FIN301 • Chapters 3–4 Combined Study Guide
Financial Statements + Financial Ratios • Built for fast review
How to use Skill checklist Chapter 3: Statements Income Statement Balance Sheet Cash Flow Chapter 4: Ratios Story method Practice set Concept check (T/F)

FIN301 — Chapter 3 + Chapter 4 Combined Study Guide

Financial Statements + Financial Ratios
Tip: Use Ctrl + F to find keywords Goal: You can do the checklist → you’re ready Mode: Study + Practice
How to use this guide: Expand each section, read the “Key idea,” then do the practice. If you can explain the story method, you’re ready for Chapters 3–4 topics.
Official vs. interactive: The Word/PDF study guide is the official version for exam coverage. This HTML version adds worked solutions and why-this-is-true/false explanations for practice.
Skill checklist
  1. Read the 3 statements and explain what each one means.
  2. Build a simple income statement in the correct order.
  3. Use Assets = Liabilities + Equity to solve missing BS items.
  4. Explain CFO/CFI/CFF and classify source vs use of cash (working capital).
  5. Compute and interpret core ratios: liquidity, leverage, profitability, efficiency, market.
  6. Tell a 2–3 sentence story using ratios + statements.
Quick links
Tip: searching “ΔAR” or “working capital” helps with CFO logic.

PART I — Chapter 3 Foundations: the three financial statements

A) Income Statement (IS) — Profit over time (flow) order matters
Website: https://www.jufinance.com/10k/is/
Key idea: EBIT focuses on operations. Net income is affected by debt (interest) and taxes.
Order to memorize: Revenue − COGS = Gross Profit − Operating expenses (SG&A, etc.) − Depreciation = EBIT EBIT − Interest = EBT EBT − Taxes = Net Income Net Income − Dividends = Change in Retained Earnings (RE)
Vocabulary: SG&A = Selling, General & Administrative expenses (operating costs, not production costs).
B) Balance Sheet (BS) — Snapshot today (stock) Assets = Liab + Equity
Website: https://www.jufinance.com/10k/bs/
Core identity
Total Assets (TA) = Total Liabilities (TL) + Total Equity (TE)
Assets side: TA = Current Assets (CA) + Net Fixed Assets (NFA) CA = Cash + Accounts Receivable (AR) + Inventory NFA = Gross Fixed Assets − Accumulated Depreciation
Liabilities + Equity
Liabilities side (simple): TL = Current Liabilities (CL) + Long-Term Debt (LTD) CL = Accounts Payable (AP) + Current Debt (CD) Debt relationships: Total Debt (TD) = CD + LTD If you know TL and LTD: CL = TL − LTD Equity: TE = Common Stock + Retained Earnings (RE) TE = TA − TL RE_end = RE_begin + Net Income − Dividends
Working capital
Net Working Capital (NWC) = CA − CL
Rearrange: CA = NWC + CL CL = CA − NWC
C) Cash Flow Statement (CF) — Cash truth CFO + CFI + CFF
Website: https://www.jufinance.com/10k/cf/
Three parts: CFO (operations), CFI (investing), CFF (financing).
Identity: Change in Cash = CFO + CFI + CFF.
Source vs Use (working capital rule):
Asset ↑ = Use of cash; Asset ↓ = Source of cash
Liability ↑ = Source of cash; Liability ↓ = Use of cash
CFO (indirect method — basic recipe): CFO = Net Income + Depreciation − ΔA/R − ΔInventory + ΔA/P
Bridge: Ratios are just “statement math.” Chapter 4 formulas summarize the statements.

PART II — Chapter 4 Core Ratios

1) Liquidity ratios (short-term safety) can pay bills?
Current Ratio = Current Assets / Current Liabilities Quick Ratio = (Current Assets − Inventory) / Current Liabilities
Interpretation: higher usually means safer short-run, but too high can mean idle cash/inventory.
2) Leverage / solvency ratios (long-term risk) too much debt?
Debt Ratio = Total Liabilities / Total Assets Debt-to-Equity = Total Debt / Total Equity (be consistent)
Interpretation: more debt usually increases risk (more required payments + higher bankruptcy risk).
3) Profitability ratios (profit per dollar) margins + ROA/ROE
Gross Margin = Gross Profit / Sales Operating Margin (EBIT margin) = EBIT / Sales Net Profit Margin = Net Income / Sales ROA = Net Income / Total Assets (or average assets) ROE = Net Income / Total Equity (or average equity)
Interpretation: margins show cost control/pricing power; ROA/ROE show return on resources/funding.
4) Efficiency / activity ratios (how fast assets work) turnover + days
Inventory Turnover = COGS / Inventory Days Inventory Outstanding (DIO) = 365 / Inventory Turnover Days Sales Outstanding (DSO) = 365 / Receivables Turnover
Interpretation: higher turnover = assets used faster; high DSO = slower collections.
5) Market ratios investor expectations
EPS = Net Income / Shares outstanding P/E = Price per share / EPS
Interpretation: market ratios reflect expectations about growth and risk.

PART III — Connecting statements + ratios

Use this 4-step story method (works for Nike or any firm):
  1. Profitability (margins): are profits improving?
  2. Efficiency (turnovers): are assets used better or worse?
  3. Liquidity + leverage: is the firm safe short-term and not over-borrowed?
  4. Cash logic: do working capital changes support or drain cash?

Practice Set

IMPORTANT: These are NOT the exam questions. They practice the same skills.
Practice 1 — Build IS + compute margins (ABC Outdoors) IS order + margins
Given (in $000s): Sales 6,400; COGS 3,840; SG&A 1,120; Depreciation 280; Interest 160; Tax rate 25%. Tasks: A) Build the income statement in the correct order. B) Compute Gross margin, EBIT margin, Net profit margin. C) Write 2 sentences: what does each margin tell you?
Solution + explanation (click to expand)
Income Statement ($000s): Sales (Revenue) = 6,400 − COGS = 3,840 = Gross Profit = 2,560 − SG&A = 1,120 − Depreciation = 280 = EBIT = 1,160 − Interest = 160 = EBT = 1,000 − Taxes (25% × 1,000) = 250 = Net Income = 750 Margins: Gross margin = 2,560 / 6,400 = 0.4000 = 40.00% EBIT margin = 1,160 / 6,400 = 0.1813 = 18.13% Net margin = 750 / 6,400 = 0.1172 = 11.72%
Interpretation (how to talk about it):
  • Gross margin is production cost control / pricing power (COGS vs. Sales).
  • EBIT margin adds operating cost control (SG&A + depreciation).
  • Net margin includes financing (interest) and taxes—so it can fall even if operations improve.
Practice 2 — Balance sheet equation + liquidity ratios CR + QR
Given: Current assets 2,100; Current liabilities 1,400; Inventory 600. Tasks: A) Compute Current ratio and Quick ratio. B) If inventory increases to 850 with everything else unchanged, how do the two ratios change? Explain in 1 sentence.
Solution + explanation (click to expand)
A) Ratios (given CA = 2,100; CL = 1,400; Inventory = 600) Current ratio = CA / CL = 2,100 / 1,400 = 1.50 Quick ratio = (CA − Inv) / CL = (2,100 − 600) / 1,400 = 1,500 / 1,400 = 1.0714 ≈ 1.07 B) If inventory rises to 850 and everything else is unchanged: New CA = 2,100 + (850 − 600) = 2,350 Current ratio = 2,350 / 1,400 = 1.6786 ≈ 1.68 Quick ratio = (2,350 − 850) / 1,400 = 1,500 / 1,400 = 1.07 (unchanged)
Why this happens: the quick ratio subtracts inventory, so an “inventory-only” change cancels out in the numerator.
Real life note: inventory usually rises because you used cash or increased A/P—then the quick ratio often falls.
Practice 3 — Working capital changes + CFO effect signs matter
During the year: AR increases by 120; Inventory decreases by 70; AP increases by 55; Depreciation = 40; Net income = 300. Tasks: A) Compute CFO using: CFO = NI + Dep − ΔAR − ΔInv + ΔAP. B) Explain each sign in plain English (one sentence each).
Solution + explanation (click to expand)
Given: ΔAR = +120 (AR increases) ΔInv = −70 (inventory decreases) ΔAP = +55 (AP increases) Depreciation = 40 Net Income = 300 CFO = NI + Dep − ΔAR − ΔInv + ΔAP = 300 + 40 − 120 − (−70) + 55 = 340 − 120 + 70 + 55 = 345
Sign explanations (plain English):
  • ΔAR (+) is a use of cash: you sold on credit, but haven’t collected yet → subtract it.
  • ΔInventory (−) is a source of cash: you sold inventory (or reduced purchases) → subtracting a negative adds cash.
  • ΔAP (+) is a source of cash: you delayed paying suppliers → add it.
  • Depreciation is non-cash: it reduced accounting profit, so we add it back to get cash.
Practice 4 — Short story (ratios + statements) 3–4 sentences
A firm’s gross margin rises, net margin falls, and debt ratio rises. Task: Write a 3–4 sentence explanation of one situation that could cause gross margin to rise, net margin to fall, and the debt ratio to rise.
Sample answer + explanation (click to expand)
One realistic story:
  • Gross margin rises because the firm lowered COGS (better supplier pricing, cheaper inputs, improved production efficiency).
  • Debt ratio rises because the firm borrowed more (new loan or bond issue) to fund growth or cover cash needs.
  • Net margin falls because interest expense increased (more debt) and/or the firm had higher non-operating expenses or taxes, which pull net income down even if operations improved.
Key link: Gross margin is “operations before overhead,” while net margin is “after interest + taxes,” so they can move in opposite directions.
Practice 5 — Build a Cash Flow Statement (Indirect Method) CFO / CFI / CFF
Given information Decrease in Accounts Receivable (A/R): 20 Decrease in Inventory: 10 Increase in Accounts Payable (A/P): 20 Operating income (EBIT): 120 Interest expense: 20 Income tax expense: 10 Depreciation: 5 Increase in Net Fixed Assets (NFA): 10 Increase in Common Stock: 30 Dividends paid: 10 Beginning cash: 100
Your tasks
  1. Source vs. use (quick check): For each item below, decide whether it is a source of cash (cash increases) or a use of cash (cash decreases):
    • A/R decreases by 20 → Source or Use?
    • Inventory decreases by 10 → Source or Use?
    • A/P increases by 20 → Source or Use?
    • Dividends paid 10 → Source or Use?
    • Common stock increases 30 → Source or Use?
    • Net fixed assets increase 10 (with depreciation 5) → What does this imply about CapEx?
  2. Build the Cash Flow Statement (indirect method): show CFO, CFI, CFF, and compute ending cash.
Solution + explanation (click to expand)
Quick check answers — Source vs. Use
“Source” = cash increases. “Use” = cash decreases.
ItemSource/UseCashWhy?
A/R decreases by 20Source+20Collecting receivables brings cash in (less money tied up in A/R).
Inventory decreases by 10Source+10Lower inventory means less cash tied up in inventory (or you sold inventory without replacing it yet).
A/P increases by 20Source+20You delayed paying suppliers, so you kept cash longer.
Dividends paid 10Use−10Cash paid out to shareholders reduces cash.
Common stock increases 30Source+30Issuing stock raises cash from owners.
Net fixed assets increase 10 with depreciation 5Use−15CapEx = ΔNFA + Depreciation = 10 + 5 = 15 → investing cash outflow.
Step 1 — Start from the Income Statement to get Net Income
  • EBIT = 120
  • EBT = EBIT − Interest = 120 − 20 = 100
  • Net income = EBT − Taxes = 100 − 10 = 90
Step 2 — Cash Flow from Operations (CFO): Indirect method
Rule of thumb: Decrease in a current asset is a source of cash; increase in a current liability is a source of cash.
Operating cash flows (CFO)CashWhy?
Net income+90Starting point (accrual profit).
Add back: Depreciation+5Non-cash expense (reduced NI but did not use cash).
A/R decreases+20Collected cash from customers faster than sales recognized.
Inventory decreases+10Sold/used inventory without replacing it (less cash tied up in inventory).
A/P increases+20Delayed paying suppliers (kept cash longer).
Net cash provided by operating activities+14590 + 5 + 20 + 10 + 20
Step 3 — Cash Flow from Investing (CFI)
Net fixed assets (NFA) is reported after depreciation. If net fixed assets increased by 10 while depreciation was 5, the firm must have purchased more than 10 of new assets.
  • CapEx = Increase in Net Fixed Assets + Depreciation = 10 + 5 = 15
  • So, CFI = −15 (cash used to buy fixed assets).
Investing cash flows (CFI)CashWhy?
Capital expenditures (CapEx)−15Buying long-term assets is an investing use of cash.
Net cash used in investing activities−15
Step 4 — Cash Flow from Financing (CFF)
Financing = transactions with owners and lenders (stock issues, debt issues/repayments, dividends).
Financing cash flows (CFF)CashWhy?
Issue common stock+30Raising equity capital brings cash in → financing.
Dividends paid−10Cash distributed to owners → financing outflow.
Net cash provided by financing activities+2030 − 10
Step 5 — Reconcile to ending cash
Cash reconciliationCash
Net increase in cash = CFO + CFI + CFF145 − 15 + 20 = +150
Beginning cash+100
Ending cash250
Where each item comes from (Source): “What statement did we use?”
  • EBIT, interest, taxes, depreciation → Income statement (and notes for depreciation).
  • A/R, Inventory, A/P changes → Balance sheet (current assets/liabilities).
  • Net fixed assets change → Balance sheet (PP&E); combine with depreciation to infer CapEx.
  • Common stock change + dividends → Equity section (balance sheet / statement of stockholders’ equity).
Operating = day-to-day business cash (customers/suppliers, working capital). Investing = long-term assets. Financing = owners/lenders.

Concept Check (True/False style)

Click True/False. Use “Show TF Answers” when you’re done.
Goal: 12/14 correct Fix mistakes → re-try
Ctrl+P prints a clean version

Links (course pages)

Chapter 3 website:
https://www.jufinance.com/fin301_26s/chapter3.html
Chapter 4 website:
https://www.jufinance.com/fin301_26s/chapter4.html