chapter 18
TRANSCRIPT
CHAPTER 18
FINANCIAL STATEMENT ANALYSIS
CHAPTER 18
FINANCIAL STATEMENT ANALYSIS
F/S are historical data But we need estimated future data to make decisions However, we can start with historical data
actual and crediblecompiled by mgtaudited by independent CPA’smonitored by SECreviewed by investment analysts
So F/S provide actual numbers to benchmark to:PY’s; internal budgets; other companies,
Objectives of Financial Statement Analysis
Analyzing financial statements involves a Company’s
LiquidityProfitabilitySolvency.
Comparisons can be made on several difference bases
intracompany basisindustry averagesintercompany basis.
BASICS OF FINANCIAL STATEMENT ANALYSIS
BASICS OF FINANCIAL STATEMENT ANALYSIS
1 Horizontal analysis (trend analysis) evaluates a series of financial statement data over a period of time.
2 Vertical analysis evaluates financial statement data expressing each item in a financial statement as a percent of a base amount.
3 Ratio analysis expresses the relationship among selected items of financial statement data.
TOOLS OF FINANCIAL STATEMENT ANALYSIS
TOOLS OF FINANCIAL STATEMENT ANALYSIS
HORIZONTAL ANALYSIS –BALANCE SHEETS
HORIZONTAL ANALYSIS –BALANCE SHEETS
HORIZONTAL ANALYSIS – INCOME STATEMENTSHORIZONTAL ANALYSIS – INCOME STATEMENTS
HORIZONTAL ANALYSIS - RETAINED EARNINGS STATEMENTS
HORIZONTAL ANALYSIS - RETAINED EARNINGS STATEMENTS
VERTICAL ANALYSIS - BALANCE SHEETS
VERTICAL ANALYSIS - BALANCE SHEETS
VERTICAL ANALYSIS - INCOME STATEMENTSVERTICAL ANALYSIS - INCOME STATEMENTS
FINANCIAL RATIO CLASSIFICATIONSFINANCIAL RATIO CLASSIFICATIONS
Liquidity Ratios
Measures of short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash
Profitability Ratios
Measures of the income or operating success of an enterprise for a given period of time
Solvency Ratios
Measures of the ability of the enterprise to survive over a long period of time
(1) CURRENT RATIO(1) CURRENT RATIO
Current Assets Current Liabilities
CURRENT ASSETS OF QUALITY DEPARTMENT STORE
CURRENT ASSETS OF QUALITY DEPARTMENT STORE
(2) ACID-TEST RATIO(2) ACID-TEST RATIO
Quick Assets* Current Liabilities
* = Cash, Mkt Sec, A/R
(3) Receivables Turnover
Net Credit Sales
Average Net Receivables
2007 2006
2,097,000
(180,000 + 230,000) / 2 = 10.2x
1,837,000
(200,000 + 180,000) /2 = 9.7x
Industry average 10.8x
(4) Inventory Turnover
Cost of Good Sold
Average Inventory
2007 2006
1,281,000
(500,000 + 620,000) / 2 = 2.3x
1,140,000
(450,000 + 500,000) /2 = 2.4x
Industry average 6.7x
(5) PROFIT MARGIN RATIO(5) PROFIT MARGIN RATIO
Net Income Net Sales
(6) Asset Turnover
2007 2006
2,097,000
(1,595,000 + 1,835,000) / 2 = 1.2
1,837,000
(1,446,000 +1,595,000) /2 = 1.1
Industry Average = 2.34x
Net SalesAverage Assets
Measure of efficiency of assets to produce sales
(7) Return on Assets
2007 2006
263,800
(1,595,000 + 1,835,000) / 2 = 15.4
208,500
(1,446,000 +1,595,000) /2 = 13.7
Industry average 8.29
Guideline 10%
Net IncomeAverage Assets
(8) RETURN ON COMMON STOCKHOLDERS’ EQUITY(8) RETURN ON COMMON STOCKHOLDERS’ EQUITY
2007 2006 $263,800 $208,500 ——————————— = 29.3% ——————————— = 28.5% $795,000 + $1,003,000 $667,000 + $795,000 ——————————— ——————————— 2 2
[ ] [ ]
Net Income
Ave. Com. SH Equity
Guideline > 15%
(9) EARNINGS PER SHARE(9) EARNINGS PER SHARE
Net Income Wtd Ave Com. Shares
O/S
2007 2006
$263,800 $208,500————————— = $9.67 ————— = $7.72 27,000 + 27,540 27,000————————— 2
[ ]No Guideline – compare to PY – if >, it’s ok, drives stock market up and down.
(10) PRICE-EARNINGS RATIO
(10) PRICE-EARNINGS RATIO
MV per Share C/S
Earnings per Share
2007 2006
$145 $ 93——— = 15.0 times ——— = 12 times$ 9.67 7.72
Industry average————————
18 times
(11) PAYOUT RATIO(11) PAYOUT RATIO
Cash Dividends Net Income
Industry average————————
14.5%
(12) Debt to Total Assets Ratio
Total DebtTotal DebtTotal AssetsTotal Assets
20072007 20062006
832,000832,000 = 45.30 = 45.30 800,000800,000 = 50.20 = 50.201,835,000 1,595,000 1,835,000 1,595,000
Industry AverageIndustry Average38.0038.00
(13) TIMES INTEREST EARNED
(13) TIMES INTEREST EARNED
Income Before Income Tx & Int Exp Interest Expense
2007 2006
$468,000 $388,000———— = 13 times ———— = 9.6 times $36,000 $40,500
(14) GROSS PROFIT RATIO(14) GROSS PROFIT RATIO
Gross Profit
Net Sales2007 2006
$816,000 $697,000———— = 38.90% ———— = 37.92%
2,097,000 1,837,000
(15) OPERATING EXPENSE RATIO
(15) OPERATING EXPENSE RATIO
Operating Expenses (S,G&A) Net Sales
2007 2006
$357,000 $320,000———— = 17.02% ———— = 17.42%
2,097,000 1,837,000
11 Estimates: Estimates: Financial statements contain numerous estimatesFinancial statements contain numerous estimates22 Cost: Cost: Traditional financial statements are based on cost Traditional financial statements are based on cost and are not and are not adjusted for price-level changes. adjusted for price-level changes. 33 Alternative Accounting Methods Alternative Accounting Methods Variations among companies in the Variations among companies in the application of application of GAAPGAAP may hamper comparability. may hamper comparability. 44 Atypical Data Atypical Data Fiscal year-end data may not be typical of the financial Fiscal year-end data may not be typical of the financial condition during the year. condition during the year. 55..Diversification of Firms Diversification of Firms Diversification in industryDiversification in industry restricts usefulness of restricts usefulness of financial analysis. financial analysis.
LIMITATIONS OF FINANCIAL ANALYSIS
LIMITATIONS OF FINANCIAL ANALYSIS
Irregular Items
“Irregular” items are separately identified on the income statement:
1. Discontinued operations
2. Extraordinary items
These items are added to NI and EPS (but separately disclosed)
I nterest expense (21,000) Total other (4,000)
I ncome bef ore taxes 79,000 I ncome tax expense 24,000 I ncome from continuing operations 55,000
Discontinued operations:
Loss from operations, net of tax 315
Loss on disposal, net of tax 189
Total loss on discontinued operations 504
I ncome before extraordinary item 54,496
Extraordinary loss, net of tax 539
Net income 53,957$
I ncome Statement (in thousands)
Sales 285,000$
Cost of goods sold 149,000
Reporting when both Reporting when both
Discontinued Discontinued
Operations and Operations and
Extraordinary Items Extraordinary Items
are present. are present.
Discontinued OperationsDiscontinued Operations
Extraordinary ItemExtraordinary Item
LO 6 Understand the concept of earning power, and how irregular items are presented.
Earning Power and Irregular ItemsEarning Power and Irregular ItemsEarning Power and Irregular ItemsEarning Power and Irregular Items
Change in Accounting Principle
Occurs when the principle used in the current year is different from the one used in the preceding year.
Accounting rules permit a change if justified.
Changes are reported retroactively.
Example would include a change in inventory costing method such as FIFO to average cost.
Extraordinary ItemsExtraordinary ItemsExtraordinary ItemsExtraordinary Items
Companies have incentives to manage income to meet or beat Wall Street expectations, so that
the market price of stock increases and
the value of stock options increase.
A company that has a high quality of earnings provides full and transparent information that will not confuse or mislead users of the financial statements.
Quality of EarningsQuality of EarningsQuality of EarningsQuality of Earnings
LO 7 Understand the concept of quality of earnings.
Alternative Accounting Methods
Variations among companies in the application of GAAP may hamper comparability and reduce quality of earnings.
Quality of EarningsQuality of EarningsQuality of EarningsQuality of Earnings
LO 7 Understand the concept of quality of earnings.
Pro Forma Income
Pro forma income usually excludes items that the company thinks are unusual or nonrecurring.
Some companies have abused the flexibility that pro forma numbers allow.
Improper Recognition
Some managers have felt pressure to continually increase earnings and have manipulated the earnings numbers to meet these expectations.
Abuses include:
Improper recognition of revenue (channel stuffing).
Improper capitalization of operating expenses (WorldCom).
Failure to report all liabilities (Enron).
Quality of EarningsQuality of EarningsQuality of EarningsQuality of Earnings