leverage can be equally devastating when the firm’s return on assets falls
below its cost of debt. Leverage, the use of other people’s money, enhances
stockholder returns when the firm is profitable. We examine leverage more
closely in Chapter 4.
THE OPERATING STATEMENTS: THE INCOME
STATEMENT AND SOURCES AND USES OF FUNDS
The balance sheet is an accounting snapshot at a point of time, whereas
the income statement is a condensation of the firm’s operating revenues
and expenses over a given period of time, most often during a quarter or
year.^2 It depicts certain changes that have occurred between the prior
balance sheet and the present one. The balance sheet (position state-
ment) and the income statement may be reconciled through the earned
surplus account. If this reconciliation is presented formally, it becomes
the surplus statement.
The income statement is very important. The balance sheet depicts
how much in assets historically have been invested in a firm; the operating
statement indicates how successful (whether by efficiency or luck) the com-
pany has been in making a return on the assets committed to it. The de-
18 AN INTRODUCTION TO FINANCIAL STATEMENTS
TABLE 2.2 Liquidity and Total Debt Ratios of Johnson & Johnson, Selected
Years, 1970–2003
Ratio 1970 1975 1980 1985 1990 1995 2000 2001 2002 2003
Johnson & Johnson
CATA 0.628 0.610 0.590 0.568 0.491 0.444 0.493 0.478 0.475 0.476
CLTA 0.168 0.204 0.231 0.230 0.275 0.244 0.228 0.209 0.282 0.279
TDTA 0.203 0.229 0.252 0.286 0.414 0.363 0.293 0.267 0.332 0.340
Firm: Median—WRDS Ratio
CATA 0.569 0.574 0.571 0.551 0.524 0.544 0.491 0.480 0.489 0.489
CLTA 0.223 0.243 0.260 0.247 0.255 0.247 0.233 0.236 0.242 0.228
TDTA 0.474 0.498 0.498 0.473 0.491 0.458 0.458 0.466 0.458 0.427
N 3,580 5,857 5,740 6,542 6,405 8,314 8,110 7,549 6,931 5,889
CATA—Current assets to total assets.
CLTA—Current liabilities to total assets.
TDTA—Total debt to total assets.
N—Number of firms.