5-2
             Learning Objectives
  1. Understand the relation between the expected return and risk of 
    investment alternatives, and the role of analysis in providing 
    risk and return information.
  2. Understand the usefulness of the rate of return on assets (ROA) 
    as a measure of a firm’s operating profitability.
  3. Understand the usefulness of the rate of return on common 
    shareholders’ equity (ROCE) as a measure of profitability.
  4. Understand the strengths and weaknesses of earnings per 
    common share as a measure of profitability.
  5. Understand the distinction between short-term liquidity risk 
    and long-term liquidity (solvency) risk.
  6. Develop skills to interpret an analysis of profitability and risk.
  7. (Appendix) Develop skills to prepare pro forma financials.
  8. (Appendix) Understand the usefulness of pro forma financials.
  5-3
                   Chapter Outline
  1. Objectives of financial statement analysis
  2. Usefulness of ratios
  3. Analysis of profitability
  4. Analysis of risk
  5. Limitations of ratio analysis
  6. International perspective
  Chapter Summary
  7. Appendix 5.1: Pro Forma Financial 
    Statements
  5-4  1. Objectives of Financial Statement 
                 Analysis
   To understand the economics of a firm and 
   To help forecast its future profitability and 
    risk
     Profitability is an increase in wealth
     Risk is the probability that a specific level 
      of  profitability will be achieved.
  5-5           2. Usefulness of Ratios
   Help compare different firms, and
   Help compare the firm against its past 
    performance 
   Standards against which to compare ratios
     1. The planned ratio for the period
     2. The corresponding ratio from a prior period
     3. The corresponding ratio for another firm in 
       the same industry
     4. The average ratio for other firms in the 
       same industry
  5-6
              3. Analysis of Profitability
   Profitability is subtle and complex concept.  
     Doing well may be measured by different 
     standards.  Three concepts of profitability are 
     given by:
   a. Return on assets
     b. Return on common equity
     c. Earnings per common share
   Each of these are discussed in turn.