Financial Statements & Analysis
FIL 240 Prepared by Keldon Bauer
Financial Statement Fundamentals
• Publicly traded companies must file an annual (10-K) report with the SEC. • The purpose of the 10-K is to report to owners on the status of their investment. • The 10-K report contains both verbal and quantitative information about the performance of the firm.
Financial Statement Fundamentals
Financial Sections Include: • Income Statement (usually 3 years) • Balance Sheet (usually 2 years) • Statement of Retained Earnings • Statement of Cash Flows • Key operating statistics for 5-10 years • The purpose is both informative and marketing
The Balance Sheet
• The balance sheet is an attempt to show the sources of investment funds and their uses in the firm at the present time. • Accountants should be looking out for the interests of the investor.
• Conservatism.
• Lower of cost or market.
The Balance Sheet
• Assets are listed in order of liquidity
• Ease of conversion to cash • Without significant loss of value
• The less liquid an item on the balance sheet is, the less reliably it reflects its current value over time.
• Standard practice of inventory accounting, depreciation, etc. do not reflect actual value.
The Balance Sheet
• Balance Sheet Identity
• Assets = Liabilities + Stockholders’ Equity • Uses = Debt Sources + Equity Sources
• The amount the firm owes on its liabilities is usually exactly what is on its balance sheet. • The value of the equity is never what appears on the balance sheet.
• Equity is what is used to balance the identity.
Market versus Book Value
• The balance sheet provides the book value of the assets, liabilities and equity. • Market value is the price at which the assets, liabilities or equity can actually be bought or sold. • Market value and book value are often very different. Why? • Which is more important to the decisionmaking process?
Income Statement
• The income statement acts as a basis of change in the equity section of the balance sheet.
• You either pay equity investors back with income, or increase their book value (reinvest).
• You generally report revenues first and then deduct any expenses for the period. • Matching principle – GAAP requires revenue to be recognized when it accrues and match the expenses required to generate the revenue.
Ratio Analysis
• Financial ratios are the vital signs of the business.
• They are used to assess the health of the business. • When they are off the norm, they should be taken together with all known information to get a correct diagnosis.
• Norms should be seen as a normal range, not just one number.
Ratio Analysis
• Ratios also allow for better comparison through time or between companies • As we look at each ratio, ask yourself what the ratio is trying to measure and why is that information important • Ratios are used both internally and externally
Categories of Financial Ratios
• • • • • Short-term solvency or liquidity ratios Activity Ratios Debt Ratios Profitability ratios Market value ratios
Liquidity Ratios
• Relate short-term sources of and uses for cash. • Current Ratio:
Current Assets Current Ratio Current Liabilitie s
57,666 Current Ratio 4.51 12,788
Liquidity Ratios
• Quick (Acid Test) Ratio:
Current Assets - Inventory Quick Ratio Current Liabilitie s
(57,666 - 37,009) Quick Ratio 1.62 12,788
Asset Management Ratios
• Purpose is to assess how well the firm is managing assets • Inventory turnover ratio (IT):
Cost of Goods 131,924 IT 3.56 Inventory 37,009
365 365 Inventory Days 102 days IT 3.56
Asset Management Ratios
• Accounts receivable turnover (ART):
Sales 169,565 ART 9.05 Acct.Rec. 18,735
365 365 Average Collection Period 40 days ART 9.05
Asset Management Ratios
• Accounts payable turnover (APT):
Cost of Goods 131,924 APT 24.22 Accts.Payable 5,448
365 365 Average Payment Period 15 days APT 24.22
Asset Management Ratios
• Total Asset Turnover (TAT):
• Measure of asset use efficiency • Interpret in industry context.
Sales 169,565 TAT 1.90 Total Assets 89,259
Debt Ratios
• Relate debt to equity sources of investment funds . • Debt Ratio:
Total Liabilitie s Debt Ratio Total Assets
16,597 Debt Ratio 18.59% 89,259
Leverage Ratios
• Equity Multiplier:
Total Assets Equity Multiplier Total Equity
89,259 Equity Multiplier 1.23 72,662
Coverage Ratios
• Measure of ability to meet debt contracts. • Times Interest Earned (TIE) Ratio:
EBIT TIE Ratio Interest Expense
11,110 TIE Ratio 14.75 753
Leverage Ratios
• EBITDA Ratio:
(EBIT Depreciati on Amortizati on) EBITDA Ratio Interest Expense CMLTD
• Can’t calculate example, CMLTD is not disclosed.
Profitability - Standardizing
• Common-Size Balance Sheets
• Compute all accounts as a percent of total assets
• Common-Size Income Statements
• Compute all line items as a percent of sales
• Standardized statements make it easier to compare financial information, particularly as the company grows • They are also useful for comparing companies of different sizes, particularly within the same industry
Profitability Ratios
• What’s the bottom line? • Gross Profit Margin (GPM):
Gross Profit 37,641 GPM 22.20% Total Revenue 169,565
Profitability Ratios
• Operating Profit Margin (OPM):
Operating Profits 11,110 OPM 6.55% Total Revenue 169,565
Profitability Ratios
• What’s the bottom line? • Net Profit Margin (NPM):
Net Income 7,245 NPM 4.27% Total Revenue 169,565
Profitability Ratios
• Earnings per Share (EPS):
Net Income $7,245 EPS $1.69 # of Common Shares Outstandin g 4,277
Profitability Ratios
• Return on Total Assets (ROA):
• This is a measure of the return on assets owned. • Therefore, it is a measure of return to all invested funds.
Net Income 7,245 ROA 8.12% Total Assets 89,259
Profitability Ratios
• Return on Common Equity (ROE):
• This is a measure of return to the equity holder (whether or not they get a dividend).
Net Income 7,245 ROE 9.97% Total Equity 72,662
Using the Du Pont Identity
• ROE = PM * TAT * EM
• Profit margin is a measure of the firm’s operating efficiency – how well does it control costs • Total asset turnover is a measure of the firm’s asset use efficiency – how well does it manage its assets • Equity multiplier is a measure of the firm’s financial leverage
Market Value Ratios
• Price Earnings (P/E) Ratio:
Market Price per Share P/E Ratio Earnings per Share
Market Value Ratios
• Market /Book (M/B) Ratio:
Market Price per Share M/B Ratio Book Value per Share
Benchmarking
• Ratios are not very helpful by themselves; they need to be compared to something • Time-Trend Analysis
• Used to see how the firm’s performance is changing through time • Internal and external uses
• Peer Group Analysis
• Compare to similar companies or within industries • SIC and NAICS codes
Time-Series Analysis
• Evaluation of the firm’s financial performance over time using financial ratios.
• Look for trends.
Interpretation
• The firm needs to take advantage of opportunities for maximizing shareholder wealth. • That means you need to understand the real problem, not just the symptoms. • Students typically describe symptoms
• Take a system wide approach.
• What is the root problems?