Financial Statement Analysis

1. Financial Statement Analysis P.V. Viswanath Based on Damodaran’s Corporate Finance

2. Questions we would like answered… As financial analysts… However, the information we have comes from the firm’s financial statements… P.V. Viswanath

3. Basic Financial Statements • The balance sheet, which summarizes what a firm owns and owes at a point in time. • The income statement, which reports on how much a firm earned in the period of analysis • The statement of cash flows, which reports on cash inflows and outflows to the firm during the period of analysis P.V. Viswanath

4. The Balance Sheet This is what we can see from the firm’s balance sheet… P.V. Viswanath

5. An example : Maxwell Shoe Company, Inc Maxwell Shoe Company Inc. designs, develops and markets casual and dress footwear for women and children under multiple brand names, each of which is targeted to a distinct segment of the footwear market. The Company offers casual and dress footwear for women in the moderately priced market segment under the Mootsies Tootsies brand name, in the upper moderately priced market segment under the Sam & Libby and Dockers Khakis Footwear For Women brand names and in the better market segment under the Anne Klein 2 and A Line Anne Klein brand names. It also sells moderately priced and upper moderately priced children's footwear under both the Mootsies Tootsies and Sam & Libby brand names. In addition, it designs and develops private label footwear for selected retailers under the retailers' own brand names. Maxwell has licensed the J.G. Hook trademark to source and develop private label products for retailers who require brand identification. P.V. Viswanath

6. An example of an Accountant’s Balance Sheet Maxwell Shoe Company, Inc. As of October 31, 2000 (In ‘000s) P.V. Viswanath

7. Notes on the Maxwell Balance Sheet • Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred tax assets are created when future taxable income is expected to exceed pretax income, while deferred tax liabilities occur in the reverse case. • If more deductions have been taken in the current period for reporting purposes, then tax payable (according to the GAAP income statement) will be lower than the actual tax paid. Hence it will seem like taxes have been prepaid. This is reflected in the balance sheet as an asset. • Deferred tax assets ($798) reflect allowance for doubtful accounts, stock option compensation, inventory capitalization, and inventory reserve. Deferred tax liabilities ($479) reflect amortization of trademarks (long-term) and depreciation of property and equipment (short-term). P.V. Viswanath

8. A Financial Analyst’s Balance Sheet This is what we would like to see… P.V. Viswanath

9. The Income Statement P.V. Viswanath

10. The Income Statement Maxwell Shoe Company, Inc. For the year ended October 31, 2000 (In ‘000s) P.V. Viswanath

11. The Income Statement The Income Statement provides us with information about changes in the balance sheet from one year to another. Hence it is crucial to creating the financial balance sheet that we want. However, the income statement is prepared according to GAAP. Underlying GAAP are certain principles, such as revenue recognition when the service for which the firm is being paid has been performed substantially, the matching principle governing recognition of expenses, a historical cost-based approach, and a basic conservatism in the recognition of assets. This leads to certain accounting practices that need to be corrected, from a financial analyst’s point of view… P.V. Viswanath

12. P.V. Viswanath