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Overview of Financial Statement Analysis

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					Overview of Financial
Statement Analysis
17 November 2007




FN 421 Financial Statement and Reporting Analysis of Commerce and Accountancy,
 1  FN 421 Financial Statement and Reporting Analysis Faculty                                     Thammasat University




 Business Analysis

                             Evaluate                               Evaluate
                             Prospects                               Risks




                               Business Decision Makers

                               •     Equity investors
                               •     Creditors
                               •     Managers
                               •     Merger and Acquisition Analysts
                               •     External Auditors
                               •     Directors
                               •     Regulators
                               •     Employees & Unions
                               •     Lawyers

 2   FN 421 Financial Statement and Reporting Analysis        Faculty of Commerce and Accountancy, Thammasat University




 Information Sources for Business Analysis

                  Quantitative                                      Qualitative

 •   Financial Statements                                • Management Discussion &
 •   Industry Statistics                                   Analysis
 •   Economic Indicators                                 • Chairperson’s Letter
 •   Regulatory filings                                  • Vision/Mission Statement
 •   Trade reports                                       • Financial Press
                                                         • Press Releases
                                                         • Web sites




 3   FN 421 Financial Statement and Reporting Analysis        Faculty of Commerce and Accountancy, Thammasat University
Types of Business Analysis


                    Credit Analysis                              Equity Analysis



    Management &                                                               Labor Negotiations
       Control                                          Types of
                                                        Business
                                                        Analysis
     Regulation                                                                  Director Oversight


           Financial                                                          External Auditing
          Management

                                                Mergers, Acquisitions
                                                   & Divestitures

4   FN 421 Financial Statement and Reporting Analysis                Faculty of Commerce and Accountancy, Thammasat University




Types of Business Analysis


                    Credit Analysis                              Equity Analysis



    Management &                                                               Labor Negotiations
       Control                                          Types of
                                                        Business
                                                        Analysis
     Regulation                                                                  Director Oversight


           Financial                                                          External Auditing
          Management

                                                Mergers, Acquisitions
                                                   & Divestitures

5   FN 421 Financial Statement and Reporting Analysis                Faculty of Commerce and Accountancy, Thammasat University




Creditors

             Trade Creditors                                       Non-trade Creditors

•   Provide goods or services                                •    Provide major financing
•   Most short-term                                          •    Most long-term
•   Usually implicit interest                                •    Usually explicit interest
•   Bear risk of default                                     •    Bear risk of default




6   FN 421 Financial Statement and Reporting Analysis                Faculty of Commerce and Accountancy, Thammasat University
Credit Analysis

                    Credit Worthiness
     Ability to honor credit obligations (downside risk)


                     Liquidity                                                  Solvency

    Ability to meet short-term                                  Ability to meet long-term
    obligations                                                 obligations
     Focus:                                                      Focus:
      – Current financial                                         – Long-term financial
         conditions                                                  conditions
      – Current cash flows                                        – Long-term cash flows
      – Liquidity of assets                                       – Extended profitability


7    FN 421 Financial Statement and Reporting Analysis                Faculty of Commerce and Accountancy, Thammasat University




Types of Business Analysis


                     Credit Analysis                           Equity Analysis



      Management &                                                              Labor Negotiations
         Control                                         Types of
                                                         Business
                                                         Analysis
      Regulation                                                                  Director Oversight


            Financial                                                          External Auditing
           Management

                                                 Mergers, Acquisitions
                                                    & Divestitures

8    FN 421 Financial Statement and Reporting Analysis                Faculty of Commerce and Accountancy, Thammasat University




Equity Analysis

                           Assessment of downside risk
                               and upside potential


         Technical Analysis                                         Fundamental Analysis

    Determine value with                                        Determine value without
    reference to price                                          reference to price
    Charting:                                                   Analyze and interpret:
      – Patterns in price                                         – Economy
        behavior or volume                                        – Industry
        history                                                   – Company
      – Predit future price
        movements


9    FN 421 Financial Statement and Reporting Analysis                Faculty of Commerce and Accountancy, Thammasat University
  Intrinsic Value (or Fundamental Value)

           Value of Company (or stock) without
        reference to market value (or stock price)


                                                    Intrinsic value                                 Strategy

                                                                                                          Buy


Market value                                                                                             Hold


                                                                                                          Sell




  10   FN 421 Financial Statement and Reporting Analysis                        Faculty of Commerce and Accountancy, Thammasat University




  Business and Financial Statements Analysis


                                                               Business
                                                            Environment &
                                                           Strategy Analysis

                                                   Industry                Strategy
                                                   Analysis                Analysis




                                                               Financial
         Accounting                                            Analysis
                                                                                                         Prospective
          Analysis                                            Analysis                                    Analysis
                                                             of Sources
                                               Profitability & Uses of   Risk
                                                Analysis       Funds    Analysis



                                                                 Cost of Capital Estimate               Intrinsic Value

  11   FN 421 Financial Statement and Reporting Analysis                        Faculty of Commerce and Accountancy, Thammasat University




  Accounting Analysis

  Process to evaluate and adjust financial statements
  to better reflect economic reality



 Comparability Problems — across firms and across time



                                                            Manager estimation error
                                                                                                                     Accounting
 Distortion Problems                                       Earnings management                                          Risk

                                                           Distortion of business


  12   FN 421 Financial Statement and Reporting Analysis                        Faculty of Commerce and Accountancy, Thammasat University
Financial Analysis

Process to evaluate financial position and
performance using financial statements


Profitability Analysis                                    Evaluate return
                                                          on investment
                                                                                              Common Tools

Risk Analysis                                             Evaluate riskiness
                                                          & creditworthiness                                    Cash
                                                                                            Ratio
                                                                                                                Flows
                                                                                           Analysis
                                                                                                               Analysis

Analysis of                                               Evaluate sources
Cash Flows                                                & uses of funds



13   FN 421 Financial Statement and Reporting Analysis               Faculty of Commerce and Accountancy, Thammasat University




Prospective Analysis

Process to forecast future payoffs


                                           Business Environment
                                            & Strategy Analysis


                                              Accounting Analysis


                                                 Financial Analysis



                                                     Intrinsic Value

14   FN 421 Financial Statement and Reporting Analysis               Faculty of Commerce and Accountancy, Thammasat University




Dynamics of Business Activities

                 Business Activities                                                       Time

                                                                            Beginning of Period

     Investing                                           Financing
                                Planning



                               Operating



                                Planning
     Investing                                           Financing
                                                                                    End of Period


15   FN 421 Financial Statement and Reporting Analysis               Faculty of Commerce and Accountancy, Thammasat University
 Business Activities


                         Competition                                     Pricing



      Market Demands                                                                           Tactics
                                                          Planning
                                                          Activities :
                                                           Goals &
      Distribution                                        Objectives                         Promotion


          Managerial                                                                   Projections
         Performance


                                  Opportunities                      Obstacles

 16   FN 421 Financial Statement and Reporting Analysis                  Faculty of Commerce and Accountancy, Thammasat University




 Business Activities

                                                                                        Financing Activities
                                                                                        • Owner (equity)
                                                                                        • Non-owner (debts)




                                                                   Financing




 17   FN 421 Financial Statement and Reporting Analysis                  Faculty of Commerce and Accountancy, Thammasat University




 Business Activities

Investing activities
• Buying resources
• Selling resources




                                        Investing                  Financing




                                             Investing = Financing

 18   FN 421 Financial Statement and Reporting Analysis                  Faculty of Commerce and Accountancy, Thammasat University
Business Activities


                                                           Planning
                                                           Activities
        Investing                                                                                Financial
        Activities                                                                               Activities




                                  Operating Activities
               Revenues and expenses from providing
                        goods and services


19   FN 421 Financial Statement and Reporting Analysis                        Faculty of Commerce and Accountancy, Thammasat University




Financial Statements Reflect Business Activities

                                                             Planning
       Investing                                                                                    Financing
Current:                                                     Operating                      Current:
• Cash                                                                                      • Notes Payable

• Accounts Receivable
                                                 •   Sales                                  • Accounts Payable

• Inventories
                                                 •   Cost of Goods Sold                     • Salaries Payable

• Marketable Securities
                                                 •   Selling Expense                        • Income Tax Payable
                                                 •   Administrative Expense
Noncurrent:                                      •   Interest Expense                       Noncurrent:
• Land, Buildings, &
                                                 •   Income Tax Expense                     • Bonds Payable

  Equipment                                                                                 • Common Stock

• Patents                                                                                   • Retained Earnings

• Investments
                                                            Net Income

                                                                                                Liabilities & Equity
                                                         Income statement

              Assets                                        Cash Flow                               Balance Sheet



                                                           Statement of                          Statement of
       Balance Sheet                                        Cash Flows                        Shareholders’ Equity


20   FN 421 Financial Statement and Reporting Analysis                        Faculty of Commerce and Accountancy, Thammasat University




Financial Statements



• Balance Sheet
• Income Statement
• Statement of Shareholders’
  Equity
• Statement of Cash Flows




21   FN 421 Financial Statement and Reporting Analysis                        Faculty of Commerce and Accountancy, Thammasat University
 Balance Sheet




  Total Investing


        =


  Total Financing
(Creditor + Owner)




Income Statement


   Gross Profit
        =
 Revenues - COGS

 Operating Profit
        =
Gross Profit - OPEX
   Statement of
Shareholders’ Equity




   Statement of
    Cash Flows




 Net cash flows from:

 Operating activities
 Investing activities
 Financing activities
                                                                                            Financial
                                                                                           Statement
                                                                                              Links




Additional Information
(Beyond Financial Statements)

• Management Discussion & Analysis (MD&A)
• Management Report
• Auditor Report
• Explanatory Notes to Financial Statements
• Supplementary Information (Annual Reports, Form
  56-1, Prospectus)
• Proxy Statement




27   FN 421 Financial Statement and Reporting Analysis   Faculty of Commerce and Accountancy, Thammasat University
     Analysis Preview




Comparative Analysis (Across Time)

 Yr 1                Yr 2                Yr 3



Purpose:
Evaluation of consecutive
financial statements

Output:
Direction, speed and extent
of any trend(s)

Types:
• Year-to-year change analysis
• Index-number trend analysis


29   FN 421 Financial Statement and Reporting Analysis   Faculty of Commerce and Accountancy, Thammasat University
Common Size Analysis

 Yr 1                 Yr 2                Yr 3




Purpose:
• Evaluation of internal makeup
  of financial statements
• Evaluation of financial
  statement accounts across
  companies

Output:
     Proportionate size of assets,
     liabilities, equity, revenues
     and expenses
30    FN 421 Financial Statement and Reporting Analysis   Faculty of Commerce and Accountancy, Thammasat University




Ratio Analysis

Purpose:
Evaluation of 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 v.s. short term and
benchmarking)

31    FN 421 Financial Statement and Reporting Analysis   Faculty of Commerce and Accountancy, Thammasat University
Ratio Analysis                                                                            (Cont’d)




32    FN 421 Financial Statement and Reporting Analysis   Faculty of Commerce and Accountancy, Thammasat University




Valuation (Goal of Business Analysis)

Purpose:
Estimate intrinsic value of a company (or stock)

Basis:
Present value theory (time value of money)


     Bond valuation


     Equity valuation:
     Dividend discount model



     Free cash flows model



     Residual income model

33    FN 421 Financial Statement and Reporting Analysis   Faculty of Commerce and Accountancy, Thammasat University
Analysis in an Efficient Market


• Weak form                                              Price reflect information in past
                                                         prices

• Semi-strong form Prices reflect all public information


• Strong form                                            Prices reflect all public and private
                                                         information




34   FN 421 Financial Statement and Reporting Analysis                Faculty of Commerce and Accountancy, Thammasat University




Analysis in an Efficient Market

• Market Efficiency
       –    assumes competent and informed analysis
       –    distinguish aggregate from individual behavior
       –    reflects information (both reliable and unreliable)
       –    cross-country differences in rewards to analysis


• Financial statement analysis relevant to more
  than just market analysis, e.g.
       –    credit and lending
       –    auditing
       –    valuation of nonpublicly traded firms
       –    mergers and acquisitions
       –    etc.

35   FN 421 Financial Statement and Reporting Analysis                Faculty of Commerce and Accountancy, Thammasat University

				
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