2 Financial Statements Analysis

FIN AN CIAL STATEMENTS AN ALYSI S

BUS IN ESS OBJ ECTI VES  Profit Motive – to create a value for its shareholders while maintaining a sound financial position Economic Factors (Measurable) • • • •

Profit Sale Volume Assets Market Share

Non-economic Factors (Non-measurable) • • • •

Employees satisfaction Social responsibility Prestige Ethical consideration

USE OF FINA NCI AL RA TIOS To evaluate the financial condition and performance of the company. Its purpose is not only internal control but also better understanding of what capital suppliers seek in financial condition

FOU R ASPEC TS OF BUS IN ESS 

LIQUIDITY – the ability of a company to meet it’s as they come due.

obligation



STABILITY – is measured by the ability of a company to make interest and principal payments on outstanding debt and to pay regular dividends to its stockholders.



PROFITABILITY – is measured by the ability of a business to increase it’s owner’s equity from its operation.



GROWTH POTENTIAL – is measured by the expansion & growth in new markets, the rate of the growth in earnings per share & the amount of expenditures for the research & development.

FO UR M ETH ODS OF CO MPA RISO N  EXPERIENCE  BUDGETS  HISTORICAL / TREND  EXTERNAL BENCHMARKS / INDUSTRY

GRO WTH MEA SURE MEN T  AVERAGE GROWTH RATE  COMPOUND GROWTH RATE

DI FFICU LTI ES I N MA KI NG COM PAR IS ONS

 Deciding on the proper basis for comparison  Differences in the dollar measuring stick  Differences in definition/situation  Hidden short-run changes  The past as an indication of future

MET HOD S IN FINAN CI AL STA TEMEN T ANA LYSI S  Horizontal analysis  Vertical analysis

SUMM ARY OF RA TIOS  OVERALL PERFORMANCE MEASURES: Name of ratio

Formula Market price per share --------------------------Net income per share

2. Price/earnings ratio

State Results as

Times

6. Return on assets

Net income + Interest(1 - Tax rate) -------------------------------------------Percent Total assets

10.Return on invested capital

Net income + interest(1 – Tax rate) ---------------------------------------------Percent Long-term lia. + Shareholders’ equity

14.Return on shareholder’s equity Percent

Net income --------------------------

SUMM ARY OF RA TIOS  PROFITABILITY MEASURES: Name of ratio

5. Gross margin percentage

6. Profit margin Percent

Formula Gross margin --------------------------Net sales revenues

State Results as

Percent

Net income ----------------------Net sales revenues

7. Earnings per share

Net income -------------------------------No. of shares outstanding

Dollars

SUMM ARY OF RA TIOS  TESTS OF INVESTMENT UTILIZATION: Name of ratio

8. Asset turnover Times

Formula

State Results as

Sales revenues ----------------------Total assets

9. Invested capital turnover

10. Equity turnover

Sales revenues ----------------------------------------------- Times Long-term lia. + Shareholders’ equity Sales revenues ---------------------------Shareholders’ equity

Times

SUMM ARY OF RA TIOS  TESTS OF INVESTMENT UTILIZATION (cont..): Name of ratio

Formula

State Results as

11. Capital intensity

Sales revenues -----------------------------------Property, plant & equipment

Times

12. Days’ cash

Cash ---------------------------------Cash expenses / 365 days

Days

Accounts receivables ---------------------------Sales / 365 days

Days

13. Days’ receivables

SUMM ARY OF RA TIOS  TESTS OF INVESTMENT UTILIZATION (cont..): Name of ratio

14. Days’ inventory

15. Inventory turnover

16. Working capital turnover Times

Formula Inventory ------------------------------Cost of sales / 365 days Cost of sales ---------------------Inventory Sales revenues ----------------------Working capital

State Results as

Days

Times

SUMM ARY OF RA TIOS  TESTS OF FINANCIAL CONDITION: Name of ratio

Formula

State Results as

Current assets -----------------------

17. Current ratio Ratio

Current liabilities 6.

Monetary current assets ---------------------------------

Acid-test (quick) ratio Ratio

Current liabilities Long-term liabilities --------------------------Shareholders’ equity

19. Debt/equity ratio or

Total liabilities

Percent

SUMM ARY OF RA TIOS  TESTS OF FINANCIAL CONDITION (cont..): Name of ratio

20. Debt/capitalization Percent

Formula

State Results as

Long-term liabilities ---------------------------------------------Long-term lia. + Shareholders’ equity

21. Times interest earned Times

Pretax operating profit + Interest -----------------------------------------Interest

22. Cash flow/debt

Cash generated by operations --------------------------------------Total debt

Percent

SUMM ARY OF RA TIOS  TESTS OF FINANCIAL CONDITION (cont..): Name of ratio

23. Dividend yield

24. Dividend payout

Formula Dividends per share -----------------------------Market price per share Dividends -----------------Net income

Source: ACCOUNTING TEXT AND CASES By: Robert N. Anthony, D.B.A. James S. Reece, D.B.A., C.M.A. Julie H. Hertenstein, D.B.A.

State Results as

Percent

Percent

RET UR N ON INV EST ME NT • ROI is broadly defined as Net Income divided by investment

Return on assets (ROA) • reflects how much the firm has earned on the investment of all the financial resources committed to the firm • it is a measure how well an enterprise has used its funds, without regard to the relative magnitudes of the sources of those funds

RET UR N ON INV EST ME NT (cont.) Return on Owners’ Equity (ROE) • reflects how much the firm has earned on the funds invested by the stockholders Return on Invested Capital (ROIC) • is equal to non-current liabilities plus shareholders’ equity and hence represents the funds entrusted to the firm for long periods

INVES TM ENT TURNOVER & PR OF IT MAR GIN Equity Turnover Net Income ----------------Investment

=

Profit Margin (Return on Sales)

=

Net Income -----------------------Sales

+

+

Investment Turnover (Asset Turnover) Sales ---------------Investment

Ways of Improving ROI 1. Increase profit margin 2. Increase investment turnover a. Generate more sales w/same amount of investment b. Reduce amount of investment for a given volume

PRI CE/ EAR NI NG S RAT IO Price Earning Ratio

=

Market Price per Share -----------------------------------Net Income per Share

- The P/E Ratio is an indicator of how investors judge the firm’s future performance - Management compares its P/E Ratio with similar companies to determine the marketplace’s relative rankings of the firm

EAR NI NGS PE R SH AR E

Net Income After Taxes ------------------------------------No. of Shares Outstanding

LIQUI DI TY & SOL VE NCY  LIQUIDITY – the company’s ability to meet its current obligations  SOLVENCY – the company’s ability to meet interest costs and repayment schedules associated with long-term obligations

I. LI QUI DI TY RA TIO  Used to judge a firm’s ability to meet short-term obligations 1. Current Ratio Current Assets -----------------------------------Current Liabilities 7. Quick Ratio Current Assets – Inventories --------------------------------------Current Liabilities

1. Liquidity of Receivables - indicates the slowness of receivables - tests the efficiency of credit and collection policies a. Average Collection Period

- too low an average collection period may suggest an excessively restrictive credit policy - too high an average collection period may indicate too liberal a credit policy

Receivables x Days in year ---------------------------------------Annual Credit Sales b. Receivable Turnover Ratio

c. Aging of Accounts

Annual Credit Sales -----------------------------------Receivables

- Receivables are categorized at a moment in time according to the proportions billed in previous months - Gives considerably more information than the calculation of the average collection period because it pinpoints the trouble spots more specifically

4. Liquidity of Inventories Inventory Turnover Ratio - Tells the rapidity with which the inventory is turned over into receivables thru sales - The higher inventory turnover, the more efficient the inventory management - When the inventory turnover ratio is relatively low, it indicates slow-moving inventory or obsolescence of stock Cost of Goods Sold ---------------------------------Average Inventory

II . DEBT RATIO  Tells the relative proportions of capital contribution by creditors and by owners 1. Debt-to-Equity - A comparison of the debt ratio for a given company with those of similar firms gives us a general indication of the creditworthiness and financial risk of the firm Total Debt -----------------------------------Shareholder’s Equity 10.Long-term Capitalization - All long-term debt, preferred stock, and shareholder’s equity - Tells the relative importance of long-term debt in the capital structure Long-term Debt --------------------------------------Total Capitalization

3. Cash-flow-to-total-liabilities ratio - Useful in assessing the creditworthiness of a company seeking debt funds - Useful in predicting the deteriorating financial health of a company Cash Flow (EBITDA) -------------------------------------Total Liabilities

4. Cash-flow-to-long-term ratio - Used to evaluate the bonds of a company - Helpful in corporate restructuring - Useful in predicting the deteriorating financial health of a company Cash Flow (EBITDA) -------------------------------------Long-term Debt 5. Cash Flow (EBITDA) - Long-term debt - Enterprise-value-to-EBITDA ratio - Bank loans, notes payable and long-term debt represent total borrowings - The higher the ratio, the greater the value that is being placed on the securities Total Borrowings + Equity -----------------------------------------Cash Flow (EBITDA)

III. COV ERAGE R ATI OS  Designed to relate the financial charges of a firm to its ability to service them 1. Interest Cover Ratio - Ratio of earnings before interest and taxes for a particular reporting period to the amount of interest charges for the period

5. Cash-Flow Coverage Ratios a. Cash-Flow Coverage of Interest - Useful in determining whether a borrower is going to be able to service interest payments on a loan

EBITDA --------------------------------------Annual Interest Payments b. Cash-Flow Coverage of Interest and Principal Ratio EBITDA --------------------------------------------------Interest + Principal payments (1/(1-t))

IV. DURA TION OF PAYA BLES  Average Payable Period  Valuable in evaluating the probability that a credit applicant will pay on time Accounts Payable x 365 ----------------------------------Purchases

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