1. Financial Statement Analysis
K R Subramanyam
John J Wild

2. Overview of Financial Statement Analysis1
CHAPTER

3. Business Decision Makers
Business Analysis
Evaluate Prospects
Evaluate Risks
Business Decision Makers
Equity investors
Creditors
Managers
Merger and Acquisition Analysts
External Auditors
Directors
Regulators
Employees & Unions
Lawyers 3

4. Information Sources for Business Analysis
Trade reports
Regulatory filings
Economic Indicators
Industry Statistics
Financial Statements
Quantitative
Web sites
Vision/Mission Statement
Financial press
Press Releases
Chairperson’s Letter
Management discussion & Analysis
Qualitative 4

5. Types of Business Analysis Credit Analysis Equity Analysis
Management &
Control
Mergers, Acquisitions
& Divestitures
Director Oversight
Regulation
External Auditing
Labor Negotiations
Financial
Management 5

6. Credit Analysis Creditors Non-trade Creditors Provide major financing
Provide goods or services
Most short-term
Usually implicit interest
Bear risk of default
Non-trade Creditors
Provide major financing
Most long-term
Usually explicit interest
Bear risk of default 6

7. Credit worthiness: Ability to honor credit obligations
Credit Analysis
Credit worthiness: Ability to honor credit obligations
(downside risk)
Liquidity
Ability to meet short-term obligations
Focus:
Current cash flows
Make up of current assets and liabilities
Liquidity of assets
Solvency
Ability to meet long-term obligations
Focus:
Long-term profitability
Capital structure 7

8. Equity Analysis Assessment of downside risk and upside potential
Technical analysis / Charting
Patterns in price or volume history of a stock
Predict future price movements
Fundamental Analysis
Determine Intrinsic value without reference to price
Analyze and interpret key factors
Economy
Industry
Company 8

9. Technical analysis / Charting

10. Technical analysis / Charting

11. Equity Analysis Assessment of downside risk and upside potential
Technical analysis / Charting
Patterns in price or volume history of a stock
Predict future price movements
Fundamental Analysis
Determine Intrinsic value without reference to price
Analyze and interpret key factors
Economy
Industry
Company 11

12. Cost of Capital Estimate
Prospective
Analysis
Accounting
Business
Environment &
Strategy Analysis
Industry
Strategy
Financial
of cash
flows
Profitability
Risk
Cost of Capital Estimate
Intrinsic Value
Component Processes of Business Analysis 12

13. Business Environment and Strategy Analysis
56-1 แบบแสดงรายการข้อมูลประจำปี
56-2 รายงานประจำปี
ฯลฯ

14. Business Environment and Strategy Analysis
56-1 และ 56-2
ข้อมูลทั่วไป
ปัจจัยความเสี่ยง
ลักษณะการประกอบธุรกิจ
โครงสร้างเงินทุนและการจัดการ
รายการระหว่างกัน
การวิเคราะห์ฐานะการเงินและผลการดำเนินงาน

15. Business Environment and Strategy Analysis
56-1
การประกอบธุรกิจของแต่ละสายผลิตภัณฑ์
ทรัพย์สินที่ใช้ในการประกอบธุรกิจ
ข้อพิพาททางกฎหมาย
การควบคุมภายใน

16. Accounting Analysis
Process to evaluate and adjust financial statements to better reflect economic reality
Comparability problems — across firms and across time
Manager estimation error
Distortion problems Earnings management
Accounting Standards
Accounting
Risk 16

17. Financial Analysis
Process to evaluate financial position and performance using financial statements
Profitability analysis — Evaluate return
on investments
Risk analysis ——— Evaluate riskiness
& creditworthiness
Analysis of — Evaluate source &
cash flows deployment of funds
Common tools
Ratio
analysis
Cash
flow
analysis 17

18. Process to forecast future payoffs
Prospective Analysis
Process to forecast future payoffs
Business Environment
& Strategy Analysis
Accounting Analysis
Financial Analysis
Intrinsic Value 18

19. Dynamics of Business Activities
Time
Investing
Operating
Financing
Planning
End of period
Beginning of period 19

20. Managerial performance
Business Activities
Planning
Activities:
Goals
& Objectives
Competition
Pricing
Market demands
Tactics
Promotion
Managerial performance
Opportunities
Projections
Distribution
Obstacles 20

21. Business Activities Financing Financing activities Owner (equity)
Nonowner (liabilities)
Creditor
Debt creditor
Operating creditor 21

22. Business Activities Investing Financing Investing = Financing
Investing activities
Buying resources
Selling resources
Investing activities
Operating asset/Financial asset
Current/Non-current asset
Investing = Financing 22

23. Revenues and expenses from providing
Business Activities
Planning
Activities
Investing
Financial
Operating Activities
Revenues and expenses from providing
goods and services 23

24. Financial Statements Reflect Business Activities
Planning
Investing
Current:
Cash
Accounts Receivable
Inventories
Marketable Securities
Noncurrent:
Land, Buildings, & Equipment
Patents
Investments
Assets
Balance Sheet
Financing
Notes Payable
Accounts Payable
Salaries Payable
Income Tax Payable
Bonds Payable
Common Stock
Retained Earnings
Liabilities & Equity
Statement of Shareholders’ Equity
Operating
Sales
Cost of Goods Sold
Selling Expense
Administrative Expense
Interest Expense
Income Tax Expense
Net Income
Income statement
Cash Flow
Statement of
Cash Flows 24

25. Statement of Shareholders’ Equity Statement of Cash Flows
Financial Statements
Balance Sheet
Income Statement
Statement of Shareholders’ Equity
Statement of Cash Flows 25

26. 1-26 26

27. Balance Sheet Colgate Financing (in $billions)
Total Investing = Total Financing
= Creditor Financing + Owner Financing
Colgate Financing
(in $billions)
$9.138 = $ $1.410 27

28. 1-28 28

29. Income Statement Colgate’s Profitability (in $billions)
Revenues – Cost of goods sold = Gross Profit
Gross profit – Operating expenses = Operating Profit
Colgate’s Profitability
(in $billions)
$ $5.536 = $6.701 Gross Profit
$ $ = $2.160 Operating profit 29

30. 1-30 30

31. Statement of Cash Flows
Net Cash Flows from Operating Activities
Net Cash Flows from Investing Activities
Net Cash Flows from Financing Activities 31

32. 1-32 32

33. Additional Information (Beyond Financial Statements)
Management’s Discussion & Analysis (MD&A)
Management Report
Auditor Report
Explanatory Notes to Financial Statements
Supplementary Information
Proxy Statement 33

34. Analysis Preview Comparative Analysis
Yr2
Yr1
Yr3
Comparative Analysis
Purpose: Evaluation of consecutive financial statements
Output: Direction, speed, & extent of any trend(s)
Types:  Year-to-year Change Analysis
 Index-Number Trend Analysis 34

35. 1-35
Analysis Preview 35

36. Analysis Preview Common-Size Analysis
Purpose :  Evaluation of internal makeup
of financial statements
 Evaluation of financial statement accounts across companies
Output: Proportionate size of assets, liabilities, equity, revenues, & expenses 36

37. Analysis Preview 37

38. Analysis Preview 38

39. Analysis Preview Ratio Analysis
Purpose : Evaluate relation between two or more economically important items (one starting point for further analysis)
Output: Mathematical expression of relation between two or more items
Cautions:  Prior Accounting analysis is important
 Interpretation is key - long vs short term & benchmarking 39

40. Valuation - an important goal of many types
Analysis Preview
Valuation
Valuation - an important goal of many types
of business analysis
Purpose: Estimate intrinsic value of a
company (or stock)
Basis: Present value theory (time value of
money) 40

41. Analysis Preview Debt (Bond) Valuation
Bt is the value of the bond at time t
It +n is the interest payment in period t+n
F is the principal payment (usually the debt’s face value)
r is the investor’s required interest rate (yield to maturity) 41

42. Analysis Preview Equity Valuation
Vt is the value of an equity security at time t
Dt +n is the dividend in period t+n
k is the cost of capital
E refers to expected dividends 42

43. Equity Valuation - Free Cash Flow to Equity
Analysis Preview
Equity Valuation - Free Cash Flow to Equity
Model
FCFt+n is the free cash flow in the period t + n [often defined as cash flow from operations less capital expenditures]
k is the cost of capital
E refers to an expectation 43

44. Equity Valuation - Residual Income Model
Analysis Preview
Equity Valuation - Residual Income Model
BVt is the book value at the end of period t
Rit+n is the residual income in period t + n [defined as net income, NI, minus a charge on beginning book value, BV, or RIt = NIt - (k x BVt-1)]
k is the cost of capital
E refers to an expectation 44

45. Financial Statement Analysis Introduction and Overview
Book Organization
Financial Statement Analysis
Part I
Introduction and Overview
Part III
Financial Analysis
Part II
Accounting Analysis
Chapter 1: Overview of
Financial Statement
Analysis
Chapter 2: Financial
Reporting and
Chapter 3: Analyzing
Financial Activities
Chapter 4: Analyzing
Investing Activities
Chapter 5: Analyzing
Investing Activities:
Special topic
Chapter 6: Analyzing
Operating Activities
Chapter 7: Cash Flow
Chapter 8: Return on
Invested Capital
Chapter 9: Profitability
Chapter 10: Prospective
Chapter 11: Credit
Chapter 12: Equity
Analysis and Valuation 45