understanding and using financial statements
DESCRIPTION
Understanding and Using Financial StatementsTRANSCRIPT
Lesson 10Understanding and Using
Financial Statements
Lesson 10Understanding and Using
Financial Statements
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
22
Demand and supply of financial analysisDemand and supply of financial analysisBasic analytical proceduresBasic analytical proceduresAnalysis methodsAnalysis methodsComprehensive analysis of financial ratiosComprehensive analysis of financial ratiosThe limitations of financial analysisThe limitations of financial analysis
OutlineOutline
33
What’s wrong with accounting What’s wrong with accounting information?information?
44
Demand and supply of financial analysis
Demand and supply of financial analysis
InvestorsInvestorsManagersManagersEmployeesEmployeesCustomersCustomersauditorsauditorsGovernment/regulatory Government/regulatory agenciesagencies
InvestorsInvestorsManagersManagersEmployeesEmployeesCustomersCustomersauditorsauditorsGovernment/regulatory Government/regulatory agenciesagencies
DemandDemandDemandDemand
Internal analystsInternal analysts IntermediariesIntermediariesFinancial analystsFinancial analysts
Bond rating agenciesBond rating agencies
Internal analystsInternal analysts IntermediariesIntermediariesFinancial analystsFinancial analysts
Bond rating agenciesBond rating agencies
SupplySupplySupplySupply
55
Basic analytical proceduresBasic analytical procedures
ConcludeConcludeConcludeConcludeContriveContriveanalysisanalysis schemescheme
ContriveContriveanalysisanalysis schemescheme
Analyze Analyze datadata
Analyze Analyze datadata
DetermineDetermineobjective objective
DetermineDetermineobjective objective
CollectCollectdatadata
CollectCollectdatadata
66
Techniques of Financial Statement Analysis
Techniques of Financial Statement Analysis
Horizontal analysis Comparative financial statements are presented
side by side
Trend analysisVertical analysis
Common-size financial statement
Ratio analysis
Horizontal analysis Comparative financial statements are presented
side by side
Trend analysisVertical analysis
Common-size financial statement
Ratio analysis
77
Horizontal analysisHorizontal analysis
X CompanyX Company
Comparative Balance SheetComparative Balance Sheet
December 31, 2004 and 2005December 31, 2004 and 2005
December December 3131
Increase or DecreaseIncrease or Decrease
20042004 20052005 AmountAmount PercentagePercentageAssetAsset
Liabilities Liabilities and and Stockholders Stockholders
EquityEquity
-- -- -- --
88
Comparing a company’s financial condition and Comparing a company’s financial condition and performance across timeperformance across time
Trend AnalysisTrend Analysis
Cash
0
200000000
400000000
600000000
800000000
1000000000
1999 2000 2001 2002 2003
Year
Cash
Cash
0
200000000
400000000
600000000
800000000
1000000000
1999 2000 2001 2002 2003
Year
Cash
99
Vertical analysisVertical analysis
Vertical analysis is used to show the relationship of the component parts to the total in a single statement In the vertical analysis of the balance sheet,
each asset or equity item is stated as a percent of total assets;
In the vertical analysis of the income statement, each item is stated as a percent of net sales;
Vertical analysis is used to show the relationship of the component parts to the total in a single statement In the vertical analysis of the balance sheet,
each asset or equity item is stated as a percent of total assets;
In the vertical analysis of the income statement, each item is stated as a percent of net sales;
1010
A example of vertical analysisA example of vertical analysis
Year endedYear ended
20032003 20022002 20012001
Net SalesNet Sales 100.00100.00 100.00100.00 100.00100.00
Less: Cost of goods soldLess: Cost of goods sold 854.96854.96 85.6185.61 87.8887.88
Gross profit on salesGross profit on sales 15.0115.01 14.3914.39 11.4011.40
Selling expensesSelling expenses 11.2911.29 11.0111.01 11.4111.41
Administrative expensesAdministrative expenses 2.712.71 2.592.59 2.402.40
Interest expensesInterest expenses 0.200.20 0.150.15 -0.81-0.81
Total expensesTotal expenses 14.2014.20 13.7513.75 13.0013.00
Income before taxesIncome before taxes 0.810.81 0.640.64 1.401.40
Income taxesIncome taxes 0.020.02 0.030.03 0.060.06
Net incomeNet income 0.890.89 0.610.61 1.341.34
1111
Ratio AnalysisRatio Analysis
Financial ratio analysis is the calculation and comparison Financial ratio analysis is the calculation and comparison of ratios which are derived from the information in a of ratios which are derived from the information in a
company's financial statementscompany's financial statements
Financial ratio analysis is the calculation and comparison Financial ratio analysis is the calculation and comparison of ratios which are derived from the information in a of ratios which are derived from the information in a
company's financial statementscompany's financial statements
Profitability Profitability analysisanalysis
Profitability Profitability analysisanalysis
Activity Activity analysisanalysisActivity Activity analysisanalysis
Liquidity Liquidity analysisanalysisLiquidity Liquidity analysisanalysis
Long-term Long-term debt-paying debt-paying
ability ability analysisanalysis
Long-term Long-term debt-paying debt-paying
ability ability analysisanalysis
MarketMarketStrengthStrengthMarketMarket
StrengthStrength
1212
Profitability analysisProfitability analysis
Return on total asReturn on total assetssets
Net incomeNet income
Average total assetsAverage total assets
ReturnReturn on long-on long-term capitalterm capital
Net incomeNet income
Average long-term debt+average owAverage long-term debt+average owner’s equityner’s equity
Return on net assReturn on net assetsets
Net incomeNet income
average stockholders’ equityaverage stockholders’ equity
Operating marginOperating marginGross incomeGross income
Net salesNet sales
1313
A compare of company profitability
A compare of company profitability
Return on net asset
0. 00
0. 05
0. 10
0. 15
0. 20
0. 25
1999 2000 2001 2002 2003
Company A
Company B
Return on net asset
0. 00
0. 05
0. 10
0. 15
0. 20
0. 25
1999 2000 2001 2002 2003
Company A
Company B
Return on total asset s
0. 00
0. 01
0. 02
0. 03
0. 04
0. 05
0. 06
0. 07
0. 08
1999 2000 2001 2002 2003
Company ACompany B
Return on total asset s
0. 00
0. 01
0. 02
0. 03
0. 04
0. 05
0. 06
0. 07
0. 08
1999 2000 2001 2002 2003
Company ACompany B
1414
Activity analysisActivity analysis
Asset turnoverAsset turnovertotal revenue total revenue
average total assetsaverage total assets
Accounts receivable Accounts receivable turnoverturnover
Sales revenueSales revenue Average accounts receivableAverage accounts receivable
Average collection Average collection period of accounts period of accounts
receivablereceivable
365(days)365(days)Accounts receivable turnoverAccounts receivable turnover
Inventory Inventory turnoverturnover
Cost of goods soldCost of goods soldAverage inventoryAverage inventory
1515
A compare of company efficiency ratios
A compare of company efficiency ratios
Accounts recei vabl eturnover
0. 0010. 0020. 0030. 0040. 0050. 0060. 0070. 0080. 00
1999 2000 2001 2002 2003
Company A
Company B
Accounts recei vabl eturnover
0. 0010. 0020. 0030. 0040. 0050. 0060. 0070. 0080. 00
1999 2000 2001 2002 2003
Company A
Company B
I nventory turnover
0. 00
1. 00
2. 00
3. 00
4. 00
5. 00
6. 00
7. 00
8. 00
1999 2000 2001 2002 2003
Company A
Company B
I nventory turnover
0. 00
1. 00
2. 00
3. 00
4. 00
5. 00
6. 00
7. 00
8. 00
1999 2000 2001 2002 2003
Company A
Company B
1616
Liquidity analysisLiquidity analysis
Current ratio Current ratio Current assets Current assets Current LiabilitiesCurrent Liabilities
Quick ratio Quick ratio Quick assetsQuick assets
Current liabilitiesCurrent liabilities
Cash ratioCash ratio Cash+ Short-term investmentCash+ Short-term investmentCurrent liabilitiesCurrent liabilities
1717
A compare of company Liquidity ratios
A compare of company Liquidity ratios
1999
2000
2001
2002
2003
0. 00
0. 50
1. 00
1. 50
2. 00
Current Rati o
Company ACompany B
1999
2000
2001
2002
2003
0. 00
0. 50
1. 00
1. 50
2. 00
Current Rati o
Company ACompany B
1999
2000
2001
2002
2003
0. 000. 200. 400. 600. 801. 001. 201. 40
Qui ck Rati o
Company ACompany B
1999
2000
2001
2002
2003
0. 000. 200. 400. 600. 801. 001. 201. 40
Qui ck Rati o
Company ACompany B
1818
Long-term debt-paying abilityanalysis
Long-term debt-paying abilityanalysis
Debt-equity Debt-equity ratio ratio
Total liabilitiesTotal liabilities Total owner’s equityTotal owner’s equity
Debt-to-total Debt-to-total assetasset
Total liabilitiesTotal liabilitiesTotal AssetTotal Asset
Times interest Times interest earnedearned
Net income +interest expense Net income +interest expense +taxes+taxes
Interest expenseInterest expense
1919
A compare of Long-termdebt-paying ability
A compare of Long-termdebt-paying ability
1999
2000
2001
2002
2003
Company A0. 00
0. 20
0. 40
0. 60
0. 80
Debt- to- total assets
Company A
Company B
1999
2000
2001
2002
2003
Company A0. 00
0. 20
0. 40
0. 60
0. 80
Debt- to- total assets
Company A
Company B
2020
Market StrengthMarket Strength
Earning per Earning per shareshare
Net incomeNet income shares of common stock shares of common stock
outstandingoutstanding
Price-earnings Price-earnings ratioratio
Market price per shareMarket price per shareEarnings per shareEarnings per share
Dividend yieldDividend yieldDividendDividend per shareper share
Market price per shareMarket price per share
2121
A compare of market strengthA compare of market strength
P/ E Rat i o
0. 00 10. 00 20. 00 30. 00
1999
2000
2001
2002
2003
Company B
Company A
P/ E Rat i o
0. 00 10. 00 20. 00 30. 00
1999
2000
2001
2002
2003
Company B
Company A
2222
Dupond AnalysisDupond Analysis
Net incomeNet incomeNet SalesNet Sales
Net incomeNet incomeNet SalesNet Sales
ROE=Net MarginROE=Net Margin X Asset TurnoverX Asset Turnover X Leverage FactorX Leverage Factor ROE=Net MarginROE=Net Margin X Asset TurnoverX Asset Turnover X Leverage FactorX Leverage Factor
Net income Net income owner’s equityowner’s equity
Net income Net income owner’s equityowner’s equity
SalesSalesAssetsAssets
SalesSalesAssetsAssets
AssetsAssetsOwner’s equityOwner’s equity
AssetsAssetsOwner’s equityOwner’s equity
2323
Dupon analysis for five firmsDupon analysis for five firms
Firm Firm Net Net MarginMargin
AssetAssetTurnoverTurnover
ROAROA Leverage Leverage FactorFactor
ROEROE
AA 8.36%8.36% 0.56 0.56 4.65%4.65% 2.43 2.43 11.31%11.31%
BB 22.83%22.83% 0.12 0.12 2.80%2.80% 1.82 1.82 5.11%5.11%
CC 3.87%3.87% 0.86 0.86 3.34%3.34% 1.96 1.96 6.52%6.52%
DD 1.42%1.42% 1.36 1.36 1.94%1.94% 3.64 3.64 7.04%7.04%
EE 4.24%4.24% 1.12 1.12 4.74%4.74% 1.32 1.32 6.25%6.25%
2424
Why ratio analysis is useful?Why ratio analysis is useful?
They facilitate inter-company comparison;They downplay the impact of size and allow evaluation
over time or across entities without undue concern for the effects of size difference;
They serve as benchmarks for targets such as financing ratios and debt burden;
They help provide an informed basis for making investment-related decisions by comparing an entity’s financial performance to another;
……
They facilitate inter-company comparison;They downplay the impact of size and allow evaluation
over time or across entities without undue concern for the effects of size difference;
They serve as benchmarks for targets such as financing ratios and debt burden;
They help provide an informed basis for making investment-related decisions by comparing an entity’s financial performance to another;
……
2525
How is ratio analysis limited?How is ratio analysis limited?How is ratio analysis limited?How is ratio analysis limited?
It is restricted to information reported in thIt is restricted to information reported in the financial statements;e financial statements;
It is based on past performance.It is based on past performance.Comparability is hampered when accountinComparability is hampered when accountin
g policies are not uniform across an industry;g policies are not uniform across an industry;The past may not predict the future;The past may not predict the future;
2626
How is ratio analysis limited? (cont)
How is ratio analysis limited? (cont)
Trends and relationships must be carefullTrends and relationships must be carefully evaluated with reference to industry nory evaluated with reference to industry norms, budgets, and strategic decisions; ms, budgets, and strategic decisions;
Because of some potential problems in staBecause of some potential problems in standard, comparison must be careful;ndard, comparison must be careful;
2727
Standards of comparison for financial statement analysisStandards of comparison for financial statement analysis
Prior years’ Prior years’ resultsresults
Prior years’ Prior years’ resultsresults
Industry Industry averagesaverages
Industry Industry averagesaverages
Internal Internal projections or projections or
budgetbudget
Internal Internal projections or projections or
budgetbudget
May include inefficiencies or reflect May include inefficiencies or reflect different operating policies than in effect in different operating policies than in effect in
the current year.the current year.
May include inefficiencies or reflect May include inefficiencies or reflect different operating policies than in effect in different operating policies than in effect in
the current year.the current year.
May not be representative or desirable for May not be representative or desirable for this firm.this firm.
May not be representative or desirable for May not be representative or desirable for this firm.this firm.
May not be available; may be based on May not be available; may be based on different or budgets operating policies than different or budgets operating policies than
in effect in the current year.in effect in the current year.
May not be available; may be based on May not be available; may be based on different or budgets operating policies than different or budgets operating policies than
in effect in the current year.in effect in the current year.
Standard of Standard of comparisoncomparison
Standard of Standard of comparisoncomparison Potential problemPotential problem Potential problemPotential problem
2828
What should an analyst keep in mind about financial analysis?
What should an analyst keep in mind about financial analysis?
An overview of all ratios can provide important information concerning the strategic decisions of a company and the nature of its business;
However, accounting information can only provide so much data. An analyst must proceed with caution;
An overview of all ratios can provide important information concerning the strategic decisions of a company and the nature of its business;
However, accounting information can only provide so much data. An analyst must proceed with caution;
2929
SummarySummary
Users of financial statements often gain a clearer picture of the economic condition of an entity by the analysis of accounting information;
The analytical measures obtained from financial statements are usually expressed as ratios or percentages;
Users of financial statements often gain a clearer picture of the economic condition of an entity by the analysis of accounting information;
The analytical measures obtained from financial statements are usually expressed as ratios or percentages;
3030
SummarySummaryFinancial analysis techniques work best
when they are used to confirm or refute other information. When using analytical tools to evaluate a company, the analyst should keep in mind the limitations of analysis
Financial analysis techniques work best when they are used to confirm or refute other information. When using analytical tools to evaluate a company, the analyst should keep in mind the limitations of analysis
3131
Discussion questionsDiscussion questions
What is the advantage of using comparative statements for financial analysis rather than statements for a single date or period?
What does an increase in the number of days’ sales in receivables ordinarily indicate about the credit and collection policy of the firm?
Why would the dividend yield differ significantly from the rate earned on common stockholders’ equity?
What is the advantage of using comparative statements for financial analysis rather than statements for a single date or period?
What does an increase in the number of days’ sales in receivables ordinarily indicate about the credit and collection policy of the firm?
Why would the dividend yield differ significantly from the rate earned on common stockholders’ equity?
The End of Lesson 10The End of Lesson 10