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Financial Analysis Financial statement analysis is the process of applying analytical tools to a company’s financial statements to understand the company’s financial health and requires: Financial information Standards of comparison Analysis tools

To ignore product safety?? Standards of Comparison Prior Year of the Same Company Benchmark Among Competitors Industry Standards Industry benchmarks can be obtained from financial websites. Often called intracompany comparison (horizontal analysis) Often called intercompany comparison (vertical analysis) 1 2 3

Analysis Tools Horizontal Analysis Vertical Analysis Ratio Analysis comparison of a company’s financial results across time. comparison of financial balances to a base account from the same company comparison of different balances from the financial statements.

Horizontal Analysis Horizontal analysis is an analysis technique that calculates the change in an account balance from one period to the next and expresses that change in both dollar and percentage terms.

Balance Sheet – Horizontal – Best Buy (2010) Best Buy ($ in millions, except per share amounts $ Change% Change Current Assets: Cash and cash equivalents1,1031,826(723)(39.6%) Receivables2,3482, % Merchandise Inventories5,8975, % Other current assets1,1251,234(109)(8.8%) Total Current Assets10,47310,566(93)(0.9%) Property and Equipment, net3,8234,070(247)(6.1%) Goodwill2,4542, % Other Assets1,0991,214(115)(9.5%) Total Assets17,48918,302(453)(2.5%) $ Current Year - $ Base Year = $2,348 – 2,020 = 16.2% $ Base Year $2,020 $ Change = $ 2,348 – 2,020 = $328

Vertical Analysis Vertical analysis is an analysis technique that states each account balance on a financial statement as a percentage of a base amount on the statement.

Balance Sheet Vertical – Best Buy (2010) Asset accounts are stated as a percentage of Total Assets (set at 100%). For example, on 31/12/2010, Receivables is 13.2% of Total Assets (calculated as $2,348 ÷ $17,849).

Profitability Analysis

Creditors Stockholders Managers Indicates potential for bonuses and incentive plans linked to performance. Indicates the ability to make required principal and interest payments. Indicates related stock price increases or dividends paid. Profitability Ratios – importance of Profitability

Liquidity Analysis Liquidity ratios assess the ability of a company to meet its immediate or short-term financial obligations. Failing to do so can result in additional expenses and, ultimately, bankruptcy. Receivables Turnover Ratio Quick Ratio Inventory Turnover Ratio Current Ratio

Liquidity Ratios

Solvency Ratios Solvency focuses on capital structure and assesses the extent of borrowing needed. - Debt to Equity Times Interest Earned Debt to Assets Ratio Solvency refers to a company’s ability to satisfy its long-term obligations.

Solvency Analysis

DuPont Analysis A DuPont analysis provides insight into how a company’s return on equity was generated by decomposing the return into three components: operating efficiency, asset effectiveness, and capital structure.

DuPont Calculation The higher the ratio, the more efficient a company is in turning sales into profits. The higher the ratio, the more a company is financing its assets with debt rather than equity (riskier). This is the leverage multiplier. The higher the ratio, the more effective a company is in generating sales given its assets.

Benefit of DuPont Analysis One of the main benefits of a DuPont analysis is the ability to ask what-if questions. ??? What if Best Buy was able to squeeze out another $.02 of profit on each dollar of sales? How would that affect the return to owners? Answer: 2008 return would increase to (0.042 X 2.84 X 3.41). What if the market for electronics took a significant downturn and Best Buy was only able to generate sales of 1.5 times assets on hand? Would that significantly affect the return to investors? Answer: 2008 return would fall almost in half to (0.022 X 1.50 X 3.41).

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