1 / 33

Chapter 3 Evaluation of Financial Performance

Chapter 3 Evaluation of Financial Performance. Introduction. This chapter introduces financial statement analysis techniques that are used to accurately evaluate a company’s performance. We will assume that the financial statements are fairly and accurately presented.

cora
Download Presentation

Chapter 3 Evaluation of Financial Performance

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 3 Evaluation of Financial Performance Finance 311

  2. Introduction • This chapter introduces financial statement analysis techniques that are used to accurately evaluate a company’s performance. We will assume that the financial statements are fairly and accurately presented. Finance 311

  3. Financial Ratios Are Used By • Management for planning and evaluating • Credit managers and bankers to estimate the riskiness of potential borrowers • Investors to evaluate corporate securities • Managers to identify and assess potential merger candidates • Widely used and accepted technique • Use started in the 1920s Finance 311

  4. Ratio Analysis • Many, many ratios • Choose the ones that are most relevant for you • Must be compared with a standard and also the past (three years, for example) • A financial ratio is only an indicator • One can possibly manipulate ratios • Accounting differences in firms • WorldCom (MCI), ENRON, HealthSouth, Ahold, Tyco, etc. Finance 311

  5. Ratio Classifications • Liquidity • Asset management • Financial leverage management • Profitability • Market-based • Dividend policy Finance 311

  6. Major Financial Statements • Balance sheet • Common-sized balance sheet shows assets, liabilities, and equity as a % of total assets • Income statement • Common-sized income statement shows income and expense items as a % of net sales • Statement of cash flows Finance 311

  7. Common-Sized Statements • Publicly-owned firms must publish financial statements quarterly and annually • Widely used in banking and investments Finance 311

  8. Liquidity Ratios • Current ratio = Current assets Current liabilities • Quick ratio = Current assets - Inventories Current liabilities Aging Schedule for Accounts Receivable Finance 311

  9. Asset Management Ratios • Average collection period = Accounts receivable Annual credit sales/ 365 • Inventory turnover = Cost of sales Average inventory • Fixed-asset turnover = Sales Net fixed assets • Total asset turnover = Sales Total assets Finance 311

  10. Financial Leverage Management • Debt ratio = Total debt Total assets • Debt-to-equity ratio = Total debt Total equity • Times interest earned = EBIT Interest charges • Fixed charge coverage = EBIT + Lease payments Interest + Lease payment + P/S div before tax+ Before-tax sinking fund Finance 311

  11. Profitability Ratios • Gross profit margin = Sales - Cost of sales Sales • Net profit margin = EAT Sales • ROI = EAT Total Assets • ROE = EAT Stockholders equity Finance 311

  12. Market-Based Ratios • P/E ratio = Market price per share Current earnings per share • Market to book ratio = Market price per share Book value per share Stock Price/ Free Cash Flow Finance 311

  13. Dividend Policy Ratios • Payout ratio = Dividends per share Earnings per share • Dividend yield = Expected dividends per share Stock price Finance 311

  14. Relationships Among Ratios • ROI = EAT x Sales = EAT Sales Total assets Total assets • ROE = EAT x Sales x Total assets Sales Total assets Equity • ROE = Net Profit Margin x Total Asset Turnover x Equity Multiplier DuPont Analysis Finance 311

  15. Dupont Analysis • Widely used in industry • Shows impacts that operating changes can have on returns Finance 311

  16. Trend analysis 2002 2003 2004 XYZ current ratio 1.9 2.2 2.3 Cross-sectional analysis 2004 XYZ current ratio 2.3 Industry norms 2.5 Both simultaneously 2002 2003 2004 XYZ current ratio 1.9 2.2 2.3 Industry norms 2.5 2.4 2.5 Financial Ratio Analysis Finance 311

  17. Trading Room (406 Sirrine Hall) Bridge (Telerate) Bloomberg Reuters General Business File of Cooper Library Factiva Mergent Database TableBase Reuters Business Insight RMA Annual Statement Studies Reserves on 2nd Floor Visit Index Table 3 in Library Annual reports 10K’s - SEC EDGAR Corporate Database Standard and Poor’s Value Line Industry Norms and Key Business Ratios The Internet Some Sources of Information Finance 311

  18. A Few of the Sources of Information on the Web • http://www.bloomberg.com/ • http://www.sec.gov/ • http://finance.yahoo.com/ • http://www.dnbcorp.com/ • http://www.rmahq.org/ • http://www.moodys.com/ • http://www.hoovers.com/ • But, please be careful. Remember you get what you pay for… Finance 311

  19. Quality of a firm’s earningsis positively related to the proportion of cash earnings to total earnings and to the proportion of recurring income to total income. Large non-cash component in the earnings Significant non-recurring transactions in the income figure 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 assets and inversely related to the amount of its hidden liabilities. Presence of obsolete inventories and charging off assets Hidden assets Assets have market values significantly below book values Finance 311

  20. Problems in Reporting • Time of revenue recognition • Pension Fund Earnings Assumptions • Amortization of intangible assets • Including all losses and debt • Off-Balance-Sheet Financing - ENRON Finance 311

  21. Ratios Can Be Misleading • Differing accounting practices • Might be significant dispersion in the ratio for the industry • Many firms operate in more than one industry - Industry classification • Financial ratios provide a historical record of performance Finance 311

  22. The Bridge System • Turn on Monitor • Log on • Click on Telerate • Double Click on the background • Go to Analytics Page • Type: /LU/Company for Ticker Symbol • Type: the Ticker Symbol/CF • CF = Corporate Fundamentals • Scroll through the Corporate Fundamentals • Type: the Ticker Symbol[Beta Finance 311

  23. To Obtain the Latest Corporate News • Tab to another page in Telerate • Double click on the background • Go to News Watch • Right Click then Search by Ticker Symbol • Type in the Ticker Symbol • Then double click on any headline story to bring up the entire story. • You can print out the story or possibly save it to a disk. Finance 311

  24. Analysis Based on the Market Value of the Firm • Market value added ( MVA )= Total Market value – Total Capital MVA is the market value of debt, preferred stock, and common equity less the Capital raised by investors or Retained Earnings. The capital market’s assessment of the accumulated NPV of all of the firm’s past and present projected investment projects. Finance 311

  25. Economic Value Added (EVA) • Economic value added ( EVA ) = [ Return on total capital (r) – Cost of Capital (k )] x Capital • EVA = EBIT(1 – Corporate tax rate) – (Operating Capital)(k) • r = net operating profits after taxes divided by beginning of year capital (Return on Capital) • k = Weighted After-Tax Cost of Capital Finance 311

  26. EVA - Continued The yearly contribution of a firm’s operations to the creation of MVA. • EVA measures the extent to which the firm has increased shareholder value in a given year. • EVA represents the residual value that remains after the cost of all capital, including equity capital has been deducted. Finance 311

  27. Increase Economic Value Added (EVA) • Increase operating efficiency • Commit new resources that promise a high return • Redirect resources to more productive uses • Make prudent use of tax benefits of debt financing Finance 311

  28. Problems Caused by Inflation • Inventory profit as a result of timing of price increases • Inventory valuation methods ( LIFO ) ( FIFO ) • Rising interest rates causes a decline in the value of long term debt • Differences in the reporting of earnings • Understatement of fixed assets • Recognition of sales Finance 311

  29. The Cash Flow Concept • Accounting income Vs Cash flow • Cash flow is the relevant source of value for the firm • ATCF = EAT + Noncash charges • ATCF = EAT + Depreciation + Deferred taxes • Free Cash Flow (FCF) = EBIT(1 – T) – Net Investment in operating capital • FCF = (EBIT(1 – T) + Depreciation) – Gross investment in operating capital Finance 311

  30. Statement of Cash Flows • Presents the net cash provided by operating, investing, or financing activities • Direct method presents the net cash provided by operating, investing, or financing activities • Indirect method presents the adjustments to net income to show net cash provided Used for public financial reports • The final results are identical Finance 311

  31. Complex International Aspects of Financial Statement Analysis • Influenced by fluctuating exchange rates • SFAS No. 52 deals with foreign currency translation Finance 311

  32. Accuracy of Financial Statements • External auditor • Generally accepted accounting principles • People pose for a picture like a corporation poses for a financial statement • Sarbanes-Oxley Act of 2002 Finance 311

  33. Financial Statements Balance Sheet Income Statement Statement of Cash Flows Common-sized Sarbanes-Oxley Act Ratios Liquidity Asset management Financial leverage Profitability Market-based Dividend policy DuPont Analysis Sources of information Market Value Added Economic Value Added Conclusion Finance 311

More Related