McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Financial Statement Analysis CHAPTER 14

THE MAJOR FINANCIAL STATEMENTS

14-3 Income Statement Four broad classes: –Cost of goods sold –General and administrative expenses –Interest expense –Taxes on earnings Common Sizing

14-4 Table 14.1 Consolidated Statement of Income

14-5 Balance Sheet Assets –Current –Long-term Liability and stockholders’ equity

14-6 Table 14.2 Consolidated Balance Sheet

14-7 Statement of Cash Flows Recognizes only transactions in which cash changes hands

14-8 Table 14.3 Consolidated Statement of Cash Flows

ACCOUNTING VERSUS ECONOMIC EARNINGS

14-10 Accounting Versus Economic Earnings Accounting earnings –Affected by several conventions regarding the valuation of assets Economic earnings –Earnings above or below a trend line

PROFITABILITY MEASURES

14-12 Past Versus Future ROE Data from recent past may provide information regarding future performance Analysts should always keep an eye on the future Expectations of future dividends and earnings determine intrinsic value of stock

14-13 Financial Leverage and ROE The relationship among ROE, ROA, and leverage:

RATIO ANALYSIS

14-15 Ratio Analysis Purpose of Ratio Analysis Uses –Trend analysis –Comparative analysis –Combination Use by External Analysts –Important information for investment community –Important for credit markets

14-16 Decomposition of ROE ROE = Net Profit Net Profit Pretax Profit x EBIT EBIT x EBITSalesSalesAssets xx AssetsEquity (1) x (2) x (3) x (4) x (5) x Margin x Turnover x Leverage Tax TaxBurdenInterestBurden x

14-17 Type of Financial Ratios Profitability Ratios Turnover or Asset Utilization Ratios Liquidity Ratios Leverage Ratios Market Price Ratios

14-18 Profitability Ratios Net Profit Margin % Net Income Sales Sales Operating Return on Assets % Earnings Before Int. & Taxes Earnings Before Int. & Taxes Total Assets

14-19 Profitability Ratios (cont.) Return on Equity % Net Income Net Income Common Equity Operating Margin After Depreciation % Operating Profit Sales

14-20 Activity or Management Efficiency Ratios Inventory Turnover Sales or Cost of Goods Sold Inventory Total Asset Turnover Sales Sales Total Assets

14-21 Activity or Management Efficiency Ratios (cont.) Average Collection Period Accounts Receivable Sales Per Day Sales Per Day Days to Sell Inventory Inventory Sales Per Day Sales Per Day

14-22 Liquidity Ratios Current Ratio Current Assets Current Liabilities Quick Ratio Current Assets - Inventory Current Liabilities

14-23 Leverage Ratios Times Interest Earned Earnings Before Int. & Taxes Interest Expense Interest Expense Fixed Charge Coverage Ratios Lease Payments Principal Repayments Preferred Dividends

14-24 Leverage Ratios (cont.) Debt to Assets % Long Term Debt Assets Debt to Equity % Long Term Debt Long Term Debt Shareholders Equity

14-25 Market Price Ratios Price to Earnings Market Price of Stock Earnings EarningsMarket-to-Book-Value Market Price of Stock Market Price of Stock Book Value Per Share Book Value Per Share

14-26 Figure 14.1 DuPont Decomposition for Hewlett-Packard

ECONOMIC VALUE ADDED

14-28 Economic Value Added Approach to compare accounting profitability with the cost of capital Definition –ROA-K (Capital Invested in the firm) –K = opportunity cost for capital Ties accounting to return by investors

14-29 Table Economic Value Added, 2006

AN ILLUSTRATION OF FINANCIAL STATEMENT ANALYSIS

14-31 Table Key Financial Ratios of Growth Industries Inc.

14-32 Table Growth Industries Statement of Cash Flows

COMPARABILITY PROBLEMS

14-34 Comparability Problems Inventory valuation –LIFO and FIFO Depreciation Inflation and interest expense

14-35 Quality of Earnings: Areas of Accounting Choices Allowance for bad debts Non-recurring items Earnings smoothing Stock options Revenue recognition Off-balance sheet assets and liabilities

14-36 International Accounting Conventions Reserving practices DepreciationIntangibles

14-37 Figure 14.2 Adjusted Versus Reported Price-Earnings Ratios