FINANCIAL STATEMENT FINANCIAL STATEMENT ANALYSISANALYSIS

UNITUNIT

1212

• Analysing financial statements involves evaluating three characteristics of a company:

1. its liquidity

2. its profitability

3. its solvency

BASICS OF BASICS OF FINANCIAL STATEMENT FINANCIAL STATEMENT

ANALYSISANALYSIS

BASICS OF BASICS OF FINANCIAL STATEMENT FINANCIAL STATEMENT

ANALYSISANALYSIS

COMPARATIVE ANALYSISCOMPARATIVE ANALYSIS

• Three types of comparisons:– Intracompany basis-compare

previous years data with current year within the company.

– Intercompany basis – compare data with specific competitors.

– Industry averages - compare overall industry data.

COMPARATIVE ANALYSISCOMPARATIVE ANALYSIS

• Three tools:– Horizontal analysis

– Vertical analysis

– Ratio analysis

HORIZONTAL ANALYSISHORIZONTAL ANALYSIS

127% 121% 119% 112% 100%

ANY COMPANY INC.Assumed Net Sales

For the Year Ended December 31 (in millions)

2003 2002 2001 2000 1999

$ 6,562.8 $ 6,295.4 $ 6,190.6 $ 5,786.6 $ 5,181.4

Change since base

period

VERTICAL ANALYSISVERTICAL ANALYSIS

• Expresses each item in a financial statement as a percent of a base amount (total assets or net sales)

ANY COMPANY, INC.Condensed Balance Sheets (Partial)

December 31 (in millions)

2002 2001 .

Assets Amount Percent Amount PercentCurrent assets $1,496.5 29.6 $1,467.7 30.1Capital assets 2,888.8 57.2 2,733.3 56.9Other assets 666.2 13.2 636.6 13.0 Total assets $5,051.5 100.0% $4,837.6 100.0%

VERTICAL ANALYSISVERTICAL ANALYSIS

RATIO ANALYSISRATIO ANALYSISRATIO ANALYSISRATIO ANALYSISLiquidity Ratios

Measure short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash.

Profitability Ratios

Measure the income or operating success of an enterprise for a given period of time.

Solvency Ratios

Measure the ability of the enterprise to survive over a long period of time.

Ratios may be expressed as percentages (50%), proportions (1:2), Days (32 days), or rate (3.23)

LIQUIDITY RATIOSLIQUIDITY RATIOS

• Current ratio

• Acid test ratio

• Receivables turnover

• Collection period

• Inventory turnover

• Days sales in inventory

CURRENT RATIOCURRENT RATIO

• Measures short-term debt-paying ability

Current ratio =Current assetsCurrent liabilities

(Discussed in Chapter 4)

ACID TEST RATIOACID TEST RATIO

• Measures immediate short-term debt-paying ability

Acid test ratio =Cash + temporary investments + net

receivablesCurrent liabilities

(Discussed in Chapter 9)

RECEIVABLES TURNOVERRECEIVABLES TURNOVER

• Measures liquidity of receivables

Receivables turnover =Net credit sales

Average net receivables

(Discussed in Chapter 9)

COLLECTION PERIODCOLLECTION PERIOD

• Measures number of days receivables are outstanding

Collection period =365 days

Receivables turnover

(Discussed in Chapter 9)

INVENTORY TURNOVERINVENTORY TURNOVER

• Measures liquidity of inventory

Inventory turnover =Cost of goods soldAverage inventory

(Discussed in Chapter 5)

DAYS SALES IN INVENTORYDAYS SALES IN INVENTORY

• Measures number of days inventory is on hand

Days in inventory =365 days

Inventory turnover

(Discussed in Chapter 5)

PROFITABILITY RATIOS PROFITABILITY RATIOS

• Profit margin

• Gross profit margin

• Return on assets

• Return on common shareholders’ equity

• Book value per share

• Earnings per share (EPS)

• Price-earnings (PE) ratio

• Dividend yield

PROFIT MARGINPROFIT MARGIN

• Measures net income generated by each dollar of sales

(Discussed in Chapter 5)

Profit margin =Net incomeNet sales

GROSS PROFIT MARGINGROSS PROFIT MARGIN

• Measures margin between selling price and cost of goods sold generated by each dollar of sales

(Discussed in Chapter 5)

Gross profit margin =Gross profit

Net sales

RETURN ON ASSETSRETURN ON ASSETS

• Measures overall profitability of assets

Return on assets =Net income

Average total assets

(Discussed in Chapter 10)

RETURN ON COMMON RETURN ON COMMON SHAREHOLDERS’ EQUITYSHAREHOLDERS’ EQUITY

• Measures profitability of common shareholders’ investment

Return on common shareholders’ equity =Net income

Average common shareholders’ equity

(Discussed in Chapter 14)

BOOK VALUE PER SHAREBOOK VALUE PER SHARE

• Measures the equity (net assets) per common share

Book value per share =Common shareholders’ equity

Number of common shares

(Discussed in Chapter 14)

EARNINGS PER SHARE (EPS)EARNINGS PER SHARE (EPS)

• Measures net income earned on each common share

(Discussed in Chapter 15)

Earnings per share =Net income

Number of common shares

PRICE-EARNINGS (PE) RATIOPRICE-EARNINGS (PE) RATIO

• Measures relationship between market price per share and earnings per share

(Discussed in Chapter 15)

Price-earnings ratio =Share price

Earnings per share

DIVIDEND YIELDDIVIDEND YIELD

• Measures rate of return earned from dividends

(Discussed in Chapter 15)

Dividend yield =Cash dividends per share

Share price

SOLVENCY RATIOSSOLVENCY RATIOS

• Debt to total assets

• Cash total debt coverage

DEBT TO TOTAL ASSETSDEBT TO TOTAL ASSETS

• Measures % of total assets provided by creditors

Debt to total assets =

Total liabilities Total assets

(Discussed in Chapter 16)

CASH TOTAL DEBT COVERAGECASH TOTAL DEBT COVERAGE

• Measures long-term debt-paying ability (cash basis)

Cash total debt coverage ratio =Net cash provided by operating

activitiesAverage total liabilities

(Discussed in Chapter 18)

• Estimates

• Historical cost

• Alternative accounting methods

• Atypical data

• Diversification

LIMITATIONS OF FINANCIAL LIMITATIONS OF FINANCIAL ANALYSISANALYSIS