working with financial statements
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Chapter Three. Working With Financial Statements. Key Concepts and Skills. Understand sources and uses of cash and the Statement of Cash Flows Know how to standardize financial statements for comparison purposes Know how to compute and interpret important financial ratios - PowerPoint PPT PresentationTRANSCRIPT
© 2003 The McGraw-Hill Companies, Inc. All rights reserved.
Working With Financial Statements
Chapter
Three
3.2
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Key Concepts and Skills
• Understand sources and uses of cash and the Statement of Cash Flows
• Know how to standardize financial statements for comparison purposes
• Know how to compute and interpret important financial ratios
• Be able to compute and interpret the Du Pont Identity
• Understand the problems and pitfalls in financial statement analysis
3.3
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Chapter Outline
• Cash Flow and Financial Statements: A Closer Look
• Standardized Financial Statements
• Ratio Analysis
• The Du Pont Identity
• Using Financial Statement Information
3.4
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Sample Balance Sheet
2000 1999 2000 1999
Cash & Equivalents
3,171 6,489 A/P 313,286 340,220
A/R 1,095,118 1,048,991 N/P 227,848 86,631
Inventory 388,947 295,255 Other CL 1,239,651 1,098,602
Other CA 314,454 232,304 Total CL 1,780,785 1,525,453
Total CA 1,801,690 1,583,039 LT Debt 1,389,615 871,851
Net FA 3,129,754 2,535,072 C/S 1,761,044 1,648,490
Total Assets 4,931,444 4,118,111 Total Liab. & Equity
4,931,444 4,118,111
Numbers are in thousands
See 3.5: Sources & Uses of Cash
3.5
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Sample Income Statement
Revenues 4,335,491
Cost of Goods Sold 1,762,721
Expenses 1,390,262
Depreciation 362,325
EBIT 820,183
Interest Expense 52,841
Taxable Income 767,342
Taxes 295,426
Net Income 471,916
EPS 2.29
Dividends per share 0.54
Numbers are in thousands, except EPS & DPS
3.6
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Sources and Uses of Cash 3.1
• Sources– Cash inflow – occurs when we “sell” something– Decrease in asset account– Increase in liability or equity account
• Uses– Cash outflow – occurs when we “buy” something– Increase in asset account– Decrease in liability or equity account
3.7
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Statement of Cash Flows
• Statement that summarizes the sources and uses of cash
• Changes divided into three major categories– Operating Activity – includes net income and
changes in most current accounts– Investment Activity – includes changes in fixed
assets– Financing Activity – includes changes in notes
payable, long-term debt and equity accounts as well as dividends
3.8
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Sample Statement of Cash FlowsCash, beginning of year 6,489 Financing Activity
Operating Activity Increase in Notes Payable
141,217
Net Income 471,916 Increase in LT Debt 517,764
Plus: Depreciation 362,325 Decrease in C/S -248,209
Increase in Other CL 141,049 Dividends Paid -111,153
Less: Increase in A/R -46,127 Net Cash from Financing
299,619
Increase in Inventory -93,692 Net Decrease in Cash (+68,999)
Increase in Other CA -82,150 Cash End of Year (assume correct) 3,170*
Decrease in A/P -26,934 So we do not have to change all the figures
(ratios)
Net Cash from Operations 726,387
Investment Activity
Fixed Asset Acquisition -957,007
Net Cash from Investments -957,007 *Difference due to rounding of dividends
3.9
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Standardized Financial Statements 3.2
• Common-Size Balance Sheets– Compute all accounts as a percent of total
assets• Common-Size Income Statements
– Compute all line items as a percent of sales• Standardized statements make it easier to
compare financial information, particularly as the company grows
• They are also useful for comparing companies of different sizes, particularly within the same industry
3.10
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Ratio Analysis 3.3
• Ratios also allow for better comparison through time or between companies
• As we look at each ratio, ask yourself what the ratio is trying to measure and why is that information important
• Ratios are used both internally and externally
3.11
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Categories of Financial Ratios
• Short-term solvency or liquidity ratios
• Long-term solvency or financial leverage ratios
• Asset management or turnover ratios
• Profitability ratios
• Market value ratios
3.12
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Computing Liquidity Ratios
• Current Ratio = CA / CL (s.t. liquidity)– 1,801,690 / 1,780,785 = 1.01 times
• Quick Ratio = (CA – Inventory) / CL– (1,801,690 – 388,947) / 1,780,785 = .793 times
• Cash Ratio = Cash / CL– 3,171 / 1,780,785 = .002 times
3.13
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Computing Long-term Solvency Ratios
• Total Debt Ratio = (TA – TE) / TA– (4,931,444 – 1,761,044) / 4,931,444 = .6429 times
or 64.29%– The firm finances a little over 64% of its assets
with debt.
• Debt/Equity = TD / TE– (4,931,444 – 1,761,044) / 1, 761,044 = 1.800
times
• Equity Multiplier = TA / TE = 1 + D/E– 1 + 1.800 = 2.800
3.14
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Computing Coverage Ratios
• Times Interest Earned = EBIT / Interest– 820,183 / 52,841 = 15.5 times
• Cash Coverage = (EBIT + Depreciation) / Interest– (820,183 + 362,325) / 52,841 = 22.38 times
3.15
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Computing Inventory Ratios
• Inventory Turnover = Cost of Goods Sold / Inventory– 1,762,721 / 388,947 = 4.53 times
• Days’ Sales in Inventory = 365 / Inventory Turnover– 365 / 4.53 = 81 days
3.16
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Computing Receivables Ratios
• Receivables Turnover = Sales / Accounts Receivable– 4,335,491 / 1,095,118 = 3.96 times
• Days’ Sales in Receivables = 365 / Receivables Turnover– 365 / 3.96 = 92 days
3.17
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Computing Total Asset Turnover
• NWC Turnover = Sales / NWC– 4,335,491 / (1,801,690 - 1,780,785) = 207.390 times
• Fixed Asset Turnover = Sales / Net Fixed Assets– 4,335,491 / 3,129,754 = 1.385 times
• Total Asset Turnover = Sales / Total Assets– 4,335,491 / 4,931,444 = .88 times
• Measure of asset use efficiency• Not unusual for TAT < 1, especially if a firm has a
large amount of fixed assets
3.18
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Computing Profitability Measures
• Profit Margin = Net Income / Sales– 471,916 / 4,335,491 = .1088 times or 10.88%
• Return on Assets (ROA) = Net Income / Total Assets– 471,916 / 4,931,444 = .0957 times or 9.57%
• Return on Equity (ROE) = Net Income / Total Equity– 471,916 / 1,761,044 = .2680 times or 26.8%
3.19
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Computing Market Value Measures
• Market Price = $60.98 per share
• Shares outstanding = 205,838,910
• PE Ratio = Price per share / Earnings per share– 60.98 / 2.29 = 26.62 times
• Market-to-book ratio = market value per share / book value per share– 60.98 / (1,761,044,000 / 205,838,910) = 7.1 times
3.20
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Table 3.8 – Common Financial Ratios
3.21
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Table 3.8 – Common Financial Ratios
3.22
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Deriving the Du Pont Identity 3.4
• ROE = NetInc / TE
• Multiply by 1 and then rearrange– ROE = (NI / TE) (TA / TA)– ROE = (NI / TA) (TA / TE) = ROA * EMult
• Multiply by 1 again and then rearrange– ROE = (NI / TA) (TA / TE) (Sales / Sales)– ROE = (NI / Sales) (Sales / TA) (TA / TE)– ROE = ProfMarg * TotAsTurnov * EMult
3.23
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Using the Du Pont Identity
• ROE = PM * TAT * EM– Profit margin is a measure of the firm’s operating
efficiency – how well does it control costs– Total asset turnover is a measure of the firm’s
asset use efficiency – how well does it manage its assets
– Equity multiplier is a measure of the firm’s financial leverage
3.24
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Using Financial Statement Information 3.5
• Internal uses– Performance evaluation – compensation and
comparison between divisions– Planning for the future – guide in estimating future
cash flows
• External uses– Creditors– Suppliers– Customers– Stockholders
3.25
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Benchmarking
• Ratios are not very helpful by themselves; they need to be compared to something
• Time-Trend Analysis– Used to see how the firm’s performance is
changing through time– Internal and external uses
• Peer Group Analysis– Compare to similar companies or within industries– NAICS codes, Financial Post Datagroup, and Dun
& Bradstreet Canada
3.26
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Potential Problems
• There is no underlying theory, so there is no way to know which ratios are most relevant
• Benchmarking is difficult for diversified firms• Globalization and international competition
makes comparison more difficult because of differences in accounting regulations
• Varying accounting procedures, i.e. FIFO vs. LIFO
• Different fiscal years• Extraordinary events
3.27
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Quick Quiz
• What is the Statement of Cash Flows and how do you determine sources and uses of cash?
• How do you standardize balance sheets and income statements and why is standardization useful?
• What are the major categories of ratios and how do you compute specific ratios within each category?
• What are some of the problems associated with financial statement analysis?
3.28
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Summary 3.6
• You should be able to:– Identify sources and uses of cash– Understand the Statement of Cash Flows– Understand how to make standardized financial
statements and why they are useful– Calculate and evaluate common ratios– Understand the Du Pont identity– Describe how to establish benchmarks for
comparison purposes and understand some key problems that can arise