Presentation Transcript

1. Financial Statement Analysis Presented by: William Galle UNO/TRAC
2. Introduction During this session we will discuss various techniques used to extract from financial statements meaningful observations and conclusions about an enterprise’s financial health and operating results. UNO/TRAC
3. Ratio Analysis The fundamental method of analyzing financial statements is ratio analysis. The four primary categories of information that ratio analysis provide are: Liquidity: How able is the company to meet its near-term obligations? Working capital utilization: How efficiently is the company using the various components of its current assets and current liabilities? Capital structure: What are the company’s sources of capital? Profitability: How profitable is the company in terms of both its sales and invested capital? UNO/TRAC
4. Liquidity Ratios A company unable to meet its obligations as they come due runs the risk of bankruptcy. A company that has substantial liquid assets in relationship to its near-term obligations has a strong liquidity position, i.e., is very liquid. Lets look at two such ratios. UNO/TRAC
5. Current Ratio This test answers the question of “What is the health of working capital of this company?” It is defined as: Current assets  Current liabilities. For the Acme Company we have: Thus for each $1 of current liabilities, there is $1.63 in current assets to back it up. UNO/TRAC
6. Quick Ratio This test measures the adequacy of a company to meet sudden emergencies – the assets that could be taken to the bank right away, if necessary. It is defined as: QR = (Cash + Marketable securities + accounts receivable)  current liabilities UNO/TRAC
7. Quick Ratio, continued For the Acme Company, the Quick Ratio is: QR = $490,000  $724,000 = 0.68 This means that for each $1 of current liabilities, there is only $0.68 in quick assets available. UNO/TRAC
8. Working Capital One very important balance sheet concept is working capital. Working capital is the difference between total current assets and total current liabilities. It is, therefore, the amount of current assets that is left if all current debts are paid. UNO/TRAC
9. Working Capital For the Acme Company, the working capital is: Working Capital = Current assets - current liabilities = $1,170,000 – $724,000 = $446,000 A company’s ability to meet obligations, expand volume and take advantage of opportunities is often determined by its working capital. Year-to-year increases in working capital are a positive sign of a company’s growth and health. UNO/TRAC
10. Working Capital Utilization The more efficiently a company uses its current assets – that is, the faster it collects from customers and the less inventory it requires to accomplish its sales– the less capital the company will require. The ratios described in this section indicate how efficiently the company is utilizing its working capital. UNO/TRAC
11. Accounts Receivable Collection Period A comparison of sales volume with outstanding accounts receivable indicates how promptly customers are paying. The accounts receivable collection period ratio is: UNO/TRAC
12. Accounts Receivable Collection Period First, for the Acme Company, we calculate average sales per day: UNO/TRAC
13. Accounts Receivable Collection Period Then, the collection period is: Collection period = $440,000 $13,424/day = 32.7 days UNO/TRAC
14. Inventory Turnover A comparison of inventory and cost of goods sold, indicates the rate at which inventory is used – that is, the speed with which inventory is moving from receipt to final sales. Inventory turnover, in times per year, is: UNO/TRAC
15. Inventory Turnover For the Acme Company, UNO/TRAC
16. Inventory Turnover Note that if the inventory flow periodis wanted just divide 365 by the inventory turnover, or for Acme Lumber we see that: Inventory flow period = 365/5.92 = 61.6 days UNO/TRAC
17. Working Capital Turnover Ratio This ratio summarizes the efficiency with which the company is using its net investment in current assets less current liabilities. It shows the dollars of sales achieved per dollar of working capital invested. If the ratio decreases, the company is investing more in working capital per dollar of sales; if the ratio increases, the company is making more efficient use of its working capital. This ratio is expressed in times per year. Hence, UNO/TRAC
18. Working Capital Turnover Ratio Acme’s working capital turnover was: UNO/TRAC
19. Capital Structure Ratios These ratios assess the financial riskiness of the business as well as the potential for improved returns through judicious use of debt. UNO/TRAC
20. Debt to Equity Ratio This is an indicator of whether the company is using debt excessively. The ratio is defined as total liabilities divided by the total shareholders’ equity, or: UNO/TRAC
21. Debt to Equity Ratio In 2007 and 2008, Acme had a debt to equity ratio of: 2007 = 587/443 = 1.33 2008 = 774/596 = 1.30 UNO/TRAC
22. Debt to Equity Ratio What this means is that Acme used $1.33 of liabilities for every dollar of shareholder equity to perform its business in 2007, and $1.30 in 2008. Usually a company tries to keep the ratio around 1, so that the debt will be less than the investment level of the owners of the business. UNO/TRAC
23. Profitability Ratio Profitability ratios measure a company’s performance, the rate at which it is earning financial returns. Two types of profitability ratios are useful: profit in relation to sales, and profit in relation to investment. UNO/TRAC
24. Percentage Relationships: Income Statement The ratio of net income to total sales is a useful indicator of the company’s profitability. In addition, the percentage that each line item on the income statement is of total revenue, or sales, also provides useful insights. UNO/TRAC
25. Acme Company Income as Percent of Sales UNO/TRAC
26. Return on Sales (ROS) The last item in the previous chart shows that for every dollar of sales for Acme, only 3.1 cents is profit. UNO/TRAC
27. Return on Equity This is the most fundamental ratio, and is the net income divided by owner’s equity. To compensate for growth, the ratio compares earnings for the year to average equity, or UNO/TRAC
28. Return on Equity For Acme, the return on equity is: UNO/TRAC
29. Return on Assets This ratio compares earnings to total assets. We use earnings before interest and taxes (EBIT) in calculating return on assets: UNO/TRAC
30. Return on Assets At Acme in 2008, return on assets was UNO/TRAC
31. The Value of Ratios By now, you undoubtedly wonder: “what should be the value of these various ratios? What represents an appropriate current ratio, or total debt to total assets ratio, or collection period, or return on equity? Unfortunately, your question cannot be specifically answered. UNO/TRAC
32. The Best Answer In short, judging the appropriateness of a particular ratio is not easy. An analyst’s judgment is aided by two techniques, however: 1. reviewing trends over time, and 2. comparing the ratios with those of similar companies in the same industry. UNO/TRAC
33. Financial Statement Analysis Summary Many different ratios are in active use. We have covered only the most common ratios. Ratios that are highly relevant to certain industries or companies may be of marginal or no interest in other circumstances. UNO/TRAC
34. Thank you! Comments? Questions? UNO/TRAC