Financial Statement Analysis Sustainable Income Comparative Analysis Ratio Analysis Limitations

Sustainable Income Value of company = present value of future cash flows –Cash flow from Dividends Increase in stock value As rough approximation of cash flows, accountants use net income –Finance types would disagree Sustainable income = expected future net income Exclude irregular items

Irregular items Extraordinary items –Unusual in nature For that area –Earthquake in Los Angeles vs. New York City –Not expected to recur in forseeable future Mount St. Helens

Irregular items Extraordinary items –Acts of God seldom occur in the area Cost of snow removal in Charleston versus Miami –New regulations NCAA ban of Rawlings bats for collegiate use –Expropriation Shell in Mexico

Irregular items Change in accounting principle Remember…want consistency Must –Provide better information –Impact of change is shown separately Executive stock options

Irregular items Discontinued operations –Disposal of a large segment of business Tribune Company sells Chicago Cubs –Show separately gain (loss) from business and gain (loss) from sale –Will not happen again in the future

Comparative Analysis Intracompany analysis –Compare company trends over time Valid comparison Competitors: how do we measure up? Intercompany analysis –Compare with a competitor Industry leader??? Competitor: comparable?

Comparative Analysis Comparison with industry averages –Which industry? –Better than “mediocre”?

---- Horizontal Analysis -  Sales$100,000$110,000 A/R 10,000 15,000 Inventory 30,000 60,000 Calculating percentage change: (New – Old)/(Old) Want A/R to grow faster than Sales??? Want Inventory to grow faster than Sales???

Vertical Analysis Percent Cash10,00010% A/R12,00012% Total Assets100,000100% Liabilities, equity and asset accounts are all calculated as a percent of Total Assets… Not Total Liabilities or Equity.

Vertical Analysis Percent Sales100,000100% Cost of goods sold60,00060% Gross profit40,00040% Selling and admin expenses25,00025% Net income15,00015% Prefer to see COGS increase as a percent of sales??? Prefer to see selling and admin expense increase???

FINANCIAL RATIOS TYPES LIQUIDITY PAY BILLS??? Short-term Creditors SOLVENCY PAY LONG- TERM DEBT? Long-term creditors PROFITABILITY MAKING $$$$? Owners, long-term creditors MARKET VALUE OWNERS WEALTHY?? Owners

Further Look At Financial Statements Financial ratios –Liquidity: Current ratio: CA/CL –What is current asset? Current liability? Working capital: CA – CL Quick: (CA – Inv)/CL –Solvency Debt: Debt/Assets Free cash flow: Operating cash flow – capital expenditures – dividends –Profitability: ROA: Net income/Assets ROE: Net income/Stockholders Equity Profit Margin = Net income/Sales

Further Look At Financial Statements Financial ratios –Market P/E ratio = Stock Price / Earnings Per Share –Average –High –Low PEG ratio = P/E ratio / Growth rate EPS Beta –Average –Change over years? –Growth ratios Payout = Dividends / Net Income Retention = 100% - Payout