Financial Statement Analysis Financial Statements Balance Sheet Income Statement Flow of Funds Statement Ratio Analysis

Primary Types of Financial Statements Balance Sheet A summary of a firm’s financial position on a given date that shows total assets = total liabilities + owners’ equity. Income Statement A summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period.

Flow of Funds Statement A summary of a firm’s changes in financial position from one period to another; it is also called a sources and uses of funds statement or a statement of changes in financial position. Has been replaced by the cash flow statement (1989) in U.S. audited annual reports.

Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2003a Cash and C.E. $ 90 Acct. Rec.c 394 Inventories 696 Prepaid Exp d 5 Accum Tax Prepay 10 Current Assetse $1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g (329) Net Fix. Assets $ 701 Investment, LT 50 Other Assets, LT 223 Total Assets b $2,169 a. How the firm stands on a specific date. b. What BW owned. c. Amounts owed by customers. d. Future expense items already paid. e. Cash/likely convertible to cash within 1 year. f. Original amount paid. g. Acc. deductions for wear and tear.

Basket Wonders’ Balance Sheet (Liability Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2003 Notes Payable $ 290 Acct. Payablec 94 Accrued Taxes d 16 Other Accrued Liab. d 100 Current Liab. e $ 500 Long-Term Debt f 530 Shareholders’ Equity Com. Stock ($1 par) g 200 Add Pd in Capital g 729 Retained Earnings h 210 Total Equity $1,139 Total Liab/Equitya,b $2,169 a. Note, Assets = Liabilities + Equity. b. What BW owed and ownership position. c. Owed to suppliers for goods and services. d. Unpaid wages, salaries, etc. e. Debts payable < 1 year. f. Debts payable > 1 year. g. Original investment. h. Earnings reinvested.

Basket Wonders’ Income Statement Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2003a Net Sales $ 2,211 Cost of Goods Sold b 1,599 Gross Profit $ 612 SG&A Expenses c 402 EBITd $ 210 Interest Expensee 59 EBT f $ 151 Income Taxes 60 EATg $ 91 Cash Dividends 38 Increase in RE $ 53 a. Measures profitability over a time period. b. Received, or receivable, from customers. c. Sales comm., adv., officers’ salaries, etc. d. Operating income. e. Cost of borrowed funds. f. Taxable income. g. Amount earned for shareholders.

Flow of Funds Statement What are “funds”? All of the firm’s investments and claims against those investments. Extends beyond just transactions involving cash.

Sources and Uses Statement The letters labeling the boxes stand for Uses, Sources, Assets, and Liabilities (broadly defined). The pluses (minuses) indicate increases (decreases) in assets or liabilities. A L - + + - S U

Use of Financial Ratios Types of Comparisons Internal Comparisons External Comparisons A Financial Ratio is an index that relates two accounting numbers and is obtained by dividing one number by the other.

External Comparisons and Sources of Industry Ratios Examples: Robert Morris Associates Dun & Bradstreet Almanac of Business and Industrial Financial Ratios This involves comparing the ratios of one firm with those of similar firms or with industry averages. Similarity is important as one should compare “apples to apples.”

For Basket Wonders December 31, 2003 Liquidity Ratios Current Current Assets Current Liabilities For Basket Wonders December 31, 2003 Balance Sheet Ratios Liquidity Ratios Shows a firm’s ability to cover its current liabilities with its current assets. $1,195 $500 = 2.39

Liquidity Ratio Comparisons Current Ratio Year 2003 2002 2001 BW Industry 2.39 2.15 2.26 2.09 1.91 2.01 Ratio is stronger than the industry average.

For Basket Wonders December 31, 2003 Liquidity Ratios Acid-Test (Quick) Current Assets - Inv Current Liabilities For Basket Wonders December 31, 2003 Balance Sheet Ratios Liquidity Ratios Shows a firm’s ability to meet current liabilities with its most liquid assets. $1,195 - $696 $500 = 1.00

Liquidity Ratio Comparisons Acid-Test Ratio Year 2003 2002 2001 BW Industry 1.00 1.25 1.04 1.23 1.11 1.25 Ratio is weaker than the industry average.

Summary of the Liquidity Ratio Comparisons Ratio BW Industry Current 2.39 2.15 Acid-Test 1.00 1.25 Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account. Note that this industry has a relatively high level of inventories.

Current Ratio -- Trend Analysis Comparison

Acid-Test Ratio -- Trend Analysis Comparison

Summary of the Liquidity Trend Analyses The current ratio for BW has been rising at the same time the acid-test ratio has been declining. The current ratio for the industry has been rising slowly at the same time the acid-test ratio has been relatively stable. This indicates that inventories are a significant problem for BW.

Financial Leverage Ratios Debt-to-Equity Total Debt Shareholders’ Equity For Basket Wonders December 31, 2003 Balance Sheet Ratios Financial Leverage Ratios Shows the extent to which the firm is financed by debt. $1,030 $1,139 = .90

Financial Leverage Ratio Comparisons Debt-to-Equity Ratio Year 2003 2002 2001 BW Industry .90 .90 .88 .90 .81 .89 BW has average debt utilization relative to the industry average.

Financial Leverage Ratios Debt-to-Total-Assets Total Debt Total Assets For Basket Wonders December 31, 2003 Balance Sheet Ratios Financial Leverage Ratios Shows the percentage of the firm’s assets that are supported by debt financing. $1,030 $2,169 = .47

Financial Leverage Ratio Comparisons Debt-to-Total-Asset Ratio Year 2003 2002 2001 BW Industry .47 .47 .45 .47 BW has average debt utilization relative to the industry average.

Financial Leverage Ratios Total Capitalization Total Debt For Basket Wonders December 31, 2003 Balance Sheet Ratios (i.e., LT-Debt + Equity) Financial Leverage Ratios Shows the relative importance of long-term debt to the long-term financing of the firm. $1,030 $1,669 = .62

Financial Leverage Ratio Comparisons Total Capitalization Ratio Year 2003 2002 2001 BW Industry .62 .60 .62 .61 .67 .62 BW has average long-term debt utilization relative to the industry average.

Coverage Ratios Interest Coverage EBIT Interest Charges For Basket Wonders December 31, 2003 Income Statement Ratios Coverage Ratios Indicates a firm’s ability to cover interest charges. $210 $59 = 3.56

Coverage Ratio Comparisons Interest Coverage Ratio Year 2003 2002 2001 BW Industry 3.56 5.19 4.35 5.02 10.30 4.66 BW has below average interest coverage relative to the industry average.

Coverage Ratio -- Trend Analysis Comparison

Summary of the Coverage Trend Analysis The interest coverage ratio for BW has been falling since 2001. It has been below industry averages for the past two years. This indicates that low earnings (EBIT) may be a potential problem for BW. Note, we know that debt levels are in line with the industry averages.

Annual Net Credit Sales For Basket Wonders December 31, 2003 Activity Ratios Receivable Turnover Annual Net Credit Sales Receivables For Basket Wonders December 31, 2003 Income Statement / Balance Sheet Ratios (Assume all sales are credit sales.) Activity Ratios Indicates quality of receivables and how successful the firm is in its collections. $2,211 $394 = 5.61

Activity Ratios Avg Collection Period Income Statement / Balance Sheet Days in the Year Receivable Turnover For Basket Wonders December 31, 2003 Income Statement / Balance Sheet Ratios Activity Ratios Average number of days that receivables are outstanding. (or RT in days) 365 5.61 = 65 days

Activity Ratio Comparisons Average Collection Period Year 2003 2002 2001 BW Industry 65.0 65.7 71.1 66.3 83.6 69.2 BW has improved the average collection period to that of the industry average.

Activity Ratios Payable Turnover (PT) Income Statement / Balance Sheet Annual Credit Purchases Accounts Payable For Basket Wonders December 31, 2003 Income Statement / Balance Sheet Ratios (Assume annual credit purchases = $1,551.) Activity Ratios Indicates the promptness of payment to suppliers by the firm. $1551 $94 = 16.5

Activity Ratios PT in Days Income Statement / Balance Sheet Days in the Year Payable Turnover For Basket Wonders December 31, 2003 Income Statement / Balance Sheet Ratios Activity Ratios Average number of days that payables are outstanding. 365 16.5 = 22.1 days

Activity Ratio Comparisons Payable Turnover in Days Year 2003 2002 2001 BW Industry 22.1 46.7 25.4 51.1 43.5 48.5 BW has improved the PT in Days. Is this good?

For Basket Wonders December 31, 2003 Activity Ratios Inventory Turnover Cost of Goods Sold Inventory For Basket Wonders December 31, 2003 Income Statement / Balance Sheet Ratios Activity Ratios Indicates the effectiveness of the inventory management practices of the firm. $1,599 $696 = 2.30

Activity Ratio Comparisons Inventory Turnover Ratio Year 2003 2002 2001 BW Industry 2.30 3.45 2.44 3.76 2.64 3.69 BW has a very poor inventory turnover ratio.

Inventory Turnover Ratio --Trend Analysis Comparison

For Basket Wonders December 31, 2003 Activity Ratios Total Asset Turnover Net Sales Total Assets For Basket Wonders December 31, 2003 Income Statement / Balance Sheet Ratios Activity Ratios Indicates the overall effectiveness of the firm in utilizing its assets to generate sales. $2,211 $2,169 = 1.02

Activity Ratio Comparisons Total Asset Turnover Ratio Year 2003 2002 2001 BW Industry 1.02 1.17 1.03 1.14 1.01 1.13 BW has a weak total asset turnover ratio. Why is this ratio considered weak?

Profitability Ratios Gross Profit Margin Income Statement / Net Sales For Basket Wonders December 31, 2003 Income Statement / Balance Sheet Ratios Profitability Ratios Indicates the efficiency of operations and firm pricing policies. $612 $2,211 = .277

Profitability Ratio Comparisons Gross Profit Margin Year 2003 2002 2001 BW Industry 27.7% 31.1% 28.7 30.8 31.3 27.6 BW has a weak Gross Profit Margin.

Gross Profit Margin -- Trend Analysis Comparison

For Basket Wonders December 31, 2003 Profitability Ratios Net Profit Margin Net Profit after Taxes Net Sales For Basket Wonders December 31, 2003 Income Statement / Balance Sheet Ratios Profitability Ratios Indicates the firm’s profitability after taking account of all expenses and income taxes. $91 $2,211 = .041

Profitability Ratio Comparisons Net Profit Margin Year 2003 2002 2001 BW Industry 4.1% 8.2% 4.9 8.1 9.0 7.6 BW has a poor Net Profit Margin.

Net Profit Margin -- Trend Analysis Comparison

For Basket Wonders December 31, 2003 Profitability Ratios Return on Investment Net Profit after Taxes Total Assets For Basket Wonders December 31, 2003 Income Statement / Balance Sheet Ratios Profitability Ratios Indicates the profitability on the assets of the firm (after all expenses and taxes). $91 $2,160 = .042

Profitability Ratio Comparisons Return on Investment Year 2003 2002 2001 BW Industry 4.2% 9.8% 5.0 9.1 9.1 10.8 BW has a poor Return on Investment.

Return on Investment – Trend Analysis Comparison

For Basket Wonders December 31, 2003 Profitability Ratios Return on Equity Net Profit after Taxes Shareholders’ Equity For Basket Wonders December 31, 2003 Income Statement / Balance Sheet Ratios Profitability Ratios Indicates the profitability to the shareholders of the firm (after all expenses and taxes). $91 $1,139 = .08

Profitability Ratio Comparisons Return on Equity Year 2003 2002 2001 BW Industry 8.0% 17.9% 9.4 17.2 16.6 20.4 BW has a poor Return on Equity.

Return on Equity -- Trend Analysis Comparison