Analysis of Financial Statements Analysis of Financial Statements n Financial statements and reports n Ratio analysis

n A verbal description of the firms operating results during the past year n Discussion of new developments n Financial statements The Annual Report Provides

Key Financial Statements n Balance sheet n Income statement n Statement of cash flows

2011 Cash9,000 Short-term inv.48,600 Acct Receivable351,200 Inventories715,200 Total Current Asset1,124,000 Gross Fixed Asset491,000 Less: Depreciation 146,200 Net Fixed Asset344,800 Total assets1,468,800 Example of Balance Sheets: Assets

Liabilities and Equity Example of Balance Sheets: Liabilities and Equity 2011 Accts payable145,600 Notes payable200,000 Accruals 136,000 Total Current Liability481,600 Long-term debt323,432 Common stock460,000 Retained earnings 203,768 Total equity 663,768 Total liability and equity1,468,800

Example of Income Statement Sales3,432,000 COGS2,864,000 Other expenses340,000 Deprecication 18,900 Tot. operating. costs 3,222,900 EBIT209,100 Interest expenses 62,500 EBT 146,600 Taxes (30%) 43,980 Net income 102,

EBITDA (Earnings before interest, taxes, depreciation and amortization To measure cash earnings without accrual accounting, cancelling tax jurisdiction effects, and cancelling the effects of different capital structures. Good to Know!!

n The Statement of Cash Flows reports: Operating activitiesOperating activities Investing activitiesInvesting activities Financing activitiesFinancing activities Statement of Cash Flows

To determine whether a change in a balance sheet account by using these rules Sources of Cash Increase in a liabilities or equity account - Borrowing funds or selling stock provides the firm with cash Decrease in an asset account - Selling inventory or collecting receivables provides cash Uses of Cash Decrease in a liabilities or equity account - Paying off a loan or buying back stock uses cash Increase in an asset account - Buying fixed assets or buying more inventory uses cash.

2011 Statement of Cash Flows Cash flow from operating activities: Net income$ 44,220 Additions (sources of cash): Depreciation 20,000 Incr. in accruals 4,000 Incr. in accounts payable 29,600 Subtractions (uses of cash): Incr. in receivables (50,800) Incr. in inventories( 120,800) NCF from operations($ 73,780)

Cash flow from investing activities: Investment in fixed assets($ 36,000) Increase in notes payable$ 25,000 Increase in L-T debt101,180 Common dividends ( 22,000) NCF from financing$104,180 Net increase (decr.) in cash($ 5,600) Cash at beginning of year 57,600 Cash at end of year$ 52,000 Cash flow from financing activities:

Management Reports Daily Revenue Report Daily Payroll Cost Report Rooms Revenue Forecast Food and Beverage Menu Abstract Accounts Receivable Aging Schedule

Daily Revenue Report ALL SPORTS RESORT As of Friday, 11/10/2008 Today KEY METRICS Period-to-Date ActualBudgetLast Year ActualBudgetLast Year 70.3%90.4%91.8%TOTAL OCCUPANCY %70.4%80.0%72.2% 76.8%91.2%92.5%AVAILABLE OCCUPANCY %76.7%80.6%73.4% 391 TOTAL ROOMS10, ROOMS SOLD7,7068,7537, OCCUPIED ROOMS7,8188,8357, COMPLIMENTARY ROOMS VACANT ROOMS3,1302,1132, AVAILABLE ROOMS10,05210,86610, REVPAR N/A267ARRIVALS4,382N/A4, N/A218DEPARTURES4,149N/A4, N/A636GUESTS9,482N/A9, ROOMS SOLD-Transient3,2434,2974, ROOMS SOLD-Group3,1312,8702, ROOMS SOLD-Contract1,3321,5861, AVERAGE RATE- Transient AVERAGE RATE- Group AVERAGE RATE- Contract

Daily Payroll Cost Report Daily Payroll Report Florencia Hotel and Conference Center Date:6/5/2008 DailyMonth-to-Date RoomsRegularOvertimeTotalPayroll $%RegularOvertimeHoursPayroll $Payroll %Budgeted % Front Desk $ % $9, %3.49% Reservations $ % $4, %1.74% Guest Services $ % $4, %1.98% Housekeeping $ %1, ,810.74$19, %9.50% Management0.00 $ %0.00 $ %0.30% Total Rooms $1, %2, ,122.25$37, %16.70% DailyMonth-to-DateBudget RoomsRegularOvertimeTotalPayroll $Cost/RoomRegularOvertimeHoursPayroll $Cost/Room Front Desk $565.79$ $9,930.64$6.23$5.29 Reservations $206.70$ $4,131.34$2.59$2.64 Guest Services $252.39$ $4,412.27$2.77$3.00 Housekeeping $905.15$6.291, ,810.74$19,480.01$12.23$14.43 Management0.00 $ $0.00 $0.45 Total Rooms $1,930.03$13.402, ,122.25$37,954.26$23.83$25.36

Rooms Revenue Forecast FORECAST: as of 11/30/08 City:Los Angeles Property:Huntington - Airport # Rooms:86 Division:RoomsHuntington Los Angeles Airport 12-Day Forecast Report12/1/0812/2/0812/3/0812/4/0812/5/0812/6/0812/7/0812/8/0812/9/08 12/10/00 812/11/0812/12/08 Avail Rooms86 Forecast # Forecast Occupancy %63.95%61.63%30.23%29.07%41.86%55.81%53.49%61.63% 75.58%26.74% Net Rooms Revenues Average Rate $ $ $ $ $ $ $ $ $ $ $ $

Food and Beverage Menu Abstract Food Menu Abstract Date:January-March, 2008 Restaurant:Mexicana Cantina MealPeriod:Lunch Menu Item NameNumberMenuItem Menu SoldMixFoodSellingCMCostsRevenuesCM (MM)%CostPrice(E - D)(D * B)(E * B)(F * B) Bean, Cheese and Jalapeno Nachos %$2.44$7.25$4.81$414.80$1,232.50$ Beef, Bean, Cheese and Jalapeno Nachos %$2.78$8.50$5.72$500.40$1,530.00$1, Chicken Fajita, Bean, Cheese and Jalapeno Nachos %$2.83$9.95$7.12$628.26$2,208.90$1, Beef Fajita, Bean, Cheese and Jalapeno Nachos %$3.28$9.95$6.67$829.84$2,517.35$1, Cheese Quesadillas %$1.64$7.75$6.11$319.80$1,511.25$1, Chicken Fajita Quesadillas %$2.02$8.95$6.93$577.72$2,559.70$1, Beef Fajita Quesadillas %$2.48$8.95$6.47$642.32$2,318.05$1, Shrimp and Scallop Quesadillas %$3.82$11.50$7.68$603.56$1,817.00$1, Shrimp Quesadillas %$3.44$11.50$8.06$605.44$2,024.00$1, Spinach Quesadillas %$1.83$8.50$6.67$228.75$1,062.50$ Mixed Vegetable Quesadillas910.65%$1.75$8.50$6.75$159.25$773.50$ Mixed Vegetable Queso Flameado370.26%$1.24$7.50$6.26$45.88$277.50$231.62

Accounts Receivable Aging Schedule Aging Schedule for Hanover Country Club MembersTotalNumber of Days Past Due Over 90 C. DeCarlo$200 T. Vangard$450 J. Samuel$100 F. Engel$320 M. Pratel$335 M. Morgan$600 Others$26,875$14,000$10,000$1,000$2001,675 Total$28,880$14,200$10,450$1,600$535$2,095 Estimated uncollectible1.5%2.0%10%20%40% Total Bad Debts$1,527$213$209$160$107$838

n Liquidity n Asset management n Debt management n Profitability n Market value Ratio Analysis Categories

n Liquidity = the ability of a firm to meet its short-term obligations as they come due. n Liquidity analysis requires use of a forecasted cash budget but ratio analysis provides some quick measures of liquidity.

Current ratio =. CACL Measures of Liquidity To indicate the extent to which the claims of S-T creditors are covered by assets that will soon be converted to cash

To measure how quick the firm can pay off S- T debt without liquidating inventories To measure how quick the firm can pay off S- T debt without liquidating inventories Quick ratio =. CA - Inv. CL

Current ratio =. CA CL Quick ratio =. CA - Inv. CL Current Quick 2.3x 0.8x 2.4x 0.8x 2.7x 1.0x Industry A little weaker than average.

n Inventory turnover ratio n Days sales outstanding (accounts receivable) n Fixed assets turnover n Total assets turnover Asset Management Ratios

Sales Inventory x x Industry 7.0x Low inventory turnover--excess inventory for current level of sales. Inventory turnover =. (To indicate whether a firm carries too many inventories and whether it manages inventories effectively.)

n Sales prices include markups but inventories carried at cost. n Sales occur throughout the year, but inventory is at a particular point in time. n Differences in accounting methods may make comparisons difficult (e.g. LIFO vs. FIFO). Problems with Inventory Turnover Measurement

Days Sales Outstanding (DSO) is the average number of days the firm must wait after making a sale before it receives cash. DSO = Receivables Sales/day.

2011 DSO = $402,000 $3,850,000/360 = days.

DSO Industry High DSO--firm is collecting too slowly or has overly liberal credit terms.

Fixed assets turnover =. Sales Fixed assets [ To show how effective the firms utilizes its fixed assets to generate sales.] Total assets turnover =. Sales TA [To indicate the extent to which a firm uses its total resources to generate sales.] [To indicate the extent to which a firm uses its total resources to generate sales.]

FATO TATO Industry Fixed assets turnover OK, but total assets turnover is low--indicates problem with current assets (inventory and receivables).

n Debt ratio (balance sheet) n Debt/equity ratio (balance sheet) n Times interest earned (income statement) n Fixed charge coverage (income statement) Debt Management Ratios

Debt ratio = =. D A D D + E Debt/equity =. Debt Management Ratios D E [It measures the proportion of a firm’s total assets that is financed with creditors’ funds.] [It is similar to debt ratio and relates the amount of a firm’s debt financing to the amount of equity financing.]

and Equity multiplier = A/E = 1/(1 - D/A). = 1/(1 - D/A). Times interest earned (TIE) EBIT Interest charges =. [It tells the extent to which the firm’s current earnings are able to meet current interest payments.]

DR TIE 54.8% % % Industry Debt ratio high, TIE low and falling. Debt is risky; would have high k d.

Profitability Ratios n Profit margin (PM) n Basic earning power (BEP) n Return on assets (ROA) n Return on equity (ROE) n Return on investors capital (ROC)

PM =. NI Sales % % Industry 3.5% Indicates: Sales prices are low and/or costs are high. [ It gives the profit per dollar of sales.]

BEP =. EBIT TA % % Industry 19.1% Indicates: Firm is doing a poor job of generating earnings from its assets. [It shows the raw earning power of the firm’s assets, before influence of taxes and leverage. ]

ROA =. NI TA ROE =. NI Common equity [It measures a firm’s net income in relation to the total asset investment.] [It measures the rate of return that the firm earns on stockholders’ equity.]

ROAROE 6.0%13.3%2.7%6.4% 9.1% 9.1%18.2% Industry All profitability measures are low and falling. High inventory, A/R levels lead to low profits. Profitability Ratios Summary

P/E =. Price/Share Earnings/Share Book value/Share =. Common equity # Shares Market/Book =. Price/Share Book value/Share Market Value Ratios [The price the market places on $1 of a firm’s earnings.] [The higher the rate of return a firm is earning on its common equity relative to the return required by investors (the cost of common equity), the higher will be the M/B.]

P/EM/BP/EM/B9.7%1.39.7% % % 14.2% % IndustryIndustry P/E ratios can rise if a decline in EPS is not expected to be permanent. M/B ratio is low. “Normalized” P/E probably low too.

ROE = x x Profit Profitmargin Total asset turnover turnover Equity EquitymultiplierNIENISSTATAE = x x. Use the Du Pont Equation to get an overview of the firm’s financial position

n Profitability measured by ROE n Expense control measured by PM n Asset utilization measured by TATO n Financial leverage measured by EM (debt utilization) n The interaction between the determinants of ROE Du Pont Equation Provides an Overview

ROE = PM x TATO x EM ROE = PM x TATO x EM IND % % % %

n Converting income statement and balance sheet values into % to facilitate comparison between firms of different sizes and firms over time. u Income statement: Divide by sales. u Balance sheet: Divide by total assets. n Used to supplement ratio analysis. What is common size analysis?

Readers of Financial Analysis Owners Track and evaluate management’s performance Lenders Determine the risk of the business defaulting on its loan Managers Compare actual and budgeted results Government Ensure that taxes have been paid

Readers of Financial Analysis cont. Suppliers Evaluate the company’s ability to pay its obligations Investment Analysts Evaluate the company’s performance Mergers and Acquisitions Highlight financial strengths, upside potential, and future value

Types of Analysis Vertical Analysis  Used to analyze variable expenses  All accounts are sized using either:  Total revenue or  Departmental revenue  Variable expenses should increase or decrease with the level of sales

Management Decision Making Employee Scheduling  Based on:  Accurate revenue forecasts  Productivity goals  Customer service goals

Management Decision Making Food and Beverage Pricing  Track sales of each menu item  Calculate each items gross profitability  Set menu prices  Remove unprofitable items from the menu

Management Decision Making Revenue Management  Goal is to maximize RevPAR RevPar= Rooms Revenue/Rooms Available  Rooms revenue = the revenue generated by room sales  Rooms Available= the number of rooms available for sale in the time period

Management Decision Making Revenue Management  Strategies  Close lower levels of pricing during high demand  Open all pricing levels during times of low demand

Management Decision Making Profit Flexing  Utilized when revenues fall behind budget  Adjust pricing and reduce expenses  Without impacting customer service  Maximize remaining revenue opportunities

Management Decision Making Cost-volume-profit Modeling  Also known as Breakeven Analysis  Target the amount of revenue required to reach the owner’s goal

Cost-volume-profit Equations Breakeven Volume of Sales = Fixed costs (sale price – variable cost) Desired Occupancy % = Rooms sold Rooms available for sale Desired Volume = Fixed Costs + Desired Profits Sale Price – Variable Cost

Breakeven Volume Example Sale price = $250 a night Fixed costs = $40,000 per month Variable cost = $35 per room Breakeven Volume of Sales = Fixed costs (sale price – variable cost) = 40,000 ( ) = 40, = 186 rooms