Financial Statement Analysis

1. Financial Statement Analysis

2. Managers Officers Internal Auditors Shareholders Lenders Customers Purpose of Analysis Financial statement analysis helps users make better decisions. Internal Users External Users

3. Purpose of Analysis

4. Outcomes • Describe meaning and usage of financial statement analysis • 3 Types of Analysis • 5 Types of Financial Ratios

5. numbers versus ratios Ratio Analysis Why? EX : COMPANY AA BB NET INCOME $ 1,000,000 $ 10,000 TOTAL ASSETS $ 5,000,000 $ 20,000 NI / TA 0.20 = 20% 0.50 = 50%

6. Ratio Analysis • Types of ratio analysis • Industry Comparative You Industry average NI / TA 28 % 22 % To compare with the average of the companies in the same industry (your performance is higher or lower than the mean?)

7. Ratio Analysis • Types of ratio analysis • Trend or time series YEAR 2001 2002 2003 NI / TA 22 % 23 % 25 % To compare with yourself along the period of time (your performance is improving or getting worse?)

8. Ratio Analysis • Types of ratio analysis • Cross-sectional COMPANY You C1 C2 C3 NI / TA 28 % 19 % 22 % 36 % To compare with your main competitors (your performance is better or worse than them?)

9. Types of Financial Ratios • Liquidity • Asset Management (Efficiency) • Debt Management (Financial Leverage) • Profitability • Market Value

10. 1. Liquidity Ratios = Ability to pay current obligations (S-T debts; A/P, N/P) By using current sources of cash (Current Assets) • Current ratio = CA ÷ CL Example You Co1 Co2 Current ratio 1.20 1.00 0.70 Analysis Good Normal Bad • Quick or acid-test ratio = (CA - Inventories) ÷ CL Inventories are the least liquid current assets so exclude it out

11. 2. Asset Management Ratios = Measure how efficient the assets can turn into sales $$$ $$$ $$$$ $$$$ (Investment) $ 1,000,000 (Sales) $ 3,000,000 • Meaning: investing $1 can generate sales $3

12. 2. Asset Management Ratios • Inventory Turnover = COGS ÷ Inventory • Average collection period (ACP) = A/R x 365 ÷ S • Receivables Turnover = S ÷ A/R Example: A/R = $100, Sales = $3,650 ACP = A/R x 365 ÷ S ACP = $100 x 365 days ÷ $3,650 ACP = 10 days 0 10 days • Meaning: Make sales today Collect cash from customer

13. Inventory Turnover Cost of Goods Sold Average Inventory = Inventory Turnover $140,000 ($10,000 + $12,000) ÷ 2 = = 12.73 times Inventory Turnover Rate This ratio measures the number of times merchandise inventory is sold and replaced during the year.

14. Accounts Receivable Turnover Net Sales AverageAccounts Receivable = Accounts Receivable Turnover $500,000 ($17,000 + $20,000) ÷ 2 = = 27.03 times Accounts Receivable Turnover Rate This ratio measures how many times a company converts its receivables into cash each year.

15. Average Collection Period 365 Days Accounts Receivable Turnover = Average Collection Period 365 Days 27.03 Times = = 13.50 days Number of Days to Collect Receivables This ratio measures, on average, how many days it takes to collect an account receivable.

16. 2. Asset Management Ratios • Fixed Asset Turnover = Sales ÷ Fixed Assets • Total Asset Turnover = Sales ÷ Total Assets Example You Co1 Co2 Sales $ 3 m $ 1 m $ 1.4 m Total Assets $ 1 m $ 1 m $ 2 m TATO 3.00 1.00 0.70 Analysis Good Normal Bad

17. 3. Debt Management Ratios = How much the firm has borrowed to make an investment = Ability of a firm to meet total debt obligations (S-T & L-T) • Debt ratio = TL ÷ TA • Total Debt to Equity ratio = TL ÷ TE Brown Co. Green Co. TL TA TL TA TA $100,000 TL $ 80,000 TA $100,000 TL $ 20,000 80 % 20 % = = TE $ 80,000 TL TE TL TE 4x 0.25x = = TE $ 20,000

18. 4. Profitability Ratios = Ability to earn profit generated from sales = Ability to control costs, expenses • Gross Profit Margin • = Gross Profit / Sales • How many %profit left after paying cost of goods sold • Higher  good control of cost of goods sold • Lower  cost of goods sold are too high

19. 4. Profitability Ratios (cont.) • Operating Profit Margin • = EBIT / Sales • How many %profit left after paying cost of goods sold and operating expense • Higher  good control of both CGS and operating exp • Lower  CGS and operating expense are too high

20. 4. Profitability Ratios (cont.) • Net Profit Margin (NPM) = NI to CS ÷ S Ex : Co. 1 Co. 2 Sales 100,000 100,000 - expenses - 40,000 - 60,000 NI to CS 60,000 40,000 NPM 60 % 40 %

21. 4. Profitability Ratios (cont.) • Return on Assets (ROA) = NI to CS ÷ TA = How much is the profit from $ 1 total investment Example : Brown Co: TA = $100,000 NICS = $10,000 ROA = 10% Green Co : TA = $100,000 NICS = $20,000 ROA = 20% • Return on Equity (ROE) = NI to CS ÷ CE = How much is the profit from $ 1 owners’ investment CE = Investment from Common Shareholders = CS par + Paid in + RE

22. 5. Market Value Ratios = How much the investors value the firm in the market = Tell you what investors think about the firm’s future • Price to earnings ratio (P/E) = Market price per share Earnings per share **Earnings per share = NI to CS ÷ # of Common Shares = How much the investors are willing to pay for each $ 1 of earnings per share (EPS)

23. 5. Market Value Ratios (cont.) • Dividend Yield (DY) = DPS Market price per share • Dividend per share (DPS) = Dividends to CS # of Common Shares

24. Dividend Yield Ratio Dividends Per Share Market Price Per Share = Dividend Yield Ratio $1.50 $15.25 = = 9.84% Dividend Yield Babson Builders pays an annual dividend of $1.50 per share of capital stock. The market price of the company’s capital stock was $15.25 at the end of 2007. This ratio identifies the return, in terms of cash dividends, on the current market price of the stock.