Financial Statement Analysis

1
Chapter 3

• Financial Statement Analysis

2
BS Basics

• Balance Sheet Basics
• CA FA
• CL LDT SE
• Book Value vs. Market Value

3
IS Basics

• Income Statement
• Profits Cash Flow
• Cash Flow
• Cash In Sales - Increase in Rcvbls.
• Cash Out COGS Inventories
• Accrual vs. Cash
• Taxes

4
FS Analysis

• Common-Size Balance Sheets
• Compute all accounts as a percent of total assets
• Common-Size Income Statements
• Compute all line items as a percent of sales
• Standardized statements make it easier to
• compare financial information, particularly as
  the company grows.
• comparing companies of different sizes,
  particularly within the same industry.

5
Ratio Analysis

• Ratios allow for better comparison through time
  or between companies.
• Always Ask
• How is the ratio computed?
• What is the ratio trying to measure and why?
• What does the value indicate?
• How can we improve the companys ratio?

6
Categories of Financial Ratios

• Liquidity ratios
• Financial leverage, ratios
• Asset management or turnover ratios
• Profitability ratios
• Market value ratios

7
Current Ratios (Liquidity)

• s taken from Table 3.1, 3.3
• Current Ratio CA / CL
• 708 / 540 1.31 times
• Quick Ratio (CA Inventory) / CL
• (708 - 422) / 540 .53 times
• Cash Ratio Cash / CL
• 98 / 540 .18 times

8
Leverage Ratios (Solvency)

• Total Debt Ratio (TA TE) / TA
• (3588 - 2591) / 3588 28
• Debt/Equity TD / TE
• (3588 2591) / 2591 38.5
• Equity Multiplier TA / TE 1 D/E
• 1 .385 1.385

9
Coverage Ratios

• Times Interest Earned EBIT / Interest
• 691 / 141 4.9 times
• Cash Coverage (EBIT Depreciation) / Interest
• (691 276) / 141 6.9 times

10
Inventory Ratios

• Inventory Turnover Cost of Goods Sold /
  Inventory
• 1344 / 422 3.2 times
• Days Sales in Inventory 365 / Inventory
  Turnover
• 365 / 3.2 114 days
• Normally use Avg Inventory, may use Ending be
  consistent.

11
Receivables

• Receivables Turnover Sales / Accounts
  Receivable
• 2311 / 188 12.3 times
• Days Sales in Receivables 365 / Receivables
  Turnover
• 365 / 12.3 30 days
• Technically, should be credit sales. Will
  overstate using total sales biased.

12
Asset Turnover

• Total Asset Turnover Sales / Total Assets
• 2311 / 3588 .64 times
• It is not unusual for TAT lt 1, especially if a
  firm has a large amount of fixed assets produce
  over long periods of time. Is why depreciated
  instead of expensed.

13
Profitability

• Profit Margin Net Income / Sales
• 363 / 2311 15.7
• Return on Assets (ROA) Net Income / Total
  Assets
• 363 / 3588 10.1
• Return on Equity (ROE) Net Income / Total
  Equity
• 363 / 2591 14.0

14
Market Value

• Market Price 88 per share
• Shares outstanding 33 million
• PE Ratio Price per share / Earnings per share
• 88 / 11 8 times
• Market-to-book ratio market value per share /
  book value per share
• 88 / (2591 / 33) 1.12 times

15
Du Pont

• ROE PM TAT EM
• Profit margin is a measure of the firms
  operating efficiency how well it controls
  costs.
• Total asset turnover is a measure of the firms
  asset use efficiency how well it manages its
  assets.
• Equity multiplier is a measure of the firms
  financial leverage.
• ROE (NI / Sales) (Sales / TA) (TA / TE)
• ROE NI / TE

16
FS Utility

• Ratios aint worth dooky by themselves they NEED
  (long to be, strongly desirous of) to be
  compared to something
• Time-Trend Analysis
• Used to see how the firms performance is
  changing through time
• Peer Group Analysis
• Compare to similar companies or within industries
• SIC and NAICS codes

17
Potential Problems with Ratios

• No way to know which ratios are most relevant.
• Benchmarking is difficult for diversified firms
  no comparative group.
• Globalization and international competition makes
  comparison more difficult because of differences
  in accounting regulations.
• Firms use varying accounting procedures.
• Firms have different fiscal years.
• Extraordinary, or one-time, events
• Fudge Factors

18
Impact of Decisions

• Investment in new assets determined by capital
  budgeting decisions
• Degree of financial leverage determined by
  capital structure decisions
• Cash paid to shareholders determined by
  dividend policy decisions
• Liquidity requirements determined by net
  working capital decisions

19
EFN

• Difference between the forecasted increase in
  assets and the forecasted increase in liabilities
  and equity.

20
EFN and Growth

• At low growth levels, internal financing
  (retained earnings) may exceed the required
  investment in assets.
• As the growth rate increases, EFN- the firm will
  have to go to the capital markets for financing.
• Examining the relationship between growth and
  external financing required is a useful tool in
  long-range planning.

21
Growth Rates

• The internal growth rate tells us how much the
  firm can grow assets using retained earnings as
  the only source of financing.
• Internal Growth Rate
• (ROA b) / (1 ROA b)

22
Sustainable G

• The sustainable growth rate tells us how much the
  firm can grow by using internally generated funds
  and issuing debt to maintain a constant debt
  ratio.
• Sustainable Growth Rate
• (ROE b) / (1 ROE b)

23
What Determines Growth?

• Profit margin operating efficiency
• Total asset turnover asset use efficiency
• Financial leverage choice of optimal debt ratio
• Dividend policy choice of how much to pay to
  shareholders versus reinvesting in the firm

24
Quick Quiz

• How do you standardize balance sheets and income
  statements?
• Why is standardization useful?
• What are the major categories of financial
  ratios?
• How do you compute the ratios within each
  category?
• What are some of the problems associated with
  financial statement analysis?

25
Quick Quiz Problems

• What is the purpose of long-range planning?
• What are the major decision areas involved in
  developing a plan?
• What is the percentage of sales approach?
• What is the internal growth rate?
• What is the sustainable growth rate?
• What are the major determinants of growth?
• Problems
• Concepts Review (all chapters),
• 3, 4, 7, 23, 24.