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  • 1. Chapter 13 Financial Statement Analysis
  • 2. Financial Statement Analysis Stockholders Creditors Management Will I be paid? How good is our investment? How are we performing?
  • 3. Limitations of Financial Statement Analysis
    • Use of different accounting methods
    • Changes in accounting methods
    LIFO FIFO
  • 4. Limitations of Financial Statement Analysis
    • Failure to understand trends or use industry ratios
    • Difficulty of making industry comparisons (i.e. conglomerates)
    ????
  • 5. Limitations of Financial Statement Analysis
    • Nonoperating items on income statement
    • Effects of inflation
    =
  • 6. Horizontal Analysis
    • Net Sales
    • Earnings before
    • factory sale
    • Net earnings
    • Dividends paid
    • Increase (Decrease)
    • 1999 1998 Dollars Percent
    • $2,062 $2,005 $57 2.8 %
    • 308 298 10 3.3
    • 308 305 3 1.0
    • 154 151 3 2.0
    Wm. Wrigley Jr. Company (in millions)
  • 7. Trend Analysis
    • Return on
    • Avg. Equity
    • 1999 1998 1997 1996 1995
    • 26.8% 28.4% 28.9% 27.2% 30.1%
    Wm. Wrigley Jr. Company Tracking items over a series of years
  • 8. Vertical Analysis
    • Common-size statements recast items as a percentage of a selected item
    • Allows comparisons of companies of different size
    • Compares percentages across years to identify trends
    % % %
  • 9. Common-Size Statements
    • Sales revenue
    • Cost of goods sold
    • Gross profit
    • Selling & admin. exp.
    • Operating income
    • Interest expense
    • Income before tax
    • Income tax expense
    • Net income
    Dollars Percent $60,000 100% 24,000 40 36,000 60 6,000 10 30,000 50 3,000 5 27,000 45 10,000 17 $ 17,000 28%
  • 10. Analysis of Liquidity
    • Nearness to cash
    • Ability to pay debts as they become due
    Cash Ratios Turnover Ratios Working Capital Ratios
  • 11. Working Capital
    • Excess of current assets over current liabilities
    • Lacks meaningful comparisons for companies of different size
    -
  • 12. Current Ratio
    • Measure of short-term financial health
    • Consider composition of current assets
    Rule of thumb 2:1
  • 13. Acid-Test (Quick) Ratio
    • Stricter test of ability to pay debts
    • Excludes inventories and prepaid assets
    Quick Assets Current Liabilities
  • 14. Cash Flow from Operations to Current Liabilities
    • Focuses on cash only
    • Covers period of time
    Net Cash Provided by Operating Activities Average Current Liabilities
  • 15. Accounts Receivable Turnover
    • Net Credit Sales
    • Average Accounts Receivable
    Indicates how quickly a company is collecting (i.e. turning over) its receivables
  • 16. Accounts Receivable Turnover
    • Too fast
    • credit policies too stringent; may be losing sales
    • Too slow
    • credit department not operating effectively; possible quality problems
  • 17. Days’ Sales in Receivables Represents the average # of days accounts are outstanding 360 Days Accts. Receivable Turnover 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27
  • 18. Days’ Sales in Receivables
    • If this company’s credit terms are net 30, what would this tell you about the efficiency of the collection process?
    360 Days 5.6 Times = 64 days Example: 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27
  • 19. Inventory Turnover Represents the number of times per period inventory is turned over (i.e. sold). Cost of Goods Sold Average Inventory
  • 20. Inventory Turnover
    • Circuit City 6.1 times per year
    • Safeway 9.5 times per year
    • Can you compare the two ratios?
  • 21. # of Days’ Sales in Inventory Represents the average # of days inventory is on hand before its sold # of Days in Period Inventory Turnover Ratio 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27
  • 22. # of Days’ Sales in Inventory
    • Circuit City 59 days
    • Safeway 38 days
    • Do these averages seem reasonable?
    1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27
  • 23. Cash Operating Cycle
    • Time between purchase of merchandise and collection from the sale
    # of days sales in receivables + # of days sales in inventory
  • 24. Analysis of Solvency
    • Ability to stay in business over the long-term
    Debt-to-Equity Ratio Debt Service Coverage Times Interest Earned Cash Flow to Capital Expenditures
  • 25. Debt-to-Equity Ratio Total liabilities Total Stockholders’ Equity How much have creditors contributed compared to owners?
  • 26. Debt-to-Equity Ratio Total liabilities Total Stockholders’ Equity = .60 For every dollar contributed by owners, creditors have loaned $.60
  • 27. Times Interest Earned Ratio
    • Measures ability to meet current interest payments
    • The greater the coverage the better
    Net Income + Interest Expense + Income Tax Expense Interest Expense
  • 28. Debt Service Coverage Ratio
    • Measures amount of cash from operations available to service the debt
    Cash Flow from Operations before Interest & Taxes Interest and Principal Payments P + i
  • 29. Cash Flow from Operations to Capital Expenditures Ratio
    • Measures company’s ability to use operations (vs. creditors and owners) to finance acquisitions of productive assets
    Cash Flow from Operations - Dividends Cash Paid for Capital Acquisitions
  • 30. Analysis of Profitability
    • Rate of Return on Assets
    • Return on Common S/E
    • EPS
    • P/E Ratio
    • Dividend Ratios
  • 31. Rate of Return on Assets
    • Measures return to all providers of capital (creditors and owners)
    Net Income + Interest Expense, net of tax Average Total Assets
  • 32. Return on Common Stockholders’ Equity Net Income - Preferred Dividends Average Common Stockholders’ Equity The owners earned 15% on their investment in ABC Co... Not bad!
  • 33. Earnings per Share
    • Presents profits on a per-share basis
    Net Income - Preferred Dividends Wtd. # of Common Shares Outstanding Certificate of Stock
  • 34. Price/Earnings Ratio
    • Relates earnings to the market price of the stock
    Current Market Price Earnings per Share very high P/E very low P/E possibly overvalued possibly undervalued
  • 35. Price/Earnings Ratio Both companies have earnings of $2 per share. So why the different P/E ratios? P/E Ratios Co. A = 6 to 1 Co. B = 8 to 1
  • 36. Dividend Payout Ratio Common Dividends per Share Earnings per Share We need to decide what % of the firm’s income we can return to owners.
  • 37. Dividend Yield Ratio
    • Investors willing to forgo dividends in lieu of price appreciation
    Common Dividends per Share Market Price per Share usually < 5% =
  • 38. End of Chapter 13