WARNING

This collection of slides provides an idea of the course

structure and key words.

It is NOT intended to substitute the readings required

by the instructor.

1
 TCH321
CORPORATE FINANCE
Nguyễn Mạnh Hiệp
2020

2
 CHAPTER 2
FINANCIAL STATEMENT ANALYSIS
Nguyen Manh Hiep

3
 In this chapter
• FINANCIAL STATEMENTS AND COMPANY’S
I. ACTIVITIES

• FINANCIAL REPORTING FRAMEWORK

II.

• FINANCIAL RATIOS
III

• FINANCIAL FORECASTING
IV

• HOMEWORK
V
4
 I. FIN. STATEMENTS VS
ACTIVITIES
Production-Investment Cycles

(Adopted and modified from R. Higgins, Analysis for Financial Management)

5
 I. FIN. STATEMENTS VS
ACTIVITIES
 The value of the firm comes from net cash flow
(expected cash inflow from production-investment
cycles is higher than cash outflow).
 Financial statements record firm activities based
on accounting standards.
 Financial statements are used by stakeholders to
support their decision making.

6
 I. FIN. STATEMENTS VS
ACTIVITIES
Underlying Assumptions in Financial Statements
 Accrual accounting.
 Going concern.
 If cash flows are so important why do people use accrual accounting but not cash-basic
accounting, i.e., recognizing revenues and expenses when there are actual flows of cash?

7
 I. FIN. STATEMENTS VS
ACTIVITIES
Accrual Accounting
Example: Tuan Bach Corp. sells VND100 million
stationary to Mai Linh Book Store on 30-day
credit. Cost of production is VND70 million. On the
day of delivery Tuan Bach records:
A. Nothing.
B. A 70 mil increase in sales.
C. A 100 mil increase in liabilities.
D. A 70 mil decrease in inventory and 100 mil
increase in receivables.
8
 I. FIN. STATEMENTS VS
ACTIVITIES
Accrual Accounting
Example: December 15th, 2018 Tuan Bach Inc.
makes a payment of Euro 120k to Mai Linh Estate
to pay for office rent for the year 2019. On the day
of payment Mai Linh records:
A. Nothing.
B. A 120k increase in revenue.
C. A 120k increase in liabilities.
D. A 120k increase in cash.

9
 II. FINANCIAL REPORTING
FRAMEWORK
A Set of Financial Statements
 Balance Sheet.
 Income Statement/Profit and Loss Statement.
 Cash Flow Statement.
 Notes to the Financial Statements.
 Others.

10
 II. FINANCIAL REPORTING
FRAMEWORK
Qualities of Financial Statements
 Relevance (Materiality, Timeliness,…)
 Faithful representation (complete, neutral, free
from error)
 Comparability.
 Verifiability.
 Understandability.
(IASB: Conceptual Framework for Financial Reporting 2010)

11
 II. FINANCIAL REPORTING
FRAMEWORK
Example: History shows that Tuan Bach Co.’s
uncollectable accounts from customers are on
average 2% of sales revenue. Should Tuan Bach
Co. accordingly record an estimated expense
reflecting this potential loss simultaneously when
recording sales revenue?
A. Yes, because this information provide relevant
information and faithfully represents the
economic event.
B. No, because this information is non-verifiable
until a later period. 12
 II. FINANCIAL REPORTING
FRAMEWORK
The Elements of Financial Statements
 Elements of financial statements:
o Assets, Liabilities, Equity.
o Revenue, Expenses.
 An element should be recognized when it is
probable and can be measured with reliability.

13
 II. FINANCIAL REPORTING
FRAMEWORK
Measurement of Financial Statement Elements
 Historical cost.
 Amortized cost.
 Current cost.
 Realizable/Settlement value.
 Present value.
 Fair value.

14
 II. FINANCIAL REPORTING
FRAMEWORK
 Assets = Liabilities + Equity
 Equity = Assets – Liabilities

 Equity = Contributed Capital + Retained Earnings

 Revenue – Expenses = Income/Loss

 Ending retained earnings = Beginning retained
earnings + Net Income – Dividend
15
 II. FINANCIAL REPORTING
FRAMEWORK
The Relationship between BS and IS
Balance Sheet Income Statement Balance sheet
(at a point in time) (for a period of (at a point in time)
(billion đồng) time) (billion đồng) (billion đồng)

Mai Linh Co. 31/12/2019 31/12/2020 31/12/2020

Assets 3345 Revenue 1828 Assets 4911

Liabilities 853 Expenses 1482 Liabilities 2000

Contributed Capital 2156 Net Income 346 Contributed Capital 2413

Retained Earnings 336 *Dividends 184 Retained Earnings 498

*Dividends are usually not seen on the Income Statement. It is shown here only to facilitate the
calculations that follow. 16
 II. FINANCIAL REPORTING
FRAMEWORK
The Relationship between BS and IS

Changes (VND billion)

Assets 1566
Liabilities 1147
Contributed Capital 257
Retained Earnings 162

17
 II. FINANCIAL REPORTING
FRAMEWORK
The Relationship between BS and IS
1566 = 1147 + 257 + 162
∆Assets = ∆Liabilities + ∆Con. Capital+ ∆Ret. Earn.
Or:
∆Assets = ∆Sources of Capital
And:
346 = 184 + 162
Net Income= Dividends + ∆ Ret. Earnings.

18
 II. FINANCIAL REPORTING
FRAMEWORK
The Relationship between BS and IS
Example: Mai Linh Inc. records an expense related
to research and development. How does this
action affect the balance sheet?
A. Increases assets.
B. Decreases liabilities.
C.Reduce revenue.
D.Increases equity.

19
 II. FINANCIAL REPORTING
FRAMEWORK
Balance Sheet
 A statement of financial condition/position at a
point in time.
 Used to assess a firm’s liquidity, solvency, and
ability to make distributions to shareholders.
 Three elements: assets, liabilities, equity.
Assets  Liabilities  Stockholders' Equity
 Assets and liabilities are classified as current and
non-current.

20
 II. FINANCIAL REPORTING
FRAMEWORK
The Balance Sheet: An Example

21
 II. FINANCIAL REPORTING
FRAMEWORK
The Balance Sheet
Example: What would happen to Mai Linh Corp.’s
balance sheet when it tightens sales policy,
specifically, it stops allowing sales on credit?
A. A decrease in receivables.
B. A decrease in payables.
C.An increase in sales revenue.
D.An increase in net income.

22
 II. FINANCIAL REPORTING
FRAMEWORK
The Balance Sheet
Example: Tuan Bach, CEO of Tuan Bach Corp. has
found an excellent method of inventories
management that will help to coordinate
production and selling process more efficiently
and significantly reduce the levels inventories the
firm must maintain to guarantee smooth operation.
How will this invention affect the balance sheet of
the company?

23
 II. FINANCIAL REPORTING
FRAMEWORK
The Balance Sheet
Example: Mai Linh Commercial is a chain of retail
supermarkets. Tuan Bach Corp. is a real estate
company which owns, trades and rents buildings,
offices, apartments, houses… How would you
expect their balance sheet to be different?

24
 II. FINANCIAL REPORTING
FRAMEWORK
Balance Sheet: Some Notes
 WC= CA– CL.
 Strictly speaking, WC does not include current
financial assets and liabilities (for instance, excess
cash, short-term debts,…).
 Operating (current) liabilities should not be viewed
as parts of firm’s financial activities.
 Cash is usually viewed as negative debt. (Although
some economists would not agree. See Acharya et. al (2007), “Is cash a
negative debt? A hedging perspective on corporate financial policies”,
Journal of Financial Intermediation)
25
 II. FINANCIAL REPORTING
FRAMEWORK
Income Statement
 Reports the revenues and expenses of the firm
over a period.
The Income Statement: An example.

26
 II. FINANCIAL REPORTING
FRAMEWORK
Income Statement: General Format
Revenue
- Cost of goods sold
Gross profit
+ Other recurring income
- Other recurring expense
Income from continuing operations
+/- Other non-recurring income/expense
Income before tax
- Taxes  
Net income
27
 II. FINANCIAL REPORTING
FRAMEWORK
Example: Tuấn Bách Company:
Revenue 4 bil
CoGS 3 bil
Other operating expense 0.5 bil
Interest expense 0.1 bil
Provision for income tax 0.12 bil
 Gross profit = ?
 Operating income = ?
 EBIT = ?
 Net income = ? 28
 II. FINANCIAL REPORTING
FRAMEWORK
Income Statement
Example: In order to prepare for Tuan Bach Inc.’s share
offerings next year, Tuan Bach, CFO wants to inflate
earnings. The company is installing a new machine which
costs euro 5 million and have economic life of 5 years.
The accounting standards allow Tuan Bach some
discretion in the estimation of assets life. He could:
A. Lengthen the estimate of asset’s life to 7 years, record a
lower depreciation expense each year and record an
impairment loss after 5 years.
B. Shorten the estimate of asset’s life to 3 years, record a
lower depreciation expense each year and write-up the
asset after 5 years.
29
 II. FINANCIAL REPORTING
FRAMEWORK
Income Statement

Example: Which of the following is fixed costs?

A. Interest expenses on fixed-rate debt.
B. Overhead expenses.
C. Land lease expenses.
D. Depreciation of fixed assets
E. Raw materials.

Example: Which of the following is period costs and which

is product costs?
F. Direct materials, direct labor, manufacturing overhead.
G. Selling, general, administrative expenses.
30
 II. FINANCIAL REPORTING
FRAMEWORK
Review: Depreciation
Example: Mr. Hà, Chairman of HHG (9/2014): hầu hết
các phương tiện vận tải của HHG hiện nay đã
khấu hao hết nhưng giá trị còn lại vẫn rất lớn. Đơn
cử như một xe 46 chỗ trước đây HHG mua 1.2-1.5 tỷ
đồng, nhưng giá bây giờ khoảng 3 tỷ đồng và nếu
Công ty bán lại thời điểm này (sau hơn 3 năm hoạt
động) thì cũng có giá khoảng 1.5 tỷ đồng, tức là bằng
với mức giá mua ban đầu.
Could the change in the buses’ value be recorded in the
financial statements?
Predict what happens for future financial statements.31
 II. FINANCIAL REPORTING
FRAMEWORK
Income Statement
 Earnings per share:

Example: Mai Linh Co. had a net income of

VND100bil, paid 500 bil dividends to common
shareholders. Jan 1st there were 500000 shares
outstanding. Calculate basic EPS.

32
 II. FINANCIAL REPORTING
FRAMEWORK
Income Statement
Example: Is higher EPS good or bad?
Does the choice between debt and equity funding
affect EPS?

33
 II. FINANCIAL REPORTING
FRAMEWORK
Inventory
 Recorded at the lower of either cost or fair value.
 COGS = Beginning Inventory + Purchases-
Ending Inventory

34
 II. FINANCIAL REPORTING
FRAMEWORK
Inventory Systems
 Periodic inventory system.
 Perpetual inventory system (more common).
Valuation Methods
 FIFO.
 LIFO.
 Weighted Average Cost.
 Specific Identification.

35
 II. FINANCIAL REPORTING
FRAMEWORK
Example: 3 units from beginning inventory and 5 units
from Jan 7’s purchase are taken for sales on Jan 15.
Calculate revenue and CoGS in January and ending
inventory on January 31 under Specific Identification,
FIFO, LIFO, and weighted average cost methods in
periodic and perpetual system.
Unit Price Value
Jan 1 (Beginning inventory) 5 $5 $25
Jan 7 purchase 10 $6 $60
Jan 15 sell 8 $9 $72
Jan 22 purchase 6 $7 $42
36
 II. FINANCIAL REPORTING
FRAMEWORK
Example: Under which method is CoGS (inventory)
the best approximation of current CoGS
(inventory)?
Example: Assuming inflation and stable or
increasing quantities of inventory, compare LIFO
to FIFO with regard to:
 Inventory, working capital, non-current assets,
liabilities, equity.
 Sales, CoGS, taxes, net income, dividend.
 Cash flows.
37
 II. FINANCIAL REPORTING
FRAMEWORK
Example:
In 2014, An Giang Sao Mai (ASM) issues stock warrants
for employees with exercise price of VND10
thousand. Market price was VND15 thousand per
share.
In 2020 Thien Long (TLG) repurchased 1.5 million
shares at VND30 thousand per share. Few days after,
TLG sold these treasury shares to employees at
VND10 thousand per share.
Do these operations impose any costs/losses to the
company and the shareholders? How do accountants
record these costs/losses? 38
 II. FINANCIAL REPORTING
FRAMEWORK
Example: Which of the following statements is most likely incorrect?
A. To operating executives, a company's income statement is interesting
because the income statement measures operating performance or
profitability.
B. To financial executives, when planning for future financing requirements, a
projected balance sheet shows how much external financing will need to be
raised because it forecasts future uses of funds (i.e., assets) and sources of
funds (i.e., liabilities plus equity).
C. As the income statement and balance sheet are prepared under accrual
accounting, financial executives need to prepare cash budgets, which list
projected cash receipts and disbursements over a forecast period for the
purpose of anticipating future cash shortages or surpluses.
D. If a firm has seasonal financing requirements, such as in some seasonal
industries the financial executive should make monthly or quarterly
forecasts rather than annual ones.
E. Receivables and inventory can be used to pay liabilities.
F. Equity can be used to pay liabilities. 39
 II. FINANCIAL REPORTING
FRAMEWORK
Cash Flow Statement
 Information about a company actual cash inflows
and outflows.
 Cash flows are more reliable than earnings
because it is less affected by management
discretion and estimates. (Do you agree?)
 Empirical research shows that cash flows
component of earnings are more persistent than
accrual component.
 Net Cash Flow = Ending Cash – Beginning Cash.
 Net Cash Flow = CFO + CFI + CFF. 40
 II. FINANCIAL REPORTING
FRAMEWORK
Cash Flow Statement
Example:
Na Ri Hamico (KSS): Positive earnings 9 years in a
row but Negative CFOs. May 2015: arrest of
CEO, Chairman and Chief Accountant.
Machinco (SMA): Always had positive earnings but
negative cash flows in 2011-2013. Dividend
payment for 2011, 2012 and 2013 was postponed
for years until 2015 (2011’s dividend was
postponed 11 times).
41
 II. FINANCIAL REPORTING
FRAMEWORK
Cash Flow Statement: An example

42
 II. FINANCIAL REPORTING
FRAMEWORK
Cash Flow Statement
 CFO calculation: direct methods
o Add/Subtract cash receipts and cash payments
from operation, or
o Readjust revenue and cost for:
 Non-cash charges or income.
 Non-operation cash-flow.

43
 II. FINANCIAL REPORTING
FRAMEWORK
Cash Flow Statement
 CFO indirect calculation: adjust net income (or
income before tax) for
o Non-cash income (-), non-cash charges (+).
o Non-operation income or charges.

44
 II. FINANCIAL REPORTING
FRAMEWORK
Example: What type of cash flow are these:
A. Repurchase shares.
B. Pay interest.
C. Receive dividend.
D. Pay salary.
E. Buy materials on 3-month credit.
F. Convert bonds into stock.
G. Depreciation.
45
 II. FINANCIAL REPORTING
FRAMEWORK
Example: Predict what happens to Tuan Bach
Corp.’s financial statements in short-term and in
long-term in the following cases.
A. Tuan Bach Corp. makes it easier for customers to
buy on credit.
B. Tuan Bach Corp. produces too much more
products than it can sell.

46
 II. FINANCIAL REPORTING
FRAMEWORK
Free Cash-Flow to the Firm (FCFF)

FCFF = NI + NCC + Int(1 – t) – FCInv – WCInv

Where:
NI: Net income
NCC: Non-cash charges
Int: Interest expense
t: Tax rate
WCInv: Working capital investment
FCInv: Fixed capital investment
47
 II. FINANCIAL REPORTING
FRAMEWORK
FCFF
FCFF = NI + NCC – WCInv + Int(1 – t) – FCInv
= CFO + Int(1 – t) – FCInv
= EBIT*(1 – t) + NCC – FCInv – WCInv
If Depreciation is the only NCC:
FCFF = EBIT*(1 – t) + Dep– FCInv – WCInv
= EBITDA*(1 – t) + Dep*t – FCInv – WCInv
48
 II. FINANCIAL REPORTING
FRAMEWORK
Free Cash Flow to Equity (FCFE)

FCFE = FCFF – Int(1 – t) + Net Borrowings

= NI + NCC – FCInv – WCInv + Net Borrowings
= CFO – FCInv + Net Borrowings

49
 III. RATIO ANALYSIS
Uses of Ratio Analysis
 Evaluate a firm’s ability to meet obligations.
 Evaluate a firm’s ability to growth.
 Assess management’s performance.
 III. RATIO ANALYSIS
Limitation of Ratio Analysis
 Financial ratios are only useful when compared to
those of other comparable firms or historical ratios.
 Companies that operate in multiple industries or
using different accounting standards… are difficult
to compare.
 Requires some range of acceptable values rather
than a single target value.
 III. RATIO ANALYSIS

A Financial Statement Analysis Framework

 Identify the purpose and context.
 Collect data.
 Process data.
 Analyze processed data.
 Develop and communicate conclusions and
recommendations.
 Follow-up.
(source: CFA Curriculum, CFA Institute)
 III. RATIO ANALYSIS
Operating Returns
EBIT(1-tax)
Return on assets =
Total assets
Net income
Return on equity =
Equity
EBIT
Return on Capital Employed =
Capital Employed
53
 III. RATIO ANALYSIS
DuPont Identity
Net income
Return on equity =
Equity
Net income Sales Assets
= X X
Sales Assets Equity
 It is said that there is a trade-off between profit margins and assets turnovers: When one is high,
the other is low. Do you think it is true and why
 III. RATIO ANALYSIS
DuPont Identity ROE

Net Profit Margin Assets Turnover Financial Leverage

Gross profit Inventory

turnover D/E
margin

Receivables
Tax turnover Interest
coverage

Fixed-assets
Common-size
turnover Debt payment
income statement
coverage…

Common-size
balance sheet
 III. RATIO ANALYSIS

Cautions on the use of ROE

 Timing problem.
 Risk problem.
 Value problem.
 III. RATIO ANALYSIS
Liquidity Ratios
Current assets
Current ratio =
Current liabilities
Cash + Receivables
Quick ratio =
Current liabilities
Cash
Cash ratio =
Current liabilities
 III. RATIO ANALYSIS
Example: Tuan Bach Inc., producer of TubaPhone,
want to hedge the risk of supply constraints that
existed in the past. Tuan Bach maintains high levels
of inventory and entered long-term contracts for
certain components. Now that there is a significant
decrease in demand for TubaPhone, inventory
levels exceed requirements based on new sales
forecasts. Excess inventory is not expected to be
used in the foreseeable future. Tuan Bach, CEO,
decides to record a $3 billion provision for inventory.
How will the recognition of inventory charge affect
the firm’s liquidity ratios?
 III. RATIO ANALYSIS
Solvency Ratios
Total debt
Debt-to-equity=
Total equity

Total assets
Financial leverage=
(Equity multiplier) Total equity
 III. RATIO ANALYSIS
Interest Coverage Ratios

EBIT
Interest coverage=
Interest payments

EBITDA
Debt Service =
Coverage ratio
Interest Pmt(1-tax)+Principal Pmt
 III. RATIO ANALYSIS

Example: Following the previous example of Tuba

Inc., producer of TubaPhone. How will the
recognition of inventory allowance affect the firm’s
leverage ratios and interest-coverage ratios?
Example: How does the following transaction affect
debt-to-equity ratio?
Investment in new PP&E
 III. RATIO ANALYSIS

Working Capital Ratios

Cost of Sales
Inventory turnover=
Inventory
365
Inventory days=
Inventory turnover
 III. RATIO ANALYSIS

Working Capital Ratios

Sales
Receivables turnover=
Receivables
365
Receivables days=
Receivables turnover
 III. RATIO ANALYSIS
Working Capital Ratios
Purchases
Payables turnover=
Trade payables
365
Payables days=
Payables turnover

Purchases= Ending inventory – beginning inventory

+ CoGS
 III. RATIO ANALYSIS
Cash Conversion Cycle

Cash Conversion Cycle

= days of inventory on hand
+ days of sales outstanding
- days of payables
 III. RATIO ANALYSIS
Profitability Ratios
Gross profit
Gross margin=
Sales
Operating income
Operating margin=
Sales
Net income
Net profit margin=
Sales
 III. RATIO ANALYSIS
Example: Based on past experience on
uncollectable receivables, Mai Linh Corp. records
a EUR3 million provision for doubtful accounts. It
is recorded as a reduction to Accounts
Receivables on the balance sheet, also as an
SG&A expense on the income statement. How will
it affect the firm’s profitability ratios?
Example: This year Mai Linh Corp. produces too
much more products than it can sell. How will this
affect the firm’s profitability ratios, inventory
turnover, and asset turnover in the current year?
67
 III. RATIO ANALYSIS

Long-Term Assets Turnover

Sales
Total assets turnover=
Total Assets
Sales
Fixed-assets turnover=
Fixed-assets

68
 III. RATIO ANALYSIS
Example: Which of the following will most likely
increase total asset turnover?
A. Investment in new PP&E.
B. Share repurchases.
C. Debt repayment.
D. Impairment write-downs of fixed assets.

69
 III. RATIO ANALYSIS

Market valuation ratios

Price
P/E=
EPS
Price
P/B=
Book value per share

70
 IV. FINANCIAL
FORECASTING
 Financial forecast and planning can be either for
specialized department/individual project or
company-wide.
 For company-wide forecasting, future financial
statements are projected, from which problems are
pointed out. Solving these problem means financial
planning.
 Examples of problems: funding needs, trends in
costs, treasury management…

71
 IV. FINANCIAL
FORECASTING
 Forecasting is usually based on Percentage-of-
sales method.
- Forecast sales.
- Determine the financial accounts that vary with
sales using past data.
- Forecast the financial statements.
- Scenario analysis.

72
 IV. FINANCIAL
FORECASTING
Example: In order to meet the market’s increasing
demand for the current bestseller muscle-building drug,
Tuan Bach Inc. is considering expanding the current
production facility. As a result, fixed assets will increase.
Working capital will also increase to support increased
production and sales. Total increase in assets is
estimated to be VND300 bil. However, liabilities are
forecasted to be unchanged, and equity to increase
VND50bil due to the increase in retained earnings.
How may Tuan Bach solve the shortage in funding?
- By financing activities?
- By operating activities, i.e. free cash flows? 73
 V. HOMEWORK
Financial model using Excel: An Example
Read the excel file “Financial model – Training
material.xlsx”.
 Note: This file is confidential and intended for the sole
and exclusive and personal use of the intended learner
of this course. Any other use, dissemination,
distribution, copying or storing of the file is strictly
prohibited.

74
 V. HOMEWORK

Earnings Management in Practice

Find out about SLB operations of VietJet Air.
 V. HOMEWORK

Earnings Management Methods

 Refer to Dechow2002 and Roychowdhury2006,
describe the difference between accrual earnings
management and real earnings management.
 V. HOMEWORK

Earnings Management to Meet or Beat

Thresholds (optional)
Refer to Degorge1999.pdf, predict the management
behavior when the company’s EPS is:
 Slightly negative.
 Slightly lower than last year.
 Largely negative.
 Largely positive.
 V. HOMEWORK
Earnings Management around Corporate Events
(optional)
Predict the management behavior when:
 The firm is about to issue new shares.
(Teoh1998)
 The firm is about to repurchase its own shares
(Gong2008).
 Out-going, In-coming, retiring, and new CEO
(Wells2002, Kalyta2009, Ali2015).
 CEOs with stock-based compensation
(Berstresser2006).
END OF CHAPTER 2