Analysis and Interpretation of Financial Statements

1
Analysis and Interpretation of Financial
Statements

• Tools and concepts

2
Financial Analysis and Interpretation

• Tools and concepts
• What are tools?

3
Financial Analysis and Interpretation

• Tools and concepts (continued)
• What are tools?
• Items used to achieve some purpose
• They are NOT end results!!!!!!!!!!!!!!!!!!
• They are not precise
• They are only as good as the raw material from
  which they are derived
• Accounting information is based on estimates so
  tools are estimates

4
Financial Analysis and Interpretation

• Tools and concepts (continued)
• What are concepts?

5
Financial Analysis and Interpretation

• Tools and concepts (continued)
• What are concepts?
• Notions general ideas
• Are NOT precise measurements!!!!
• Are NOT exact formulas to be memorized!!!
• Are EXAMPLES of what users of financial reports
  use in practice

6
Financial Analysis and Interpretation

• Purpose of financial analysis and interpretation
• Primary focus on investors others find useful
  (e.g. creditors)
• Primary interest is in value
• Have views of enterprise been borne out?
• Expectations about future

7
Financial Analysis and Interpretation

• Two basic types of tools and approaches
• Trends same enterprise over time
• Cross sectional at single point in time, often
  in comparison with other enterprises
• Users use mixture which vary among situations

8
Financial Analysis and Interpretation

• Two basic types of tools and approaches - trends
  and cross sectional (continued)
• Lecture focuses on cross sectional
• Why?

9
Financial Analysis and Interpretation

• Two basic types of tools and approaches - trends
  and cross sectional (continued)
• Lecture focuses on cross sectional
• Why?
• Trends adequately covered in textbook
• BUT, textbook has only EXAMPLES!!!!
• Trend follows logically after cross-sectional

10
Financial Analysis and Interpretation

• Liquidity and solvency
• What do terms mean?

11
Financial Analysis and Interpretation

• Liquidity and solvency-meaning?
• Liquidity net liquid assets current
• Liquid varies
• Generally cash and equivalents
• Assets becoming cash shortly
• shortly varies.
• Solvencypay amounts when due
• Can be un-liquid but solvent!!!!!!!!!!

12
Financial Analysis and Interpretation

• Liquidity and solvency tools at point in time
• Current ratio
• Quick ratio
• Cash ratio
• Many slight variations in computation

13
Financial Analysis and Interpretation

• Liquidity and solvency toolsturnovers
• Working capital to Sales-variations
• Inventory turnover and days
• Trade receivables turnover and days
• Trade payables turnover and days

14
Financial Analysis and Interpretation

• Liquidity and solvency toolslong term solvency
  and risk (gearing)
• Debt ratio
• Debt total assets
• Debt liabilities owners equity
• Debt to owners equity
• Assume debt and equity separate!!!

15
Financial Analysis and Interpretation

• Operating performance
• Return on investment (ROI)
• Concept, not a computation
• Relation of profit (can be estimated many ways)
  to invested capital (can be estimated many ways)

16
Financial Analysis and Interpretation

• Operating performance
• Possible ways to estimate profits
• Net income
• Income before minority interests
• Operating income (EBIT)
• EBITDA discredited not allowed to be reported
  in some countries (e.g. USA)

17
Financial Analysis and Interpretation

• Operating performance (continued)
• Return on assets (ROA or ROTA)
• Relates profit (computed various ways) to ASSETS
• Generally, how well enterprises uses its
  resources
• Use of EBIT in textbook is EXAMPLE

18
Financial Analysis and Interpretation

• Operating performance ROTA (continued)
• Major strength is ability to decompose
• Margin on sales (income sales)
• Asset turnover (sales assets)
• Widely used Anglo-Saxon concept

19
Financial Analysis and Interpretation

• Operating performance (continued)
• Return on Equity (ROE)
• Income Owners equity
• EAT in text is an EXAMPLE!!!!
• Minority interest often excluded from both
  numerator and denominator

20
Financial Analysis and Interpretation

• Operating performance ROE (continued)
• Indicator of use of shareholders investment
• Indicator of increase in shareholder value

21
Financial Analysis and Interpretation

• Operating performance ROE (continued)
• Compare with ROA to assess consequences of
  gearing
• Assumes that owners equity can be separated from
  debt!!!!!!!!!!!!!!

22
Financial Analysis and Interpretation

• Investment ratios
• Earnings per share (EPS)
• Very complex computations
• Focus on understanding and interpreting, not
  computing
• Assumes owners equity is separate from debt
• Useful only if shares widely held

23
Financial Analysis and Interpretation

• Investment ratios-EPS (continued)
• Basic profit average shares
• Eliminate minority interest and preference
  dividends
• Average shares adjusted for bonus and splits

24
Financial Analysis and Interpretation

• Investment ratios-EPS (continued)
• Diluted assumes all possible future shares from
  conversions and options become issued
• Worst case scenario
• Hypothetical!!!!!!!!!!!!!!!

25
Financial Analysis and Interpretation

• Investment ratios-others
• Price earnings
• Dividend ratios
• Market to book
• See textbook
• Not widely used in Europe (but may be in the
  future)