Chapter 14Financial Statement Analysis

Who and Why? To understand the economics of a firm and To help forecast its future profitability and risk

Profitability is an increase in wealth Risk is the probability that a specific level of profitability will be achieved.

Managers Responsible for day to day operations and and long-range performance Responsible and accountable for efficiency, effective deployment of capital,

human resource and other resource management Owners

Interested in current and long-term returns on their investments Expect growing earnings, dividends Affected by how earnings are distributed and how their shares are valued in the

market Lenders and creditors

Concerned about liquidity and cash flow of the company Interested in the degree of financial leverage employed

Others: employees, government, society

Financial Statement Analysis Should start with an understanding of

Global and local macro economic condition Industry (past performance, future expectations,

competition etc…) Should involve time series analysis, Should compare performance with peers,

competitors, industry averages

Tools Analytical Analysis

Vertical Analysis Horizontal Analysis

Ratio Analysis

Analytical Analysis

Vertical Analysis Express the items in the financial statements as a

percentage of total assets or sales

Income Statement- Vertical AnalysisIncome Statement

01.01.2006- 31.12.2006

01.01.2005- 31.12.2005

01.01.2004- 31.12.2004

Sales Revenue 679.109.952 100% 533.179.059 100% 484.217.501 100%

Cost of Sales (494.829.354) -73% (384.957.208) -72% (334.949.677) -69%

Gross Profit 184.280.598 27% 148.221.851 28% 149.267.824 31%

Operating expenses (109.625.499) -16% (64.064.255) -12% (59.149.709) -12%

Operating income 74.655.099 11% 84.157.596 16% 90.118.115 19%

Other income 42.965.316 6% 21.707.341 4% 29.896.364 6%

Other expense (69.646.923) -10% (33.921.481) -6% (23.463.677) -5%

Financial expenses, net (19.455.362) -3% (7.271.009) -1% (10.447.308) -2%

Income before monetary loss and taxes28.518.130 4% 64.672.447 12% 86.103.494 18%

Loss on monetary position 0 0% 0 0% (5.603.281) -1%

Minority Interest (1.978.179) 0% 894.625 0% (2.388.309) 0%

Income before taxes 26.539.951 4% 65.567.072 12% 78.111.904 16%

Tax expense 10.485.947 2% (12.359.914) -2% (17.031.347) -4%

Net Income 37.025.898 5% 53.207.158 10% 61.080.557 13%

Earnings per share 0,2445 0,3514 0,4034

Balance Sheet Vertical Analysis

Balance Sheet 12.31.2006 2006 31.12.2005 2005 31.12.2004 2004AssetsCurrent Assets 323.005.585 26% 270.115.547 26% 212.197.885 27%Cash and cash equivalents 68.780.065 6% 74.834.352 7% 49.026.423 6%Trading securities, net 52.842 0% 100.156 0% 25.755 0%Trade receivables, net 74.261.814 6% 53.030.694 5% 40.472.344 5%Due from related parties, net 19.179.748 2% 43.892.285 4% 50.714.258 6%Other receivables, net 36.018.789 3% 23.747.722 2% 18.484.620 2%Inventories, net 124.425.343 10% 74.411.768 7% 52.128.304 7%Other current assets 286.984 0% 98.570 0% 1.346.181 0%Long-term assets 905.421.795 74% 777.097.920 74% 587.857.590 73%Trade receivables, net 11.734 0% 61.484 0% 21.288 0%Due from related parties, net 0% 10.250 0%Financial assets, net 118.236.407 10% 101.513.970 10% 68.170.577 9%Goodw ill 13.181.689 1% 16.249.281 2% 4.196.133 1%Property plant & equipment, net 760.036.354 62% 653.345.452 62% 515.019.808 64%Intangible assets, net 816.222 0% 378.815 0% 439.534 0%Deferred Tax Assets 13.139.389 1% 5.548.918 1%Total assets 1.228.427.380 100% 1.047.213.467 100% 800.055.475 100%

LiabilitiesCurrent liabilities 273.773.294 22% 189.106.987 18% 104.017.119 13%Financial liabilities 111.909.791 9% 59.274.699 6% 39.619.889 5%Current portion of long-term debt 66.179.457 5% 27.725.877 3% 13.899.645 2%Other f inancial liabilities, net 9.974.767 1% 9.661.133 1% 7.131.426 1%Trade payables 31.376.464 3% 45.300.618 4% 13.294.594 2%Due to related parties 46.244.139 4% 44.590.564 4% 23.351.021 3%Advances received 1.022.139 0% 852.778 0% 1.459.347 0%Accrued expenses 674.264 0% 163.255 0% 288.234 0%Other liabilities 6.392.273 1% 1.538.063 0% 4.972.963 1%Long-term liabilities 254.733.661 21% 213.920.436 20% 125.084.120 16%Financial liabilities 204.283.035 17% 152.063.743 15% 71.323.248 9%Provisions 19.748.369 2% 19.032.720 2% 16.458.811 2%Deferred tax laibilitity 30.702.257 2% 42.782.723 4% 37.052.488 5%Other liabilities 0 0% 41.250 0% 249.573 0%Minority Interest 66.778.345 5% 40.198.563 4% 39.237.953 5%Shareholders' Equity 633.142.080 52% 603.987.481 58% 531.716.283 66%Share Capital 151.431.691 12% 151.431.691 14% 151.431.691 19%Capital reserves 344.775.869 28% 327.475.774 31% 304.246.330 38%Additional paid in capital 35 0% 35 0% 35 0%Financial asset reserve 47.011.512 4% 29.711.417 3% 6.481.973 1%Inflation adjsutment 297.764.322 24% 297.764.322 28% 297.764.322 37%Profit reserves 63.858.215 5% 60.696.208 6% 52.177.043 7%Legal reserves 13.541.041 1% 9.581.837 1% 6.823.524 1%Special reserves 1.259.266 0% 549.568 0% 25.125 0%Extraordinary reserves 45.017.611 4% 44.278.183 4% 44.001.350 5%Foreign currency translation reserve 4.040.297 0% 6.286.620 1% 1.327.044 0%Net Income for the year 37.025.898 3% 53.207.158 5% 61.080.557 8%Retained Earnings (accumulated loss) 36.050.407 3% 11.176.650 1% (37.219.338) -5%Total equity and liabilities 1.228.427.380 100% 1.047.213.467 100% 800.055.475 100%

Trend Analysis Analytical Analysis

Vertical AnalysisVertical Analysis Express the items in the financial statements as a Express the items in the financial statements as a

percentage of total assets or salespercentage of total assets or sales

Horizontal Analysis A base year is selected and the changes overtime are

expressed as percentage of the base year Annual percentage changes are computed

Balance Sheet 2006 2005 2004 2003AssetsCurrent Assets 174% 145% 114% 100%Cash and cash equivalents 291% 316% 207% 100%Trading securities, net 63% 120% 31% 100%Trade receivables, net 340% 243% 186% 100%Due from related parties, net 24% 55% 63% 100%Other receivables, net 336% 221% 172% 100%Inventories, net 250% 150% 105% 100%Other current assets #DIV/0! #DIV/0!Long-term assets 164% 141% 106% 100%Trade receivables, net 23% 120% 42% 100%Due from related parties, net #DIV/0! #DIV/0!Financial assets, net 191% 164% 110% 100%Goodw ill 77% 95% 24% 100%Propertt plant & equipment, net 161% 138% 109% 100%Intangible assets, net 178% 83% 96% 100%Deferred Tax AssetsTotal assets 166% 142% 108% 100%

Ratio Analysis Important point: to be selective-too many ratios would lead to

information overload Understand the meaning and limitations of the ratios Define the following elements before starting:

The viewpoint taken The objectives of the analysis The potential standards of comparison

Remember ratios are not absolute: they are relative performances over time, over a number of companies, over an industry, etc.

Ratios might indicate changes in patterns and help to assess future risk of the company in question

Usefulness of Ratios Help compare different firms, and Help compare the firm against its past performance Standards against which to compare ratios

1. The planned ratio for the period

2. The corresponding ratio from a prior period

3. The corresponding ratio for another firm in the same industry

4. The average ratio for other firms in the same industry

Ratio Analysis Cross-sectional and time series analysis Controls for size differences Controls for currency differences Evaluate related components of different

financial statements simultaneously Ratios are easily (and commonly) modified

Ratio Analysis Categories Activity (operations and asset management) Liquidity (meeting short-term obligations) Solvency (meeting long-term obligations) Profitability (earnings and cost coverage) Cash Flow (quality of earnings) Price Multiples (stock price)

Activity Ratios Receivable turnover

Average collection period

sreceivable tradeAverage

net sales,Credit

turnoverreceivable

365

Activity Ratios Inventory turnover

Average days in inventory

sinventorie average

sold goods ofCost

turnoverinventory

365

Activity Ratios Payable Turnover

Average payment period

payables tradeAverage

sinventoriein COGS

turnoverpayable

365

Activity Ratios Cash Cycle:

periodpayment -inventory in days period Collection

Activity Ratios PP&E Turnover

Asset Turnover

E&PP Average

SalesNet

assets Average

SalesNet

Liquidity Ratios Current ratio

Ability to meet short-term obligations [Current assets/current liabilities]

Quick ratio Remove less liquid assets Keep cash, liquid investments, A/R [(Cash+short-term investments + A/R)/current liabilities]

Solvency Ratios Debt to assets: Total liabilities/Total assets

Proportion of assets financed with debt Could include interest bearing debt only

[(short term debt + noncurrent debt)/total assets] Be aware that assets are recorded at historical

cost, which may be different from current market value

Solvency Ratios Debt to equity: Total liabilities/Total equity

A measure of how assets are financed

Solvency RatiosCoverage Ratios

Adequacy of resources for meeting firm’s contractual obligations

Times interest earned Can the firm cover its interest obligations? (EBIT/Interest expense)

Cash interest coverage (Cash from ops + interest paid + tax paid)/Interest paid

Profitability Ratios Gross Margin: profitability of sales Return on Sales: Net profitability of the

company

net Sales,

IncomeNet Saleson Return

net Sales,

Profit Gross %Margin Gross

Profitability Ratios Retun on Assets Return on Equity

ROA = Net Income/ Average Total Assets

ROE = Net Income/Average SH's Equity

Cash Flow RatiosQuality of earnings

Ability to pay obligations CFO/Total liabilities CFO = Cash flows from operations

Profitability (cash flow relative to sales) CFO/Sales revenue

Cash flow-earnings index CFO/Net income

Price Multiple Ratios

Market’s valuation of a firm’s common stockP/E = Share price/Earnings per share

Price/book ratio compares stock’s price to the recorded value of the net assets[Share price/(Book value of equity/Share outstanding)]

Limitation of Ratio Analysis

Represent the average conditions and influenced by the accounting methods used

Based on historical data and do not reflect price level effects and real economic values

Changes in many ratios are strongly associated with each other and interrelationships among/between the ratios should be examined

During comparison of ratios over a period of time changes in operating conditions should be taken into consideration

During comparison between companies differences among the companies should be examined

Use audited financial statements to perform ratio analysis