Cash flows and financial anayisis ppt @ bec doms

Cash Flows andFinancial Analysis

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Users of Financial Information

Investors and Financial Analysts Make judgments about the firm’s securities Financial Analysts report to investment community

Vendors Sell to the firm on credit

Management Hi-light areas in which attention will improve

performance

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SOURCES OF FINANCIAL INFORMATION

Annual Report Management's report

card to stockholders on own performance

Positively biased

The primary source of financial information

Required of publicly traded companies

Must be audited

Other SourcesReports from brokerage firms and advisory services

Value Line

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STATEMENT of CASH FLOWS

Businesses run on cash, not accounting profits

Statement of Cash Flows Also called or Sources and Uses of Cash or

Statement of Changes in Financial Position Shows where money comes from - goes to Developed from the Income Statement

and Balance Sheet

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Building the Statement of Cash Flows – Basic Approach

Build a Statement of Cash Flows from two balance sheets and an income statement

Analyze where money has come from and gone to by: Adjusting net income for non-cash items Analyzing changes between beginning

and ending Balance Sheets Classify as sources or uses of cash

Begin with a personal example

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Buying a Car on CreditJoe Jones and His New Car

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Cash Flow Rules

Asset Increase = Use

Asset Decrease = Source

Liability Increase = Source

Liability Decrease = Use

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Buying and Selling Cars -Sally Smith and Her Two Cars

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Business Cash Flows

Three sources of cash flows:

Operating Activities – day-to-day activities

Investing Activities – firm buys or sells fixedassets that enable it to do business, long-term purchases, and sales of financial assets.

Financing Activities – borrow money, pay off

loans, sell stock, pay dividends.

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BUSINESS CASH FLOWS Figure 3.2

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Free Cash Flows

Cash generated beyond reinvestment needs is free cash flow

Net cash flow less non-operating cash requirements (such as worn out fixed assets)

If negative, then borrow or sell equity

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RATIO ANALYSIS

Pairs of financial statement numbers formed into ratios Ratios highlight different aspects of performance

The current ratio measures liquidity - ability to pay bills in the short run

Current Assets: Money coming in within a yearCurrent Liabilities: Money going out within a yearNeeded for solvency: Current ratio >> 1.0

sliabilitiecurrent assetscurrent = ratioCurrent

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CATEGORIES OF RATIOS

Five Classifications Liquidity Asset Management Debt Management Profitability Market Value

Ratios Don’t Provide Answers -

They Help You Ask the Right Questions

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LIQUIDITY RATIOS

Measure the ability to meet short term financial obligations

Current Ratio – primary measurement of a company’s liquidity

sliabilitiecurrent assetscurrent = ratiocurrent

current ratio = $7,500

$2,500 = 3.0

(Examples from Belfry Company)

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LIQUIDITY RATIOS

Quick Ratio (Acid Test) – A liquidity measure that does not depend on inventory

1.72 = $2,500

$3,200 - $7,500 = Ratio Quick

sliabilitiecurrent

inventory - assestscurrent = Ratio Quick

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ASSET MANAGEMENT RATIOS

The fundamental efficiency with which a company is run

AVERAGE COLLECTION PERIOD (ACP) – the time it takes to collect on credit sales

days 104.4 = 360 $10,000

$2,900 = ACP

360 sales

receivable accounts = ACP

sales daily average

receivable accounts = ACP

Interpretation: Customers pay slowly OR there are a few very old accounts that will probably never be collected.

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INVENTORY TURNOVER

Measures efficiency of inventory use

Interpretation: Too much inventory is expensive to carry. Too little causes stockouts which lead to inefficient production and lost sales

3.1 = $3,200

$10,000 =turnover Inventory

1.9 = $3,200

$6,000 =turnover Inventory

inventory

sales =turnover Inventory

OR inventory

sold goods ofcost =turnover Inventory

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FIXED ASSET TURNOVER AND TOTAL ASSET TURNOVER

Measure the relationship of the firm’s assets to a year’s sales

Interpretation: Are there idle or inefficient assets?

.83 = $12,000$10,000 =turnover asset Total

2.2 = $4,500$10,000 =turnover asset Fixed

assets totalsales =turnover asset Total

assets fixedsales =turnover asset Fixed

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DEBT MANAGEMENT RATIOS

Measures the firm’s debt level relative to assets, equity, and income

DEBT RATIOUses a broad concept of debt including current liabilities

A high debt ratio is viewed as risky by investors

Debt ratio = long- term debt + current liabilities

total assets

Debt ratio = $6,200 + $2,500

$12,000 = 72.5%

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DEBT TO EQUITY RATIO Measures the mix of debt and equity within total capital. An important risk measurement - a high debt level burdens the

income statement with excessive interest making failure more likely.

Debt to Equity Ratio = Long Term Debt : Equity

Debt to Equity = $6,200 : $3,300 = 1.9 : 1

(Stated as 1.9 to 1, since $6,200/$3,300 = 1.9)

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TIMES INTEREST EARNED (TIE) Measures the number of times interest can be paid out of earnings

before interest and taxes (EBIT)

TIE = EBIT

interest

TIE = $1,900

$400 = 4.8

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Cash CoverageA variation on TIE. Adds depreciation to EBIT to better

approximate the cash available to interest.

Cash coverage = EBIT + depreciation

interest

Cash coverage = $1,900 + $500

$400 = 6.0

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FIXED CHARGE COVERAGE

A variation on TIE to include lease payments as fixed financial charges equivalent to interest

Interpretation: Business failure is often a result of the inability to pay interest. Coverage ratios measure the interest burden relative to the ability to pay.

Fixed charge coverage = EBIT + lease payments

interest + lease payments

Fixed charge coverage = $1,900 + $700

$400 + $700 = 2.4

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PROFITABILITY RATIOS

Relative measures of the firm’s money-making success

RETURN ON SALES (ROS)

ROS = net income

sales

ROS = $1,000

$10,000 = 10%

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RETURN ON ASSETS (ROA)Measures the overall ability of the firm to utilize the

assets in which it has invested to earn a profit

8.3% = $12,000

$1,000 = ROA

assets total

incomenet = ROA

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RETURN ON EQUITY (ROE)The most fundamental profitability ratio

Measures the firm’s ability to earn a return on the owners’ invested capital.

30.3% = $3,300

$1,000 = ROE

equity

incomenet = ROE

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MARKET VALUE RATIOS

PRICE / EARNINGS RATIO (P/E)Measures the market’s opinion of the stock as an

investment

Interpretation: The amount investors will pay for each dollar of earnings. Based primarily on expected growth.

11.4 = $3.33

$38 = P/E

$3.33 = 300

$1,000 = EPS

EPS

price stock = Ratio P/E

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MARKET VALUE RATIOS

MARKET TO BOOK VALUE RATIOTotal value of the equity on the balance sheet

Market to book value ratio = stock price

book value per share

Market to book value ratio = $38

$11 = 3.5

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Financial Ratios

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Financial Ratios

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Financial Ratios

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Limitations and Weaknesses of Ratio Analysis

Diversified Companies Analysis of consolidated results generally

offers limited insight

Window Dressing Yearend efforts to make ratios look good

Accounting Principles Allow a great deal of reporting latitude

Cash flows and financial anayisis ppt @ bec doms

Economy & Finance

Transcript of Cash flows and financial anayisis ppt @ bec doms