Financialanalysis.ppt
description
Transcript of Financialanalysis.ppt
Overview of Financial Analysis
o SPECIFY THE OBJECTIVES OF THE ANALYSIS
o Focus on who is the financial statement user
o The identity of the user helps define what information is needed
Financial
The company’s return on equity
has dipped considerably over
the last period
I had better
sell that stock ASAP!
Steps of a F/S Analysis1. Establish objectives of the analysis2. Study the industry and relate industry
climate to current and projected economic developments -
o a growth industry? o a dying industry? o a changing industry?
3. Develop knowledge of firm and quality of management
4. Evaluate financial statements using basic tools
5. Summarize findings6. Reach conclusions relevant to established
objectives
Potential Financial Statement Users:
oCreditorso InvestorsoManagersoWho else?
oWhat types of questions do each of these users seek answers to?
Data sourceso Financial statements (and notes)o Auditor’s reporto MD&Ao Supplementary scheduleso 10K and 10Q reports filed with SECo Computerized data bases
o Info on industry norms/ratioso Info on particular
companies/industries/mutual funds
o Articles in popular/business press o Websites
Tools for analysiso Common size financial
statementso Financial ratioso Trend analysiso Structural analysiso Industry comparisonso Common sense and
judgment
Financial Ratio Categories
o Liquidity Ratiosmeasure a firm’s ability to meet
cash needs as they arise
o Activity Ratiosmeasure the liquidity of specific
assets and the efficiency of managing assets
Ratio Categories (continued)
o Leverage Ratiosmeasure the extent of a firm’s
financing with debt relative to equity and its ability to cover interest and other fixed charges
o Profitability Ratiosmeasure the overall performance of a
firm and its efficiency in managing assets, liabilities and equity
Caution!o Ratios are valuable, BUT…..
o They do not provide answers in an of themselves and are not predictive
o They should be used with other elements of financial analysis
o There are no “rules of thumb” that apply to interpretation of ratios
Profitability Ratioso Gross Profit Margin
Gross Profit/Net Saleso Operating Profit Margin
Operating Profit/Net Saleso Net Profit Margin
Net Earnings/Net Saleso All measure firm’s ability to translate
sales dollars into profits
Profitability Ratios (continued)
o Return on Investment (or Return on Assets)Net Earnings/Total Assets
o Return on EquityNet Earnings/Stockholders’ Equity
o Both measure overall efficiency of firm in managing investment in assets and generating return to stockholders
2005 KD Hatheway-Dial
Average Operating Average Operating AssetsAssets
Net Operating Net Operating IncomeIncome==
Return on Investment
ROROII
o Return on Investment (ROI)
o Net operating incomeo Income before interest and
taxeso Operating assets
oAssets held for operating purposes ONLY
o i.e. cash, accounts receivable, inventory, plant and equipment
Understanding ROI
2005 KD Hatheway-Dial
ROROII
== MargiMarginn
XX TurnovTurnoverer
==Operating Operating
MarginMargin
==TurnovTurnoverer
Net Operating Net Operating IncomeIncome
SalesSales
SalesSales
Average Operating Average Operating AssetsAssets
Understanding ROI
2005 KD Hatheway-Dial
12.512.5%%
== XX 2.52.5
==5%5%
==2.2.55
$10,000$10,000
$80,000$80,000$200,000$200,000
$200,000$200,000XX 1010
00
55%%
APPLYING ROI
2005 KD Hatheway-Dial
23.2523.25%%
== 8.4548.45455
XX 2.752.75
==8.4548.45455
==2.752.75
$18,600$18,600
$80,000$80,000$220,000$220,000
$220,000$220,000
10% Increased Sales without Any Increase in Operating Assets (assume 6% increase in operating expenses)
XX 101000
86% increase with 10% increase in sales
APPLYING ROI
2005 KD Hatheway-Dial
36.2536.25%%
== 14.5%14.5% XX 2.502.50
==14.5%14.5%
==2.502.50
$29,000$29,000
$80,000$80,000$200,000$200,000
$200,000$200,000
10% Decrease in operating expenses and no change in sales
XX 101000
190% increase with 10% decrease in operating expenses
APPLYING ROI
2005 KD Hatheway-Dial
13.9013.90%%
== 5.0%5.0% XX 2.782.78
==5.0%5.0%
==2.782.78
$10,000$10,000
$72,000$72,000$200,000$200,000
$200,000$200,000
10% Decrease in operating assets and no change in sales or operating expenses
XX 101000
11.2% increase with 10% decrease in operating assets
APPLYING ROI
2005 KD Hatheway-Dial
16.2516.25%%
== 6.8%6.8% XX 2.392.39
==6.86.8%%
==2.392.39
$14,300$14,300
$88,000$88,000$210,000$210,000
$210,000$210,000
10% increase in operating assets and 5% change in sales and 3% operating expenses
XX 101000
30% increase with 10% decrease in operating assets
Profitability Ratios (continued)
o Cash Flow MarginCash Flow from Operating
Activities /Net SalesMeasures ability to translate
sales into cash (with which to pay bills)
Profitability Ratios (continued)
o Cash Return on AssetsCash Flow from Operating
Activities /Total Assets
Useful comparison to return on investment
Indicates firm’s ability to generate cash from utilizing its assets
Liquidity Ratioso Current Ratio
Current Assets/Current LiabilitiesMeasures ability to meet short-term cash
needs
o Quick or Acid Test RatioCurrent Assets-Inventory/Current LiabilitiesMeasure ability to meet short-term cash
needs more rigorously
o Cash Flow Liquidity RatioCash+Marketable Securities+Cash Flow from
Operating Activities/Current LiabilitiesFocuses on ability of the firm to generate
operating cash flows as a source of liquidity
Activity Ratioso Average Collection Period
Accounts Receivable/Average Daily Sales
Helps gauge liquidity of accounts receivable (ability to collect cash from customers)
o Accounts Receivable TurnoverNet Sales/Accounts ReceivableAnother measure of efficiency of
firm’s collection and credit policies
Activity Ratios (continued)
o Inventory TurnoverCost of Goods Sold/InventoryMeasures efficiency of inventory
managemento Fixed Asset and Total Asset
TurnoverNet Sales/Net PP&E (Fixed Asset
T/O)Net Sales/Total Assets (Total
Asset T/O)Both assess effectiveness in
generating sales from investment in assets
Leverage: Debt Ratioso Debt Ratio
Total Liabilities/Total Assets
o Long-Term Debt to Total CapitalizationLong-term Debt/Long-term Debt +
Stockholders’ Equity
o Debt to Equity RatioTotal Liabilities/Stockholders’ Equity
o All three measure extent of firm’s financing with debt
Leverage: Coverage Ratios
o Proportion and amount of debt in capital structure is important to analyst
o Tradeoff between risk and return
o Use of debt involves risk -- commitment to fixed charges
o Fixed charges must be COVERED -- following are some ratios to assess coverage
Coverage Ratios (continued)
o Times Interest EarnedOperating Profit/Interest
ExpenseIndicates how well operating
earnings cover fixed interest charges
o Fixed Charge CoverageOperating Profit + Lease
Payments/Interest Expense + Lease Payments
Broader measure of how well operating earnings cover fixed charges
Coverage Ratios (continued)
o Cash Flow AdequacyCash Flow from Operating
Activities/ Average Annual Long-Term Debt Maturities
Measures firm’s ability to cover long-term debt maturities each year
Rationale is that over the long-run operating cash flows must be adequate to cover investing activities financed with debt
Other Ratioso Earnings per Common Share
Net Earnings/Average Common Shares Outstanding
Indicates return on a per share basis
o Price to EarningsMarket Price of Common
Stock/Earnings per Common ShareExpresses a multiple the stock market
places on earnings
Other Ratios (continued)o Dividend Payout
Dividends per Share/Earnings per Share
Shows percentage of earnings paid out to stockholders
o Dividend YieldDividends per Share/Market
Price of Common ShareShows rate earned by
shareholders from dividends relative to current stock price