Download
1 / 41
410 likes | 537 Views
Module 3. Analyzing and Interpreting Financial Statements. Creditor Investor Manager. Can the company pay the interest and principal on its debt? Does the company reply too much on nonowner financing?
E N D
Module 3 Analyzing and Interpreting Financial Statements
Creditor Investor Manager Can the company pay the interest and principal on its debt? Does the company reply too much on nonowner financing? Does the company earn an acceptable return on invested capital? Is the gross profit margin growing or shrinking? Does the company effectively use nonowner financing? Are costs under control? Are the company’s markets growing or shrinking? Do observed changes reflect opportunities or threats? Is the allocation of investment across different assets too high or too low? Common Questions that F/S Analysis Can Help To Answer
Ratio Analysis • Examining various income statement and balance sheet components in relation to one another facilitates financial statement analysis. This type of examination is called ratio analysis. • This module focuses on the disaggregation of Return Measures into • Level I – RNOA and LEV • Level II – Profit Margins and Turnover • Level III – GPM, SGA, ART, INVT, PAT, APT, WCT • As well as Liquidity and Solvency Measures
Return on Equity • Return on equity (ROE) is computed as: ROE = Net Income / Average Equity
Return on Net Operating Assets(RNOA) RNOA = NOPAT / Average NOA where, NOPAT is net operating profit after tax NOA is net operating assets
NOPAT • Net operating profit includes Operating revenues less Operating expenses (COGS, SG&A, Taxes) • Excluded are after-tax earnings from investments returns and interest expenses.
Financial Leverage and Risk • LEV is the other component of ROE • Given that increases in financial leverage increase ROE, why are all companies not 100% debt financed? • The answer is because debt is risky. This increased risk increases the expected return that investors require to provide capital to the firm. • Higher financial leverage also results in a higher interest rate on the company’s debt. • Standard & Poor’s and Moody’s Investor Services ratings partly determine the debt’s interest rate—with lower quality ratings yielding higher interest rates and vice-versa. • So, all else equal, higher financial leverage lowers a company’s debt rating and increases the interest rate it must pay.
Gross Profit Margin • It allows a focus on average unit mark-ups • A high gross profit margin is preferred to a lower one, which also implies that a company has relatively more flexibility in product pricing.
Gross Profit Margin • Two main factors determine gross profit margins: • Competition – as the level of competition intensifies, more substitutes become available, which limits a company’s ability to raise prices and pass along price increases to customers. • Product mix – if the proportion of lower price, higher volume products increases relative to that of higher priced, lower volume products, then gross profit dollars may stay the same, but gross profit margin declines.
Operating Expense Margin • Operating expense ratios (percents) are used to examine the proportion of sales consumed by each major expense category. • Expense ratios are calculated as follows: Operating expense percentage = Expense item/Net sales
Turnover • Turnover measures relate to the productivity of company assets. Such measures seek to answer the amount of capital required to generate a specific sales volume. • Turnover ratios are calculated as follows: Turnover = Sales volume/Average Assets • As turnover increases, there is greater cash inflow as cash outflow for assets to support the current sales volume is reduced.
Liquidity and Solvency Measures • Liquidity refers to cash: how much we have, how much is expected, and how much can be raised on short notice. • Solvency refers to the ability to meet obligations; primarily obligations to creditors, including lessors.
Cash Operating Cycle • Average Cash (Operating) Cycle - the period of time from cash to inventories to receivables to cash.
