Overview of Financial Statement Analysis

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Overview of Financial Statement Analysis

  1. 1. Overview of Financial Statement Analysis 17 November 2007 FN 421 Financial Statement and Reporting Analysis of Commerce and Accountancy, 1 FN 421 Financial Statement and Reporting Analysis Faculty Thammasat University Business Analysis Evaluate Evaluate Prospects Risks Business Decision Makers • Equity investors • Creditors • Managers • Merger and Acquisition Analysts • External Auditors • Directors • Regulators • Employees & Unions • Lawyers 2 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Information Sources for Business Analysis Quantitative Qualitative • Financial Statements • Management Discussion & • Industry Statistics Analysis • Economic Indicators • Chairperson’s Letter • Regulatory filings • Vision/Mission Statement • Trade reports • Financial Press • Press Releases • Web sites 3 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  2. 2. Types of Business Analysis Credit Analysis Equity Analysis Management & Labor Negotiations Control Types of Business Analysis Regulation Director Oversight Financial External Auditing Management Mergers, Acquisitions & Divestitures 4 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Types of Business Analysis Credit Analysis Equity Analysis Management & Labor Negotiations Control Types of Business Analysis Regulation Director Oversight Financial External Auditing Management Mergers, Acquisitions & Divestitures 5 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Creditors Trade Creditors Non-trade Creditors • Provide goods or services • Provide major financing • Most short-term • Most long-term • Usually implicit interest • Usually explicit interest • Bear risk of default • Bear risk of default 6 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  3. 3. Credit Analysis Credit Worthiness Ability to honor credit obligations (downside risk) Liquidity Solvency Ability to meet short-term Ability to meet long-term obligations obligations Focus: Focus: – Current financial – Long-term financial conditions conditions – Current cash flows – Long-term cash flows – Liquidity of assets – Extended profitability 7 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Types of Business Analysis Credit Analysis Equity Analysis Management & Labor Negotiations Control Types of Business Analysis Regulation Director Oversight Financial External Auditing Management Mergers, Acquisitions & Divestitures 8 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Equity Analysis Assessment of downside risk and upside potential Technical Analysis Fundamental Analysis Determine value with Determine value without reference to price reference to price Charting: Analyze and interpret: – Patterns in price – Economy behavior or volume – Industry history – Company – Predit future price movements 9 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  4. 4. Intrinsic Value (or Fundamental Value) Value of Company (or stock) without reference to market value (or stock price) Intrinsic value Strategy Buy Market value Hold Sell 10 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Business and Financial Statements Analysis Business Environment & Strategy Analysis Industry Strategy Analysis Analysis Financial Accounting Analysis Prospective Analysis Analysis Analysis of Sources Profitability & Uses of Risk Analysis Funds Analysis Cost of Capital Estimate Intrinsic Value 11 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Accounting Analysis Process to evaluate and adjust financial statements to better reflect economic reality Comparability Problems — across firms and across time Manager estimation error Accounting Distortion Problems Earnings management Risk Distortion of business 12 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  5. 5. Financial Analysis Process to evaluate financial position and performance using financial statements Profitability Analysis Evaluate return on investment Common Tools Risk Analysis Evaluate riskiness & creditworthiness Cash Ratio Flows Analysis Analysis Analysis of Evaluate sources Cash Flows & uses of funds 13 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Prospective Analysis Process to forecast future payoffs Business Environment & Strategy Analysis Accounting Analysis Financial Analysis Intrinsic Value 14 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Dynamics of Business Activities Business Activities Time Beginning of Period Investing Financing Planning Operating Planning Investing Financing End of Period 15 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  6. 6. Business Activities Competition Pricing Market Demands Tactics Planning Activities : Goals & Distribution Objectives Promotion Managerial Projections Performance Opportunities Obstacles 16 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Business Activities Financing Activities • Owner (equity) • Non-owner (debts) Financing 17 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Business Activities Investing activities • Buying resources • Selling resources Investing Financing Investing = Financing 18 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  7. 7. Business Activities Planning Activities Investing Financial Activities Activities Operating Activities Revenues and expenses from providing goods and services 19 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Financial Statements Reflect Business Activities Planning Investing Financing Current: Operating Current: • Cash • Notes Payable • Accounts Receivable • Sales • Accounts Payable • Inventories • Cost of Goods Sold • Salaries Payable • Marketable Securities • Selling Expense • Income Tax Payable • Administrative Expense Noncurrent: • Interest Expense Noncurrent: • Land, Buildings, & • Income Tax Expense • Bonds Payable Equipment • Common Stock • Patents • Retained Earnings • Investments Net Income Liabilities & Equity Income statement Assets Cash Flow Balance Sheet Statement of Statement of Balance Sheet Cash Flows Shareholders’ Equity 20 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Financial Statements • Balance Sheet • Income Statement • Statement of Shareholders’ Equity • Statement of Cash Flows 21 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  8. 8. Balance Sheet Total Investing = Total Financing (Creditor + Owner) Income Statement Gross Profit = Revenues - COGS Operating Profit = Gross Profit - OPEX
  9. 9. Statement of Shareholders’ Equity Statement of Cash Flows Net cash flows from: Operating activities Investing activities Financing activities
  10. 10. Financial Statement Links Additional Information (Beyond Financial Statements) • Management Discussion & Analysis (MD&A) • Management Report • Auditor Report • Explanatory Notes to Financial Statements • Supplementary Information (Annual Reports, Form 56-1, Prospectus) • Proxy Statement 27 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  11. 11. Analysis Preview Comparative Analysis (Across Time) Yr 1 Yr 2 Yr 3 Purpose: Evaluation of consecutive financial statements Output: Direction, speed and extent of any trend(s) Types: • Year-to-year change analysis • Index-number trend analysis 29 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  12. 12. Common Size Analysis Yr 1 Yr 2 Yr 3 Purpose: • Evaluation of internal makeup of financial statements • Evaluation of financial statement accounts across companies Output: Proportionate size of assets, liabilities, equity, revenues and expenses 30 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Ratio Analysis Purpose: Evaluation of relation between two or more economically important items (one starting point for further analysis) Output: Mathematical expression of relation between two or more items Cautions: • Prior accounting analysis is important. • Interpretation is key. (Long v.s. short term and benchmarking) 31 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  13. 13. Ratio Analysis (Cont’d) 32 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Valuation (Goal of Business Analysis) Purpose: Estimate intrinsic value of a company (or stock) Basis: Present value theory (time value of money) Bond valuation Equity valuation: Dividend discount model Free cash flows model Residual income model 33 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University
  14. 14. Analysis in an Efficient Market • Weak form Price reflect information in past prices • Semi-strong form Prices reflect all public information • Strong form Prices reflect all public and private information 34 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University Analysis in an Efficient Market • Market Efficiency – assumes competent and informed analysis – distinguish aggregate from individual behavior – reflects information (both reliable and unreliable) – cross-country differences in rewards to analysis • Financial statement analysis relevant to more than just market analysis, e.g. – credit and lending – auditing – valuation of nonpublicly traded firms – mergers and acquisitions – etc. 35 FN 421 Financial Statement and Reporting Analysis Faculty of Commerce and Accountancy, Thammasat University

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