Financial Management Analysis of Financial Statements

Using Financial Ratios Ratio analysis involves methods of calculating and interpreting financial ratios to assess a firm’s financial condition and performance. It is of interest to shareholders, creditors, and the firm’s own management.

Trend or time-series analysis Used to evaluate a firm’s performance over time Using Financial Ratios Types of Ratio Comparisons

Trend or time-series analysis Cross-sectional analysis Used to compare different firms at the same point in time Using Financial Ratios Types of Ratio Comparisons

Trend or time-series analysis cross-sectional analysis –industry comparative analysis One specific type of cross sectional analysis. Used to compare one firm’s financial performance to the industry’s average performance Using Financial Ratios Types of Ratio Comparisons

Trend or time-series analysis cross-sectional analysis –industry comparative analysis Combined Analysis Combined analysis simply uses a combination of both time series analysis and cross-sectional analysis Using Financial Ratios Types of Ratio Comparisons

Ratios must be considered together; a single ratio by itself means relatively little. Financial statements that are being compared should be dated at the same point in time. Use audited financial statements when possible. The financial data being compared should have been developed in the same way. Be wary of inflation distortions. Using Financial Ratios

Ratio Analysis Example Bartlett Company

Ratio Analysis Liquidity Ratios Current Ratio Current ratio = total current assets total current liabilities Current ratio = $1,233,000 = 1.97 $620,000

Liquidity Ratios –Current Ratio –Quick Ratio Quick ratio = Total Current Assets - Inventory total current liabilities Ratio Analysis Quick ratio = $1,233,000 - $289,000= 1.51 $620,000

Liquidity Ratios Activity Ratios –Inventory Turnover Inventory Turnover = Cost of Goods Sold Inventory Ratio Analysis Inventory Turnover = $2,088,000 = 7.2 $289,000

Liquidity Ratios Activity Ratios –Average Collection Period ACP = Accounts Receivable Net Sales/360 Ratio Analysis ACP = $503,000 = 58.9 days $3,074,000/360

APP = Accounts Payable Annual Purchases/360 Liquidity Ratios Activity Ratios –Average Payment Period Ratio Analysis APP = $382,000 = 94.1 days (.70 x $2,088,000)/360

Liquidity Ratios Activity Ratios –Total Asset Turnover Total Asset Turnover= Net Sales Total Assets Ratio Analysis Total Asset Turnover= $3,074,000 =.85 $3,579,000

Liquidity Ratios Activity Ratios Debt Ratio = Total Liabilities/Total Assets Financial Leverage Ratios –Debt Ratio Ratio Analysis Debt Ratio = $1,643,000/$3,597,000 = 45.7%

Liquidity Ratios Activity Ratios Leverage Ratios –Times Interest Earned Ratio Times Interest Earned = EBIT/Interest Ratio Analysis Times Interest Earned = $418,000/$93,000 = 4.5

Liquidity Ratios Activity Ratios Leverage Ratios Profitability Ratios Ratio Analysis

Liquidity Ratios Activity Ratios Leverage Ratios GPM = Gross Profit/Net Sales Profitability Ratios –Gross Profit Margin Ratio Analysis GPM = $986,000/$3,074,000 = 32.1%

Liquidity Ratios Activity Ratios Leverage Ratios Profitability Ratios –Operating Profit Margin OPM = EBIT/Net Sales Ratio Analysis OPM = $418,000/$3,074,000 = 13.6%

Liquidity Ratios Activity Ratios Leverage Ratios Profitability Ratios –Net Profit Margin NPM = Net Profits After Taxes/Net Sales Ratio Analysis NPM = $231,000/$3,074,000 = 7.5%

Liquidity Ratios Activity Ratios Leverage Ratios Profitability Ratios –Return on Total Assets (ROA) ROA= Net Profits After Taxes/Total Assets Ratio Analysis ROA= $231,000/$3,597,000 = 6.4%

Liquidity Ratios Activity Ratios Leverage Ratios ROE= Net Profits After Taxes/Stockholders Equity Profitability Ratios –Return on Equity (ROE) Ratio Analysis ROE= $231,000/$1,954,000 = 11.8%

Liquidity Ratios Activity Ratios Leverage Ratios EPS= Earnings Available to Common Stockholders Number of Shares Outstanding Profitability Ratios –Earnings Per Share (EPS) Ratio Analysis EPS = $221,000/76,262 = $2.90

Liquidity Ratios Activity Ratios Leverage Ratios P/E= Market Price Per Share of Common Stock Earnings Per Share Profitability Ratios –Price Earnings (P/E) Ratio Ratio Analysis P/E = $32.25/$2.90 = 11.1

Summarizing All Ratios

IAS 7 Cash Flows Users of an entity’s financial statements are interested in how the entity generates and uses cash and cash equivalents Provide information about the historical changes in cash and cash equivalents of an entity by means of a statement of cash flows Classification of cash flows during the period as operating, investing and investing activities Presentation as an integral part of financial statements 32

IAS 7 Cash Flows Operating Activities Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the entity. They arise from the transactions and other events that enter into the determination of profit or loss. The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the entity have generated sufficient cash flows to: repay loans, maintain the operating capability of the entity, pay dividends make new investments without recourse to external sources of financing. forecast future operating cash flows. 33

IAS 7 Cash Flows Direct Method Direct method statement of cash flows 20X2 Cash flows from operating activities Cash receipts from customers Cash paid to suppliers and employees (27600) Cash generated from operations2550 Interest Paid(270) Income Tax Paid(900) Net cash from operating activities1380

IAS 7 Cash Flows Operating Activities It represent the extent to which expenditures have been made for resources intended to generate future income and cash flows. It includes: Payments to acquire property, plant and equipment, intangibles and other long-term assets. Cash advances and loans made to other parties except by FIs Cash receipts from sales of equity or debt instruments of other entities and interests in joint ventures 35

IAS 7 Cash Flows Direct Method Net cash from operating activities1380 Cash flows from investing activities Acquisition of subsidiary X, net of cash acquired ( 550) Purchase of property, plant and equipment (350) Proceeds from sale of equipment20 Interest Received200 Dividends received200 Net cash used in investing activities(480)

Financing Activities Need to disclose of cash flows arising from financing activities arises because it is useful in predicting claims on future cash flows by providers of capital to the entity 1. Cash proceeds from issuing shares or other equity instruments; 2. Cash payments to owners to acquire or redeem the entity’s shares; 3. Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short-term or long-term borrowings 37

IAS 7 Cash Flows Direct Method Cash flows from financing activities Proceeds from issue of share capital250 Proceeds from long-term borrowings250 Payment of finance lease liabilities(90) Dividends paid(1200) Net cash used in financing activities(790)

IAS 7 Cash Flows Direct Method Effect of exchange rate changes Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period ( 40)

IAS 7 Cash Flows Indirect Method Cash flows from operating activities Profit before taxation3350 Depreciation450 Foreign exchange loss40 Investment income(500) Interest expense400 Increase in trade and other receivables (500) Decrease in inventories1050 Decrease in trade payables(1740) Cash generated from operations2550

IAS 7 Cash Flows Indirect Method Cash generated from operations2550 Interest paid(270) Income taxes paid(900) Net cash from operating activities1,380

IAS 7 Cash Flows Indirect Method Net cash from operating activities1380 Cash flows from investing activities Acquisition of subsidiary X, net of cash acquired ( 550) Purchase of property, plant and equipment(350) Proceeds from sale of equipment20 Interest Received200 Dividends received200 Net cash used in investing activities(480)

IAS 7 Cash Flows Direct Method Cash flows from financing activities Proceeds from issue of share capital250 Proceeds from long-term borrowings250 Payment of finance lease liabilities(90) Dividends paid(1200)

IAS 7 Cash Flows Direct Method Effect of exchange rate changes Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period ( 40)