Financial Statement Analysis CHAPTER 19 Financial Statement Analysis

Overview Purpose Tools Used Statement analysis Ratio analysis Limitations

Financial Statements Balance Sheet Common Sized Trend or Indexed Income Statement Statement of Cash Flows

Table 19.1 Consolidated Statement of Income for Hewlett-Packard, 2006

Table 19.2 Consolidated Balance Sheet for Hewlett-Packard, 2006

Table 19.3 Statement of Cash Flows for Hewlett-Packard, 2006

Accounting Versus Economic Earnings Sustainable cash flow that can be paid to stockholders without impairing productive capacity of the firm Accounting earnings Affected by conventions regarding the valuation of assets

Profitability Measures ROE: measures the profitability for contributors of equity capital ROA: measures the profitability for all contributors of capital Leverage has a significant effect on profitability measures

Table 19.4 Nodett’s Profitability over the Business Cycle

Table 19.5 Impact of Financial Leverage on ROE

ROE, ROA and Leverage

Decomposition of ROE (1) x (2) x (3) x (4) x (5) ROE = x Net Profit Pretax Profit x EBIT Sales Assets Equity (1) x (2) x (3) x (4) x (5) x Margin x Turnover x Leverage Tax Burden Interest x

Table 19.6 Ratio Decomposition Analysis for Nodett and Somdett

Table 19.7 Differences between Profit Margin and Asset Turnover across Industries

Table 19.8 Growth Industries Financial Statements, 2004 – 2007 ($ thousands)

Table 19.9 Summary of Key Financial Ratios: Leverage, Asset Utilization, Liquidity, Profitability and Market Price

Figure 19.1 DuPont Decomposition for Hewlett-Packard

Table 19.10 Financial Ratios for Major Industry Groups

Economic Value Added Difference between return on assets (ROA) and the opportunity cost of capital (k) EVA is also called residual income EVA can be positive or negative for firms that have positive earnings

Table 19.11 Economic Value Added, 2007

Table 19.12 Key Financial Ratios of Growth Industries, Inc

Table 19.13 Growth Industries Statement of Cash Flows ($ thousands)

Comparability Problems Accounting Differences Inventory Valuation Depreciation Inflation and Interest Expense Fair Value Accounting Quality of Earnings International Accounting Conventions

International Accounting Differences Reserves – many other countries allow more flexibility in use of reserves Depreciation – US allows separate tax and reporting presentations Intangibles – treatment varies widely

Figure 19.2 Adjusted Versus Reported Price-Earnings Ratios

The Graham Technique Careful analysis of a firm’s financial statements could turn up bargain stocks Purchase common stocks at less then their working-capital value Give no weight to plant or other fixed assets Deduct all liabilities in full from assets