# Chapter03

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Unformatted text preview: income statement shown in Table 3.3 is to express each item as a percentage of total sales, as illustrated for Prufrock in Table 3.4. PRUF R O C K C O R P O R AT I O N 2008 Income Statement ( \$ i n m i l l i o n s) Sales Cost of goods sold Depreciation Earnings before interest and taxes Interest paid Taxable income Taxes (34%) Net income Dividends Addition to retained earnings \$2,311 1,344 276 \$ 691 141 \$ 550 187 \$ 363 \$121 242 TA B LE 3. 3 CHAPTER 3 Financial Statements Analysis and Long-Term Planning 47 ros82361_ch03.indd 47 5/27/08 10:14:57 AM Confirming Pages TABL E 3 .4 P R U FR O C K C O R P O R AT I O N C o m m o n - S i ze I n c o m e S t a t e m e n t 2008 Sales Cost of goods sold Depreciation Earnings before interest and taxes Interest paid Taxable income Taxes (34%) Net income Dividends Addition to retained earnings 100.0% 58.2 11.9 29.9 6.1 23.8 8.1 15.7% 5.2% 10.5 This income statement tells us what happens to each dollar in sales. For Prufrock, interest expense eats up \$.061 out of every sales dollar, and taxes take another \$.081. When all is said and done, \$.157 of each dollar flows through to the bottom line (net income), and that amount is split into \$.105 retained in the business and \$.052 paid out in dividends. These percentages are very useful in comparisons. For example, a very relevant figure is the cost percentage. For Prufrock, \$.582 of each \$1.00 in sales goes to pay for goods sold. It would be interesting to compute the same percentage for Prufrock’s main competitors to see how Prufrock stacks up in terms of cost control. 3 . 2 R AT I O A N A LY S I S Another way of avoiding the problems involved in comparing companies of different sizes is to calculate and compare financial ratios. Such ratios are ways of comparing and investigating the relationships between different pieces of financial information. We cover some of the more common ratios next, but there are many others that we don’t touch on. One problem with ratios is that different people and different sources frequently don’t compute them in exactly the same way, and this leads to much confusion. The specific definitions we use here may or may not be the same as ones you have seen or will see elsewhere. If you are ever using ratios as tools for analysis, you should be careful to document how you calculate each one, and, if you are comparing your numbers to those of another source, be sure you know how their numbers are computed. We will defer much of our discussion of how ratios are used and some problems that come up with using them until a bit later in the chapter. For now, for each of the ratios we discuss, several questions come to mind: 1. 2. 3. 4. How is it computed? What is it intended to measure, and why might we be interested? What is the unit of measurement? What might a high or low value be telling us? How might such values be misleading? 5. How could this measure be improved? Financial ratios are traditionally grouped into the following categories: 1. Short-t...
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## This note was uploaded on 10/28/2009 for the course FINA 505 taught by Professor Deborahcernauskas during the Summer '09 term at Northern Illinois University.

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