1CHAPTER

Overview of FinancialStatement Analysis

1-2

Business Analysis

Evaluate Prospects Evaluate Risks

Business Decision Makers• Equity investors• Creditors• Managers• Merger and Acquisition Analysts• External Auditors• Directors• Regulators• Employees & Unions• Lawyers

1-3

Information Sources forBusiness Analysis

Quantitative• Financial Statements• Industry Statistics• Economic Indicators• Regulatory filings• Trade reports

Qualitative• Management

Discussion &Analysis

• Chairperson’s Letter• Vision/Mission

Statement• Financial Press• Press Releases• Web sites

1-4

Types of BusinessAnalysis

Credit Analysis Equity Analysis

Management & Control

Mergers, Acquisitions& Divestitures

Director OversightRegulation

External Auditing

Labor Negotiations

Financial Management

1-5

Types of BusinessAnalysis

Credit Analysis Equity Analysis

Management & Control

Mergers, Acquisitions& Divestitures

Director OversightRegulation

External Auditing

Labor Negotiations

Financial Management

1-6

Trade Creditors• Provide goods or

services• Most short-term• Usually implicit

interest• Bear risk of default

Non-trade Creditors• Provide major financing• Most long-term• Usually explicit interest• Bear risk of default

Creditors

Credit Analysis

1-7

Credit Analysis

LiquidityAbility to meet short-term obligations Focus:• Current Financial

conditions• Current cash flows• Liquidity of assets

SolvencyAbility to meet long-term obligations Focus:• Long-term financial

conditions• Long-term cash flows• Extended profitability

Credit worthiness: Ability to honor credit obligations(downside risk)

1-8

Seniority - order claims are paidCollateral - asset earmarked for claimsCovenants - constraints on debtholders

to protect creditorsOther provisions - sinking fund

requirements, etc.

Debt Characteristics

Credit Analysis

1-9

Types of BusinessAnalysis

Credit Analysis Equity Analysis

Management & Control

Mergers, Acquisitions& Divestitures

Director OversightRegulation

External Auditing

Labor Negotiations

Financial Management

1-10

Equity Analysis

Passive InvestingAim:• Diversification based

on risk propensity &investment horizon

Example: Indexing

Active InvestingAim:• Beat the market --

earn above normal stock returns

Examples: Technicalanalysis & Fundamentalanalysis

1-11

Intrinsic Value(or Fundamental Value)

Intrinsic value > Market value Buy Intrinsic value < Market value Sell Intrinsic value = Market value Hold

Value of Company (or stock) withoutreference to market value (or stock price)

Str

ateg

y

1-12

Types of BusinessAnalysis

Credit Analysis Equity Analysis

Management & Control

Mergers, Acquisitions& Divestitures

Director OversightRegulation

External Auditing

Labor Negotiations

Financial Management

1-13

Components ofBusinessAnalysis

ProspectiveAnalysis

AccountingAnalysis

BusinessEnvironment &

Strategy Analysis

Analysisof Sources&Uses of

FundsProfitability

Analysis

RiskAnalysis

Cost of Capital Estimate Intrinsic Value

Industry Analysis

Strategy Analysis

FinancialAnalysis

1-14

Comparability problems — across firms and across time

Manager estimation error

Distortion problems Earnings management

Distortion of business

AccountingRisk

Process to evaluate and adjust financialstatements to better reflect economic reality

Accounting Analysis

1-15

Profitability analysis — Evaluate return on investments

Risk analysis ——— Evaluate riskiness & creditworthiness

Sources and uses —Evaluate source & of funds analysis deployment of funds

Common tools

Ratioanalysis

Cash flow

analysis

Process to evaluate financial position andperformance using financial statements

Financial Analysis

1-16Intrinsic Value

Business Environment& Strategy Analysis

Accounting Analysis

Financial Analysis

Process to forecast future payoffs

Prospective Analysis

1-17

Planning Activities:

Goals& Objectives

Competition Pricing

Market demands Tactics

Promotion

Managerial performance

Opportunities

Projections

Distribution

Business Activities

Obstacles1-18

Financing

Financing activities

• Owner (equity)

• Nonowner (liabilities)

Business Activities

1-19

Investing Financing

Investing activities

• Buying resources

• Selling resources

Investing = Financing

Business Activities

1-20

PlanningActivitiesInvesting

ActivitiesFinancialActivities

Operating ActivitiesRevenues and expenses from providing

goods and services

Business Activities

1-21

Financial Statements Reflect Business Activities

PlanningInvesting

Current:l Cashl Accounts Receivablel Inventoriesl Marketable SecuritiesNoncurrent:l Land, Buildings, &

Equipmentl Patentsl Investments

Assets

Balance Sheet

FinancingCurrent:l Notes Payablel Accounts Payablel Salaries Payablel Income Tax PayableNoncurrent:l Bonds Payablel Common Stockl Retained Earnings

Liabilities & Equity

Balance Sheet

Statement ofShareholders’ Equity

Operating

l Salesl Cost of Goods Soldl Selling Expensel Administrative Expensel Interest Expensel Income Tax Expense

Net Income

Income statement

Cash Flow

Statement ofCash Flows

1-22

KodakDec 31, 1998 (In millions, except per share data)

Liabilities andAssets Shareholders’ EquityCurrent Assets

Current Liabilities Cash and cash equivalents $ 457 Payables $ 3,906 Marketable securities 43 Short-term borrowings 1,518 Receivables 2,527 Taxes - income and other 593 Inventories 1,424 Dividends payable 142 Deferred income tax charges 855 Deferred income tax credits 19 Other 293 Total current liabilities 6,178 Total current assets 5,599 Other LiabilitiesProperties Long-term borrowings 504 Land, buildings and equipment at cost 13,482 Post-employment liabilities 2,962 Less: Accumulated depreciation 7,568 Other long-term liabilities 1,032 Net properties 5,914

Deferred income tax credits 69Other Assets

Total liabilities 10,745 Goodwill (net of accumulated amortization of $534) 1,232 Shareholders' Equity

Long-term receivables andother non-current assets 1,705 Common stock, par value $2.50 per share,

Deferred income tax charges 950,000,000 shares authorized; issued

Total Assets 391,292,760 shares Additional paid in capital

978

Retained earnings902

Accumulated other comprehensive loss 6,163

(111)

Treasury stock, as cost, 68,494,402 shares7,932

Total shareholders' equity3,944

Total liabilities and equity3,988

$ 14,733

283

$ 14,733

1-23

Income StatementKodak

For Year Ended Dec. 31, 1998 (In millions, except per share data)

Sales $13,406Cost of goods sold 7,293Gross profit 6,113Selling, general and administrative expenses 3,303Research and development costs 880Purchased research and development 42Restructuring costs and asset impairments - EARNINGS FROM OPERATIONS 1,888Interest expense 110Other income (charges) 328Earnings before income taxes 2,106Provision for income taxes 716Earnings from continuing operations 1,390Gain on sale of discontinued operations - NET EARNINGS $ 1,390

1-24

Statement of Shareholders’ EquityKodak

For year ended Dec. 31, 1998Accumulated

Additional OtherCommon Pail In Retained Comprehensive Treasury

(In millions, except number of shares) Stock Capital Earnings Income (Loss) Stock TotalShareholders’ Equity Dec 31, 1997 978 914 5,343 (202) (3,872) 3,161Net earnings - - 1,390 - - 1,390Other comprehensive income (loss): Unrealized holding gains arising during period ($122 million pre-tax) - - - - - 80 Reclassification adjustment for gains included

in net earnings ($66 million pre-tax) - - - - - (44)

Currency translation adjustment - - - - - 59 Minimum pension liability adjustment ($7 million pre-tax) - - - - - (4) Other comprehensive income - - - 91 - 91Comprehensive income - - - - - 1,481Cash dividends declared - - (570) - - (570)

Treasury stock repurchased (3,541,295 shares) - - - - (258) (258)Treasury stock issued under employee plans (3,272,713 shares) - (58) - - 186 128

Tax reductions - employee plans - 46 - - - 46

Shareholders’ Equity Dec 31, 1998 $978 $902 $6,163 ($111) ($3,944) $3,988

1-25

Statement of Cash Flows

Cash flows from operating activities:Earnings from continuing operations $ 1,390Adjustments to reconcile to net cash provided by operating activities: Depreciation and amortization Purchased research and development Provisions (benefit) for deferred income taxes (Gain) loss on sale/retirement of assets (Increase) decrease in receivables (1) (Increase) decrease in inventories (Decrease) increase in liabilities excluding borrowings (516) Other items, net (278)

Total adjustments 931,483

Cash flow from Investing activities: Additions to properties (1,108) Proceeds from sale of assets Cash flows related to sales of businesses (59) Acquisitions, net of cash acquired (949) Marketable securities - sales 162 Marketable securities - purchases (182)

Net cash used in investing activities (1,839)Cash flows from financing activities: Net increase (decrease) in borrowings with original maturities of 90 days or less 894 Proceeds from other borrowings 1,133 Repayment of other borrowings (1,251) Dividends to shareholders (569) Exercise of employee stock options 128 Stock repurchase programs (258)

Net cash provided by (used in) financing activities 77Effect of exchange rate changes on cash 8Net (decrease) increase in cash and cash equivalents (271)

KodakFor year Ended Dec. 31, 1998 (In millions)

Net cash provided by operating activities

(166)

42 853

202

(43)

297

1-26

FinancialStatement Links- Kodak

Statement of Cash Flows for Year Ended Dec. 31, 1998Operating Cash flows $ 1,483 Investing Cash flows (1,839)Financing Cash flows 77Exchange rate changes on cash 8Net Change in Cash $ (271)Cash Balance, Dec. 31, 1997 728Cash Balance, Dec. 31, 1998 $ 457

Statement of Shareholders’ Equity for Year Ended Dec. 31, 1998

Share Capital, Dec. 31, 1997 $ 1,892 Adjustments/Stock Issue (12)Share Capital, Dec. 31, 1998 $ 1,880

Retained Earnings, Dec. 31, 1997 $ 5,141Add: Comprehensive Income 1,481 Less: Dividends (570)Retained Earnings, Dec. 31, 1998 $ 6,052

Treasury Stock, Dec. 31, 1997 $ 3,872Treasury Stock Issued 186Treasury Stock Repurchased (258)Treasury Stock, Dec. 31, 1998 $ 3,944

Income Statement

for Year Ended Dec. 31, 1998Sales $13,406 Expenses 12,016 Net Earnings $ 1,390 Other Comprehensive Income 91 Comprehensive Income $ 1,481

Balance Sheet Dec. 31, 1997

Assets Cash $ 728 Non-Cash Assets 12,417 Total Assets $13,145

Liabilities & Equity Total liabilities $ 9,984 Equity: Share Capital 1,892 Retained Earnings 5,141 Treasury Stock (3,872) Total equity $ 3,161 Liabilities & Equity $13,145

Balance Sheet Dec. 31, 1998

Assets Cash $ 457 Non-Cash Assets 14,276 Total Assets $14,733

Liabilities & Equity Total liabilities $10,745 Equity: Share Capital 1,880 Retained Earnings 6,052 Treasury Stock (3,944) Total equity $ 3,988 Liabilities & Equity $14,733

(Period of time)

(Period of time)(P

erio

d of

tim

e)

1-27

Additional Information(Beyond Financial Statements)

•Management Discussion & Analysis (MD&A)•Management Report•Auditor Report•Notes to Financial Statements•Supplementary Information (10-K, 10-Q, 8-K, 20-F)•Proxy Statement•Social Responsibility Report

1-28

Analysis Preview

Purpose: Evaluation of consecutive financial statements

Output: Direction, speed, & extent of anytrend(s)

Types: • Year-to-year Change Analysis • Index-Number Trend Analysis

Comparative AnalysisYr2Yr1 Yr3

1-29

Analysis PreviewYear-to-Year Analysis

Kodak's Comparative Income Statements

1998 1997 Change Change (in mil.) %

Sales $ 13,406 $14,538 ($ 1,132) (7.8)%Cost of goods sold 7,293 7,976 (683) (8.5)Gross profit $ 6,113 $ 6,562 ($ 449) (6.8)Operating Expenses: Selling, general and admin. 3,303 3,912 (609) (15.6) Research and development 922 1,230 (308) (25.0) Restructuring costs - 1,290 (1,290) (100)Earnings from operations $ 1,888 $ 130 $ 1,758 1,352Interest Expense 110 98 12 (12.2)Other income (charges) 328 21 307 1,461Earnings before income taxes $ 2,106 $ 53 $ 2,053 3,873Provision for income taxes 716 668 1,391Net earnings $ 1,390 $ 1,385 27,700

48

$ 5

1-30

Analysis Preview

Index-Number Trend Analysis

Kodak's Index - Number Trend Series (base year 1994)

1998 1997 1996 1995 1994Sales 99 107 117 110 100Total operating expenses 94 118 115 106 100Earnings from operations 144 10 141 148 100Net earnings 249 1 182 224 100Total assets 98 88 96 97 100Shareholders' equity 99 79 118 127 100

1-31

Analysis Preview

Purpose : • Evaluation of internal makeup of financial statements

• Evaluation of financial statementaccounts across companies

Output: Proportionate size of assets,liabilities, equity, revenues, &expenses

Common-Size Analysis

1-32

Analysis PreviewCommon-Size Analysis

Kodak's Common-Size Income Statements

1998 1997

Sales 100.0% 100.0%Cost of goods sold 54.4 54.9 Gross profit

10.4%

Selling, general and administrative expenses 24.6 26.9Research and development costs 6.9 8.5Restructuring Costs 0 8.9Earnings from operationsInterest expense 0.8 0.7Other income 2.4 0.1Earnings before income taxesProvision for income taxes 5.3 0.3Net earnings

45.6%

15.7%

14.1% 0.9%

45.1%

0.3%

0.0%

1-33

Analysis Preview

Purpose : Evaluate relation between two or more economically important items (one starting point for further analysis)

Output: Mathematical expression of relation between two or more items

Cautions: •• Prior Accounting analysis is important•• Interpretation is key -- long vs short

term & benchmarking

Ratio Analysis

1-34

Analysis Preview

Purpose: Estimate intrinsic value of a company (or stock)Basis: Present value theory (time value of

money)

Valuation

Valuation - an important goal of many typesof business analysis

1-35

Analysis in an Efficient Market

Three assumed forms of market efficiency

Weak Form - prices reflect information in past prices

Semi-strong Form - prices reflect all publicinformation

Strong Form - prices reflect all public and private information

1-36

Analysis in an Efficient Market

• Market Efficiency• assumes competent and informed analysis• distinguish aggregate from individual behavior• reflects information (both reliable and unreliable)• cross-country differences in rewards to analysis

• Financial statement analysis relevant tomore than just market analysis, e.g.,• credit and lending• auditing• valuation of nonpublicly traded firms• mergers and acquisitions• etc...