FINANCIAL STATEMENT AND RATIO ANALYSIS. Annual report.The report describes the firm’s operating performance during the year and discuss new development.

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Presentation transcript:

FINANCIAL STATEMENT AND RATIO ANALYSIS

Annual report.The report describes the firm’s operating performance during the year and discuss new development that might effect the future operations and gives an accounting picture of the firm’s financial position.

Income Statement It presents the result of business operation during a specified period of time such as a quarter or a year and summarizes the revenue generated and expenses incurred by the firm during the accounting period.

Net Sales Less Cost of goods Sold = Gross Profit from Sales Less Fixed Operating Expenses Less Depreciation Expense = Operating Income (EBIT) Less Interest Expense = Pre-tax Income (EBT) Less Taxes = Net Income (EAT) Less Dividend to Preferred Stockholders = Earnings Available to Common Stockholders Less Dividend to Common Stockholders = Addition to Retained Earnings. The Corporate Income Statement

Assets: A: Current Assets:  Cash  Marketable Securities (investments in government securities. Up to 100% redeemable)  Accounts Receivable  Inventory (Raw materials, Work-in-process and Finished goods) Prepaid and advances B: Fixed Assets:  Property, Plant and Equipment  Long-Term Investments (money used in procuring assets that are not used for the company’s main operations). The Corporate Balance Sheet

LIABILITIES: A: Current Liabilities:  Accounts Payable  Short-term Notes Payable  Short-term Loans B: Long-Term Liabilities:  Long-term Notes Payable  Bonds  Long-term loans  Mortgaged Loans. The Corporate Balance Sheet

SHAREHOLDERS’ EQUITY  Common Stock  Paid-In Capital  Preferred Stock  Retained Earnings THE CORPORATE BALANCE SHEET

Cash flow analysis Source of CashUse of Cash Increase in a liability or Equity accountDecrease in a liability or Equity account Borrowing funds or selling stockPaying off a loan or buying back stock Decrease in asset accountIncrease in asset account Selling inventory or collecting receivables Buying fixed assets or buying more inventory

Statement of Retained Earning Shows changes in the common equity accounts between balance sheet dates Balance of Retained Earning form the previous year Add: Net income of the current year Less: Dividend paid to the stockholders Balance of retained earning of the current year

Using Financial Ratios: Interested Parties Ratio analysis involves methods of calculating and interpreting financial ratios to analyze and monitor the firm ’ s performance. Reasons for Analysis n Different Questions è Will they go bust before they pay? è Where will they be in ten years time è What can we learn and apply to ourselves? è Is it a good investment? n Different Users è Suppliers è Customers è Competitors è Shareholders

Areas of Financial Analysis Liquidity The company’s ability to pay of its current liabilities from its current assets. Asset Management /activity ratio The company’s efficiency in using its assets in generating sales. Debt Management /debt ratio The optimum amount of the firm’s Debt compared to its assets and equity.

Areas of Financial Analysis Profitability The company’s ability to earn different types of profits and return compared to the capital employed. Market Value /market ratio How the company’s share price is appealing the current and potential investors

1.Liquidity Ratios a)Current ratio = Current assets ÷ Current liabilities The current ratio for Bartlett Company in 2012 is: $1,223,000 ÷ $620,000 = 1.97

Expressed as a multiple. Answers the question "Can the company meet all current liabilities with its current assets ?" Obviously a ratio of 1 would satisfy this, but whether 1 is too low or too high will depend on the industry. The liquidity of the current assets is a key question. That is, how fast can they be turned into cash.

Ratio Analysis (cont.) b)Quick ratio: As Current ratio, but the stocks are assumed to be too illiquid to be included in the current assets figure. The quick ratio for Bartlett Company in 2012 is: Ratio of 1.51 means that for every dollar of current liabilities, it has $1.51 of current assets excluding inventories.

The importance of inventories: – From Table 3.5: CompanyCurrent ratioQuick ratio Dell Home Depot Lowes All three firms have current ratios of 1.3. However, the quick ratios for Home Depot and Lowes are dramatically lower than their current ratios, but for Dell the two ratios are nearly the same. Why?

2. Activity Ratios Measures the speed at which various accounts converted in to sales or cash inflows or outflows. 1.Inventory turnover = Cost of goods sold ÷ Inventory Applying this relationship to Bartlett Company in 2012 yields: $2,088,000 ÷ $289,000 = 7.2 Measures the number of times, on average, the inventory is sold during the period An inventory turnover of 20 would not be unusual for a grocery store whereas a common inventory turnover for aircraft manufacturer is 4.

Average Age of Inventory = 365 ÷ Inventory turnover For Bartlett Company, the average age of inventory in 2012 is: 365 ÷ 7.2 = 50.7 days

Fixed Asset Turnover (FAT) Tells how efficiently fixed assets are used to generate sales. The higher the FAT, the better.

Average collection period or debtor ratio: Expressed as days outstanding. A long debtor ratio may be due to long payment terms (e.g. export sales) or to poor collection. A falling ratio is usually a sign of improving financial management, but it might also imply a shortage of cash with discounts being offered for early payment. Debtor payment periods are part of the pricing negotiation

The average collection period for Bartlett Company in 2012 is: On average it takes the firm 59.7 days to collect its accounts receivables.

Who gets credit? – Companies in the building materials, grocery, and merchandise store industries collect in just a few days, whereas firms in the computer industry take roughly two months to collect on their sales. – The difference is primarily due to the fact that these industries serve very different customers.

If we assume that Bartlett Company ’ s purchases equaled 70 percent of its cost of goods sold in 2012, its average payment period is:

A rising ratio may imply a cash shortage. There is an obvious cash advantage to late payment, but there are also downsides.....

Total Asset Turnover : Measures how efficiently a company uses its assets to generate sales. Total asset turnover = Sales ÷ Total assets The value of Bartlett Company ’ s total asset turnover in 2012 is: $3,074,000 ÷ $3,597,000 = 0.85 The company turns over its assets 0.85 times per year. Greatest interest of management whether the firm’s operations have been financially viable.

Matter of Fact Sell it fast – the grocery business turns over assets faster than any of the other industries listed. – That makes sense because inventory is among the most valuable assets held by these firms, and grocery stores have to sell baked goods, dairy products, and produce quickly or throw them away when they spoil. – On average, a grocery stores has to replace its entire inventory in just a few days or weeks, and that contributes to the rapid turnover of the firms total assets.

Debt Ratios Measures the percentage of the total assets that creditors provide Debt ratio = Total liabilities ÷ Total assets The debt ratio for Bartlett Company in 2012 is $1,643,000 ÷ $3,597,000 = = 45.7% The company has financed 45% of its assets with debt.

Debt-Equity Ratio

Times interest earned ratio = EBIT ÷ interest Expressed as a multiple measuring the number of times interest payable is covered by profit. Gives the degree to which the company is vulnerable to being unable to meet interest payments from profit. The greater the proportion of capital from debt, the lower the ratio The figure for earnings before interest and taxes (EBIT) is the same as that for operating profits shown in the income statement. Applying this ratio to Bartlett Company yields the following 2012 value: $418,000 ÷ $93,000 = 4.5

Table 2.7 Bartlett Company Common-Size Income Statements

Profitability Ratios Bartlett Company ’ s gross profit margin for 2012 is:

Operating profit margin = Operating profits ÷ sales Bartlett Company ’ s operating profit margin for 2012 is: $418,000 ÷ $3,074,000 = 13.6% Net profit margin = Earnings available for common stockholders ÷ Sales Bartlett Company ’ s net profit margin for 2012 is: $221,000 ÷ $3,074,000 = = 7.2%

Bartlett Company ’ s earnings per share (EPS) in 2012 is: $221,000 ÷ 76,262 = $2.90

Return on total assets (ROA) = Earnings available for common stockholders ÷ Total assets Bartlett Company ’ s return on total assets in 2012 is: $221,000 ÷ $3,597,000 = = 6.1%

Return on Equity (ROE) = Earnings available for common stockholders ÷ Common stock equity This ratio for Bartlett Company in 2012 is: $221,000 ÷ $1,754,000 = = 12.6%

Market Ratios Price Earnings (P/E) Ratio = Market price per share of common stock ÷ Earnings per share Measures the amount that investors are willing to pay for each dollar of a firms earnings. The higher the ratio the greater the confidence level of firms investors If Bartlett Company ’ s common stock at the end of 2012 was selling at $32.25, using the EPS of $2.90, the P/E ratio at year-end 2012 is: $32.25 ÷ $2.90 = 11.1 The investors were paying $11.1 for each $1 of earnings. Informative for cross sectional analysis using an industry average.

Provides an assessment how investors view the firms performance. where,

Substituting the appropriate values for Bartlett Company from its 2012 balance sheet, we get: Substituting Bartlett Company ’ s end of 2012 common stock price of $32.25 and its $23.00 book value per share of common stock (calculated above) into the M/B ratio formula, we get: $32.25 ÷ $23.00 = 1.40 Investors are currently paying $1.40 for each $1 of book value of firms stock

Table 2.8a Summary of Bartlett Company Ratios

Table 3.8b Summary of Bartlett Company Ratios

DuPont System of Analysis The DuPont system of analysis is used to dissect the firm ’ s financial statements and to assess its financial condition. It merges the income statement and balance sheet into two summary measures of profitability. The Modified DuPont Formula relates the firm ’ s ROA to its ROE using the financial leverage multiplier (FLM), which is the ratio of total assets to common stock equity: ROA and ROE as shown in the series of equations on the following slide.

The DuPont system first brings together the net profit margin, which measures the firm ’ s profitability on sales, with its total asset turnover, which indicates how efficiently the firm has used its assets to generate sales. ROA = Net profit margin  Total asset turnover Substituting the appropriate formulas into the equation and simplifying results in the formula given earlier,

When the 2012 values of the net profit margin and total asset turnover for Bartlett Company, calculated earlier, are substituted into the DuPont formula, the result is: ROA = 7.2%  0.85 = 6.1%

Modified duPont Formula ROE=ROA*FLM ROE=Earnings available for cs/total assets*Total assets/common equity =Earnings available for CS/CS equity ROE=6.1%*2.06 =12.6%

Using Financial Ratios: Types of Ratio Comparisons Cross-sectional analysis is the comparison of different firms ’ financial ratios at the same point in time; involves comparing the firm ’ s ratios to those of other firms in its industry or to industry averages Benchmarking is a type of cross-sectional analysis in which the firm ’ s ratio values are compared to those of a key competitor or group of competitors that it wishes to emulate. Comparison to industry averages is also popular, as in the following example.

Using Financial Ratios: Types of Ratio Comparisons (cont.) Caldwell Manufacturing ’ s calculated inventory turnover for 2012 and the average inventory turnover were as follows: Inventory turnover, 2012 Caldwell Manufacturing14.8 Industry average 9.7

Table 2.5 Financial Ratios for Select Firms and Their Industry Median Values

Using Financial Ratios: Types of Ratio Comparisons (cont.) Time-series analysis is the evaluation of the firm ’ s financial performance over time using financial ratio analysis Comparison of current to past performance, using ratios, enables analysts to assess the firm ’ s progress. Developing trends can be seen by using multiyear comparisons. The most informative approach to ratio analysis combines cross-sectional and time-series analyses.