Financial Statement Analysis-

1
Session XII

• Financial Statement Analysis-
• Introduction

2
The 3 Ps

• Preparation
• Processing
• Presentation

3
Reasons for Analysis

• Investment decisions
• Credit decisions
• Performance
• Valuation (investment)
• Legal liability amount (credit perf.)
• Going concern decisions (credit perf.)
• Unreasonable returns (performance)

4
FSA Steps

• Identify the economic characteristics
• Identify the corporate strategies
• Understand the financial statements
• Assess the profitability and risk
• Value the particular firm

5
Tools for Economic Analysis

• Value Chain Analysis
• Porters Five Forces
• Economic Attributes Framework

6
Porters Five Forces

• Buyer Power
• Supplier Power
• Rivalry among Firms
• Threat of New Entrants
• Threat of Substitutes

7
Economic Attributes Framework

• Demand
• price sensitivity
• demand growth
• cyclical demand
• seasonal demand
• Supply
• number of suppliers
• barriers to entry
• Manufacturing
• capital intensity
• process complexity
• Marketing
• marketing channel--corporate or consumer
• demand pull or demand creation
• Financing
• Nature of assets
• Asset risk
• Source of cash flow--internal or external

8
Strategic Analysis Framework

• Nature of product or service
• Degree of Integration
• Degree of Geographical Diversification
• Degree of Industry Diversification

9
Sources of Information

• Annual Report
• Form 10-K
• Form 10-Q
• Form 8-K
• Prospectus
• Form 20-F (foreign entity 10-K)

10
Financial Statements

• Balance Sheet
• Income Statement
• Statement of Cash Flows
• Footnotes
• Auditors Report
• Management Discussion and Analysis

11
Income Statement Classification

• Operating income
• Other income and expense
• Income from continuing operations
• Income, gains losses from discontinued
  operations
• Extraordinary gains and losses
• Changes in accounting principles

12
Comprehensive Income

• Net income plus or minus the changes in
  shareholders equity from other than net income
  or transactions with owners.

13
Other F/S Considerations

• Quality of Earnings
• Statement of Cash Flows
• Auditors Report

14
Quality of Earnings Issues

• Non-recurring itemssustainability
• Earnings measurementchps. 5-7
• Earnings managementchps. 5-7
• Essentially we are trying to determine if what is
  reported is going to recur in the future.

15
Sustainability Issues

• Discontinued operations
• Extraordinary gains and losses
• Changes in accounting principles
• Impairment of long-lived assets
• Restructuring charges
• Changes in estimates
• Peripheral gains and losses
• Mgmt. analysis including the MDA

16
Statement of Cash Flows

• FASB 95--1987
• Components
• Operating cash Operations and working capital
• Investing cash Non-current assets and
  investments
• Financing cash L/T debt, equity and dividends

17
Tools of Profit and Risk Analysis

• Common Size Financial Statements
• Percentage Change Statements
• Comparative Analysis
• Critical Financial Ratios

18
Risks of Comparative Analysis

• Timing
• GAAP Application
• Degree of Conservatism
• Management Attitude
• Size
• Geographic Diversification

19
Profitability Analysis

• Rate of Return on Assets--ROA
• Measures success in using assets to generate
  earnings (excluding financing)
• Disaggregated ROA
• ROA Profit Margin X Asset Turnover
• Line by line P L Analysis
• A/R, Inventory F/A turnover

20
ROA Summary

• Level 1 ROA as a whole
• Level 2 Disaggregate ROA
• Level 3a Margin analysis in detail
• Level 3b Disaggregate turnover
• Level 4 ROA, margin turnover by geographic
  segment

21
L/T Financial Risk

• L/T Debt Ratio
• Debt/Equity Ratio
• Cash Sufficiency Ratio
• (CFO I T)
• (PPE D I T Div)

22
Disaggregated ROCE

• ROCE ROA X CEL X CSL
• Common Earnings Leverage op. Income available
  to common s/h
• Cap. Structure Leverage multiplier effect of
  other capital sources

23
Risk Analysis

• Types of risk
• International
• Domestic
• Industry
• Firm-specific
• Financial
• Solvency
• Liquidity

24
S/T Financial Risk

• Current ratio
• Quick ratio
• Working Capital Activity ratios
• A/R turnoverDSO
• Inventory turnoverDays in inventory
• A/P turnoverDIP
• Cash Conversion Cycle
• DSO DII - DIP.should be negative

25
ROCE--Return on Common Shareholders Equity

• Return after O-I-F activities
• ROA and ROCE
• ROCE gt ROA when ROA exceeds the cost of creditor
  and pref. Shareholder capital

26
Relationship to O-I-F

• S/T riskOworking capital
• L/T riskIplant capacity
• L/T riskFdebt service rqmts.