2.0 Chapter 2 Intro to Financial Statements Analysis.
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Transcript of 2.0 Chapter 2 Intro to Financial Statements Analysis.
2.1
Chapter
2Intro to Financial Statements Analysis
2.2
Key Concepts and Skills
Know the difference between book value and market value
Know the difference between accounting income and cash flow
Know the difference between average and marginal tax rates
Know how to determine a firm’s cash flow from its financial statements
2.3
Key Concepts and Skills
Know how to standardize financial statements for comparison purposes
Know how to compute and interpret important financial ratios
Know the determinants of a firm’s profitability and growth
Understand the problems and pitfalls in financial statement analysis
2.4
Chapter Outline
The Balance SheetThe Income StatementTaxesCash Flow
2.5
Balance Sheet
The balance sheet is a snapshot of the firm’s assets and liabilities at a given point in time
Assets are listed in order of liquidityEase of conversion to cashWithout significant loss of value
Balance Sheet IdentityAssets = Liabilities + Stockholders’ Equity
2.6
Balance SheetAssets = Liabilities + Owners’ Equity
2.7
Market Vs. Book ValueThe balance sheet provides the book value of
the assets, liabilities and equity.Market value is the price at which the assets,
liabilities or equity can actually be bought or sold.
Market value and book value are often very different. Why?
Which is more important to the decision-making process?
2.8
Income Statement
2.9
Income Statement
The income statement is more like a video of the firm’s operations for a specified period of time.
You generally report revenues first and then deduct any expenses for the period
Matching principle – GAAP say to show revenue when it accrues and match the expenses required to generate the revenue
2.10
Ratio Analysis
Ratios also allow for better comparison through time or between companies
As we look at each ratio, ask yourself what the ratio is trying to measure and why is that information important
Ratios are used both internally and externally
2.11
Standardized Financial StatementsCommon-Size Balance Sheet
Compute all accts as % of Tot. AssetsCommon-Size Income Statements
Compute all accts as % of Sales
Standardized stmts make it easier to compare financial info, particularly as firm grows
Also useful for comparing co.’s of different sizes, particularly in same industry
2.12
Categories of Financial Ratios
Short-term solvency or liquidity ratiosLong-term solvency or financial leverage ratiosAsset management or turnover ratiosProfitability ratiosMarket value ratios
2.13
Sample Balance SheetCash 6,489 A/P 340,220
A/R 1,052,606 N/P 86,631
Inventory 295,255 Other CL 1,098,602
Other CA 199,375 Total CL 1,525,453
Total CA 1,553,725 LT Debt 871,851
Net FA 2,535,072 C/E 1,691,493
Total Assets 4,088,797 Total Liab. & Equity
4,088,797
Numbers in thousands
2.14
Sample Income StatementRevenues 3,991,997
Cost of Goods Sold 1,738,125
Gross Profit 2,253,872
Expenses 1,269,479
Depreciation 308,355
EBIT 739,987
Interest Expense 42,013
Taxable Income 697,974Taxes 272,210
Net Income 425,764
# Shs outstanding = 205,838.594
EPS $2.17
Dividends per share $0.86
Numbers in thousands, except EPS & DPS
2.15
Computing Liquidity Ratios
Current Ratio = CA / CL = 1.02 times
Quick Ratio = (CA – Inventory) / CL = .825 times
Cash Ratio = Cash / CL = .004 timesNet Working Capital= CA-CL
=
2.16
Long-term Solvency Measures
Total Debt Ratio = (TA – TE) / TA = .5863 times or 58.63%The firm finances almost 59% of their assets with
debt.
Debt/Equity = TD / TE = 1.417 times
Equity Multiplier = TA / TE = 1 + D/E = 2.417
2.17
Computing Coverage Ratios
Times Interest Earned = EBIT / Interest = 17.6 times
Cash Coverage = (EBIT + Depreciation) / Interest = 24.95 times
2.18
ASSET MGMT RATIOS:Computing Inventory RatiosInventory Turnover = Sales / Inventory
= 13.52 times
Days’ Sales in Inventory = 365 / Inventory Turnover = 27 days
2.19
Computing Receivables Ratios
Receivables Turnover = Sales / Accounts Receivable = 3.79 times
Days’ Sales in Receivables = 365 / Receivables Turnover = 96 days
2.20
Computing Total Asset Turnover
Total Asset Turnover = Sales / Total Assets = .98 times
Measure of asset use efficiencyNot unusual for TAT < 1, especially if a firm
has a large amount of fixed assets
2.21
Computing Profitability Measures
Profit Margin = Net Income / Sales = .1067 times or 10.67%
Return on Assets (ROA) = Net Income / Total Assets = .1041 times or 10.41%
Return on Equity (ROE) = Net Income / Total Equity = .2517 times or 25.17%
2.22
Computing Market Value Measures
Market Price = $61.625 per shareShares outstanding = 205,838,594PE Ratio = Price per share / Earnings per share
= 28.4 times
Market-to-book ratio = market value per share / book value per share = 7.5 times
2.23
Market Value MeasuresValue Stocks: Firms w/ low Mrkt to Book
ratios Growth Stocks: Firms w/ high Mrkt to Book
ratiosMarket Capitalization = Mrkt Value of
Common EquityEnterprise Value= MV equity + MV debt –
Cash – mrktbl securities. Measures value of firm’s underlying business
2.24
Using the Du Pont Identity
ROE = PM * TAT * EMProfit margin is a measure of the firm’s operating
efficiency – how well does it control costsTotal asset turnover is a measure of the firm’s asset
use efficiency – how well does it manage its assetsEquity multiplier is a measure of the firm’s financial
leverage
2.25
Payout and Retention Ratios
Dividend payout ratio = Cash dividends / Net income = .3963 or 39.63%
Retention ratio = Additions to retained earnings / Net income = 1 – payout ratio = .6037 = 60.37%Or = .6037 = 60.37%
2.26
The Internal Growth Rate
The internal growth rate tells us how much the firm can grow assets using retained earnings as the only source of financing.
%71.6
0671.bROA - 1
bROA RateGrowth Internal
2.27
The Sustainable Growth Rate
The sustainable growth rate tells us how much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt ratio.
%92.17
1792.bROE-1
bROE RateGrowth eSustainabl
2.28
Determinants of Growth
Profit margin – operating efficiencyTotal asset turnover – asset use efficiencyFinancial leverage – choice of optimal debt
ratioDividend policy – choice of how much to pay
to shareholders versus reinvesting in the firm
2.29
Why Evaluate Financial Statements?Internal uses
Performance evaluation – compensation and comparison between divisions
Planning for the future – guide in estimating future cash flows
External usesCreditorsSuppliersCustomersStockholders
2.30
BenchmarkingRatios are not very helpful by themselves; they
need to be compared to somethingTime-Trend Analysis
Used to see how the firm’s performance is changing through time
Internal and external usesPeer Group Analysis
Compare to similar companies or within industriesSIC and NAICS codes
2.31
Quick QuizHow do you standardize balance sheets and income
statements and why is standardization useful?What are the major categories of ratios and how do
you compute specific ratios within each category?What are the major determinants of a firm’s growth
potential?What are some of the problems associated with
financial statement analysis?
2.32
Taxes
The one thing we can rely on with taxes is that they are always changing
Marginal vs. average tax ratesMarginal – the percentage paid on the next dollar
earnedAverage – the tax bill / taxable income
Other taxes
2.33
Example: Marginal Vs. Average RatesSuppose your firm earns $4 million in taxable
income.What is the firm’s tax liability?What is the average tax rate?What is the marginal tax rate?
If you are considering a project that will increase the firm’s taxable income by $1 million, what tax rate should you use in your analysis?
2.34
The Concept of Cash FlowCash flow is one of the most important pieces
of information that a financial manager can derive from financial statements
The statement of cash flows does not provide us with the same information that we are looking at here
We will look at how cash is generated from utilizing assets and how it is paid to those that finance the purchase of the assets
2.35
2.36
Cash Flow Problem 2-19Belyk Paving has sales of $2,000,000. COGS,
SGA, and depreciation expenses were $1,200,000, $300,000, & $400,000 respectively. It also had interest expense of $150,000, & a 35% tax rate. Ignore any tax loss carry back or forward provisions,
What is the Net Income?What is the Operating Cash Flow?
2.37
2.38
Quick QuizWhat is the difference between book value and
market value? Which should we use for decision making purposes?
What is the difference between accounting income and cash flow? Which do we need to use when making decisions?
What is the difference between average and marginal tax rates? Which should we use when making financial decisions?
How do we determine a firm’s cash flows? What are the equations and where do we find the information?