F INANCIAL S TATEMENT A NALYSIS Assessment of the firm’s past, present and future financial conditions Done to find firm’s financial strengths and weaknesses Primary Tools: Financial Statements Comparison of financial ratios to past, industry, sector and all firms 1

F INANCIAL S TATEMENTS Balance Sheet Income Statement Cashflow Statement Statement of Retained Earnings 2

S OURCES OF D ATA Annual reports Via mail, SEC or company websites Published collections of data e.g., DSE’s Monthly/Annual Reviews Investment sites on the web Examples 3

R EVIEW : M AJOR B ALANCE S HEET I TEMS 4 Assets Current assets: Cash & securities Receivables Inventories Fixed assets: Tangible assets Intangible assets Liabilities and Equity Current liabilities: Payables Short-term debt Long-term liabilities Shareholders' equity

R EVIEW : M AJOR I NCOME S TATEMENT I TEMS Gross Profit = Sales - Costs of Goods Sold EBITDA = Gross Profit - Cash Operating Expenses EBIT = EBDIT - Depreciation - Amortization EBT= EBIT - Interest NI or EAT = EBT- Taxes Net Income is a primary determinant of the firm’s cashflows and, thus, the value of the firm’s shares 5

A N E XAMPLE : D ELL A BBREVIATED I NCOME S TATEMENT Sales$25, Costs of Goods Sold-$19, Gross Profit$5, Cash operating expense-$2, EBITDA2, Depreciation & Amortization-$ EBIT$2, Interest-$0.00 EBT$2, Income Taxes-$ Special Income/Charges-$ Net Income (EAT)$1,

O BJECTIVES OF R ATIO A NALYSIS Standardize financial information for comparisons Evaluate current operations Compare performance with past performance Compare performance against other firms or industry standards Study the efficiency of operations Study the risk of operations 7

R ATIONALE B EHIND R ATIO A NALYSIS A firm has resources It converts resources into profits through production of goods and services sales of goods and services Ratios Measure relationships between resources and financial flows Show ways in which firm’s situation deviates from Its own past Other firms The industry All firms- 8

T YPES OF R ATIOS Financial Ratios: Liquidity Ratios Assess ability to cover current obligations Current ratio Quick/Acid test ratio Debt management/Leverage Ratios Assess ability to cover long term debt obligations Debt to total assets Time interest earned Fixed charge coverage 9

Operational Ratios: Asset Management/Activity (Turnover) Ratios Assess amount of activity relative to amount of resources used Inventory turnover Receivable turnover (Days sales outstanding) Fixed asset turnover Total assets turnover Profitability Ratios Assess profits relative to amount of resources used Net profit margin Return on total assets (ROA) Return on equity (ROE) 10

Market Value/ Valuation Ratios: Assess market price relative to assets or earnings P/E or Price/earning ratio Market to Book ratio 11

T HE D U P ONT S YSTEM An evaluation technique Greater detail by dissecting a single ratio into two or more related ratio Method to breakdown ROE into: ROA and Equity Multiplier ROA is further broken down as: Profit Margin and Asset Turnover Helps to identify sources of strength and weakness in current performance Helps to focus attention on value drivers 12

T HE D U P ONT S YSTEM 13

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S UMMARY OF F INANCIAL R ATIOS Ratios help to: Evaluate performance Structure analysis Show the connection between activities and performance Benchmark with Past for the company Industry 17

L IMITATIONS OF R ATIO A NALYSIS Published industry averages are only guidelines Accounting practices differ across firms Sometimes difficult to interpret deviations in ratios Industry ratios may not be desirable targets 18