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  • Financial Statements & Analysis FIL 240 Prepared by Keldon Bauer
  • Financial Statement Fundamentals
    • Publicly traded companies must file an annual (10-K) report with the SEC.
    • The purpose of the 10-K is to report to owners on the status of their investment.
    • The 10-K report contains both verbal and quantitative information about the performance of the firm.
  • Financial Statement Fundamentals
    • Income Statement (usually 3 years)
    • Balance Sheet (usually 2 years)
    • Statement of Retained Earnings
    • Statement of Cash Flows
    • Key operating statistics for 5-10 years
    • The purpose is both informative and marketing
    Financial Sections Include:
  • The Balance Sheet
    • The balance sheet is an attempt to show the sources of investment funds and their uses in the firm at the present time .
    • Accountants should be looking out for the interests of the investor.
      • Conservatism.
        • Lower of cost or market.
  • The Balance Sheet
    • Assets are listed in order of liquidity
      • Ease of conversion to cash
      • Without significant loss of value
    • The less liquid an item on the balance sheet is, the less reliably it reflects its current value over time.
      • Standard practice of inventory accounting, depreciation, etc. do not reflect actual value.
  • The Balance Sheet
    • Balance Sheet Identity
      • Assets = Liabilities + Stockholders’ Equity
      • Uses = Debt Sources + Equity Sources
    • The amount the firm owes on its liabilities is usually exactly what is on its balance sheet.
    • The value of the equity is never what appears on the balance sheet.
      • Equity is what is used to balance the identity.
  • Market versus Book Value
    • The balance sheet provides the book value of the assets, liabilities and equity.
    • Market value is the price at which the assets, liabilities or equity can actually be bought or sold.
    • Market value and book value are often very different. Why?
    • Which is more important to the decision-making process?
  • Income Statement
    • The income statement acts as a basis of change in the equity section of the balance sheet.
      • You either pay equity investors back with income, or increase their book value (reinvest).
    • You generally report revenues first and then deduct any expenses for the period.
    • Matching principle – GAAP requires revenue to be recognized when it accrues and match the expenses required to generate the revenue.
  • Ratio Analysis
    • Financial ratios are the vital signs of the business.
      • They are used to assess the health of the business.
      • When they are off the norm, they should be taken together with all known information to get a correct diagnosis.
    • Norms should be seen as a normal range, not just one number .
  • Ratio Analysis
    • Ratios also allow for better comparison through time or between companies
    • As we look at each ratio, ask yourself what the ratio is trying to measure and why is that information important
    • Ratios are used both internally and externally
  • Categories of Financial Ratios
    • Short-term solvency or liquidity ratios
    • Activity Ratios
    • Debt Ratios
    • Profitability ratios
    • Market value ratios
  • Liquidity Ratios
    • Relate short-term sources of and uses for cash.
    • Current Ratio:
  • Liquidity Ratios
    • Quick (Acid Test) Ratio:
  • Asset Management Ratios
    • Purpose is to assess how well the firm is managing assets
    • Inventory turnover ratio (IT):
  • Asset Management Ratios
    • Accounts receivable turnover (ART):
  • Asset Management Ratios
    • Accounts payable turnover ( APT ):
  • Asset Management Ratios
    • Total Asset Turnover (TAT):
      • Measure of asset use efficiency
      • Interpret in industry context.
  • Debt Ratios
    • Relate debt to equity sources of investment funds .
    • Debt Ratio:
  • Leverage Ratios
    • Equity Multiplier:
  • Coverage Ratios
    • Measure of ability to meet debt contracts.
    • Times Interest Earned (TIE) Ratio:
  • Leverage Ratios
    • EBITDA Ratio:
    • Can’t calculate example, CMLTD is not disclosed.
  • Profitability - Standardizing
    • Common-Size Balance Sheets
      • Compute all accounts as a percent of total assets
    • Common-Size Income Statements
      • Compute all line items as a percent of sales
    • Standardized statements make it easier to compare financial information, particularly as the company grows
    • They are also useful for comparing companies of different sizes, particularly within the same industry
  • Profitability Ratios
    • What’s the bottom line?
    • Gross Profit Margin (GPM):
  • Profitability Ratios
    • Operating Profit Margin (OPM):
  • Profitability Ratios
    • What’s the bottom line?
    • Net Profit Margin (NPM):
  • Profitability Ratios
    • Earnings per Share (EPS):
  • Profitability Ratios
    • Return on Total Assets (ROA):
      • This is a measure of the return on assets owned.
      • Therefore, it is a measure of return to all invested funds.
  • Profitability Ratios
    • Return on Common Equity (ROE):
      • This is a measure of return to the equity holder (whether or not they get a dividend).
  • Using the Du Pont Identity
    • ROE = PM * TAT * EM
      • Profit margin is a measure of the firm’s operating efficiency – how well does it control costs
      • Total asset turnover is a measure of the firm’s asset use efficiency – how well does it manage its assets
      • Equity multiplier is a measure of the firm’s financial leverage
  • Market Value Ratios
    • Price Earnings (P/E) Ratio:
  • Market Value Ratios
    • Market /Book (M/B) Ratio:
  • Benchmarking
    • Ratios are not very helpful by themselves; they need to be compared to something
    • Time-Trend Analysis
      • Used to see how the firm’s performance is changing through time
      • Internal and external uses
    • Peer Group Analysis
      • Compare to similar companies or within industries
      • SIC and NAICS codes
  • Time-Series Analysis
    • Evaluation of the firm’s financial performance over time using financial ratios.
      • Look for trends.
  • Interpretation
    • The firm needs to take advantage of opportunities for maximizing shareholder wealth.
    • That means you need to understand the real problem, not just the symptoms.
    • Students typically describe symptoms
      • Take a system wide approach.
        • What is the root problems?