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FSA in the Boardroom

This presentation delivered to the REI Board on November 22, 2004, focuses on utilizing financial statement analysis (FSA) to improve understanding of organizational performance. Key topics include exploratory analysis, the quality of accounting, Dupont analysis, credit risk assessment, and financial valuation. The analysis reveals significant differences in stock returns of major players like Walmart and Costco, addressing questions of trust in financial numbers and how to enhance performance through strategic insights and data interpretation.

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FSA in the Boardroom

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  1. FSA in the Boardroom by Carlos A. Mello-e-SouzaSeattle University Presentation to the Board of REI on 11-22-2004

  2. - What do I expect?- Can I trust these numbers?- What is really going on?- How can performance be improved? Presentation to the Board of REI on 11-22-2004

  3. Presentation to the Board of REI on 11-22-2004

  4. Idea: Use FSA to generate questions such that the answers will enlighten and generate further questions. Presentation to the Board of REI on 11-22-2004

  5. Stock prices: COST, WMT, SP-500 COST$47 WMT$55 Presentation to the Board of REI on 11-22-2004

  6. Question: Why has the return on Wal Mart’s stock between November 2002 and November 2004 been close to zero, while COSTCO has returned almost 50 % ? Presentation to the Board of REI on 11-22-2004

  7. Plan: • Exploratory Analysis • Analysis of Quality • Dupont Analysis • Analysis of Credit Risk • Financial Planning and Valuation • Conclusion Presentation to the Board of REI on 11-22-2004

  8. 1. Exploratory Analysis - Start with the raw statements; - Look for structure, structural changes; - Observe trends and cycles; - Compare with other companies. Example: ... Presentation to the Board of REI on 11-22-2004

  9. Costco Presentation to the Board of REI on 11-22-2004

  10. Costco Presentation to the Board of REI on 11-22-2004

  11. Wal-Mart Presentation to the Board of REI on 11-22-2004

  12. Wal-Mart Presentation to the Board of REI on 11-22-2004

  13. 2. Quality of Accounting Do financial reports and other means of communication provide relevant, reliable and transparent information to investors ? Is accounting being manipulated to convey an image that does not represent the business faithfully ? Presentation to the Board of REI on 11-22-2004

  14. Accounts most often subject to manipulation AAER-1 to AAER-1745 on 294 firms that manipulated 426 different accounts. (Dechow) Presentation to the Board of REI on 11-22-2004

  15. 3. Dupont Analysis  Return on Equity ROE = ROA + ( Leverage x Spread )  Return on Assets ROA = Profit Margin x Asset Turnover Presentation to the Board of REI on 11-22-2004

  16. Map of ROA breakdown for 248 3-digit SIC industry groups from 1970 to 2001 (medians) (Soliman 2003, Dechow) Presentation to the Board of REI on 11-22-2004

  17. Wal-Mart in 2003: Dupont analysis Presentation to the Board of REI on 11-22-2004

  18. WMT vs. COST ROA in 1999 Presentation to the Board of REI on 11-22-2004

  19. WMT vs. COST ROA in 2000 Presentation to the Board of REI on 11-22-2004

  20. WMT vs. COST ROA in 2001 Presentation to the Board of REI on 11-22-2004

  21. WMT vs. COST ROA in 2002 Presentation to the Board of REI on 11-22-2004

  22. WMT vs. COST ROA in 2003 Presentation to the Board of REI on 11-22-2004

  23. WMT vs. COST ROE in 1999 Presentation to the Board of REI on 11-22-2004

  24. WMT vs. COST ROE in 2000 Presentation to the Board of REI on 11-22-2004

  25. WMT vs. COST ROE in 2001 Presentation to the Board of REI on 11-22-2004

  26. WMT vs. COST ROE in 2002 Presentation to the Board of REI on 11-22-2004

  27. WMT vs. COST ROE in 2003 Presentation to the Board of REI on 11-22-2004

  28. Dupont conclusions: - WMT beats COST in ROA and ROE every year (99-03). - The ROA gap has shrunk. Therefore maintenance of the ROE gap has come at a higher level of debt and risk. - WMT has suffered a steady decline in ATO; PM recovers in 03 because of lower ETR and other transitory items. Presentation to the Board of REI on 11-22-2004

  29. Dupont questions: - Why are WMT’s asset turnover and profit margin falling? (ROA goes from 16.3% to 12.6%, before recovering) - Why is WMT’s effective tax rate falling? (37.4% to 35.3% of EBT) - Why is the investment in operating LT assets relatively so much higher? (67 to 86 days of sales!) Presentation to the Board of REI on 11-22-2004

  30. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  31. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  32. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  33. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  34. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  35. Wal-Mart’s business segments Presentation to the Board of REI on 11-22-2004

  36. 4. Analysis of Credit Risk - Multivariate models of the association between p(default) and accounting and/or market-based measures. - OPM approach (e.g.: Moody’s KMV). Presentation to the Board of REI on 11-22-2004

  37. 5. Valuation  of equity, debt, or the “enterprise” Presentation to the Board of REI on 11-22-2004

  38.  ... and value can be based on CASH Presentation to the Board of REI on 11-22-2004

  39.  ... or on “RESIDUAL” EARNINGS Presentation to the Board of REI on 11-22-2004

  40. Valuation of WMT’s Equity market balance sheet cash earnings Presentation to the Board of REI on 11-22-2004

  41. Valuation of Costco’s Equity market balance sheet cash earnings Presentation to the Board of REI on 11-22-2004

  42. 6. Conclusion Analytical tools such as:- Dupont ratios - credit and manipulation risk models - corporate valuation modelsbased on spreadsheets can be used by senior management to assist in understanding and verifying financial reports. Presentation to the Board of REI on 11-22-2004

  43. Analytical tools are a helpful, but blunt instrument. Their biggest strength lies in guiding the investigation and thought processes:- Can I trust these figures? - How can we improve firm value? Presentation to the Board of REI on 11-22-2004

  44. Presentation to the Board of REI on 11-22-2004

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