financial statement analysis 2010
TRANSCRIPT
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Financial Statement Analysis
Padmini Srinivasan
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Financial
Statements
Accounting
System
Measurement
&
Reporting
Business
Activities
Operating
Investment
Financing
Accounting
Environment
Capital Market
Structure,
GAAP,Audit,&Legal system
Business
Environment
Labor MarketCapital Market
Product Market:
Suppliers
Customers
Accounting Strategy
Choice of:
Accounting Policy
Reporting Format
Supplementary-
Disclosures
Business
StrategyKey factors
And Risk
From Business Activities to Financial Statements
Story So far ..
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Need for Financial statement
analysis. The goal of a FSA is to assess the performance of
a firm in the context of its stated goals and
strategies It provides a link to the different statements
Provides answers to questions like:
How has the business performed during the year
Does the earnings record a growth, stability ordecline
How is profit derived
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Need for Financial statement
analysis
Some Additional purposes:
How is the financial condition of the companyHow investment activities have performed
during the year
How does the unit stand in comparison to theindustry
Preparation of Forecasts
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Where to look for data
The Annual reports
Directors Report - Working of the
Company
Auditors Report
Profit and loss account
Balance Sheet
Cash Flow statements
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Where to look for
Management Discussion &Analysis
Supplementary schedules and Notes Segmental analysis
Accounting Policies
Subsidiary Company Information
look further... Fine prints
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Other Data Sources
Forms filed with the ROC (In the US 10K and
10Q reports filed with SEC: Edgar Data Base)
Data bases CMIE: Prowess; Capitaline.com,insight.asiancerc.com
-Info on industry norms/ratios (Crisil )
Articles in press Ever-expanding websites
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Steps in
Financial Statement Analysis
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STEPS in Financial Statement
Analysis4 Step Approach to Analysis
1. Business Strategy Analysis
2. Accounting Analysis
3. Financial Analysis
4. Prospective Analysis
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4 Step Approach to Analysis
1. Business strategy analysis
- Identifying the company's strategy to create asustainable competitive advantage & profit
- Study the COMMON characteristics of theIndustry in which the firm operates and relate theindustry climate to current and projectedeconomic developments
- For e.g. Type of Industry Are we dealing with agrowth industry? A dying industry? A changingindustry?...
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4 Step Approach to Analysis
Business strategy analysis
Identify the strategies adopted by the firm
Choice of industry, competitive positioning
Creating synergies ie corporate strategy
are they taking advantage of opportunities?
are they innovative, forward-looking, etc? (Industry growth, Scale Economies, Existing Rivalry, New
entrants, substitute products legal barriers, etc)
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4 step Approach to Analysis2. Accounting Analysis
Involves evaluating the accounting polices which
helps capture the degree of distortion in the firmsaccounting numbers.
Evaluate and Understand the financial numbers(number-crunching !)
Look into non recurring & unusual items, priorperiod items
Indian Annual Repots need to be re- organized
Looking into accounting policies changes
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4 step Approach to AnalysisIndian Annual Repots need to be re- organized:
Items such as Secured loans : To divide into current
and Non Current
Gross Profit: Cannot be found
Secured loans also include Bank overdraft facilities
Look for : Inter Divisional Transfers, Excise duty inSales etc.
& many such adjustments to be made
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4 step Approach to Analysis
3. Financial Analysis
To evaluate current and pastperformance of a firm.
Some of the common tools used are
Ratio Analysis , cash flow analysis etc
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4 step Approach to Analysis
4. Prospective Analysis
Final step is forecasting firms futureIe. Using Financial Statement
Forecasting and Valuation tools
These tools use inputs from steps 1,2,and 3 in order to make predictions
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Analyzing the Company
Now that some of the tools of financial
analysis have been identified, whats next ?
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Steps in a FSA Establish objectives of the analysis
Who are you and why are you interested in this
company?What questions would you like to have
answered?
What info is vital to the decision at hand?
Summarize findings
Reach conclusions about the firm relevant toyour established objectives
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MANAGEMENT PREPARES financialstatements
Analyst should be alert to the potential for
management to influence reporting to make datamore appealing
Therefore, Supplement analysis with informationapart from Annual Report prepared by
management Financial analysis is only as good as the
information upon which it is based
CAUTION
!!!
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Financial Statement Analysis Financial statement analysis is a collective
name for the tools and techniques that
provide the users with relevant informationfor decision making
Helps Develop an understanding of theStatus and Performance of the firm
Helps in forecasting and predicting theValue of the firm
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TOO
LS FO
R EVALUATION
Common size financial statements
Horizontal analysis (Year to Year
Comparison) Financial Ratio analysis
Index analysis
Cash Flow Analysis
Common sense and judgment (often the
hardest to use)
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Common Size Statements Common size income statement
Expresses each income statement category as a
percentage of net sales
Common size balance sheet
Expresses each item on balance sheet as a
percentage of total assets or equities Facilitate structural analysis of the firm
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Common Size Statements Common size income statement
Explains cost structures and the changes
Distribution policy and change
Common size balance sheet
Explains the distribution of assets How the funds are distributed among assets
The financing pattern of the firm
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2002 2003
SALES 8000 100.00% 10000 100.00%
Cost of Goods Sold 7000 87.50% 8800 88.00%
Gross Profits 1000 12.50% 1200 12.00%
Admn and Selling Exp 500 6.25% 550 5.50%
Operating Profit 500 6.25% 650 6.50%
Non Operating Income
Profit On saLe of Fixed Assets 10 0.13% 20 0.20%
EBIT 510 6.38% 670 6.70%
Interest 60 0.75% 100 1.00%
Profit berfore tax 450 5.63% 570 5.70%
Provisoion for Tax 150 1.88% 220 2.20%PROFIT AFTER TAX 300 3.75% 350 3.50%
Dividends 100 1.25% 150 1.50%
Profit and Loss Statement OF ABC LTD
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COMMON SIZE : BALANCE SHEETBALANCE SHEET OF ABC LTD. AS ON MAR 31, 2003
LIABILITIES 2002 2003
% %
SHARE CAPITAL
Equity Share Capital 2400 20.34 3160 20.65
RESERVES & SURPLUS
Share Premium A/c ???? 900 7.63 1340 8.76
Profit and Loss A/c. 2100 17.80 2300 15.03
NET WORTH 5400 6800
SECURED LOANS
Debentures 300 2.54 700 4.58
CURRENT LIABILITIES
Creditors 500 4.24 800 5.23
Provisions 200 1.69 200 1.31
TOTAL 11800 100 15300 100
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HORIZONTAL ANALYSIS
Year to year changes
Changes in amounts and percentages
Reveals a trend & direction
Helps understand the growth in size of the firm
Look at growth in sales and other parameters,asset growth inventory growth etc
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HORIZONTAL ANALYSISPROFIT AND LOSS ACCOUNT FOR YEAR ENDING MAR 31,
2002 2003 HORIZONT
SALES 8000 10000 25%
Cost of Goods Sold 7000 8800 26%
Gross Profits 1000 1200 20%
Admn and Selling Exp 500 550 10%Operating Profit 500 650 30%
Non Operating Income
Profit On saLe of Fixed Assets 10 20 100%
EBIT 510 670 31%
Interest 60 100 67%
Profit berfore tax 450 570 27%Prov. For tax 150 220 47%
PROFIT AFTER TAX 300 350 17%
Dividends 100 200 100%
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HO
RIZON
TAL AN
ALYSISASSETS 2002 2003 2000
FIXED ASSETS
Gross Block 5500 6500
Acc. Depr. -1500 -1700
NetB
lock 4000 62.50% 4800 56.47% 20.00
INVESTMENTS 1100 17.19% 2100 24.71% 90.91
CURRENT ASSETS LOANS..
Cash 200 3.13% 100 1.18% -50.00
Receivables 350 5.47% 450 5.29% 28.57
Inventories 750 11.72% 1050 12.35% 40.00
Others
TOTAL 6400 100.00% 8500 100.00%
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RATIO ANALYSIS
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RATIO
AN
ALYSIS GIVES THE LINK BETWEEN INVESTMENT,
FINANCING AND OPERATING ACTIVITY
i.e. how various items in the financial statements
relate to one and another
Used to understand the sources of profit, theefficiency of resources
To understand the risk associated wit the business
To understand the short term liquidity
Analysis of Past performance helps in forecastingthe future performance
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Ratio AnalysisRatio Analysis to assess the:
Profitability
Asset Utilization
Liquidity
Long term solvency
Other Ratios for investor
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FSA-Basic Structure
Leverage or
Financial risk
Fixed Asset Turnover
Debtors Turnover or
Collection Period
Inventory Turnover
Current Asset TOR
Asset Turnover ratios
Interest / Sales
Other expenses / Sales
Raw material/Sales
Profit Margins
Return on Investment
Return on Equity
Current Ratio
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Financial Ratio Analysis
Profitability Ratios
Measures the overall performance of a firm and
its operational efficiency
Is a function of Sales, Efficiency and Leverage
What performance are we looking into ?
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Quality of Earnings Will be affected by:- Accounting Method and Estimates
- Extra Ordinary Items- Prior Period Adjustments
- Discontinued Operations
- Change in Accounting Policies- Income from Non Operating items to
investment in non operating items
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Return RatiosReturn on Total Assets
PAT /Avg Total Assets or
PBIT/ AVG Total Assets*
NOPAT / Total Assets
The ratio measures the overall efficiency of the firmin managing investment in assets and generatingreturn to stockholders
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Return RatiosReturn on Investment
PBIT/ Total Assets*
NOPAT / Total Assets
Here the difference is the total assets includes theWorking Capital only ( CA CL)
The ratio measures the overall efficiency of the firmin managing investment in assets and generatingreturn to stockholders
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Profitability Ratios Net Profit Margin
Net Profit After Tax/Net Sales
O
perating Profit MarginOperating Profit /Net Sales
Various Expenses to Sales
Raw Materials/Net Sales
Salaries / Net Sales
All measure firms ability to translate sales into
profits
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Performance of Assets
Firms use different assets
Fixed Asset Current Assets
How Productive are these assets ?
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Turn Over Ratios or Activity
Ratios Total Asset Turn over Ratio
Sales / average Total Assets
Total Assets = All Assets in the Balance sheet
Current Asset = Inventory + Debtors+ others
Average = Opening + Closing /2
Shows how well the Resource are Utilized
The Ability of different assets like Fixed Assets,
current assets and both to generate sales
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Inventory Turnover Ratio Cost of Goods Sold / AVG Inventory
Indicating the number of times inventory can berotated (COGS = All operating Exp
including Depreciation)
Number of Days Inventory
Avg Inventory / Sales per day(Measures efficiency of inventory
management (not the inventory policy ofthe management)
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Debtors Turnover Ratio Debtors Turnover Ratio
Net Sales/ Average Debtors
Average Collection Period Accounts Receivable/Average Daily Sales
Avg Sales = Total Sales/365
(A measure of efficiency of firms ability tocollect ie realize sale into cash from customers)
Helps gauge liquidity of accounts receivable
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Payables Turnover Ratio Payables TO R = Purchases (COGS) /
Average Accounts Payable
Source of financing of the operating activity
Used for computing the cash cycle
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Financing Pattern : Short term Liquidity
Liquidity Ratios
Measures the firms ability to meet cash needs
as they arise
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Liquidity Ratios Current Ratio
Current Assets/Current Liabilities
Short term obligations are to be met from shortterm assets as and when they arise
Measures the ability of the firm to meet short-term obligations
Normally a ratio acceptable is 1.33: 1(Traditionally a ratio of 2:1 was the bench
mark) What does higher ratio indicate ?
Needs considerable rework into current and non
current. Also include current investment
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Liquidity Ratios Quick or Acid Test Ratio
(Current Assets-Inventory)/Current Liabilities
Measure ability to meet short-term cash needsmore rigorously (ratio of 1:1 is the norm taken)
Assumption made is inventory are not easily
convertible into cash
All adjustment as in earlier ratio needed
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Financial Leverage
It Pays to have Debt in your Capital Structure
Of course it is only true when: The rate of return ismore than the cost of debts
Interest is tax deductible, while dividends are not
W
hen the there is high business risk you musthave a low financial risk
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Financing Pattern : Long term Solvency
Leverage Ratios
measure the extent of a firms financing with
debt relative to equity and its ability to coverinterest and other fixed charges also called as
the Solvency ratios
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Solvency RatiosDebt to Equity Ratio
Short Term+ Long Term Debt/ Share holders funds
TO
TALO
utside liabilities /Share holders funds * (* Useful when companies have liabilities that are short
term in nature but constantly roll over)
Debt Asset Ratio:
Total outside liabilities / Total Assets
They measure the extent of firms financing withdebt and thereby the financial risk
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Coverage Ratios
Interest Cover Ratio
PBIT/Interest Expense
Indicates how well operating earnings cover
fixed interest charges
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Importance of Debt Ratios
Proportion and amount of debt in capital
structure is important to analyst to
determine the Financial Risk of the business
Tradeoff between risk and return
Use of debt involves risk -- commitment to
fixed charges
Fixed charges must be covered
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Return on Equity
Return on Equity
PAT/ AVG Stockholders Equity
Tells you the return the Share holders earn
This ratio is a function of ROA and the
Leverage multiplier Expectation is: ROE > Cost of Capital
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Other Ratios : For the Investor
Earnings per Share
PAT /Average Equity Shares
Indicates return on a per share basis
Dividend Pay out
Dividends /Net Income %
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Other Ratios : For the Investor
Dividend Yield
Dividend per share/ Market price (year end average)
(Div per share+ change in stock price over the period)/Market price
PE Ratio:
Market Price (year end avg)/ Earnings per Share
The multiple that stock market places on theearnings which reflects the growth prospects, riskcharacteristics, corporate image and degree ofliquidity
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Market Ratios
Price to book ratio:
Market price / Book value
Low ratio indicates undervaluation
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End of Ch 11
Now to Cash flow