financial statement analysis. statement analysis - 2 financial statement analysis objectives...
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FINANCIAL STATEMENT ANALYSIS
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Statement Analysis - 2FINANCIAL STATEMENT
ANALYSISObjectives
Creditors
Short term liquidity
Long-term solvency
Investors
Profitability
Dividends
Stock price appreciation
Prediction of future returns Assessment of risks associated with those returns
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Statement Analysis - 3
HORIZONTAL ANALYSIS
Percentage changes in comparative statements – (Year to Year comparisons)
– Establishment of “Base Period”
Trend percentages– Form of horizontal analysis– Series of years– Current year data / Base year data
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Statement Analysis - 4
VERTICAL ANALYSIS
Relationship of statement items to a specified “Base Item”
– Income statement = Net sales
– Balance sheet = Total assets
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Statement Analysis - 5
COMMON-SIZE STATEMENTS
Reports only percentages for statement items
“Base Items” normally same as vertical analysis
Allows comparison of firms of different size
%
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Statement Analysis - 6
BENCHMARKING
Comparison of a company to standards found in the environment
Against Industry Average
Against a Major Competitor
Against yourself (over time)
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Statement Analysis - 7
FINANCIAL STATEMENT RATIOSObjectives
Ability to pay current liabilities (Liquidity)
Ability to sell inventory and collect receivables(Liquidity / Turnover)
Ability to pay long-term debt (Solvency)
Profitability of the company
Analysis of company’s stock as an investment
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Statement Analysis - 8FINANCIAL STATEMENT
ANALYSISLimitations
Statements are largely historical and involve many estimates
Comparability between firms may be difficult
Financial ratios are only indicators– Specific reasons for problems must still be
identified
External factors will often impact the financial results of a company
Users must look at the entire picture when using financial statement analysis
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Statement Analysis - 9
Return on Sales (ROS)
A profitability measure Also known as profit margin ratio Considers relative firm size
@Cambridge Business Publishers, 2009
Net IncomeSales RevenueROS = = $39,700
$305,000= 13.0%
Cup-A-Jo expects to generate 13 cents of bottom line profit for every dollar of sales revenue.
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Statement Analysis - 10
Return on Assets (ROA)
A profitability measure Considers relative firm size
@Cambridge Business Publishers, 2009
[Net income + Interest expense × (1 – Tax rate)] Total assetsROA =
= $39,700 + [$6,300 × (62.3%)] $472,450 = 9.2%
Cup-A-Jo has earnings of 9.2% available for its business capital providers.
*Effective Tax rate = $24,000/$63,700 = 37.7%
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Statement Analysis - 11
Return on Equity (ROE)
A profitability measure Also known as return on shareholders’ equity Considers relative firm size
@Cambridge Business Publishers, 2009
Net incomeShareholders’ equity
ROE = = $39,700$371,700
= 10.7%
Cup-A-Jo is expected to generate about 10.7 cents of profit for every dollar of shareholders’ investment in the company.
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Statement Analysis - 12
Return on Equity Paradigm
Reveals four ways to improve ROE1.Improve return on sales2.Improve asset turnover3.Improve use of financial leverage4.Some combination of 1, 2, and 3
@Cambridge Business Publishers, 2009
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Statement Analysis - 13
Asset Turnover
How effective a business’s assets are being used by management to generate sales revenue
Key performance indictor
@Cambridge Business Publishers, 2009
Sales revenueTotal assets
Asset Turnover
= $305,000$472,450 = 0.646
For every dollar invested in the company’s assets. Cup-A-Jo generated 64.6 cents of sales.
=
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Statement Analysis - 14
Financial Leverage
Relative mix of debt versus equity financing used by a business
@Cambridge Business Publishers, 2009
Total assetsShareholders’
equity
FinancialLeverage
= $472,450$371,700 = 1.27
Cup-A-Jo’s assets are about 1.27 times the amount of shareholders’ equity invested
=
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Statement Analysis - 15
Return on Equity for Cup-A-Jo
@Cambridge Business Publishers, 2009
Total assetsShareholders’
equity
×
$472,450$371,700
1.27
=
ROE = Return on Sales × Assets Turnover × Financial Leverage
Sales revenueTotal assets
$305,000$472,450
0.646
Net incomeSales revenue
= $39,700$305,000
= 13.0%
× ×
×
× ×
= 10.7%
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Statement Analysis - 16
Long-term Debt-to-Equity
Reveals the relative investment of long-term lenders versus that of shareholders
Indicates whether the financing strategy of the company is heavier on debt or equity
@Cambridge Business Publishers, 2009
Debt-to-Equity
Long-term debtShareholders’
equity
$67,500$371,700
= 0.182= =
Cup-A-Jo’s long-term debt is about 18% of the amount of shareholders’ equity.
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Statement Analysis - 17
Times-Interest-Earned Ratio
Reveals the extent to which operating earnings is able to ‘cover’ current debt service charges (interest)
@Cambridge Business Publishers, 2009
Interest Coverage
Operating incomeInterest expense
$70,000$6,300 = 11.1= =
Cup-A-Jo’s operating income is able to cover interest about 11 times per year.