evaluation of financial performance
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3. Evaluation of Financial Performance. Introduction. This chapter introduces financial statement analysis techniques that are used to accurately evaluate a company’s performance. Financial Ratios Are Used By. Management for planning and evaluating - PowerPoint PPT PresentationTRANSCRIPT
Copyright ©2003 South-Western/Thomson Learning
Chapter 3Evaluation of Financial
Performance
Introduction
• This chapter introduces financial statement analysis techniques that are used to accurately evaluate a company’s performance.
Financial Ratios Are Used By
• Management for planning and evaluating
• Credit managers to estimate the riskiness of potential borrowers
• Investors to evaluate corporate securities
• Managers to identify and assess potential merger candidates
Ratio Classifications
• Liquidity
• Asset management
• Financial leverage management
• Profitability
• Market-based
• Dividend policy
Major Financial Statements
• Balance sheet– Common-sized balance sheet shows
assets, liabilities, and equity as a percent of total assets.
• Income statement – Common-sized income statement shows
income and expense items as a percent of net sales.
• Statement of cash flows
Liquidity Ratios
• Current ratio =
• Quick ratio =
Current assetsCurrent liabilities
Current assets – InventoriesCurrent liabilities
Asset Management Ratios
• Avg. collection period =
• Inventory turnover =
• Fixed-asset turnover =
• Total asset turnover =
Cost of sales Average inventory
Sales Net fixed assets
Sales Total assets
Accounts receivable Annual credit sales/365
Financial Leverage Management
• Debt ratio =
• Debt-to-equity ratio =
• Times interest earned =
• Fixed charge coverage =
Total debtTotal assets
Total debtTotal equity
EBIT Interest charges
EBIT + Lease pmts Interest + Lease pmt+ P/S div before tax
+ Before tax sinking fund
Profitability Ratios
• Gross profit margin =
• Net profit margin =
• ROI =
• ROE =
Sales – Cost of salesSales
EATSales
EAT Total assets
EAT Stockholders’ equity
Market-Based Ratios
• P/E ratio =
• Market to book ratio =
Marketing price per shareCurrent earnings per share
Market price per shareBook value per share
Dividend Policy Ratios
• Payout ratio =
• Dividend yield =
Dividends per shareEPS
Expected dividends per shareStock price
Financial Ratio Analysis
• Trend analysis 20X0 X1 X2
XYZ current ratio 1.9 2.2 2.3
• Cross-sectional analysis 20X2
XYZ current ratio 2.3
Industry norms 2.5
• Both simultaneously 20X0 X1 X2
XYZ current ratio 1.9 2.2 2.3
Industry norms 2.5 2.4 2.5
Relationships Among Ratios
• ROI =
• ROE =
• ROE =
EATSales
SalesTotal assets
EATTotal assets
=
EATSales
SalesTotal assets
Total assetsEquity
Net profitmargin
Total assetsturnover
Equitymultiplier
Dupont Analysis
• An excellent way to present ratio analysis for an assignment or for an on-the-job presentation
Sources of Information
• Dun and Bradstreet• Robert Morris
Associates• Prentice-Hall’s
Almanac of Business and Industrial Ratios
• Moody’s• Standard and Poor’s
• Annual reports• 10Ks• Trade associations• Trade journals• Commercial banks• Financial Research
Associates• Computerized
databases
Sources of Information on the Web
• http://finance.yahoo.com/
• http://www.onlinewbc.org/docs/finance/index.html
• http://www.dnbcorp.com/
• http://www.rmahq.org/
• http://www.sec.gov/
• http://www.moodys.com/
• http://www.hoovers.com/
• http://www.bloomberg.com/
Quality and Financial Analysis
• The quality of a firm’s earnings is positively related to the proportion of cash earnings to total earnings and to the proportion of recurring income to total income.
• The quality of a firm’s balance sheet is positively related to the ratio of the market value of the firm’s assets to book value of the assets and inversely related to the amount of its hidden liabilities.
Problems in Reporting
• Time of revenue recognition
• Establishment of reserves
• Amortization of intangible assets
• Including all losses and debt
• “Pro forma” profitability measures
Balance Sheet Quality Issues
• Charging off assets
• Hidden liabilities
• Hidden assets
• Off balance sheet financing
Analysis Based on the Market Value of the Firm
• Market value added (MVA) = Market value – Capital– The capital market’s assessment of the
accumulated NPV of all of the firm’s past and present projected investment projects
• Economic value added (EVA) = (r – k) Capital– The yearly contribution of a firm’s
operations to the creation of MVA
Problems Caused by Inflation
• Inventory profit as a result of timing of price increases
• Inventory valuation methods – (LIFO)– (FIFO)
• Rising interest rates causing a decline in the value of long-term debt
• Differences in the reporting of earnings
• Recognition of sales
The Cash Flow Concept
• Accounting income vs. Cash flow
• Cash flow is the relevant source of value
for the firm.
• ATCF = EAT + Noncash charges– Noncash charges = Depreciation + Deferred taxes
Statement of Cash Flow
• Presents the effects of operating, investing, and financing on the cash balance– Direct method presents the effects to net cash
provided by operating, investing, and financing.
– Indirect method presents the adjustments to net income showing the effects to net cash.
• Used for public financial reports
• The final results for both are identical.
Complex International Aspects of Financial Statement Analysis
• Influenced by fluctuating exchange rates
• Statement of Accounting Standards No. 52 deals with foreign currency translation.
Accuracy of Financial Statements
• External auditor
• Generally accepted accounting principles
• Corporations pose for a financial statement like people pose for a picture.