Financial Statement and Ratio Analysis

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Financial Statement and Ratio Analysis
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Financial Statement

• Balance Sheet
• Income Statement
• Cash Flow Statement

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Balance Sheet

• Assets the economic resources controlled by
  the company
• Current Asset assets which will be
  sold,collected, or
• consumed with in one year or firms
• operating cycle.
• Cash the most liquid asset
• Account receivable amount owed to the firm by
  its
• customer for goods and services delivered
• Inventory products that will be sold
• Prepaid expenses service paid for but not yet
  used

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Balance Sheet

• Assets the economic resources controlled by
  the company
• Fixed Asset Investments
• Land, Property, Plant, and equipment
• Intangible assets such as patents,
  trademarks,
• goodwill.

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Balance Sheet

• Liabilities responsibilities that must be met
  in the future.
• Current Liabilities liabilities which
  will be paid within
• one year or firms operating cycle.
• Account payable amount owed to suppliers for
  goods
• or services received but not yet paid for.
• Current portion of long-term debt a portion of
  long- term debt that will be paid within one
  year.
• Long-term liabilities the amount owed
  creditors that will not be paid in one year.

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Balance Sheet

• Equities the owners investment
• Common stock stockholders investment valued
  at par.
• Retained earning total net income less
  dividends from the beginning of business

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Balance Sheet

• Equities the owners investment
• Common stock stockholders investment valued
  at par.
• Retained earning total net income less
  dividends from the beginning of business

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Balance Sheet

• A snapped shot of financial status
• Use of funds and source of funds
• Total Asset Total Liability Total Equity
• Working Capital Current Asset Current
  Liability

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Inventory

• Beg. Inv. Purchases End. Inv. Cost of
  good sold
• Example
• Jan1,99 Beg. inv. (1unit Lot A) 12 each
• Jan6,99 Purchase 1 unit Lot B) 16 each
• Jan9,99 Purchase 2 units Lot C,D) 20 each
• Jan21,99 Sold 2 units
• Jan31,99 End. Inv. 2 units
• FIFO (First-In-First-Out) sold A and B, so, CGS
  28, End.Inv 40
• 12 (16 2x20) 40 (End.Inv) 28 (CGS)
• LIFO (Last-In-First-Out) sold C and D, so, CGS
  40, End.Inv 28
• 12 (16 2x20) 28 (End.Inv) 40 (CGS)
• Weighted Average CGS 2 units x (68/4) 34,
  End.Inv 34
• 12 (16 2x20) 34 (End.Inv) 34 (CGS)

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Inventory

• In periods of rising prices
• FIFO (First-In-First-Out) CGS 28, End.Inv
  40
• lower CGS, higher net income as well as higher
  taxes
• higher End.Inv, higher working capital, lower
  cash flows
• LIFO (Last-In-First-Out) CGS 40, End.Inv
  28
• higher CGS, lower net income as well as lower
  taxes
• lower End.Inv, lower working capital, higher
  cash flows

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Inventory

• Question
• During a period of rising price levels, the
  financial statements of a company using FIFO
  instead of LIFO for inventory accounting will
  show
• A. lower total assets and lower net income.
• B. lower total assets and higher net income.
• C. higher total assets and lower net income.
• D. higher total assets and higher net income.

Solution D FIFO give a smaller CGS, thus a
bigger income FIFO give a bigger inventory, thus
a higher total assets.
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Income Statement

• Total Sales (Total Revenue)
• Less Cost of goods sold (CGS)
• Equal Gross margin (Gross profit)
• Less Operating expenses
• Equal Operating income (EBITDA)
• Less Depreciation and amortization
• Equal Earning before interest and taxes (EBIT)
• Less Interest expense
• Equal Earning before taxes (EBT)
• Less Taxes
• Equal Net Income

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Income Statement

• A period of companys operation
• Results and efficiency from operation

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Depreciation Accounting

• Allocate the cost of an asset over a period of
  time
• Depreciation methods
• 1.Straight-line depre. (Cost Salvage) /
  (useful life)
• Question A machine has a historical cost
  12,000
• The estimated useful life 5 years
• Salvage value 2,000
• Find depreciation expense per year
• Answer depreciation (12,000 - 2,000)/5
  2,000 per year

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Depreciation Accounting

• 2.Double declining balance (DDB) use 200 of
  straight-line rate as the rate applied against
  the declining balance. Note that this method does
  not explicitly use the salvage value, but
  depreciation expense will be halted when the cost
  less salvage value has been depreciated.
• DDB ( 2 / useful life) x ( Cost accumulated
  depreciation)
• Answer depreciation expense using DDB is
• 1st year (2/5) x (12,000 0 ) 4,800
• 2nd year (2/5) x (12,000 4,800) 2,880
• 3rd year (2/5) x (12,000 7,680) 1,728
• 4th year (2/5) x (12,000 9,408) 1,037
• Note 4th year depreciation will actually be
  limited to 592
• 5th year depreciation is zero
• Total depreciation 4,800 2,880 1,728
  592 10,000

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Depreciation Accounting

• Depreciation is an allocation of past investment
  cash flows and has no impact on the statement of
  cash flows.
• Depreciation is a significant expense that must
  be subject to critical analysis. Although useful
  life, salvage value and the depreciation method
  must be disclosed, management chooses them. This
  allows for the possibility of income
  manipulation.
• Different depreciation method can bring different
  bottom line.

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Depreciation Accounting
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Cash Flow Statement

• A period of companys cash flow operation
• Where the money comes and goes?

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Financial Statement

• Limitation on Financial Statement Analysis.
• 1. It is difficult to compare between company
  itself and the industrial average since we have
  no acceptable industrial average numbers.
• 2. Inflation which determines the value of net
  worth is not considered.
• 3. Seasonal effect cannot be observed on
  financial statement.
• 4. Corporate governance.
• 5. Difference in accounting policy.

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Financial Statement

• Key points for evaluating a company.
• 1. Customer diversification.
• 2. Bargaining power from suppliers.
• 3. Industry Competition.
• 4. Potential Entrants
• 5. Substitutes.
• 6. Product diversification
• 7. Regulations and laws.
• 8. Geographical diversification

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Financial Ratios

• 1.Liquidity
• Current ratio CA / CL
• Quick ratio (Cash marketable securities
  receivable ) / CL
• Cash ratio (Cash marketable securities) /
  CL
• Receivable turnover Sales / AR
• Avg. receivable collection period (days) 365 /
  Receivable turnover
• Inventory turnover CGS / Inventory
• Avg.inv.processing period (days) 365 /
  Inventory turnover
• Payable turnover CGS / AP
• Payable payment period (days) 365 / payable
  turnover
• Cash conversion cycle Collection Processing
  - Payment

The longer cash conversion cycle,the longer time
need to get cash
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Financial Ratios

• 2.Operating performance how well management
  operate?
• 2.1 Efficiency
• Total asset turnover Sales / Total asset
• Fixed asset turnover Sales / Fixed asset
• Equity turnover Sales / Total equity
• 2.2 Profitability
• Gross profit margin Gross profit / Sales
• Operating profit margin EBIT / Sales
• Net profit margin Net Income/ Sales

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Financial Ratios

• 3.Financial Risk uncertainty of the firms
  income flows compared with firms debt level.
• Debt/Equity Total long-term debt / Equity
• Interest Coverage EBIT / Interest expense

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Financial Ratios

• 4.Dupont System breaking down a ratio into
  components
• ROE (NI / Equity)
• ROE (NI / Sales) x (Sales / Asset) x ( Asset /
  Equity)
• ROE (Net Profit margin) x (Asset turnover) x
  (Equity multiplier)

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Financial Ratios

• Question
• An analyst applies the Dupont system of
  financial analysis to the following data for a
  company
• Equity turnover 4.2
• Net profit margin 5.5
• Total asset turnover 2.0
• Dividend payout ratio 31.8
• The companys return on equity is closest to
• A. 1.3.
• B. 11.0.
• C. 23.1.
• D. 63.6.

Solution C ROE (Sale/Equity) (Net
Income/Sale) 4.2 x 5.5 23.1
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