Cash flows and financial anayisis ppt @ bec doms
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Transcript of 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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ASSET MANAGEMENT RATIOS
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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ASSET MANAGEMENT RATIOS
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 MANAGEMENT RATIOS
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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DEBT MANAGEMENT RATIOS
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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DEBT MANAGEMENT RATIOS
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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DEBT MANAGEMENT RATIOS
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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PROFITABILITY RATIOS
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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PROFITABILITY RATIOS
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