Financial Statement Analysis

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Financial Statement Analysis
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Determinants of Intrinsic Value Using Ratio
Analysis
Net operating profit after taxes
Required investments in operating capital
-
Free cash flow (FCF)

FCF1
FCF2
FCF8
...
Value

(1 WACC)1
(1 WACC)8
(1 WACC)2
Weighted average cost of capital (WACC)
Market interest rates
Firms debt/equity mix
Cost of debt Cost of equity
Firms business risk
Market risk aversion
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Overview

• Ratios facilitate comparison of
• One company over time
• One company versus other companies
• Ratios are used by
• Managers to identify areas of weakness and
  strength
• Lenders to determine creditworthiness
• Stockholders to estimate future cash flows and
  risk

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RATIO ANALYSIS

• Liquidity Ratios
• Asset Management Ratios
• Debt Management Ratios
• Profitability Ratios
• Market Value Ratios

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Liquidity Ratios
Can the company meet its short-term obligations
using the resources it currently has on hand?

• Current Ratio
• Quick Ratio

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Asset Management Ratios
How efficiently does the firm use its assets? How
much does the firm have tied up in assets for
each dollar of sales?

• Inventory Turnover Ratio
• Days Sales Outstanding (DSO), Average Collection
  Period (ACP)
• Fixed Asset Turnover Ratio
• Total Asset Turnover Ratio

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Asset Management Ratios
Total assets turnover
     Sales        Total assets

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Debt Management Ratios
Does the company have too much debt? Can the
companys earnings meet its debt servicing
requirements?

• Total Liabilities to Total Assets, Long Term Debt
  to Total Assets, Debt to Equity Ratio
• Times Interests Earned Ratio
• EBITDA Coverage Ratio

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Debt Management Ratios
EBITDA Coverage Ratio
EBIT Depr. Amort. Lease payments
Interest Lease expense
pmt.
Loan pmt.
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Profitability Ratios

• What is the companys rate of return on
• Sales?
• Assets?

• Profit Margin on Sales
• Basic Earning Power
• Return on Total Assets
• Return on Common Equity

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Profit Margin
Gross profit margin (GPM)
Sales - COGS Sales
GPM
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Basic Earning PowerReturn on Asset, Return on
Equity
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Market Values Ratios

• Market value ratios incorporate the
• High current levels of earnings and cash flow
  increase market value ratios
• High expected growth in earnings and cash flow
  increases market value ratios
• High risk of expected growth in earnings and cash
  flow decreases market value ratios

• Price/Earnings Ratio
• Price/Cash Flow Ratio
• Market/Book Value Ratio

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Market Values Ratios
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DU PONT EQUATION
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ANALYTICAL APPROACHES

• Trend Analysis
• Common Size Analysis
• Percent Change Analysis

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Limitations

• Different divisions in different industries
• Average is not good enough
• Inflation
• Seasonal factors
• Window dressing
• Different accounting practices
• What is a good ratio?
• Financial statements accuracy

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Qualitative Factors

• Dependence on key customer(s)
• Dependence on key product(s)
• Dependence on key supplier(s)
• Competition
• Future prospects
• Legal regulatory environment