Financial Statement Analysis

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Internal Users External Users

Financial statement analysis helps users make better decisions.

Financial statement analysis helps users make better decisions.

ManagersOfficers

Internal Auditors

ShareholdersLenders

Customers

Purpose of Analysis

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Grow thin sales

Return tostockholders

Profitm argins

Return onequity

Determ ined byanalyzing the

financialstatements.

F in an c ial m easu res a re o ften u sedto ran k corp orate perfo rm ance.E xam p les o f m easu res in clu d e:

Purpose of Analysis

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Outcomes

Describe meaning and usage of

financial statement analysis

3 Types of Analysis

5 Types of Financial Ratios

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Ratio Analysis

numbers versus ratios Why?

AA BBCOMPANY

$ 1,000,000 $ 10,000NET INCOME

$ 5,000,000 $ 20,000TOTAL ASSETS

0.20 = 20% 0.50 = 50%NI / TA

EX :

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Ratio Analysis

Types of ratio analysis1. Industry Comparative

You

28 % 22 %NI / TA

To compare with the average of the companies in the same industry

(your performance is higher or lower than the mean?)

Industry average

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Ratio Analysis

Types of ratio analysis2. Trend or time series

2001YEAR

22 % 25 %NI / TA

To compare with yourself along the period of time

(your performance is improving or getting worse?)

2002 2003

23 %

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Ratio Analysis

Types of ratio analysis3. Cross-sectional

YouCOMPANY

28 % 22 %NI / TA

To compare with your main competitors

(your performance is better or worse than them?)

C1 C2

19 %

C3

36 %

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Types of Financial Ratios

Liquidity

Asset Management (Efficiency)

Debt Management (Financial

Leverage)

Profitability

Market Value

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1. Liquidity Ratios= Ability to pay current obligations (S-T debts; A/P, N/P)

By using current sources of cash (Current Assets)

Quick or acid-test ratio = (CA - Inventories) ÷ CL

Inventories are the least liquid current assets so exclude it out

You

1.20 1.00Current ratio

Co1Example

0.70

Co2

Good NormalAnalysis Bad

Current ratio = CA ÷ CL

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2. Asset Management Ratios= Measure how efficient the assets can turn into sales

$ 1,000,000

$ 3,000,000

(Investment)

Meaning: investing $1 can generate sales $3

(Sales)

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Average collection period (ACP) = A/R x 365 ÷ S

Inventory Turnover = COGS ÷ InventoryReceivables Turnover = S ÷ A/R

2. Asset Management Ratios

Example: A/R = $100, Sales = $3,650

ACP = A/R x 365 ÷ S

ACP = $100 x 365 days ÷ $3,650

ACP = 10 days

Meaning:Make sales today Collect cash from

customer

0 10 days

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Inventory Turnover Rate

This ratio measures the numberThis ratio measures the numberof times merchandise inventoryof times merchandise inventory

is sold and replaced during the year.is sold and replaced during the year.

This ratio measures the numberThis ratio measures the numberof times merchandise inventoryof times merchandise inventory

is sold and replaced during the year.is sold and replaced during the year.

Cost of Goods Sold Average Inventory

InventoryTurnover

=

= 12.73 times12.73 times $140,000 ($10,000 + $12,000) ÷ 2

InventoryTurnover

=

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Accounts Receivable Turnover Rate

This ratio measures how many This ratio measures how many times a company converts its times a company converts its

receivables into cash each year.receivables into cash each year.

This ratio measures how many This ratio measures how many times a company converts its times a company converts its

receivables into cash each year.receivables into cash each year.

Net Sales Average Accounts Receivable

Accounts ReceivableTurnover

=

= 27.03 times27.03 times $500,000 ($17,000 + $20,000) ÷ 2

Accounts ReceivableTurnover

=

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Number of Days to Collect Receivables

This ratio measures, on average, This ratio measures, on average, how many days it takes to collect how many days it takes to collect

an account receivable. an account receivable.

This ratio measures, on average, This ratio measures, on average, how many days it takes to collect how many days it takes to collect

an account receivable. an account receivable.

Average Collection

Period=

365 Days Accounts Receivable Turnover

= 13.50 days13.50 daysAverage

Collection Period

= 365 Days 27.03 Times

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2. Asset Management Ratios

Total Asset Turnover = Sales ÷ Total Assets

You

$ 3 m $ 1 mSales

Co1Example

$ 1.4 m

Co2

$ 1 m $ 1 mTotal Assets $ 2 m

Fixed Asset Turnover = Sales ÷ Fixed Assets

3.00 1.00TATO 0.70

Good NormalAnalysis Bad

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3. Debt Management Ratios

Debt ratio = TL ÷ TA

Total Debt to Equity ratio = TL ÷ TE

= How much the firm has borrowed to make an investment

= Ability of a firm to meet total debt obligations (S-T & L-T)

Brown Co.

TA

$100,000

TL$ 80,000

TE$ 20,000

Green Co.

TA

$100,000

TL$ 20,000

TE$ 80,000

TL

TA=

TL

TE=

80 %

4x

TL

TA=

TL

TE=

20 %

0.25x

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4. Profitability Ratios= Ability to earn profit generated from sales

= Ability to control costs, expenses

Gross Profit Margin

= Gross Profit / Sales

How many %profit left after paying cost of goods sold

Higher good control of cost of goods sold

Lower cost of goods sold are too high

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4. Profitability Ratios (cont.)

Operating Profit Margin

= EBIT / Sales

How many %profit left after paying cost of goods

sold and operating expense

Higher good control of both CGS and operating

exp

Lower CGS and operating expense are too high

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4. Profitability Ratios (cont.)

Net Profit Margin (NPM) = NI to CS ÷ S

Sales

- expenses

NI to CS

100,000

- 40,000

60,000

100,000

- 60,000

40,000

60 %NPM 40 %

Ex : Co. 1 Co. 2

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4. Profitability Ratios (cont.)

= How much is the profit from $ 1 total investment

Return on Assets (ROA) = NI to CS ÷ TA

Return on Equity (ROE) = NI to CS ÷ CE

= How much is the profit from $ 1 owners’ investment

Brown Co: TA = $100,000 NICS = $10,000 ROA = 10%

Example :

Green Co : TA = $100,000 NICS = $20,000 ROA = 20%

CE = Investment from Common Shareholders

= CS par + Paid in + RE

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= How much the investors value the firm in the market

= Tell you what investors think about the firm’s future

5. Market Value Ratios

Price to earnings ratio (P/E) = Market price per shareEarnings per share

= How much the investors are willing to pay for each $ 1 of earnings per share (EPS)

**Earnings per share = NI to CS ÷ # of Common Shares

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5. Market Value Ratios (cont.)

Dividend Yield (DY) = DPS

Market price per share

Dividend per share (DPS) = Dividends to CS

# of Common Shares

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Dividend Yield

This ratio identifies the return, in This ratio identifies the return, in terms of cash dividends, on the terms of cash dividends, on the

current market price of the stock.current market price of the stock.

This ratio identifies the return, in This ratio identifies the return, in terms of cash dividends, on the terms of cash dividends, on the

current market price of the stock.current market price of the stock.

DividendYield Ratio

Dividends Per Share Market Price Per Share

=

DividendYield Ratio

$1.50 $15.25

= = 9.84%9.84%

Babson Builders pays an annual dividend of Babson Builders pays an annual dividend of $1.50 per share of capital stock. The market $1.50 per share of capital stock. The market

price of the company’s capital stock was price of the company’s capital stock was $15.25 at the end of 2007.$15.25 at the end of 2007.

Babson Builders pays an annual dividend of Babson Builders pays an annual dividend of $1.50 per share of capital stock. The market $1.50 per share of capital stock. The market

price of the company’s capital stock was price of the company’s capital stock was $15.25 at the end of 2007.$15.25 at the end of 2007.