than its interest expenses. In contrast, Walmart's interest coverage ratio was 10.52, indicating it earns just
over ten times its interest obligations. While Walmart has strong interest coverage, Costco’s metrics are superior.
APPENDIX: Costco Financial Statements
RSM 219 | CLASS 5 – TUTORIAL: Financial Statement Analysis
QUESTION (20 marks)

Following information relates to two companies in the fashion retail industry:
 Fast Retailing Co., Ltd., the parent company of Uniqlo, Helmut Lang, GU, Theory, and Comptoir des Cotonniers.
 Inditex owns several well-known brands, including Zara, Massimo Dutti, Pull&Bear, Bershka, and Stradivarius. Inditex
emphasizes rapid production and accessibility, catering to a wide range of fashion preferences globally.
 For a Bloomberg Original “Inside the Secret World of Zara”, see https://www.youtube.com/watch?v=lsR-cVRK3Y8
PART 1 (4 marks)
REQUIRED: Calculate the missing metrics in the DuPont Analysis. Round all to one decimal point.
Ratio Fast Retailing Co. Inditex

Total asset turnover = revenue / avg. total assets 0.7 B1
Net profit margin = net income / revenue A1 15.0%
Return on assets (ROA) = net income / avg. total assets A2 17.2%
Financial leverage (FL) = avg. total assets / avg. equity 1.9 1.8
Return on equity (ROE) = net income / avg. equity 16.3% B2
Ratio Calculations (optional) Answer

Net profit margin = ROA / total asset turnover
A1 = 8.6% / 0.7 = 12.3% 12.3%
ROE = ROA x FL
A2 ROA = ROE / FL = 16.3% / 1.9 = 8.6% 8.6%
ROA = total asset turnover x net profit margin

B1 Total asset turnover = ROA / net profit margin = 17.2% / 15.0% = 1.1 1.1
ROE = ROA x FL
B2 ROE = 17.2% x 1.8 = 31.0% 31.0%
PART 2 (4 marks)
REQUIRED: Using the DuPont analysis from Part 1 (above), decide which company — Fast Retailing Co. or Inditex —
had better overall financial performance in the most recent fiscal year. Compare net profit margin, total asset turnover,
and financial leverage to identify which factor had the biggest impact on Return on Equity (ROE). Consider how these
differences might relate to each company’s business model, and make some guesses about how their strategies could
affect these numbers.

PART 3 (6 marks)
REQUIRED: Estimate the cash conversion cycle for both Fast Retailing Co. and Inditex. Use the table below to help
complete your calculations. Round the cash conversion cycle values to the nearest day.

Inventory turnover 2.34 4.93
Accounts receivable turnover 36.4 36.5
Days of payables outstanding 115 116

=365 / inventory turnover
= 365 / inventory turnover
Days of inventory outstanding = 365 / 2.34 = 156 days
= 365 / 4.93 = 74 days
= 365 / accounts receivable turnover
Days of sales outstanding = 365 / 36.4 = 10 days
= 365 / 36.5 = 10 days
Days of payables outstanding 115 days 116 days
= days of inventory outstanding + days of stales

outstanding – days of payables outstanding = 74 + 10 – 116
Cash conversion cycle
= 156 + 10 – 115 = 51 days = -32 days
PART 4 (3 marks)
REQUIRED: Using the cash conversion cycle information from Part 3 (above), interpret how effectively each company
manages its inventories, receivables, and payables. How do these findings relate to the differences observed in the
DuPont Analysis from earlier? Consider how cash flow efficiency may impact metrics like total asset turnover, net profit
margin, and ultimately Return on Equity (ROE).
PART 5 (3 marks)
REQUIRED: While preparing for the midterm, your friend said, "Inditex and Fast Retailing Co. have similar financial
leverage ratios, so I think their debt-to-equity ratios must also be similar." Do you agree with your friend's statement?
Explain your reasoning.

RSM 219 | CLASS 5 – TUTORIAL: Financial Statement Analysis
QUESTION (20 marks)

Following information relates to two companies in the fashion retail industry:
 Fast Retailing Co., Ltd., the parent company of Uniqlo, Helmut Lang, GU, Theory, and Comptoir des Cotonniers.
 Inditex owns several well-known brands, including Zara, Massimo Dutti, Pull&Bear, Bershka, and Stradivarius. Inditex
emphasizes rapid production and accessibility, catering to a wide range of fashion preferences globally.
 For a Bloomberg Original “Inside the Secret World of Zara”, see https://www.youtube.com/watch?v=lsR-cVRK3Y8
PART 1 (4 marks)
REQUIRED: Calculate the missing metrics in the DuPont Analysis. Round all to one decimal point.

Total asset turnover = revenue / avg. total assets 0.7 B1
Net profit margin = net income / revenue A1 15.0%
Return on assets (ROA) = net income / avg. total assets A2 17.2%
Financial leverage (FL) = avg. total assets / avg. equity 1.9 1.8
Return on equity (ROE) = net income / avg. equity 16.3% B2
Ratio Calculations (optional) Answer

Net profit margin = ROA / total asset turnover
A1 = 8.6% / 0.7 = 12.3% 12.3%
ROE = ROA x FL
A2 ROA = ROE / FL = 16.3% / 1.9 = 8.6% 8.6%
ROA = total asset turnover x net profit margin

B1 Total asset turnover = ROA / net profit margin = 17.2% / 15.0% = 1.1 1.1
ROE = ROA x FL
B2 ROE = 17.2% x 1.8 = 31.0% 31.0%
PART 2 (4 marks)
REQUIRED: Using the DuPont analysis from Part 1 (above), decide which company — Fast Retailing Co. or Inditex —
had better overall financial performance in the most recent fiscal year. Compare net profit margin, total asset turnover,
and financial leverage to identify which factor had the biggest impact on Return on Equity (ROE). Consider how these
differences might relate to each company’s business model, and make some guesses about how their strategies could
affect these numbers.
Based on the DuPont analysis, Inditex had stronger overall financial performance compared to Fast Retailing Co. in the most recent fiscal year.
 Total Asset Turnover: Inditex had a significantly higher total asset turnover (1.1 vs. 0.7). This could be due to Inditex's fast fashion
model, which emphasizes rapid production and inventory turnover. Brands like Zara and Bershka are known for quickly adapting to
trends, leading to higher inventory turnover and greater efficiency in asset utilization. In contrast, Fast Retailing, through brands like Uniqlo
and Theory, focuses more on classic and quality apparel that is not as trend-driven. This approach tends to result in slower inventory
turnover and thus a lower total asset turnover.
 Net Profit Margin: Inditex had a higher net profit margin compared to Fast Retailing (15.0% vs. 12.3%), meaning it was more efficient at
turning sales into profit. One might consider that by quickly responding to fashion trends, Inditex ensures strong consumer demand, leading
to better margins. As noted in the Bloomberg Originals video, Inditex also spends very little on advertising – boosting its margins. Fast
Retailing also maintains good profit margins through its emphasis on quality and value, but the strategy of focusing on long-lasting, staple
pieces means less frequent releases and perhaps fewer opportunities to capitalize on short-term high-margin trends.
 Financial Leverage: both companies used similar levels of liabilities vs. equity to finance their operations. Thus, this component did not
have a significant impact on the ROE difference. Both companies are relatively “conservative” in their leverage usage, indicating a balanced
approach to risk while financing their growth. Financial leverage of 1.8 or 1.9 means that for every $1 of average equity, the companies had
less than $2 of average assets. We know from our accounting equation that Assets – Liabilities = Equity. Therefore, if a company has a
financial leverage ratio of 1.9, this means that there are $1.9 of average assets for $1 of average equity. In other words, there are $1.9 of
average assets, $0.9 of average liabilities, and $1 of average equity. This is significantly less leverage than Amazon (financial leverage of
2.8 in FY2023) and Apple (financial leverage of 6.3 in FY2023).
PART 3 (6 marks)
REQUIRED: Estimate the cash conversion cycle for both Fast Retailing Co. and Inditex. Use the table below to help
complete your calculations. Round the cash conversion cycle values to the nearest day.

Inventory turnover 2.34 4.93
Accounts receivable turnover 36.4 36.5
Days of payables outstanding 115 116

=365 / inventory turnover
= 365 / inventory turnover
Days of inventory outstanding = 365 / 2.34 = 156 days
= 365 / 4.93 = 74 days
Days of sales outstanding = 365 / 36.4 = 10 days
= 365 / 36.5 = 10 days
Days of payables outstanding 115 days 116 days
= days of inventory outstanding + days of stales

outstanding – days of payables outstanding = 74 + 10 – 116
Cash conversion cycle
= 156 + 10 – 115 = 51 days = -32 days
PART 4 (3 marks)
REQUIRED: Using the cash conversion cycle information from Part 3 (above), interpret how effectively each company
manages its inventories, receivables, and payables. How do these findings relate to the differences observed in the
DuPont Analysis from earlier? Consider how cash flow efficiency may impact metrics like total asset turnover, net profit
margin, and ultimately Return on Equity (ROE).
 The key driver of the difference in CCC between Fast Retailing and Inditex is days in inventory. Inditex's shorter inventory holding period
results in a higher total asset turnover, enabling it to utilize assets more efficiently to generate sales.
 In contrast, Fast Retailing's longer days in inventory means its inventory takes more time to sell, which lowers its total asset turnover.
This slower turnover contributes to a longer CCC and ultimately to a lower ROE.
 The DuPont analysis highlights how total asset turnover, influenced by inventory efficiency, is crucial for overall financial performance,
demonstrating the strategic advantage Inditex has through its fast inventory turnover approach.
PART 5 (3 marks)
REQUIRED: While preparing for the midterm, your friend said, "Inditex and Fast Retailing Co. have similar financial
leverage ratios, so I think their debt-to-equity ratios must also be similar." Do you agree with your friend's statement?
Explain your reasoning.
Yes, I agree that if Inditex and Fast Retailing Co. have similar financial leverage ratios, their debt-to-equity ratios should also be similar,
because the debt-to-equity ratio (total liabilities / total equity) is mathematically linked to financial leverage (avg. total assets / avg. total equity).
Since Assets – Liabilities = Equity, we can restate the debt-to equity ratio as (total assets – total equity) / total equity.
We can further restate it as (total assets / total equity) – 1.
This is mathematically related to the very similar definition of financial leverage = average assets / average equity
Main difference is that financial leverage uses average total assets and equity, while debt-to-equity ratio uses end-of-period total liabilities and
equity. Significant changes during the period could cause differences. The main cause of differences based on the definitions is likely due to the
use of “average” measure is the calculation of the financial leverage.

EASY EDUCATION | RSM219 Winter 2023
WEEK 3
RSM 219
UTSG
Charlie
导师：CHARLIE | EASY EDUCATION UTSG 校区 1

WEEK 3

WEEK 3
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WEEK 3
LEARNING OBJECTIVES
Return on investment (ROE, ROA, ROFL)

Disaggregating ROA
Liquidity and solvency

WEEK 3
Analyzing Financial Statements – Return on Investment
Return on Equity (ROE)
Return on equity (ROE) is the primary summary measure of company performance.

The net income number in the numerator measures the performance of the firm for a specific
period (typically a fiscal year) need to use average level of total equity for the period
Note that companies can choose debt to increase ROE when additional financing is needed.
Return on Asset (ROA)
Return on assets (ROA) measures the return earned on each dollar that the firm invests in
assets. It captures the returns generated by the firm’s operating and investing activities,
without regard for how those activities are financed.
Earnings without interest expense (EWI)
EWI measures the income generated by the firm before taking into account any of its
financing costs. Interest costs should be excluded from the ROA calculation so that return is
measured without the effect of debt financing.
In order to eliminate the effect of debt financing:
o Add back interesting expense

o Deduct tax savings = interest expenses * tax rate
o Net effect = interest expenses * (1-tax rate)
Return on Financial Leverage (ROFL)
Financial leverage refers to the effect that liabilities (including debt financing) have on
ROE. A firm’s management can increase the return to shareholders (ROE) by effectively
using financial leverage.

WEEK 3
ROFL captures the amount of ROE that can be attributed to financial leverage.
Practice:

WEEK 3
Calculate China Mobile’s ROE, ROA and ROFL for 2019.

WEEK 3
Disaggregating ROA
We can gain further insights into return on investment by disaggregating ROA into performance
drivers that capture profitability and efficiency.
ROA can be restated as the product of two ratios—profit margin and asset turnover—by
simultaneously multiplying and dividing ROA by sales revenue.
Profit margin (PM) measures the profit, without interest expense, that is generated from each
dollar of sales revenue.
- All other things being equal, a higher profit margin is preferable.

- PM is affected by: competition pricing, COGS gross margin, operating expenses
The asset turnover (AT) ratio reveals insights into a company’s productivity and efficiency.
- AT measures the level of sales generated by each dollar that a company invests in assets.
- Higher AT suggests assets are being used more efficiently.
- AT is affected by: sales revenue, inventory management, credit policies etc.
Trade-off between profit margin and asset turnover – Retail VS Transportation
The DuPont Model
Limitation: net profit margin is measured using net income in the numerator rather than earnings
without interest expense (EWI). This means that this measure of profitability is affected by
financial leverage—as financial leverage increases, interest expense increases and the net profit
margin decreases.
Gross Profit Margin (GPM)

WEEK 3
Gross profit margin measures the percentage of each sales dollar that is left over after product
costs are subtracted.
Accounts Receivable Rurnover (ART)
ART measures how many times receivables have been turned (collected) during the period. More
turns indicate that accounts receivable are being collected more quickly, while low turnover
often indicates difficulty with a company’s credit policies.
Inventory Turnover (INVT)
INVT measures the number of times during a period that total inventory is turned (sold). A high
INVT indicates that inventory is managed efficiently.
Retail companies focus a great deal of management attention on maintaining a high INVT ratio.
Property, plant, and equipment turnover (PPET)
PPET measures the sales revenue produced for each dollar of investment in PP&E.
PPET provides insights into asset utilisation and how efficiently a company operates given its
production technology.

WEEK 3
Practice:
Refer to the financial statements for China Mobile Limited.
1. Calculate China Mobile’s profit margin (PM) and asset turnover (AT) ratios for 2019.
2. Show that ROA = PM × AT using China Mobile’s financial data.
3. Calculate China Mobile’s gross profit margin (GPM), accounts receivable turnover (ART),
inventory turnover (INVT), and property, plant, and equipment turnover (PPET) ratios for 2019.

WEEK 3
Liquidity and Solvency
Liquidity Analysis
Liquidity ratios are particularly helpful to short-term creditors, but all investors and creditors have
an interest in these ratios.
Short term liquidity analysis assesses the company’s ability to pay its current obligations as they
come due.
Ratio Formula
Current ratio Current assets / current liabilities
Quick ratio (Cash + Short term investment + A/R) / Current

liabilities
Operating cash flow to Cash flows from operations / Average current
current liabilities
liabilities
(OCFCL)
There are no absolute standards for ratios, so a company’s ratios are typically compared to the
industry average / or competitors
Debt Management (Solvency) Ratios
Debt management ratios provide information on two aspects of debts:
1. They provide information on the relative mix of debt and equity financing
2. Second, they try to show the corporations ability to meet or cover its debt obligations to
be made as scheduled or a company can be declared bankrupt (higher debt leading to
higher leverage)
Debt-to-Equity Ratio
This ratio conveys how reliant a company is on creditor financing (which are fixed claims) compared with
equity financing (which are flexible or residual claims).
A higher ratio indicates less solvency, and more risk.

WEEK 3
Time Interest Earned
This approach assesses how much operating profit is available to cover debt obligations.
The times interest earned ratio reflects the operating income available to pay interest expense.

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FOUNDATIONS ANALYSIS OPERATIONS INVESTING & FINANCING

CLASSWORK (~ 4.5 to 8 hrs) LEARNING OUTCOMES (LOs)

TUTORIAL (~1 hr):

ONGOING WORK (~ 0.5-1 hrs)

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 2 OF 26

Business Environment (competitors, regulators, etc.)

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 3 OF 26

We use financial ratios to help diagnose financial health

1. Purpose 2. Collect 3. Process 4. Analyze &

Adjust financial statements, prepare common-size

EXERCISE: Uses and limitations of ratios

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 4 OF 26

EXERCISE: Meta Platforms (META)

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 5 OF 26

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 6 OF 26

EXERCISE: Ratios to assess performance – Apple (AAPL)

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 7 OF 26

DuPont analysis and integrative ratios

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 8 OF 26

EXERCISE: Generating revenues

Efficiency in using assets to generate revenues COMPANY FY2023 FY2022 FY2021

Sales revenue $383,285

Meta FY’23 Revenues $134,902

Insights and challenges:

PPE turnover AMZN 2.94 2.96 3.44

Sales revenue $383,285

FY’23 Revenues $383,285

Sep. 24, 2022 Sep. 30, 2023

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 9 OF 26

Sep. 24, 2022 Sep. 30, 2023

Days of inventory outstanding AMZN 41 42 38

Days in period 365

Insights and challenges:

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 10 OF 26

Net sales $383,285

FY’23 Revenues $383,285

Sep. 24, 2022 Sep. 30, 2023

Days of sales outstanding AMZN 30 27 22

Days in period 365

Insights and challenges:

EXERCISE: Business models and sales/collections

Vendor Non-Trade Receivables

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 11 OF 26

Cost of sales $214,137

Days of payables outstanding AMZN 99 100 101

Days in period 365

Insights and challenges:

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 12 OF 26

EXERCISE: Business models and cash collection cycles

DRAGAN STOJANOVIC & CATHERINE BARRETTE © 2024 PAGE 13 OF 26

EXERCISE: Business models and profitability

Gross profit margin 47%

Operating profit margin 6%

Net profit margin 5%

Gross profit margin 81%

Operating profit margin 35%

Net profit margin 29%

Gross profit margin 43%

Operating profit margin 30%