Chapter 13 Financial Statement Analysis No part of this product may be reproduced, transmitted, or used in any form or by ...
Financial Statement Analysis Stockholders Creditors Management Will I  be paid? How  good is our  investment? How are we p...
Limitations of Financial Statement Analysis <ul><li>Use of different accounting methods </li></ul><ul><li>Changes in accou...
Limitations of Financial Statement Analysis <ul><li>Failure to understand trends or use industry ratios </li></ul><ul><li>...
Limitations of Financial Statement Analysis <ul><li>Nonoperating items on income statement </li></ul><ul><li>Effects of in...
Horizontal Analysis <ul><li>Net Sales </li></ul><ul><li>Earnings before factory closure  </li></ul><ul><li>Net earnings </...
Trend Analysis <ul><li>Return on </li></ul><ul><li>Avg. Equity </li></ul><ul><li>1996 1995 1994 1993 1992 </li></ul><ul><l...
Vertical Analysis <ul><li>Common-size statements recast items as a percentage of a selected item </li></ul><ul><li>Allows ...
Common-Size Statements <ul><li>Sales revenue </li></ul><ul><li>Cost of goods sold </li></ul><ul><li>Gross profit </li></ul...
Analysis of Liquidity <ul><li>Nearness to cash </li></ul><ul><li>Ability to pay debts as they become due </li></ul>Cash  R...
Working Capital <ul><li>Excess of current assets over current liabilities </li></ul><ul><li>Lacks meaningful comparisons f...
Current Ratio <ul><li>Measure of short-term financial health </li></ul><ul><li>Consider composition of current assets </li...
Acid-Test (Quick) Ratio <ul><li>Stricter test of ability to  pay debts </li></ul><ul><li>Excludes inventories and prepaid ...
Cash Flow from Operations to Current Liabilities <ul><li>Focuses on cash only </li></ul><ul><li>Covers period of time </li...
Accounts Receivable Turnover <ul><li>Net Credit Sales </li></ul><ul><li>Average Accounts Receivable </li></ul>Indicates ho...
Accounts Receivable Turnover <ul><li>Too fast </li></ul><ul><li>credit policies too stringent; may be losing sales </li></...
Days’ Sales in Receivables Represents the average # of days  accounts are outstanding 365 Days Accts. Receivable Turnover ...
Days’ Sales in Receivables <ul><li>If this company’s credit terms are net 30,  what would this tell you about the efficien...
Inventory Turnover Represents the number of times per period inventory is turned over (i.e. sold). Cost of Goods Sold Aver...
Inventory Turnover <ul><li>Circuit City   4.3 times per year </li></ul><ul><li>Safeway   10.1 times per year </li></ul><ul...
# of Days’ Sales in Inventory Represents the average # of days  inventory is on hand before its sold # of Days in Period I...
# of Days’ Sales in Inventory <ul><li>Circuit City 84 days </li></ul><ul><li>Safeway 36 days </li></ul><ul><li>Do these av...
Cash Operating Cycle <ul><li>Time between purchase of merchandise and collection from the sale </li></ul># of days sales i...
Analysis of Solvency <ul><li>Ability to stay in business over the long-term </li></ul>Debt-to-Equity Ratio Debt Service Co...
Debt-to-Equity Ratio Total liabilities Total Stockholders’ Equity How much have creditors  contributed  compared to owners?
Debt-to-Equity Ratio Total liabilities Total Stockholders’ Equity = .60 For every dollar contributed by owners, creditors ...
Times Interest Earned Ratio <ul><li>Measures ability to meet current interest payments </li></ul><ul><li>The greater the c...
Debt Service Coverage Ratio <ul><li>Measures amount of cash from operations available to service the debt </li></ul>Cash F...
Cash Flow from Operations to Capital Expenditures Ratio <ul><li>Measures company’s ability to use operations (vs. creditor...
Analysis of Profitability <ul><li>Rate of Return on Assets </li></ul><ul><li>Return on Common S/E </li></ul><ul><li>EPS </...
Rate of Return on Assets <ul><li>Measures return to all providers of capital (creditors and owners) </li></ul>Net Income +...
Return on Common Stockholders’ Equity Net Income - Preferred Dividends Average Common Stockholders’ Equity The owners earn...
Earnings per Share <ul><li>Presents profits on a per-share basis </li></ul>Net Income - Preferred Dividends Wtd. # of Comm...
Price-Earnings Ratio <ul><li>Relates earnings to the market price of the stock  </li></ul>Current Market Price Earnings pe...
Price-Earnings Ratio Both companies have earnings of $2 per share.  So why the different P-E ratios? P-E Ratios Co. A = 6 ...
Dividend Payout Ratio Common Dividends per Share Earnings per Share We need to  decide what % of the firm’s  income we can...
Dividend Yield Ratio <ul><li>Investors willing to forgo dividends in lieu of price appreciation </li></ul>Common Dividends...
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* Copyright © 1999 by Harcourt Brace

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* Copyright © 1999 by Harcourt Brace

  1. 1. Chapter 13 Financial Statement Analysis No part of this product may be reproduced, transmitted, or used in any form or by any means except as provided in the Harcourt Brace & Company end-use license agreement found in a readme file attached to this work. Requests for permission to make copies of any part of the work should be mailed to the following address: Permissions Department, Harcourt Brace & Company, 6277 Sea Harbor Drive, Orlando, FL 32887. Portions of this work were published in previous editions. Produced in the United States of America. 0-03-021353-3
  2. 2. Financial Statement Analysis Stockholders Creditors Management Will I be paid? How good is our investment? How are we performing?
  3. 3. Limitations of Financial Statement Analysis <ul><li>Use of different accounting methods </li></ul><ul><li>Changes in accounting methods </li></ul>LIFO FIFO
  4. 4. Limitations of Financial Statement Analysis <ul><li>Failure to understand trends or use industry ratios </li></ul><ul><li>Difficulty of making industry comparisons (i.e. conglomerates) </li></ul>????
  5. 5. Limitations of Financial Statement Analysis <ul><li>Nonoperating items on income statement </li></ul><ul><li>Effects of inflation </li></ul>=
  6. 6. Horizontal Analysis <ul><li>Net Sales </li></ul><ul><li>Earnings before factory closure </li></ul><ul><li>Net earnings </li></ul><ul><li>Increase (Decrease) </li></ul><ul><li>1996 1995 Dollars Percent </li></ul><ul><li>$1,836 $1,755 81 4.6% </li></ul><ul><li> 243 224 19 8.5% </li></ul><ul><li> 230 224 6 2.7% </li></ul>Wm. Wrigley Jr. Company (in millions)
  7. 7. Trend Analysis <ul><li>Return on </li></ul><ul><li>Avg. Equity </li></ul><ul><li>1996 1995 1994 1993 1992 </li></ul><ul><li>27.2% 30.1% 36.5% 32.6% 29.4% </li></ul>Wm. Wrigley Jr. Company Tracking items over a series of years
  8. 8. Vertical Analysis <ul><li>Common-size statements recast items as a percentage of a selected item </li></ul><ul><li>Allows comparisons of companies of different size </li></ul><ul><li>Compares percentages across years to identify trends </li></ul>% % %
  9. 9. Common-Size Statements <ul><li>Sales revenue </li></ul><ul><li>Cost of goods sold </li></ul><ul><li>Gross profit </li></ul><ul><li>Selling & admin. exp. </li></ul><ul><li>Operating income </li></ul><ul><li>Interest expense </li></ul><ul><li>Income before tax </li></ul><ul><li>Income tax expense </li></ul><ul><li>Net income </li></ul>Dollars % $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. 10. Analysis of Liquidity <ul><li>Nearness to cash </li></ul><ul><li>Ability to pay debts as they become due </li></ul>Cash Ratios Turnover Ratios Working Capital Ratios
  11. 11. Working Capital <ul><li>Excess of current assets over current liabilities </li></ul><ul><li>Lacks meaningful comparisons for companies of different size </li></ul>-
  12. 12. Current Ratio <ul><li>Measure of short-term financial health </li></ul><ul><li>Consider composition of current assets </li></ul>Rule of thumb 2:1
  13. 13. Acid-Test (Quick) Ratio <ul><li>Stricter test of ability to pay debts </li></ul><ul><li>Excludes inventories and prepaid assets </li></ul>Quick Assets Current Liabilities
  14. 14. Cash Flow from Operations to Current Liabilities <ul><li>Focuses on cash only </li></ul><ul><li>Covers period of time </li></ul>Net Cash Provided by Operating Activities Average Current Liabilities
  15. 15. Accounts Receivable Turnover <ul><li>Net Credit Sales </li></ul><ul><li>Average Accounts Receivable </li></ul>Indicates how quickly a company is collecting (i.e. turning over) its receivables
  16. 16. Accounts Receivable Turnover <ul><li>Too fast </li></ul><ul><li>credit policies too stringent; may be losing sales </li></ul><ul><li>Too slow </li></ul><ul><li>credit department not operating effectively; possible quality problems </li></ul>
  17. 17. Days’ Sales in Receivables Represents the average # of days accounts are outstanding 365 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. 18. Days’ Sales in Receivables <ul><li>If this company’s credit terms are net 30, what would this tell you about the efficiency of the collection process? </li></ul>365 Days 5.6 Times = 65 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. 19. Inventory Turnover Represents the number of times per period inventory is turned over (i.e. sold). Cost of Goods Sold Average Inventory
  20. 20. Inventory Turnover <ul><li>Circuit City 4.3 times per year </li></ul><ul><li>Safeway 10.1 times per year </li></ul><ul><li>Can you compare the two ratios? </li></ul>
  21. 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. 22. # of Days’ Sales in Inventory <ul><li>Circuit City 84 days </li></ul><ul><li>Safeway 36 days </li></ul><ul><li>Do these averages seem reasonable? </li></ul>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. 23. Cash Operating Cycle <ul><li>Time between purchase of merchandise and collection from the sale </li></ul># of days sales in receivables + # of days sales in inventory
  24. 24. Analysis of Solvency <ul><li>Ability to stay in business over the long-term </li></ul>Debt-to-Equity Ratio Debt Service Coverage Times Interest Earned Cash Flow to Capital Expenditures
  25. 25. Debt-to-Equity Ratio Total liabilities Total Stockholders’ Equity How much have creditors contributed compared to owners?
  26. 26. Debt-to-Equity Ratio Total liabilities Total Stockholders’ Equity = .60 For every dollar contributed by owners, creditors have loaned $.60
  27. 27. Times Interest Earned Ratio <ul><li>Measures ability to meet current interest payments </li></ul><ul><li>The greater the coverage the better </li></ul>Net Income + Interest Expense + Income Tax Expense Interest Expense
  28. 28. Debt Service Coverage Ratio <ul><li>Measures amount of cash from operations available to service the debt </li></ul>Cash Flow from Operations before Interest & Taxes Interest and Principal Payments P + i
  29. 29. Cash Flow from Operations to Capital Expenditures Ratio <ul><li>Measures company’s ability to use operations (vs. creditors and owners) to finance acquisitions of productive assets </li></ul>Cash Flow from Operations - Dividends Cash Paid for Capital Acquisitions
  30. 30. Analysis of Profitability <ul><li>Rate of Return on Assets </li></ul><ul><li>Return on Common S/E </li></ul><ul><li>EPS </li></ul><ul><li>P/E Ratio </li></ul><ul><li>Dividend Ratios </li></ul>
  31. 31. Rate of Return on Assets <ul><li>Measures return to all providers of capital (creditors and owners) </li></ul>Net Income + Interest Expense, net of tax Average Total Assets
  32. 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. 33. Earnings per Share <ul><li>Presents profits on a per-share basis </li></ul>Net Income - Preferred Dividends Wtd. # of Common Shares Outstanding Certificate of Stock
  34. 34. Price-Earnings Ratio <ul><li>Relates earnings to the market price of the stock </li></ul>Current Market Price Earnings per Share very high P/E very low P/E possibly overvalued possibly undervalued
  35. 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. 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. 37. Dividend Yield Ratio <ul><li>Investors willing to forgo dividends in lieu of price appreciation </li></ul>Common Dividends per Share Market Price per Share usually < 5% = Harcourt Brace & Company items and derived items:

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