Financial Statement Analysis

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Presentation transcript:

Financial Statement Analysis

Financial statement analysis helps users make better decisions. Purpose of Analysis Financial statement analysis helps users make better decisions. Managers Officers Internal Auditors Shareholders Lenders Customers Financial analysis is used by many people within an organization, such as managers who use it to plan and control operations. External users of financial information, such as shareholders, lenders, and customers are interested in the results of comprehensive financial analysis, too, as they want to learn as much as possible about the financial health of the company. Internal Users External Users

Purpose of Analysis Many different financial measures are used to analyze financial statements and rank the performance of competing investment opportunities, including growth in sales, return to stockholders, profit margins, and return on equity. These are just four possible measures considered and evaluated by investors and creditors. More will be covered throughout this chapter.

Outcomes Describe meaning and usage of financial statement analysis 3 Types of Analysis 5 Types of Financial Ratios

Ratio Analysis Why? numbers versus ratios EX : COMPANY AA BB NET INCOME $ 1,000,000 $ 10,000 TOTAL ASSETS $ 5,000,000 $ 20,000 NI / TA 0.20 = 20% 0.50 = 50%

Ratio Analysis Types of ratio analysis Industry Comparative You Industry average NI / TA 28 % 22 % To compare with the average of the companies in the same industry (your performance is higher or lower than the mean?)

Ratio Analysis Types of ratio analysis Trend or time series YEAR 2001 2002 2003 NI / TA 22 % 23 % 25 % To compare with yourself along the period of time (your performance is improving or getting worse?)

Ratio Analysis Types of ratio analysis Cross-sectional COMPANY You C1 NI / TA 28 % 19 % 22 % 36 % To compare with your main competitors (your performance is better or worse than them?)

Types of Financial Ratios Liquidity Asset Management (Efficiency) Debt Management (Financial Leverage) Profitability Market Value

1. Liquidity Ratios = Ability to pay current obligations (S-T debts; A/P, N/P) By using current sources of cash (Current Assets) Current ratio = CA ÷ CL Example You Co1 Co2 Current ratio 1.20 1.00 0.70 Analysis Good Normal Bad Quick or acid-test ratio = (CA - Inventories) ÷ CL Inventories are the least liquid current assets so exclude it out

2. Asset Management Ratios = Measure how efficient the assets can turn into sales $$$ $$$ $$$$ (Investment) $ 1,000,000 (Sales) $ 3,000,000 Meaning: investing $1 can generate sales $3

2. Asset Management Ratios Inventory Turnover = COGS ÷ Inventory Receivables Turnover = S ÷ A/R Average collection period (ACP) = A/R x 365 ÷ S Example: A/R = $100, Sales = $3,650 ACP = A/R x 365 ÷ S ACP = $100 x 365 days ÷ $3,650 ACP = 10 days 10 days Meaning: Make sales today Collect cash from customer

Inventory Turnover Rate Cost of Goods Sold Average Inventory Inventory Turnover = = 12.73 times $140,000 ($10,000 + $12,000) ÷ 2 Inventory Turnover = This ratio measures the number of times merchandise inventory is sold and replaced during the year. Part I Like receivables turnover we can also calculate the inventory turnover. Inventory turnover is calculated by dividing cost of goods sold for the period by the average inventory. Part II At Babson Builders inventory turnover is 12.73 times. So, inventory is turned-over about 13 times per year. Part III The inventory turnover ratio measures the number of times inventory is sold and replaced during the year. Higher inventory turnover helps protect a company from obsolete inventory items.

Average Days Sales In Inventory Average Sale Period = 365 Days Inventory Turnover = 28.67 days Average Sale Period = 365 Days 12.73 Times Part I We can also calculate the average day's sales in inventory by dividing inventory turnover into 365 days. Part II At Babson the average days sales in inventory is 28.67 days. Inventory is sold completely in about 29 days, or less than one month. This ratio measures how many days, on average, it takes to sell the inventory.

Accounts Receivable Turnover Rate Net Sales Average Accounts Receivable Accounts Receivable Turnover = = 27.03 times $500,000 ($17,000 + $20,000) ÷ 2 Accounts Receivable Turnover = Part I We calculate accounts receivable turnover by dividing our net credit sales, or sales on account, by average accounts receivable. This is yet another example of a ratio that contains and income measure in the numerator and a balance sheet measure in the denominator. Remember, in this type of ratio we always use an average amount in the denominator. Part II At Babson accounts receivable turnover is 27.03 times. This means that on average accounts receivable turnover completely about 27 times per year. Part III This ratio helps us get a feel for the number of times per year a company can convert its accounts receivable into cash. For any company, the higher the turnover, the faster the cash collection on accounts receivable. This ratio measures how many times a company converts its receivables into cash each year.

Number of Days to Collect Receivables Average Collection Period = 365 Days Accounts Receivable Turnover = 13.50 days Average Collection Period = 365 Days 27.03 Times This ratio measures, on average, how many days it takes to collect an account receivable. Part I Another way to look at receivable turnover is to calculate the average collection period in days. To do this we divide the accounts receivable turnover into 365 days. Part II At Babson Builders the average collection period on accounts receivable is 13.5 days. If Norton offers a two-ten, net thirty cash discount, we can see that most of the customers pay off the receivable balance close to the 10 day discount period. Part III This ratio measures how many days, on average, it takes for the company to collect its accounts receivable. If the collection period becomes long, management will want to develop a plan to speed the collection of receivables.

2. Asset Management Ratios Fixed Asset Turnover = Sales ÷ Fixed Assets Total Asset Turnover = Sales ÷ Total Assets Example You Co1 Co2 Sales $ 3 m $ 1 m $ 1.4 m Total Assets $ 1 m $ 1 m $ 2 m TATO 3.00 1.00 0.70 Analysis Good Normal Bad

3. Debt Management Ratios = How much the firm has borrowed to make an investment = Ability of a firm to meet total debt obligations (S-T & L-T) Debt ratio = TL ÷ TA Total Debt to Equity ratio = TL ÷ TE Brown Co. Green Co. TL TA TL TA TA $100,000 TL $ 80,000 TA $100,000 TL $ 20,000 = 80 % = 20 % TE $ 80,000 TL TE TL TE = 4x = 0.25x TE $ 20,000

4. Profitability Ratios Gross Profit Margin = Ability to earn profit generated from sales = Ability to control costs, expenses Gross Profit Margin = Gross Profit / Sales How many %profit left after paying cost of goods sold Higher  good control of cost of goods sold Lower  cost of goods sold are too high

4. Profitability Ratios (cont.) Operating Profit Margin = EBIT / Sales How many %profit left after paying cost of goods sold and operating expense Higher  good control of both CGS and operating exp Lower  CGS and operating expense are too high

4. Profitability Ratios (cont.) Net Profit Margin (NPM) = NI to CS ÷ S Ex : Co. 1 Co. 2 Sales 100,000 100,000 - expenses - 40,000 - 60,000 NI to CS 60,000 40,000 NPM 60 % 40 %

4. Profitability Ratios (cont.) Return on Assets (ROA) = NI to CS ÷ TA = How much is the profit from $ 1 total investment Example : Brown Co: TA = $100,000 NICS = $10,000 ROA = 10% Green Co : TA = $100,000 NICS = $20,000 ROA = 20% Return on Equity (ROE) = NI to CS ÷ CE = How much is the profit from $ 1 owners’ investment CE = Investment from Common Shareholders = CS par + Paid in + RE

5. Market Value Ratios = How much the investors value the firm in the market = Tell you what investors think about the firm’s future Price to earnings ratio (P/E) = Market price per share Earnings per share **Earnings per share = NI to CS ÷ # of Common Shares = How much the investors are willing to pay for each $ 1 of earnings per share (EPS)

5. Market Value Ratios (cont.) Dividend Yield (DY) = DPS Market price per share Dividend per share (DPS) = Dividends to CS # of Common Shares

Dividend Yield Dividend Yield Ratio Dividends Per Share Market Price Per Share = Babson Builders pays an annual dividend of $1.50 per share of capital stock. The market price of the company’s capital stock was $15.25 at the end of 2007. Dividend Yield Ratio $1.50 $15.25 = = 9.84% Part I To determine the dividend yield we divide the dividends per share by the closing market price per share of the company’s common stock. Part II At Babson the dividend yield is 9.84%. If we purchase the stock today for $15.25 per share and receive an annual dividend of $1.50, we will earn a return of 9.84% on our investment. Once again, if you are an investor who required current income you will want to look for common shares with a high dividend yield. If you are willing to accept a less current income with a possibility of growth in the market price per share, you may look at companies with a lower dividend yield. This ratio identifies the return, in terms of cash dividends, on the current market price of the stock.