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Financial Statement Analysis

Financial Statement Analysis. Chapter 15. Financial Statement Analysis. To make informed decisions about a company Helpful in managing the company Comparison with competition Charting a company’s progress, measure performance Establish financial health Used for investment decisions

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Financial Statement Analysis

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  1. Financial Statement Analysis Chapter 15

  2. Financial Statement Analysis • To make informed decisions about a company • Helpful in managing the company • Comparison with competition • Charting a company’s progress, measure performance • Establish financial health • Used for investment decisions • Generally based on comparative financial data • From one year to the next • With a competing company • With the industry as a whole.

  3. Financial Statement Analysis • Three main ways to analyze financial statements • Horizontal analysis • Year-to-year comparison • Vertical analysis • Compare different companies • Using industry averages • Compare company’s performance against the industry averages

  4. Horizontal Analysis • The study of percentage changes in comparative statements • Compute dollar changes • Compute percentage changes

  5. Example: Income Statement • Step 1 • Step 2

  6. Example: Balance Sheet (partial)

  7. Trend Percentages • Form of horizontal analysis • Indicates business direction • How have things changed over the years? • Select a period of three to five years • Base year, earliest year, is selected and set equal to 100% • Subsequent years expressed as a percentage of the base period

  8. E15-13: Horizontal analysis—income statement Data for Mariner Designs, Inc., follow: 1. Prepare a horizontal analysis of the comparative income statement of Mariner Designs, Inc. Round percentage changes to one decimal place.

  9. E15-13: Horizontal Analysis—Income Statement

  10. Vertical Analysis • Shows relationship of each item to a base amount on financial statements • Income statement–each item expressed as percentage of net sales • Balance sheet–each item expressed as percentage of total assets or total liabilities and equity. • Remember total assets = total liabilities and equity

  11. Example: Income Statement • Base amount • Percentage of the base amount

  12. Example: Balance Sheet • Base amount • Percentage of base

  13. S15-3 : Vertical analysis Tri-State Optical Company reported the following amounts on its balance sheet at December 31, 2012 and 2011: Prepare a vertical analysis of Tri-State assets for 2012 and 2011. 26.6 20.7 52.7 100.0 28.4 19.8 51.8 100.0

  14. Common-Size Statements • Common-size statements compare one company to another • Report only percentages (same as vertical analysis) • Remove dollar value bias

  15. Benchmarking • Comparing a company with another leading company • Two main types: • Against a key competitor • Against the industry average

  16. S15-4 :Common-size income statement Data for Martinez, Inc., and Rosado, Corp., follow: 1. Prepare common-size income statements.

  17. S15-4 :Common-size income statement (Continued) 2. Which company earns more net income? 3. Which company’s net income is a higher percentage of its net sales? Rosado Martinez

  18. Financial Ratios • No single ratio tells the whole picture • Different ratios explain different aspects • Types: • Evaluating ability to pay current liabilities • Evaluating ability to sell inventory and collect receivables • Evaluating ability to pay long-term debt • Evaluating profitability • Evaluating stock as an investment

  19. Following examples based Greg’s Tunes

  20. Following examples based Greg’s Tunes

  21. Ability to Pay Current Liabilities • Working capital • Measures ability to meet short-term obligations Working capital = Current assets – Current liabilities • Current ratio • Proportion of current assets to current liabilities Current assets Current liabilities Current ratio =

  22. Ability to Pay Current Liabilities • Acid-test ratio • Tells if company could pay all its current liabilities immediately • Normal range 0.20 to 1.00 depending upon industry Acid-test Ratio Cash + Short-term investments + Net current receivables Current liabilities =

  23. Ability to Sell Inventory and Collect Receivables • Inventory turnover ratio • Measures number of times a company sells inventory during a year • High rate indicates ease in selling • Low rate indicates difficulty in selling • Formula Cost of goods sold Average inventory Inventory turnover = Average Inventory 113,000 + 111,0002

  24. Ability to Sell Inventory and Collect Receivables • Days in inventory ratio • Measures the average number of days inventory is held by the company • Formula Days in inventory = 365 days Inventory turnover ratio

  25. Ability to Sell Inventory and Collect Receivables • Gross profit percentage • Measures the profitability of each net sales dollar • Formula Gross profitNet sales Gross profit percentage =

  26. Ability to Sell Inventory and Collect Receivables • Accounts receivable turnover ratio • Measures ability to collect cash from credit customers • Formula Net credit sales Average net accounts receivable Accounts receivable turnover = Average Net A/R 114,000 + 85,0002

  27. Ability to Sell Inventory and Collect Receivables • Days’ sales in receivables ratio • Measures ability to collect receivables • Formula Days’ sales in average accounts = receivable 365 days Accounts receivable turnover ratio

  28. Following examples based Greg’s Tunes

  29. Ability to Pay Long-Term Debt • Debt ratio • Shows portion of assets financed with debt • The higher the ratio, the higher the risk • Formula • Average debt ratio ranges from 57% to 67% Total liabilities Total assets Debt ratio =

  30. Ability to Pay Long-Term Debt • Debt to equity ratio • The proportion of total liabilities to the proportion of total equity that is financing the company’s assets • Formula Total liabilities Total equity Debt to equity =

  31. Ability to Pay Long-Term Debt • Times-interest-earned ratio • Measures number of times income can cover interest expense • High ratio indicates ease in paying interest • Formula Earnings Before Interest and Taxes Interest expense Times-interest earned ratio =

  32. Measuring Profitability • Return on net sales(Profit Margin) • Percent of each sales dollar earned as net income • Formula Rate of return on net sales Net income Net sales =

  33. Measuring Profitability • Return on total assets • Measures success in using assets to earn a profit • Formula Rate of return on total assets Net income + Interest expense Average total assets = Average Total Assets 787,000 + 644,0002

  34. Measuring Profitability • Asset turnover ratio • Measures the amount of net sales generated for each average dollar of total assets invested • Formula Net sales Average total assets Asset turnover ratio =

  35. Measuring Profitability • Return on common stockholders’ equity • How much income is earned for each dollar invested by common shareholders • Formula Rate of return on common stockholders’ equity Net income – Preferred dividends Average common stockholders’ equity = Average Total Assets 356,000 + 320,0002

  36. Measuring Profitability • Earnings per share • Net income earned for each share of outstanding common stock • Outstanding stock = Issued stock – Treasury stock • Formula Net income – Preferred Dividends Number of shares of common stock outstanding Earnings per shareof common stock = Note: 10,000 shares assumed for this example

  37. Analyzing Stock Investments • Price/earnings ratio (P/E) • Market price compared to earnings per share • Formula Market price per share of common stock Earnings per share P/E ratio =

  38. Analyzing Stock Investments • Dividend yield • Percentage of market value that is returned as dividends • Formula Dividend yield on common stock Annual dividends per share of common stock Market price per share of common stock =

  39. Analyzing Stock Investments • Dividend Payout • The ratio of annual dividends declared relative to the earnings per share of the company • Formula Annual dividends per share Earnings per share Dividend Payout =

  40. Analyzing Stock Investments • Book value • Common equity per share • Some argue its relevance to investors • Formula Book value per share of common stock Total stockholders’ equity – Preferred equity Number of shares of common stock outstanding =

  41. Note: Book value is not an indication of market Value of the stock • Balance sheet to the right is for Apple Computer • Book Value(09/29/2012) • 118,210,000,000/939,208,000= $125.86 • Market price per share at end of day on 12/27/2012 • $510.94

  42. Eastman Chemical (partial balance sheet as of 12/31,2011 & 12/31/2010) • Book Value @ 12/31/2011 is approximately $13.64 • Closing market price on 12/27/2012 $66.00 Dollar in millions

  43. Red Flags • Analysts look for red flags that may signal financial trouble • Recent accounting scandals highlight the importance of: • Movement of sales, inventory, and receivables • Earnings problems • Decreased cash flow • Too much debt • Inability to collect receivables • Buildup of inventory

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