CHAPTER 13 Financial Statement Analysis
Financial Statement Analysis <ul><li>External users and analysts rely on publicly-available information to perform financi...
Annual Report Contents FOUR BASIC FINANCIAL STATEMENTS FOOTNOTES TO THE FINANCIAL  STATEMENTS SUMMARY OF ACCOUNTING METHOD...
Tools to Evaluate Financial Information <ul><li>Horizontal Analysis </li></ul><ul><li>Vertical Analysis </li></ul><ul><li>...
Horizontal Analysis <ul><li>Examines percentage change in each item on the financial statements </li></ul><ul><li>Compares...
Horizontal - Trend Percentages <ul><li>Specialized form of horizontal analysis </li></ul><ul><li>Shows trend of financial ...
Vertical Analysis <ul><li>Vertical Analysis </li></ul>2
Vertical Analysis <ul><li>Compares each item on the financial statement to a key, or base, item </li></ul><ul><li>Base-ite...
Benchmarking Against the Industry Average <ul><li>Benchmarking  is a term used to describe the process of comparing a comp...
<ul><li>A company also can compare its common-size financials to those of its industry’s leaders </li></ul><ul><li>Determi...
<ul><li>Ratio Analysis </li></ul>Using Ratios to Make Business Decisions 3
Using Ratios to Make Business Decisions <ul><li>Ratios - the relationship between two items on financial statements - perm...
<ul><li>Ratios measure an entity’s ability to:  </li></ul><ul><li>Pay current liabilities </li></ul><ul><li>Sell inventory...
Ratios in Chapter 13 <ul><li>Overview, pp. 630 </li></ul><ul><li>Decision guidelines lists all ratios </li></ul>
Ratio analysis <ul><li>The  current ratio  is a ratio of the current assets to the current liabilities.  Acceptable curren...
Ratio analysis <ul><li>The  acid-test (quick) ratio  measures the quick assets—cash, short-term investments, and receivabl...
Ratio analysis <ul><li>Inventory turnover  measures how many times a year the company sells its average level of inventory...
Ratio analysis <ul><li>Suppose you were analyzing Company A and Company B and the two companies reported the following: </...
Ratio analysis <ul><li>Not all ratios apply to all companies.  For example, inventory turnover would not be applicable to ...
<ul><li>Financial analysts use several ratios to assess value of stock investments: </li></ul><ul><li>Price/earnings ratio...
Earnings Per Share <ul><li>Most widely quoted of all financial statistics </li></ul><ul><li>Computed by dividing net incom...
Price/Earnings Ratio <ul><li>Decision to buy, hold, or sell stock </li></ul><ul><li>Relationship between a stock’s market ...
<ul><li>Suppose the market value of Asian Art, Inc., common stock is $15.75 on the last day of its fiscal year </li></ul><...
Price/Earnings Ratio Example <ul><li>Market value of stock </li></ul><ul><li>Earnings per share </li></ul><ul><li>$15.75 <...
Dividend Yield <ul><li>Ratio of dividends per share of stock to the stock’s market value </li></ul><ul><li>Indicates the p...
Dividend Yield <ul><li>Annual dividends per share </li></ul><ul><li>Stock’s market value per share </li></ul><ul><li>Examp...
Dividend Yield <ul><li>Annual dividends per share </li></ul><ul><li>Stock’s market value per share </li></ul><ul><li>$1.25...
Limitations  of Financial Analysis <ul><li>No one ratio or year’s worth of financial information should be relied upon to ...
End of Lecture
Upcoming SlideShare
Loading in …5
×

Chapter 13

610 views

Published on

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
610
On SlideShare
0
From Embeds
0
Number of Embeds
2
Actions
Shares
0
Downloads
7
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Chapter 13

  1. 1. CHAPTER 13 Financial Statement Analysis
  2. 2. Financial Statement Analysis <ul><li>External users and analysts rely on publicly-available information to perform financial analysis </li></ul><ul><li>Such information is contained in corporate annual report </li></ul>
  3. 3. Annual Report Contents FOUR BASIC FINANCIAL STATEMENTS FOOTNOTES TO THE FINANCIAL STATEMENTS SUMMARY OF ACCOUNTING METHODS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL STATEMENTS AUDITOR’S REPORT COMPARATIVE FINANCIAL DATA FOR A SERIES OF YEARS 1 2 3 4 5 6
  4. 4. Tools to Evaluate Financial Information <ul><li>Horizontal Analysis </li></ul><ul><li>Vertical Analysis </li></ul><ul><li>Ratio Analysis </li></ul>3 2 1
  5. 5. Horizontal Analysis <ul><li>Examines percentage change in each item on the financial statements </li></ul><ul><li>Compares current year’s dollar amount with prior year’s dollar amount </li></ul><ul><li>Expresses the change in </li></ul><ul><ul><li>Dollars </li></ul></ul><ul><ul><li>Percentage </li></ul></ul><ul><ul><li>Look at Exhibit 13-3, Pg. 610 </li></ul></ul>
  6. 6. Horizontal - Trend Percentages <ul><li>Specialized form of horizontal analysis </li></ul><ul><li>Shows trend of financial statement items over longer time periods such as 5 or 10 years </li></ul>
  7. 7. Vertical Analysis <ul><li>Vertical Analysis </li></ul>2
  8. 8. Vertical Analysis <ul><li>Compares each item on the financial statement to a key, or base, item </li></ul><ul><li>Base-item dollar amount always set to 100% </li></ul><ul><li>Produces “common-size” statements </li></ul><ul><li>Income statement </li></ul><ul><ul><li>Net sales = 100% </li></ul></ul><ul><li>Balance sheet </li></ul><ul><ul><li>Total assets = 100% </li></ul></ul><ul><ul><li>Look at exhibit 13-4, Pg 612 and 13-5, Pg 613 </li></ul></ul>
  9. 9. Benchmarking Against the Industry Average <ul><li>Benchmarking is a term used to describe the process of comparing a company’s activities to a standard of excellence achieved by industry leaders </li></ul>
  10. 10. <ul><li>A company also can compare its common-size financials to those of its industry’s leaders </li></ul><ul><li>Determine where it differs </li></ul><ul><li>Design and implement business processes to bring financial results in line with these benchmark entities </li></ul>Benchmarking Against Key Competitors
  11. 11. <ul><li>Ratio Analysis </li></ul>Using Ratios to Make Business Decisions 3
  12. 12. Using Ratios to Make Business Decisions <ul><li>Ratios - the relationship between two items on financial statements - permit users to calculate a variety of financial comparisons </li></ul><ul><li>These ratios can be compared to: </li></ul><ul><li>Prior years’ financial results </li></ul><ul><li>Industry averages </li></ul><ul><li>Benchmark entities’ ratios </li></ul>
  13. 13. <ul><li>Ratios measure an entity’s ability to: </li></ul><ul><li>Pay current liabilities </li></ul><ul><li>Sell inventory and collect receivables </li></ul><ul><li>Pay long-term debt </li></ul><ul><li>Generate profits from operations </li></ul><ul><li>Sustain shareholder wealth </li></ul>Using Ratios to Make Business Decisions
  14. 14. Ratios in Chapter 13 <ul><li>Overview, pp. 630 </li></ul><ul><li>Decision guidelines lists all ratios </li></ul>
  15. 15. Ratio analysis <ul><li>The current ratio is a ratio of the current assets to the current liabilities. Acceptable current ratios vary from industry to industry, but the norm for most companies is between 1.6 and 1.9.   </li></ul><ul><li>There are five categories of current assets that are listed in order of their liquidity: Cash, Short-term Investments, Receivables, Inventory, and Prepaid Expenses. </li></ul>
  16. 16. Ratio analysis <ul><li>The acid-test (quick) ratio measures the quick assets—cash, short-term investments, and receivables—to current liabilities. This ratio excludes inventory and prepaid expenses because these current assets are the least liquid current assets. </li></ul><ul><li>Certain ratios measure the firm’s ability to sell inventory and collect receivables , a key factor in a firm’s success. </li></ul>
  17. 17. Ratio analysis <ul><li>Inventory turnover measures how many times a year the company sells its average level of inventory. A high turnover indicates relative ease of selling inventory, while a low turnover indicates relative difficulty of selling inventory. </li></ul><ul><li>Accounts receivable turnover measures how quickly the firm collects cash from credit customers. The higher the ratio, the more quickly a firm collects its receivables. </li></ul><ul><li>Days’ sales in receivables is the number of days ’ sales that remain uncollected. </li></ul>
  18. 18. Ratio analysis <ul><li>Suppose you were analyzing Company A and Company B and the two companies reported the following: </li></ul><ul><li>Company A Company B </li></ul><ul><li>Current assets $10,000 $10,000,000 </li></ul><ul><li>Current liabilities 5,000 9,995,000 </li></ul><ul><li>Working capital $ 5,000 $ 5,000 </li></ul><ul><li>Both companies have identical working capital, but which company has a better ability to pay its short-term debt? </li></ul><ul><li>Company A, because the ratio of the current assets to current liabilities is higher for Company A. Working capital is not a ratio; it does not calculate the relative size of the current assets to current liabilities. The current ratio provides a better understanding of the two companies’ liquidity. </li></ul><ul><li>Current ratio of A is 2 ($10,000  $5,000) Current ratio of B is 1.001 ($10,000,000  $9,995,000) </li></ul>
  19. 19. Ratio analysis <ul><li>Not all ratios apply to all companies. For example, inventory turnover would not be applicable to a service company </li></ul><ul><li>Sharp changes in ratios indicate that something significant has happened, but the manager must analyze the change to determine what has occurred and what corrective action must be taken. </li></ul>
  20. 20. <ul><li>Financial analysts use several ratios to assess value of stock investments: </li></ul><ul><li>Price/earnings ratio </li></ul><ul><li>Dividend yield </li></ul><ul><li>Book value (covered in chapter 9) </li></ul>Analyzing the Company’s Stock as an Investment
  21. 21. Earnings Per Share <ul><li>Most widely quoted of all financial statistics </li></ul><ul><li>Computed by dividing net income available to common stockholders by the number of common shares outstanding during the year </li></ul><ul><li>= Net Income – Preferred Dividends </li></ul><ul><li>Number of common shares outstanding </li></ul>
  22. 22. Price/Earnings Ratio <ul><li>Decision to buy, hold, or sell stock </li></ul><ul><li>Relationship between a stock’s market price and its earnings per share </li></ul><ul><li>Measures the number of times one share of stock sells above the current period’s reported earnings </li></ul><ul><li>Widely published in The Wall Street Journal </li></ul>
  23. 23. <ul><li>Suppose the market value of Asian Art, Inc., common stock is $15.75 on the last day of its fiscal year </li></ul><ul><li>The income statement reports EPS of $.92 </li></ul><ul><li>What is Asian Art’s price/earnings ratio? </li></ul>Price/Earnings Ratio Calculating the P/E ratio Market value of stock Earnings per share
  24. 24. Price/Earnings Ratio Example <ul><li>Market value of stock </li></ul><ul><li>Earnings per share </li></ul><ul><li>$15.75 </li></ul><ul><li>$.92 </li></ul><ul><li>= 17.12 </li></ul>
  25. 25. Dividend Yield <ul><li>Ratio of dividends per share of stock to the stock’s market value </li></ul><ul><li>Indicates the percentage of a stock’s market value “returned” to the stockholder in the form of dividends </li></ul><ul><li>Assists investors who desire a steady flow of dividend revenue in their decisions to invest in a particular stock </li></ul>
  26. 26. Dividend Yield <ul><li>Annual dividends per share </li></ul><ul><li>Stock’s market value per share </li></ul><ul><li>Example: If Asian Art paid a total of $1.25 in dividends per share, what would be its dividend yield, assuming the same market value for its stock ($15.75)? </li></ul>
  27. 27. Dividend Yield <ul><li>Annual dividends per share </li></ul><ul><li>Stock’s market value per share </li></ul><ul><li>$1.25 </li></ul><ul><li>$15.75 </li></ul><ul><li>= .079 </li></ul>
  28. 28. Limitations of Financial Analysis <ul><li>No one ratio or year’s worth of financial information should be relied upon to provide a complete assessment of a corporation’s financial condition </li></ul><ul><li>Ratio analysis is most helpful when calculated over a broad time frame and when used in conjunction with other relevant information that can affect a company, such as legislation, competition, and scandals. </li></ul><ul><li>Analysts should: </li></ul><ul><li>Examine trends over time </li></ul><ul><li>Benchmark to industry and key competitors </li></ul><ul><li>Seek answers about why ratios are different </li></ul>
  29. 29. End of Lecture

×