I85PREP
⌘ K
DSST Principles of Finance study materials
DSST Principles of Finance study resources

DSST Principles of Finance: Financial Statements and Planning

DSST Principles of Finance · Work through your exam, one topic at a time.

All guide sections

Financial Statements and Planning

Financial Statements and Planning

The exam tests whether you can read the three statements, convert them into ratios, and build a simple pro forma forecast that identifies external financing need (EFN).

The three statements

  • Balance sheet: Assets = Liabilities + Equity. Current items convert to cash within one year; equity is the residual claim.
  • Income statement: revenue → gross profit (after COGS) → EBIT → EBT (after interest) → net income (after tax). Depreciation is a non-cash expense.
  • Statement of cash flows: operating (net income + non-cash charges − increase in net working capital), investing (capex, acquisitions), financing (debt, equity, dividends).
  • Ending retained earnings = beginning retained earnings + net income − dividends.
  • Common-size statements express each item as a percent of sales (income statement) or total assets (balance sheet), making cross-firm comparison possible.

Ratio families

  • Liquidity: current = CA/CL; quick = (CA − inventory)/CL.
  • Activity: inventory turnover = COGS/average inventory; receivables turnover = credit sales/average receivables.
  • Leverage: debt ratio = total debt/total assets; times interest earned = EBIT/interest.
  • Profitability: net margin = NI/sales; ROA = NI/assets; ROE = NI/equity.
  • DuPont: ROE = net margin × total asset turnover × equity multiplier.

Worked example

Sales are $1,000, assets $800, spontaneous liabilities $100, net margin 6%, dividend payout 40%. Sales rise 20% to $1,200. Percent-of-sales forecasting: required asset increase = 0.80 × $200 = $160; spontaneous financing = 0.10 × $200 = $20; addition to retained earnings = 0.06 × $1,200 × 0.60 = $43.20. EFN = 160 − 20 − 43.20 = $96.80, so the firm must raise about $97 from debt or equity. A negative result means surplus funds.

Traps

  • Mixing average and ending balances inside one ratio.
  • Treating depreciation as a cash outflow or dividends as an operating flow; dividends are financing.
  • Forecasting asset growth without the retained-earnings link, so the balance sheet will not balance.
  • Forgetting that a higher equity multiplier raises ROE without any operational improvement.
  • Using book values when the question asks for a market-based measure.