financial analysis

17-1

AANALYSIS NALYSIS AANDNDIINTERPRETATIONNTERPRETATION OOFF

FFINANCIALINANCIAL S STATEMENTSTATEMENTS

17-2

Financial Statement AnalysisFinancial Statement Analysis Financial Statement Analysis will help

business owners and other interested people to analyse the data in financial statements to provide them with better information about such key factors for decision making and ultimate business survival.

17-3

Who analyzes financial statements? Internal users (i.e., management) External users (emphasis of chapter)

Examples?

Investors, creditors, regulatory agencies & …

stock market analysts and

auditors

Financial Statement AnalysisFinancial Statement Analysis

17-4

What do internal users use it for? Planning, evaluating and controlling

company operations What do external users use it for?

Assessing past performance and current financial position and making predictions about the future profitability and solvency of the company as well as evaluating the effectiveness of management


17-5

Information is available from Published annual reports

(1) Financial statements

(2) Notes to financial statements

(3) Letters to shareholders

(4) Auditor’s report

(5) Management’s discussion and analysis

Reports filed with the governmente.g., Form 10-K, Form 10-Q and Form 8-K


17-6

Information is available from Other sources

(1) Newspapers (e.g., Journal ledger )

(2) Periodicals (e.g. Forbes, Fortune)

(3) Financial information organizations such as: Moody’s, Standard & Poor’s, Dun &

Bradstreet, Inc., and Robert Morris Associates

(4) Other business publications


17-7

Horizontal Analysis

Vertical Analysis

Common-Size Statements

Trend Percentages

Ratio Analysis

Methods ofMethods ofFinancial Statement AnalysisFinancial Statement Analysis

17-8

Horizontal AnalysisHorizontal Analysis

Using comparative financial statements to calculate amount

or percentage changes in a financial statement item from

one period to the next

Using comparative financial statements to calculate amount

or percentage changes in a financial statement item from

one period to the next

17-9

Vertical AnalysisVertical Analysis

For a single financial statement, each item

is expressed as a percentage of a

significant total, e.g., all income

statement items are expressed as a

percentage of sales

For a single financial statement, each item

is expressed as a percentage of a

significant total, e.g., all income

statement items are expressed as a

percentage of sales

17-10

Common-Size StatementsCommon-Size Statements

Financial statements that show only percentages and no

absolute amounts

Financial statements that show only percentages and no

absolute amounts

17-11

Trend PercentagesTrend Percentages

Show changes over time in given financial statement items

(can help evaluate financial information of several years)

Show changes over time in given financial statement items

(can help evaluate financial information of several years)

17-12

Ratio AnalysisRatio Analysis

Expression of logical relationships between items in a financial statement of a single period (e.g., percentage relationship

between revenue and net income)

Expression of logical relationships between items in a financial statement of a single period (e.g., percentage relationship

between revenue and net income)

17-13

Horizontal Analysis ExampleHorizontal Analysis Example

The management of Clover Company provides you with comparative balance sheets of the years ended December 31, 1999 and 1998. Management asks you to

prepare a horizontal analysis horizontal analysis on the information.

17-15

Calculating Change in Rupees Amounts

RupeesChange

Current YearFigure

Base YearFigure

= –


17-16

Calculating Change in Dollar Amounts

Since we are measuring the amount of the change between 1998 and 1999, the Rupees amounts for 1998 become the

“base” year figures.

DollarChange

Current YearFigure

Base YearFigure

= –


17-17

Calculating Change as a Percentage

PercentageChange

Rupees Change Base Year Figure

100%= ×


17-18

$12,000 – $23,500 = $(11,500)


17-19

($11,500 ÷ $23,500) × 100% = 48.9%


17-20


17-21

Let’s apply the sameprocedures to the

liability and shareholders’equity sections of the

balance sheet.


17-22

CLOVER CORPORATIONComparative Balance SheetsDecember 31, 1999 and 1998

Increase (Decrease)1999 1998 Amount %

Liabilities and Stockholders' EquityCurrent liabilities: Accounts payable 67,000$ 44,000$ 23,000$ 52.3 Notes payable 3,000 6,000 (3,000) (50.0) Total current liabilities 70,000 50,000 20,000 40.0Long-term liabilities: Bonds payable, 8% 75,000 80,000 (5,000) (6.3) Total liabilities 145,000 130,000 15,000 11.5Stockholders' equity: Preferred stock 20,000 20,000 - 0.0 Common stock 60,000 60,000 - 0.0 Additional paid-in capital 10,000 10,000 - 0.0 Total paid-in capital 90,000 90,000 - 0.0Retained earnings 80,000 69,700 10,300 14.8 Total stockholders' equity 170,000 159,700 10,300 6.4Total liabilities and stockholders' equity 315,000$ 289,700$ 25,300$ 8.7

17-23

Now, let’s apply the procedures to theincome statement.


17-24

CLOVER CORPORATIONComparative Income Statements

For the Years Ended December 31, 1999 and 1998Increase (Decrease)

1999 1998 Amount %Net sales 520,000$ 480,000$ 40,000$ 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net operating income 31,400 39,000 (7,600) (19.5)Interest expense 6,400 7,000 (600) (8.6)Net income before taxes 25,000 32,000 (7,000) (21.9)Less income taxes (30%) 7,500 9,600 (2,100) (21.9)Net income 17,500$ 22,400$ (4,900)$ (21.9)

17-25




Sales increased by 8.3% while net income decreased by 21.9%.

17-26




There were increases in both cost of goods sold (14.3%) and operating expenses (2.1%). These increased costs more than offset the

increase in sales, yielding an overall decrease in net income.

17-27

Vertical Analysis ExampleVertical Analysis Example

The management of Sample Company asks you to prepare a vertical analysis vertical analysis for the

comparative balance sheets of the company.

17-28


17-29


$82,000 ÷ $483,000 = 17% rounded$30,000 ÷ $387,000 = 8% rounded

17-30


$76,000 ÷ $483,000 = 16% rounded

17-31

Trend Percentages ExampleTrend Percentages Example

Wheeler, Inc. provides you with the following operating data and asks that

you prepare a trend analysis.

17-32


Wheeler, Inc. provides you with the following operating data and asks that

you prepare a trend analysis.

$1,991 - $1,820 = $171$1,991 - $1,820 = $171

17-33


Using 1995 as the base year, we develop the following percentage relationships.

$1,991 - $1,820 = $171$1,991 - $1,820 = $171$171 ÷ $1,820 = 9% rounded$171 ÷ $1,820 = 9% rounded

17-34

Trend linefor Sales

17-35

Ratios can be expressed in three different ways:

1. Ratio (e.g., current ratio of 2:1)

2. % (e.g., profit margin of 2%)

3. $ (e.g., EPS of $2.25)

CAUTION! “Using ratios and percentages without considering the underlying causes may be

hazardous to your health!” lead to incorrect conclusions.”

RatiosRatios

17-36

Categories of RatiosCategories of Ratios

Liquidity RatiosIndicate a company’s short-term debt-paying ability

Equity (Long-Term Solvency) RatiosShow relationship between debt and equity financing in a company

Profitability TestsRelate income to other variables

Market TestsHelp assess relative merits of stocks in the marketplace

17-37

Liquidity RatiosCurrent (working capital) ratioAcid-test (quick) ratio Cash flow liquidity ratioAccounts receivable turnoverNumber of days’ sales in accounts

receivableInventory turnover Total assets turnover

10 Ratios You Must Know10 Ratios You Must Know

17-38

Equity (Long-Term Solvency) RatiosEquity (stockholders’ equity) ratio Equity to debt


17-39

Profitability Tests Return on operating assetsNet income to net sales (return on

sales or “profit margin”“profit margin”)Return on average common

stockholders’ equity (ROEROE) Cash flow marginEarnings per share Times interest earned Times preferred dividends earned

$


17-40

Market Tests Earnings yield on common stockPrice-earnings ratio Payout ratio on common stock Dividend yield on common stock Dividend yield on preferred stock Cash flow per share of common

stock


17-41

Now, let’s look at Norton

Corporation’s 1999 and 1998 financial

statements.

17-45

Now, let’s calculate the 10 ratios based

on Norton’s financial statements.

17-46

NORTON CORPORATION

1999

Cash 30,000$

Accounts receivable, net

Beginning of year 17,000

End of year 20,000

Inventory


End of year 12,000

Total current assets 65,000

Total current liabilities 42,000

Sales on account 494,000

Cost of goods sold 140,000

We will use this

informationto calculatethe liquidity

ratios for Norton.

17-47

Working Capital*Working Capital*

12/31/99

Current assets 65,000$

Current liabilities (42,000)

Working capital 23,000$

The excess of current assets over current liabilities.

* While this is not a ratio, it does give an indication of a company’s liquidity.

17-48

Current (Working Capital) RatioCurrent (Working Capital) Ratio

CurrentRatio

$65,000 $42,000

= = 1.55 : 1

Measures the abilityof the company to pay current

debts as they become due.

CurrentRatio

Current Assets Current Liabilities

=

#1#1

17-49

Acid-Test (Quick) RatioAcid-Test (Quick) Ratio

Quick Assets Current Liabilities

=Acid-Test

Ratio

Quick assets are Cash,Marketable Securities,

Accounts Receivable (net) andcurrent Notes Receivable.

#2#2

17-50


=Acid-Test

Ratio

Norton Corporation’s quick assets consist of cash of

$30,000 and accounts receivable of $20,000.


#2#2

17-51


=Acid-Test

Ratio

$50,000 $42,000

= 1.19 : 1=Acid-Test

Ratio


#2#2

17-52

Sales on Account Average Accounts Receivable

Accounts ReceivableTurnover

=

Accounts Receivable TurnoverAccounts Receivable Turnover

= 26.70 times $494,000 ($17,000 + $20,000) ÷ 2

Accounts ReceivableTurnover

=

This ratio measures how many times a company converts its

receivables into cash each year.

#3#3 Average, net accounts receivable

Net, credit sales

17-53

Number of Days’ SalesNumber of Days’ Salesin Accounts Receivablein Accounts Receivable

Measures, on average, how many days it takes to collect an

account receivable.

Days’ Salesin AccountsReceivables

= 365 Days Accounts Receivable Turnover

= 13.67 days= 365 Days 26.70 Times

Days’ Salesin AccountsReceivables

#4#4

17-54

Inventory TurnoverInventory Turnover

Cost of Goods Sold Average Inventory

InventoryTurnover

=

Measures the number of timesinventory is sold and

replaced during the year.

= 12.73 times $140,000 ($10,000 + $12,000) ÷ 2

InventoryTurnover

=

#5#5

17-55

Equity, or Long–TermEquity, or Long–TermSolvency RatiosSolvency Ratios

This is part of the information to calculate the equity, or long-term

solvency ratios of Norton Corporation.

NORTON CORPORATION

1999

Net operating income 84,000$ Net sales 494,000 Interest expense 7,300 Total stockholders' equity 234,390

17-56NORTON CORPORATION

1999

Common shares outstanding Beginning of year 17,000 End of year 27,400

Net income 53,690$

Stockholders' equity


End of year 234,390

Dividends per share 2

Dec. 31 market price/share 20

Interest expense 7,300

Total assets


End of year 346,390

Here is therest of the

informationwe will

use.

17-57

Equity RatioEquity Ratio

EquityRatio

= Stockholders’ Equity Total Assets

EquityRatio

= $234,390 $346,390

67.7%=

Measures the proportionof total assets provided by

shareholders.

#6#6

17-58

Net Income to Net SalesNet Income to Net Sales on Sales or Profit Margin on Sales or Profit Margin

Net Incometo

Net Sales=

Net Income Net Sales

Net Incometo

Net Sales=

$53,690 $494,000

= 10.9%

Measures the proportion of the sales which is retained as profit.

#7#7

17-59

Return on Average Common Return on Average Common Shareholders’ Equity (ROE)Shareholders’ Equity (ROE)

Return onStockholders’

Equity=

Net Income Average Common

Stockholders’ Equity

= $53,690 ($180,000 + $234,390) ÷ 2

= 25.9%Return on

Stockholders’Equity

Important measure of theincome-producing ability

of a company.

#8#8

17-60

Earningsper Share

Earnings Available to Common ShareholdersWeighted-Average Number of Common

Shares Outstanding=

Earningsper Share

$53,690 (17,000 + 27,400) ÷ 2

= = $2.42

The financial press regularly publishesactual and forecasted EPS amounts.

#9#9

Earnings Per ShareEarnings Per Share

17-61

Price-Earnings RatioPrice-Earnings Ratio

Price-EarningsRatio

Market Price Per Share EPS

=

Price-EarningsRatio

= $20.00

$ 2.42= 8.3 : 1

#10#10

Provides some measure of whether the stock is under or overpriced.

17-62

Important ConsiderationsImportant Considerations

Need for comparable data Data is provided by Dun &

Bradstreet, Standard & Poor’s etc. Must compare by industry Is EPS comparable?

Influence of external factors General business conditions Seasonal nature of business operations

Impact of inflation

17-63No more ratios, please!No more ratios, please!

17-64

QuestionQuestion

The current ratio is a measure of liquidity that is computed by dividing

total assets by total liabilities.

a. True

b. False



a. True

b. False

17-65



a. True

b. False



a. True

b. False

QuestionQuestion

The current ratio is a measure ofliquidity, but is computed by

dividing currentcurrent assets bycurrentcurrent liabilities

The current ratio is a measure ofliquidity, but is computed by

dividing currentcurrent assets bycurrentcurrent liabilities

17-66

QuestionQuestion

Quick assets are defined as Cash, Marketable Securities and net

receivables.

a. True

b. False


receivables.

a. True

b. False

17-67


receivables.

a. True

b. False


receivables.

a. True

b. False

QuestionQuestion

17-68

QuestionQuestion

Accounting Ratios are important tools used by.

a. Managers c. Investors,

b. Researchers d. All of the above

Ans: d

Accounting Ratios are important tools used by.

a. Managers c. Investors,

b. Researchers d. All of the above

Ans: d

17-69

QuestionQuestion

Working Capital Turnover measures the relationship of Working Capital with.

a. Fixed Assets

b. Sales

c. Purchase

d. Stock

Ans; a

Working Capital Turnover measures the relationship of Working Capital with.

a. Fixed Assets

b. Sales

c. Purchase

d. Stock

Ans; a

17-70

QuestionQuestion

In Current Ratio, Current Assets are compared with:.

a. Current Profit

b. Current Liabilities,

c. Fixed Assets,

d. Equity Share Capital.

Ans:b

In Current Ratio, Current Assets are compared with:.

a. Current Profit

b. Current Liabilities,

c. Fixed Assets,

d. Equity Share Capital.

Ans:b

17-71

QuestionQuestion

Ratio of Net Income to Number of Equity Shares known as.

a. Price Earnings Ratio,

b. Net Profit Ratio,

c. Earnings per Share,

d. Dividend per Share.

Ans: c

Ratio of Net Income to Number of Equity Shares known as.

a. Price Earnings Ratio,

b. Net Profit Ratio,

c. Earnings per Share,

d. Dividend per Share.

Ans: c

17-72

QuestionQuestion

Gross Profit Ratio for a firm remains same but the Net Profit Ratio is decreasing. The reason for such behavior could be:

(a)Increase in Costs of Goods Sold,

(b)If Increase in Expense,

(c)Increase in Dividend,

(d)Decrease in Sales.

Ans: b

Gross Profit Ratio for a firm remains same but the Net Profit Ratio is decreasing. The reason for such behavior could be:

(a)Increase in Costs of Goods Sold,

(b)If Increase in Expense,

(c)Increase in Dividend,

(d)Decrease in Sales.

Ans: b

17-73

QuestionQuestion Which of the following statements is correct?

(a)A Higher Receivable Turnover is not desirable,

(b)Interest Coverage Ratio depends upon Tax Rate,

(c) Increase in Net Profit Ratio means increase in Sales,

(d) Lower Debt-Equity Ratio means lower Financial Risk.

Ans:d

Which of the following statements is correct?

(a)A Higher Receivable Turnover is not desirable,

(b)Interest Coverage Ratio depends upon Tax Rate,

(c) Increase in Net Profit Ratio means increase in Sales,

(d) Lower Debt-Equity Ratio means lower Financial Risk.

Ans:d

17-74

QuestionQuestion

Which of the following helps analysing return to equity Shareholders?

(a) Return on Assets,

(b) Earnings Per Share,

(c) Net Profit Ratio,

(d)Return on Investment.

Ans: b

Which of the following helps analysing return to equity Shareholders?

(a) Return on Assets,

(b) Earnings Per Share,

(c) Net Profit Ratio,

(d)Return on Investment.

Ans: b

17-75

QuestionQuestion

Trend Analysis helps comparing performance of a firm

(a)With other firms,

(b)Over a period of firm,

(c)With other industries,

(d) None of the above

Ans: b

Trend Analysis helps comparing performance of a firm

(a)With other firms,

(b)Over a period of firm,

(c)With other industries,

(d) None of the above

Ans: b

17-76

QuestionQuestion

Ratio Analysis can be used to study liquidity, turnover, profitability, etc. of a firm. What does Debt-Equity Ratio help to study?

(a)Solvency,

(b)Liquidity,

(c)Profitability,

(d) Turnover,

Ans: a

Ratio Analysis can be used to study liquidity, turnover, profitability, etc. of a firm. What does Debt-Equity Ratio help to study?

(a)Solvency,

(b)Liquidity,

(c)Profitability,

(d) Turnover,

Ans: a

17-77

QuestionQuestion

In Inventory Turnover calculation, what is taken in the numerator?

(a) Sales,

(b)Cost of Goods Sold,

(c)Opening Stock,

(d) Closing Stock.

Ans: b

In Inventory Turnover calculation, what is taken in the numerator?

(a) Sales,

(b)Cost of Goods Sold,

(c)Opening Stock,

(d) Closing Stock.

Ans: b

17-78

Thank you!!!

Ganesh.S.Uppin

financial analysis

Economy & Finance

Transcript of financial analysis