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Module 15 Module 15 Presentation Transcript

  • Module 3: Financial Statement Analysis ACG 2071 Fall 2007 Created by M. Mari
  • Basic Analytical Procedures
    • The basic financial statements provide much of the information users need to make economic decisions about businesses.
    • In order to make decisions, we must analyze the financial statements.
    • Horizontal Analysis
      • Percentage analysis of increases and decreases in related items in comparative financial statements.
      • Comparing of income statements for two years
      • Comparing of balance sheets for two years
  • Horizontal analysis -2.2% - $8,000 $1,003,000 $995,000 Total liab & equity -18% $33,000 $728,000 $695,000 Total equity -35% $105,000 $300,000 195,000 Retained earinings 17% $72,000 $428,000 $500,000 Common stock Equity 5% $30,000 $275,000 $300,000 Total liabilities -20% -$20,000 $125,000 $100,000 Long term liabilities 25% $50,000 $150,000 $200,000 Current liabilities Liabilities -2.2% -$8,000 $1,003,000 $995,000 Total assets -5.4% -$25,000 $470,000 $445,000 Fixed assets 3.2% $17,000 $533,000 $550,000 Current assets Assets Percent Amount 2005 2006
  • Vertical Analysis
      • A percentage analysis may also be used to show the relationship of each component to the total within a single statement.
      • Balance sheet
        • Each asset is shown as percentage of total assets
        • Each liability as percentage of total liabilities
      • Income statement
        • Each item is shown as percentage of net sales.
      • Common size statements
        • Can be used to compare to companies in the same industry
  • Solvency Analysis
    • Solvency is the ability of a company to pay its debts.
    • Profitability is the ability of a business to earn income.
      • They are interrelated.
    • Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its current and noncurrent liabilities.
      • Assessed by examining balance sheet relationships
      • Major analyses are:
        • Current position analysis
        • Accounts receivable analysis
        • Inventory analysis
        • The ratio of fixed assets to long-term liabilities
        • The number of times interest charges are earned.
  • Example $ 375,000.00 $ 705,000.00 $ 480,000.00 $ 320,000.00 Current liabilities $ 633,000.00 $ 813,000.00 $ 558,700.00 $ 460,000.00 Total current assets $ 10,000.00 $ 10,000.00 $ 4,200.00 $ 6,000.00 Prepaid Expenses $ 312,500.00 $ 350,000.00 $ 260,000.00 $ 218,000.00 Inventories $ 172,000.00 $ 208,000.00 $ 152,000.00 $ 106,000.00 Accounts receivable $ 26,000.00 $ 85,000.00 $ 60,000.00 $ 52,000.00 Marketable Securities $ 112,500.00 $ 160,000.00 $ 82,500.00 $ 78,000.00 Cash         Current Assets 2005 2006 2005 2006 Company B Company A
  • Solvency Analysis
    • Current Position Analysis
      • Measures to assess a business’s ability to pay its current liabilities
      • Special interest to short-term creditors
      • Working Capital
        • Current assets minus current liabilities
        • Used in evaluating a company’s ability to meet currently maturing debts.
      • Current Ratio
        • Working capital ratio or banker’s ratio
        • Computed by dividing current assets by current liabilities
  • Example 1.7 1.2 1.2 1.4 current assets/current liabilities 633000/375000 813000/705000 558700/480000 460000/320000 Current ratio         $ 258,000.00 $ 108,000.00 $ 78,700.00 $ 140,000.00 Current assets - current liabilities         Working Capital 2005 2006 2005 2006   Company B   Company A
  • Solvency
      • Quick Ratio:
        • A ratio that measures the instant debt paying ability of a company
        • Also called the acid test ratio
        • Ratio of quick assets to total current liabilities
    • Quick assets are cash and other current assets that can be quickly converted to cash such as marketable securities and accounts receivables
  • Quick Ratio Example 0.6 0.7 quick assets/ current liabilities 294500/480000 236000/320000 Quick ratio     $ 480,000.00 $ 320,000.00 Total current liabilities $ 294,500.00 $ 236,000.00 Total Quick Assets $ 152,000.00 $ 106,000.00 Accounts receivable $ 60,000.00 $ 52,000.00 Marketable Securities $ 82,500.00 $ 78,000.00 Cash     Current Assets 2005 2006   Company A
  • Accounts receivable analysis
        • The size and makeup of accounts receivable change constantly during business operations
        • Companies desire to collect receivables as promptly as possible
        • Cash collected from receivables improve solvency
        • Accounts receivable turnover
          • Relationship between sales and accounts receivable
          • Computed by net sales divided by average net accounts receivable
          • Average of accounts receivable
            • Beginning balance plus ending balance divided by 2
          • Higher the turnover the better.
  • Example 5.5 13.2 998000/180000 1500000/114000 Accounts receivable turnover $ 180,000.00 $ 114,000.00 (152000+208000)/2 (152000+76000)/2 Average Accounts Receivable $ 152,000.00 $ 76,000.00 End of Year $ 208,000.00 $ 152,000.00 Beginning of year     Accounts receivable $ 998,000.00 $ 1,500,000.00 Net sales 2005 2006   Company A
  • Number of days sales in receivables
    • Ratio is computed by dividing the average accounts receivable by the average daily sales.
          • Average daily sales is net sales divided by 365 days
    • Lower the ratio the better
  • Example 65.8 27.7   180000/2734.25 114000/4109.59 Number of days sales in receivables $ 2,734.25 $ 4,109.59   998000/365 1500000/365 Average daily sales $ 180,000.00 $ 114,000.00   (152000+208000)/2 (152000+76000)/2 Average Accounts Receivable $ 152,000.00 $ 76,000.00 End of Year $ 208,000.00 $ 152,000.00 Beginning of year     Accounts receivable $ 998,000.00 $ 1,500,000.00 Net sales 2005 2006   Company A
  • Inventory Analysis
    • Inventory has to be managed carefully
          • Too little inventory can cause customers to seek the product from another supplier
          • Too much inventory can increase storage costs, insurance, and obsolescence.
  • Inventory Turnover
            • Relationship between the volume of goods sold and inventory
            • Computed by cost of goods sold divided by average inventory
            • Average inventory is beginning inventory plus ending inventory divided by 2
    • Higher the ratio the better
  • Example 2.2 3.1   820000/367500 765000/250500 Inventory Turnover $ 367,500.00 $ 250,500.00   (312000+423000)/2 (312000+189000)/2 Average inventory $ 312,000.00 $ 189,000.00 End of year $ 423,000.00 $ 312,000.00 Beginning of year     Inventories $ 820,000.00 $ 765,000.00 Cost of goods sold 2005 2006   Company A
  • Number of days’ sales in inventory
          • Relationship between cost of goods sold and inventory
          • Computed by dividing the average inventory by the average daily cost of goods sold ( COGS/365 days)
          • Rough measure of the length of time it takes to acquire, sell, and replace inventory
          • Lower the ratio the better
  • Example 163.6 119.5   367500/2246.6 250500/2095.9 Number of days sales in inventory 2,246.6 2,095.9   820000/365 765000/365 Average COGS $ 367,500.00 $ 250,500.00   (312000+423000)/2 (312000+189000)/2 Average inventory $ 312,000.00 $ 189,000.00 End of year $ 423,000.00 $ 312,000.00 Beginning of year     Inventories $ 820,000.00 $ 765,000.00 Cost of goods sold 2005 2006   Company A
  • Ratio of fixed assets to long-term liabilities
    • Indicates the margin of safety of the noteholders or bondholders
    • Indicates the ability of the business to borrow additional funds on a long-term basis.
    • Higher the better
    2.3 2.0 Ratio of fixed assets to long-term liabilities $ 210,000.00 $ 175,000.00 Long-term liabilities $ 480,000.00 $ 350,000.00 Fixed assets (net) 2005 2006   Company A
  • Ratio of liabilities to stockholder’s equity
        • Claims against the total assets of a business are divided into two groups
          • Claims of creditors
          • Claims of owners
        • the relationship between the total claims of the creditors and owners
        • solvency measure that indicates the margin of safety for creditors
        • indicates the ability of the business to withstand adverse business conditions when the claims of creditors are large in relation to the equity of the stockholders, there are usually significant interest payments.
          • If earnings decline to the point that company is unable to meet interest payments, creditors may take over the business.
        • lower the better
  • Example 0.7 0.6 Ratio of fixed assets to long-term liabilities $ 503,000.00 $ 680,000.00 Total stockholder's Equity $ 375,000.00 $ 425,000.00 Total liabilities 2005 2006   Company A
  • Number of times interest charges earned
        • Called the fixed charge coverage ratio
        • The relative risk of the debtholders is normally measured
        • Higher the ratio, the lower the risk that interest payments will not be made if earnings decrease.
        • Indicates general financial strength of the business
  • Example 24.1 34.3   151800/6300 154500/4500 Number of times interest charges earned 151,800.0 154,500.0 Amount available to meet interest charges $ 6,300.00 $ 4,500.00 Add interest expense $ 145,500.00 $ 150,000.00 Income before taxes 2005 2006   Company A
  • Profitability Analysis
      • The ability of a business to earn profits depends of the effectiveness and efficiency of its operations as well as the resources available to it.
      • Focuses primarily on the relationship between operating results as reported in the income statement and resources available to the business as reported in the balance sheet
      • Major analysis used
        • Ratio of net sales to assets
        • Rate earned on total assets
        • Rate earned on stockholder’s equity
        • Rate earned on common stockholder’s equity
        • Earnings per share on common stock
        • Price-earning ratio
        • Dividends per share
        • Dividend yield
  • Ratio of net sales to assets
        • Is a profitability measure that shows how effectively a firm utilizes its assets
        • Higher the ratio is better
        • Computed by dividing net sales by average total assets (beginning total assets + ending total assets)/2
  • Example 0.9 0.8   820000/890000 765000/1000000 Ratio of net sales to total assets $ 890,000.00 $ 1,000,000.00   (980000+800000)/2 (980000+1020000)/2 Average Total Assets $ 980,000.00 $ 1,020,000.00 End of year $ 800,000.00 $ 980,000.00 Beginning of year     Total assets $ 820,000.00 $ 765,000.00 Net sales 2005 2006   Company A
  • Rate earned on total assets
        • Measures the profitability of total assets without considering how the assets are financed.
        • Higher the ratio is better
        • Computed by adding interest expense to net income and then dividing by average total assets
  • Example 0.3 0.2   269000/890000 171000/1000000 Rate earned on total assets $ 890,000.00 $ 1,000,000.00   (980000+800000)/2 (980000+1020000)/2 Average Total Assets $ 980,000.00 $ 1,020,000.00 End of year $ 800,000.00 $ 980,000.00 Beginning of year     Total assets $ 269,000.00 $ 171,000.00 TOTAL $ 19,000.00 $ 6,000.00 Plus interest expense $ 250,000.00 $ 165,000.00 Net income 2005 2006   Company A
  • Rate earned on stockholder’s equity
        • The measures emphasizes the rate of income earned on the amount invested by the stockholders.
        • Higher the ratio is better
        • Computed by net income divided by average stockholder’s equity
        • The rate earned by a business on the equity of its stockholders is usually higher than the rate earned on total assets.
          • Occurs when the amount earned on assets acquired with creditors’ funds is more than the interest paid to creditors
          • The difference in the rate on stockholder’s equity and the rate on total assets is called
            • LEVERAGE
  • Example 6% 8% LEVERAGE 30% 20% 24% 12%   Rate earned on assets 269000/890000 171000/1000000 Rate earned on stockholder’s equity $ 1,025,000.00 $ 1,375,000.00   (1250000+800000)/2 (1500000+1250000)/2 Average Total Assets $ 1,250,000.00 $ 1,500,000.00 End of year $ 800,000.00 $ 1,250,000.00 Beginning of year     Stockholder's equity $ 250,000.00 $ 165,000.00 Net income 2005 2006   Company A
  • Rate earned on common stockholder’s equity
        • Common stockholder’s have a residual claim on earnings
        • This measure focuses only on the rate of profits earned on the amount invested by the common stockholders
        • Computed by subtracting the preferred dividends requirements from the net income and dividing by the average common stockholder’s equity. .
        • Higher the ratio is better
  • Example 36% 19%   259000/725000 174000/900000 Rate earned on common stockholder's equity $ 725,000.00 $ 900,000.00   (950000+600000)/2 (850000+950000)/2 Average Total Assets $ 850,000.00 $ 950,000.00 End of year $ 600,000.00 $ 850,000.00 Beginning of year     Common Stockholder's equity $ 259,000.00 $ 174,000.00 TOTAL $ 9,000.00 $ 9,000.00 Preferred dividends $ 250,000.00 $ 165,000.00 Net income 2005 2006   Company A
  • Earnings per share (EPS)
        • Normally reported in the income statement on corporate annual reports
        • Computed by dividing net income by the number of shares of stock outstanding
        • If preferred and common stock are outstanding, the net income is reduced by the amount of preferred stock dividends.
  • Example $ 5.76 $ 3.48   259000/45000 174000/50000 EPS 45000 50000 Shares of common stock $ 259,000.00 $ 174,000.00 TOTAL $ 9,000.00 $ 9,000.00 Preferred dividends $ 250,000.00 $ 165,000.00 Net income 2005 2006   Company A
  • Price-Earnings Ratio
    • Indicator of a firm’s future earnings prospects
    • Computed by dividing the market price per share of common stock at a specific date by the annual earnings per share.
    12.87 16.45 Price earnings ratio $ 1.36 $ 1.52 Earnings per share $ 17.50 $ 25.00 Market price per share 2005 2006   Company A
  • Dividends per share and dividend yield
    • Indicator of a firm’s future earnings prospects
    • Computed by dividing the dividends per share by the market price
    0.07 0.03 Dividend yield $ 17.50 $ 25.00 Market price per share $ 1.20 $ 0.80 Dividends per share 2005 2006   Company A