Financial statement analysis P.W.Sims Business Program 410-650-LW Finance.
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Transcript of Financial statement analysis P.W.Sims Business Program 410-650-LW Finance.
Financial statement analysis
P.W.Sims Business Program410-650-LW
Finance
Financial statement analysis
Involves looking at• Revenues• Expenses• Liabilities
Uses this raw information from the operation of a business in new ways to • compare period over period results• compare your business to others • compare your business to your industry
Financial statement analysis – Common size statement • First step in financial statement analysis is
usually common size statement
Common size income statement• Presents each line as percent of revenue
Common size balance sheet• Presents each line as percent of total assets
Quantitative factors - Common Size Statements
$ % $ %Sales revenue 2,187,460$ 100.0% 150,845$ 100.0%COGS 1,203,103$ 55.0% 72,406$ 48.0%Gross margin 984,357$ 45.0% 78,439$ 52.0%
Expenses 505,303$ 23.1% 39,974$ 26.5%EBIT 479,054$ 21.9% 38,465$ 25.5%Interest 131,248$ 6.0% 15,386$ 10.2%EBT 347,806$ 15.9% 23,079$ 15.3%Tax 118,254$ 5.4% 3,462$ 2.3%Net Income 229,552$ 10.5% 19,617$ 13.0%
Alpha Beta
Exa
mpl
e
Financial statement analysis - Ratios
• When examined separately, ratios don’t convey much information. Ratios are compared with: History—examine trends (how ratio has changed over
time)
Competition—compare with other firms in same industry• Link to comparison charts http://biz.yahoo.com/p/industries.html
Budget—compare actual ratios with expected or desired ratios
Categories of Financial Ratios
• Profitability Ratios• Market Value Ratios• Liquidity Ratios• Asset Management Ratios• Debt Management Ratios
Categories of Financial Ratios
Profitability—allow assessment of the firm’s ability to make money
Liquidity—indicate firm’s ability to pay its bills in short run Asset Management—show firm’s ability to generate
revenue using minimum amount of assets Debt Management—determine if the firm is using so
much debt that it is assuming excessive financial risk
Profitability Ratios
• Return on Assets
Net IncomeROA
Total Assets
Adds effectiveness of asset management to Return on Sales
Measures ability of firm to utilize assets to earn profit
Often compared to firm’s cost of financing (after tax)
Profitability Ratios
• Return on Equity
Adds effect of borrowing to Return on Assets Measures ability to earn a return on owners’ investment If firm has substantial debt, ROE tends to be higher than
ROA in good times and lower in bad times Compared to returns available from alternate investments
Net IncomeR eturn on Equity =
Shareholders' Equity
Liquidity ratios
• Liquidity ratios measure the ability to convert assets to cash The ability to pay short term bills
Liquidity Ratios
• Current Ratio
Current Assets
Current Ratio Current Liabilities
To ensure solvency, current ratio is expected to exceed 1.0
Standard ratio is 2:1 May be too high if too much money is tied
up in receivables and inventory
Liquidity Ratios
• Quick Ratio (or Acid-Test Ratio)
Measures liquidity without considering inventory (least liquid current asset)
May be too high if too much money is tied up in receivables
Current Assets-InventoryQuick Ratio
Current Liabilities
Debt Management Ratios
• Debt management ratios measure financial risk from borrowing High ratios viewed as risky by lenders and
investors Riskiness associated with debt and interest is
called financial risk High level of debt can burden income statement
with excessive interest, a fixed financial charge Firm may not be able to repay debt and interest if
profits decline
Debt Management Ratios
• Debt Ratio
Need to determine if company is using so much debt that it is assuming excessive financial risk
High debt ratio is viewed as risky by investors and creditors and is negative
Range of 1:1 to 4:1
D
Debt Management Ratios
• Debt-to-equity ratio
Compares what is owned to what is financed
Measures mix of debt and equity within firm’s total capital
High ratio means cie relies to much on debt and should think of reducing debt
Debt to equity ratio
Debt Management Ratios
• Long Term Debt Ratio
Focuses the attention long term debt instead of all the debt
¿debt Ratio=𝑳𝑻𝒅𝒆𝒃𝒕
(𝑳𝑻 𝒅𝒆𝒃𝒕−𝑻𝒐𝒕𝒂𝒍𝒆𝒒𝒖𝒊𝒕𝒚 )
Debt Management Ratios
• Times Interest Earned
EBITTIE
Interest Expense
EBIT stands for Earning before interest and taxes TIE is a coverage ratio
• Reflects how much EBIT covers interest expense• High level of interest coverage implies safety for lenders
High TIE ratio often means a low debt/equity ratio Lowest acceptable ratio 1.5; best result 2 to 3
Debt Management Ratios
• Cash coverage Ratio
Same as previous but looks only at cash expenses (depreciation is an accounting expense)
Lowest acceptable ration 1.5; best result 2 to 3
C ashcoverage=(𝑬𝑩𝑰𝑻 +𝑫𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 )
𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕
Debt Management Ratios
• Debt coverage ratio
EBIT stands for Earning before interest and taxes TIE is a coverage ratio
• Reflects how much cash covers interest and principal payments
Lowest results acceptable 2 to 2.5
Debt Coverage Ratio=(𝑬𝑩𝑰𝑻 +𝑫𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 )
𝑫𝒆𝒃𝒕𝒑𝒂𝒚𝒎𝒆𝒏𝒕
Debt Management Ratios
• Fixed Charge Coverage
EBIT Lease PaymentsFixed Charge Coverage
Interest Expense Lease Payments
Interest payments are not the only fixed charges
Lease payments are fixed financial charges similar to interest• Must be paid regardless of business conditions
Question
• Debt ratio
Your debt ratio has increased from 50% to 55% in the last quarter, this means:
Your asset value has increased
Your asset value has decreased and so has your liability
Your liabilities have increased faster than your assets
Question
• What does EBIT stand for?• Debt coverage ratio, why do we
add to 𝑫𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 𝑬𝑩𝑰𝑻before comparing it to 𝑫𝒆𝒃𝒕 𝒑𝒂𝒚𝒎𝒆𝒏𝒕