Financial Statement Analysis

Every Ratio Tells a Story

Financial Statement Analysis

• Financial statement analysis can be conducted at the company, segment or divisional level.

• At the company level, the purpose is usually an investment or lending decision.

• At the segment or divisional level, the purpose can be performance evaluation, a funding decision, or an acquisition or divestiture decision.

Types of Financial Statement Analysis Tools

• Account-by-account trends over time • Percentage of individual accounts to an

aggregate total– Such as income statement items to

revenue or COGS

• Ratio analysis

Account-by-account trends over time

2003 2004 2005 2006 2007

Revenues(billions)

percentage increase

$4.1

24%

$5.3

30%

$6.4

20%

$7.8

22%

$9.4

$21%

Starbucks

Comparison of Individual Accounts to an Aggregate Total

2007 Barr Labs Pfizer

RevenuesCOGSGross ProfitR & DS.G.&A.OtherIncome before taxes

100%47%53%10%31%

4%8%

100%23%77%17%32%

9%19%

Financial Ratios

• Liquidity ratios• Long-term solvency ratios• Profitability ratios• Ratios using stock price

Liquidity Ratios

• Current Ratio• Quick Ratio• Days Accounts Receivable• Days Inventory• Inventory Turnover

Current RatioAssets Liabilities & Equity

Cash & equivalentsAccounts receivableInventoryOther current assetsCurrent AssetsP.P.&E.Other assets

Total assets

Accounts PayableOther current liabilities

Current LiabilitiesLong-term debtTotal liabilitiesEquity

Total liabilities & equity

Current Ratio

Microsoft2007(billions)

Current Assets

Current Liabilities=

$24

$40= 1.7

Quick RatioAssets Liabilities & Equity

Cash & equivalentsAccounts receivableInventoryOther current assetsCurrent AssetsP.P.&E.Other assets

Total assets

Accounts PayableOther current liabilities

Current LiabilitiesLong-term debtTotal liabilitiesEquity

Total liabilities & equity

Quick Ratio

Enron1999(billions)

Cash & cash equivalents + accounts receivable

Current liabilities=

$6.7

$3.8= 0.57

Days Accounts Receivable

Macy’s Inc. 2007

(millions)

Average net accounts receivable x 365

Net sales=

$26,313

(463 + 517)/2 x 365

= 6.8

Days Accounts Receivable

Timberland 2007

(millions)

Average net accounts receivable x 365

Net sales=

$1,436

(188 + 204)/2 x 365

= 50

Days Inventory

Hewlett-Packard 2007(billions)

Average inventory x 365

Cost of goods sold =

$63.4

($8.0 + $7.8)/2 x 365

= 45

Inventory Turnover

Hewlett-Packard 2007(billions)

Cost of goods sold

Average inventory=

($8.0 + $7.8)/2

63.4= 8

Note: 8 x 45 = 360 days

Long-term Solvency Ratios

• Equity-to-Assets• Equity-to-Debt

Equity to AssetsAssets Liabilities & Equity

Cash & equivalentsAccounts receivableInventoryOther current assetsCurrent AssetsP.P.&E.Other assets

Total assets

Accounts PayableOther current liabilities

Current LiabilitiesLong-term debtTotal liabilitiesEquity

Total liabilities & equity

Equity to Assets

Apple 2007(billions)

Shareholders’ Equity

Total Assets=

$25.3

$14.5= 0.57

Equity to DebtAssets Liabilities & Equity

Cash & equivalentsAccounts receivableInventoryOther current assetsCurrent AssetsP.P.&E.Other assets

Total assets

Accounts PayableOther current liabilities

Current LiabilitiesLong-term debtTotal liabilitiesEquity

Total liabilities & equity

Equity to Debt

Apple 2007(billions)

Shareholders’ Equity

Total Debt=

zero

$14.5= ∞

Profitability Ratios

• Return on Assets (ROA)• Return on Sales (ROS)• Return on Equity (ROE)• Earnings per Share (EPS)

Profitability Ratios• Return on Assets (ROA)

net income ÷ average total assets• Return on Sales (ROS)

net income ÷ net sales• Return on Equity (ROE)

net income ÷ average common equity• Earnings per Share (EPS)

earnings available to common shareholders ÷ weighted average common shares outstanding

Southwest Airlines

• Return on Assets (ROA)$499 ÷ $13,732 = 3.6%

• Return on Sales (ROS)$499 ÷ $9,086 = 5.5%

• Return on Equity (ROE)$499 ÷ $6,562 = 7.6%

• Earnings per Share (EPS)$0.63 per share (from the income

statement)

2006

Market Tests

• Price-Earnings Ratio• Market to Book

Price Earnings Ratio(earnings multiple)

Apple 2007

Share price

Earnings per share=

$4.04

$111= 27

Market to Book

Apple 2007

(billions)

Market value of all shares outstanding*

Book value of common equity

=$14.5

$74.5= 5.1

* Most easily obtained from the first page of the 10-K