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Chapter Eight

Chapter Eight. Financial Statement Analysis. Learning Objectives. 1. Understand the relationship of income the statement, balance sheet, and cash flow. 2. Breakdown and analyze ratios in six major categories. 3. Explain how the ratios can be applied to a specific company.

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Chapter Eight

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  1. Chapter Eight Financial Statement Analysis

  2. Learning Objectives 1. Understand the relationship of income the statement, balance sheet, and cash flow. 2. Breakdown and analyze ratios in six major categories. 3. Explain how the ratios can be applied to a specific company. 4. Be able to do long-term trend analysis based on the ratios. 5. Explain potential deficiencies of the published financial statements.

  3. The Major Financial Statements • Financial statements present a numerical picture of a company’s financial and operating health, for a given period. • Income Statement • Balance Sheet • Statement of Cash Flows • Analysts also need to examine industry characteristics and differences in accounting methods.

  4. Table 8-1. Coca-Cola Income Statement Defined period Net income Earnings per share

  5. The Balance Sheet • Delineates the firm's assets and liabilities • Provides a measure of the firm's worth

  6. Table 8-2. Coca-Cola Balance Sheet (Assets)

  7. Table 8-2. Coca-Cola Balance Sheet (Liab. and equity.

  8. Figure 8-1 Illustration of Concepts Behind Statement of Cash Flows Cash Inflows Cash Outflows Cash flows fromoperating activities Generation of funds in normal operations Expenditure of funds in normal operations Sale of plantand equipment Cash flows frominvesting activities Purchase of plant and equipment Sale of bonds, common stock, preferred stock, and other securities Retire or repurchase of bonds, common stock,preferred stock, andother securities and payment of cash dividends Cash flows fromfinancing activities Add items 1, 2 and 3 together to arrive at net change in cash

  9. Table 8-3. Coca-Cola Statement of Cash Flow

  10. Use of Ratios • Performance Evaluation • Industry Comparisons • Oligopolistic Industries • Competitive Industries • Domestic and International Markets • Breakdown of Profits and Sales among the different markets/products • Impact of Use of Derivatives on Financial Statements • Political and Economic Events Worldwide • Long-Term Trend Analysis of Performance

  11. Oper. Income Sales = 18.04% 1.Oper. Margin = 2. After-Tax a Profit Margin Net Income Sales = 10.64% = Key Coca-cola Financial Ratios (profitability) A. Profitability Ratios measure the ability of the firm to earn an adequate return on sales, total assets and invested capital.

  12. Net Income Total Assets Sale___ Total Assets Sales Net Income x = Net Income Total Assets = 10.45% 3. Return on Assets = Key Coca-cola Financial Ratios (profitability) "Return on Assets" can also be calculated by using the "Return on Assets" and the "Asset Turnover" ratios = 10.64% x .982 = 10.45% • The McGraw-Hill Companies, Inc.,1999

  13. Net Income Stockholders’ Equity 4. Return on Equity = = 23.37% Return on Assets_ (1 - Debt/Assets) 10.45% 1 - .5528 ROE = = Key Coca-cola Financial Ratios (profitability) Another form of the ROE ratio. = 23.37% • The McGraw-Hill Companies, Inc.,1999

  14. Net Income Profit Margin ÷ Sales x Total Assets ÷ Asset Turnover Total Assets Return on Equity Total Debt Financial Leverage ÷ Total Assets Figure 8-2 Du Pont Analysis Return on assets ÷ (1 - debt/assets)

  15. 5. Receivables Turnover = 7. Fixed Asset Turnover = 8. Total Asset Turnover = 6. Inventory Turnover = Sales Fixed Assets Sales Receivables Sales Inventory Sales Total Asset = 19.98x = .982x = 3.09x = 11.64x Key Coca-cola Financial RatiosAsset Utilization Ratios B. Asset utilization ratios measure the speed at which the firm is turning over accounts receivable, inventory and longer-term assets.

  16. Current Assets Current Liabilities 9. Current Ratio = = .7102 Current Assets - Inventory Current Liabilities 10. Quick Ratio = = .596 Current Assets -Current Liab. Total Assets 11. NWC to TA = =.1246 Key Coca-cola Financial RatiosLiquidity Ratios C. Liquidity Ratios determine the firm’s ability to pay off short-term obligations as they come due

  17. L.t. Debt Stockholders Equity 12. L-T Debt to Equity = = 8.96x Total Debt Total Assets EBIT____ Total Interest 13. T. Debt to T. Assets = = 55.28x 14. Times Interest Earned = = 8.26x 15. Fixed-Charge Coverage = = 8.26x Earnings before fixed charges & taxes Fixed charges & taxes Key Coca-cola Financial RatiosDebt Utilization Ratios D. Debt-Utilization Ratios provide an indication of the way the firm is financed between debt (lenders) and equity (owners) and therefore help the analyst deter-mine the amount of financial risk present in the firm.

  18. Common Stock price Earnings per share 16. Price to earnings = = 8.96x Common Stock price Book value per share 17. Price to book value = =55.28x Dividends per share_ Total Interest 18. Dividends to price = = 8.26x (Dividend Yield) Key Coca-cola Financial Ratios Price Ratios E. Price ratios relate the internal performance to the external judgement of the marketplace in terms of value.

  19. Table 8-4 Price Earnings Ratios for Selected U.S. Corporations (Table 8-4) a P/E ratio is calculated by taking the market price and dividing by the previous 12 months’ earnings per share. b cc indicates that the P/E ratio is 100 or more Source: Selected issues of Barron’s.

  20. Income Tax Taxable Income 19. Average Tax Rate = = 24.02% Dividends/Share Earnings/Share 20. Dividend Payout = = 35.71% Other Ratios F. Other Ratios help the analyst spot special tax situations that affect the profitability of the firm.

  21. Asia Pacific 25% North America 39% Asia Pacific 25% North America 18% Latin America 11% Latin America 10% Europe and Eurasia 21% Europe and Eurasia 21% Africa & Middle East 4% Africa & Middle East 4% Asia Pacific 21% North America 17% Latin America 12% Europe and Eurasia 26% Africa & Middle East 4% Net operating revenues by operating segment

  22. Asia Pacific 20% North America 29% Latin America 19% Europe & Eurasia 30% 2000 Africa & Middle East 2% North America 24% Asia Pacific 20% Asia Pacific 26% North America 31% Latin America 19% Latin America 18% Europe & Eurasia 29% Europe & Eurasia 23% Africa & Middle East 4% Africa & Middle East 2% 1999 Operating Income by Operating Segment 1998

  23. Graphical Presentation, Coca-Cola

  24. Deficiencies of Financial Statements • Inflation Effects • Revenues and profits are stated in current dollars whereas assets are stated on historical or original cost basis. • In 1979, the FASB issued a ruling which required 1,300 large companies to disclose inflation adjusted accounting data in their annual reports. Currently compliance with ruling is optional.

  25. Deficiencies of Financial Statements • Inflation Effects • Industries most sensitive to inflation-induced profits are those with cyclical products such as lumber, copper, food products as well as those in which inventory is a significant percentage of sales and profits. • In an inflationary period, a company may report higher “phantom” profits even though no actual increase in output occurred.

  26. Inventory Valuation • In an inflationary period, a company may report higher “phantom” profits even though no actual increase in output occurred. • FIFO produces higher profit margins and more income. • LIFO costing relates current costs to current prices, dollar profits increase but profit margins remain the same. LIFO leads to understatement of inventories.

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