2FinancialFinancialStatement AnalysisStatement AnalysisFinancial StatementsA Possible Framework for AnalysisRatio AnalysisTrend AnalysisCommon-Size and Index Analysis
3Examples of External UsesExamples of External Usesof Statement Analysisof Statement AnalysisTrade CreditorsTrade Creditors -- Focus on theliquidity of the firm.BondholdersBondholders -- Focus on thelong-term cash flow of the firm.ShareholdersShareholders -- Focus on theprofitability and long-term health ofthe firm.
4Examples of Internal UsesExamples of Internal Usesof Statement Analysisof Statement AnalysisPlanPlan -- Focus on assessing the currentfinancial position and evaluatingpotential firm opportunities.ControlControl -- Focus on return on investmentfor various assets and asset efficiency.UnderstandUnderstand -- Focus on understandinghow suppliers of funds analyze the firm.
5Primary Types ofPrimary Types ofFinancial StatementsFinancial StatementsIncome StatementIncome StatementA summary of a firm’s revenues andexpenses over a specified period, endingwith net income or loss for the period.Balance SheetBalance SheetA summary of a firm’s financial position ona given date that shows total assets = totalliabilities + owners’ equity.
6Basket Wonders’ BalanceBasket Wonders’ BalanceSheet (Asset Side)Sheet (Asset Side)a. How the firm stands ona specific date.b. What BW owned.c. Amounts owed bycustomers.d. Future expense itemsalready paid.e. Cash/likely convertibleto cash within 1 year.f. Original amount paid.g. Acc. deductions forwear and tear.Cash and C.E. $ 90Acct. Rec.cc394Inventories 696Prepaid Expdd5Accum Tax Prepay 10Current AssetsCurrent Assetsee$1,195$1,195Fixed Assets (@Cost)ff1030Less: Acc. Depr. gg(329)Net Fix. AssetsNet Fix. Assets $ 701$ 701Investment, LT 50Other Assets, LT 223bBasket Wonders Balance Sheet (thousands) Dec. 31, 2003Basket Wonders Balance Sheet (thousands) Dec. 31, 2003a
8Basket Wonders’Basket Wonders’Income StatementIncome Statementa. Measures profitabilityover a time period.b. Received, or receivable,from customers.c. Sales comm., adv.,officers’ salaries, etc.d. Operating income.e. Cost of borrowed funds.f. Taxable income.g. Amount earned forshareholders.Net Sales $ 2,211Cost of Goods Soldbb1,599Gross Profit $ 612SG&A Expensescc402EBITd$210 Interest Expensee59 EBTff$151 Income Taxes 60EATg$ 91Cash Dividends 38Increase in REIncrease in RE $ 53$ 53Basket Wonders Statement of Earnings (in thousands)Basket Wonders Statement of Earnings (in thousands)for Year Ending December 31, 2003for Year Ending December 31, 2003a
9Framework forFramework forFinancial AnalysisFinancial AnalysisAnalytical Tools UsedAnalytical Tools UsedSources and Uses StatementStatement of Cash FlowsCash Budgets1. Analysis of the funds1. Analysis of the fundsneeds of the firm.needs of the firm.Trend / Seasonal ComponentTrend / Seasonal ComponentHow much funding will berequired in the future?Is there a seasonalcomponent?
10Framework forFramework forFinancial AnalysisFinancial AnalysisHealth of a FirmFinancial Ratios1. Individually2. Over time3. In combination4. In comparison1. Analysis of the fundsneeds of the firm.2. Analysis of the financial2. Analysis of the financialcondition and profitabilitycondition and profitabilityof the firm.of the firm.
11Framework forFramework forFinancial AnalysisFinancial AnalysisExamplesExamples::Volatility in salesVolatility in costsProximity to break-evenpoint1. Analysis of the fundsneeds of the firm.2. Analysis of the financialcondition and profitabilityof the firm.3. Analysis of the business3. Analysis of the businessrisk of the firm.risk of the firm.Business riskBusiness risk relates tothe risk inherent in theoperations of the firm.
12Framework forFramework forFinancial AnalysisFinancial AnalysisA FinancialManagermustconsider allthree jointlywhendeterminingthefinancingneeds of thefirm.DeterminingDeterminingthethefinancingfinancingneeds ofneeds ofthe firm.the firm.1. Analysis of the funds1. Analysis of the fundsneeds of the firm.needs of the firm.2. Analysis of the financial2. Analysis of the financialcondition and profitabilitycondition and profitabilityof the firm.of the firm.3. Analysis of the business3. Analysis of the businessrisk of the firm.risk of the firm.
13Framework forFramework forFinancial AnalysisFinancial AnalysisNegotiationsNegotiationswithwithsuppliers ofsuppliers ofcapital.capital.DeterminingDeterminingthethefinancingfinancingneeds ofneeds ofthe firm.the firm.1. Analysis of the funds1. Analysis of the fundsneeds of the firm.needs of the firm.2. Analysis of the financial2. Analysis of the financialcondition and profitabilitycondition and profitabilityof the firm.of the firm.3. Analysis of the business3. Analysis of the businessrisk of the firm.risk of the firm.
14Use of Financial RatiosUse of Financial RatiosTypes ofTypes ofComparisonsComparisonsInternalInternalComparisonsComparisonsExternalExternalComparisonsComparisonsA Financial Ratio isan index that relatestwo accountingnumbers and isobtained by dividingone number by theother.
15External Comparisons andExternal Comparisons andSources of Industry RatiosSources of Industry RatiosExamples:Robert MorrisRobert MorrisAssociatesAssociatesDun & BradstreetDun & BradstreetAlmanac ofAlmanac ofBusiness andBusiness andIndustrialIndustrialFinancial RatiosFinancial RatiosThis involvescomparing the ratiosof one firm with thoseof similarsimilar firms or withindustry averages.SimilaritySimilarity is importantas one shouldcompare “apples toapples.”
16Liquidity RatiosLiquidity RatiosCurrentCurrentCurrent AssetsCurrent AssetsCurrent LiabilitiesCurrent LiabilitiesFor Basket WondersDecember 31, 2003Shows a firm’sability to cover itscurrent liabilitieswith its currentassets.Balance Sheet RatiosLiquidity Ratios$1,195$1,195$500$500= 2.392.39
17Liquidity RatioLiquidity RatioComparisonsComparisonsBW Industry2.39 2.152.26 2.091.91 2.01Year200320022001CurrentCurrent RatioRatioRatio is stronger than the industry average.
18Liquidity RatiosLiquidity RatiosAcid-Test (Quick)Acid-Test (Quick)Current Assets - InvCurrent Assets - InvCurrent LiabilitiesCurrent LiabilitiesFor Basket WondersDecember 31, 2003Shows a firm’sability to meetcurrent liabilitieswith its most liquidassets.Balance Sheet RatiosLiquidity Ratios$1,195 - $696$1,195 - $696$500$500= 1.001.00
19Liquidity RatioLiquidity RatioComparisonsComparisonsBW Industry1.00 1.251.04 1.231.11 1.25Year200320022001Acid-Test RatioAcid-Test RatioRatio is weaker than the industry average.
20Summary of the LiquiditySummary of the LiquidityRatio ComparisonsRatio ComparisonsStrong current ratio and weak acid-testratio indicates a potential problem inthe inventories account.Note that this industry has a relativelyhigh level of inventories.RatioRatio BWBW IndustryIndustryCurrent 2.39 2.15Acid-Test 1.00 1.25
21Current Ratio -- TrendCurrent Ratio -- TrendAnalysis ComparisonAnalysis ComparisonTrend Analysis of Current Ratio220.127.116.11.12.32.52001 2002 2003Analysis YearRatioValueBWIndustry
22Acid-Test Ratio -- TrendAcid-Test Ratio -- TrendAnalysis ComparisonAnalysis ComparisonTrend Analysis of Acid-Test Ratio0.50.81.01.31.52001 2002 2003Analysis YearRatioValueBWIndustry
23Summary of the LiquiditySummary of the LiquidityTrend AnalysesTrend AnalysesThe current ratio for the industryindustry hasbeen rising slowly at the same time theacid-test ratio has been relativelystable.This indicates that inventoriesinventories are asignificant problem for BWBW.The current ratio for BWBW has been risingat the same time the acid-test ratio hasbeen declining.
24Financial Leverage RatiosFinancial Leverage RatiosDebt-to-EquityDebt-to-EquityTotal DebtTotal DebtShareholders’ EquityShareholders’ EquityFor Basket WondersDecember 31, 2003Shows the extent towhich the firm isfinanced by debt.Balance Sheet RatiosFinancial LeverageRatios$1,030$1,030$1,139$1,139= .90.90
25Financial LeverageFinancial LeverageRatio ComparisonsRatio ComparisonsBW Industry.90 .90.88 .90.81 .89Year200320022001Debt-to-Equity RatioDebt-to-Equity RatioBW has average debt utilizationrelative to the industry average.
26Financial Leverage RatiosFinancial Leverage RatiosDebt-to-Total-AssetsDebt-to-Total-AssetsTotal DebtTotal DebtTotal AssetsTotal AssetsFor Basket WondersDecember 31, 2003Shows thepercentage of thefirm’s assets that aresupported by debtfinancing.Balance Sheet RatiosFinancial LeverageRatios$1,030$1,030$2,169$2,169= .47.47
27Financial LeverageFinancial LeverageRatio ComparisonsRatio ComparisonsBW Industry.47 .47.47 .47.45 .47Year200320022001Debt-to-Total-Asset RatioDebt-to-Total-Asset RatioBW has average debt utilizationrelative to the industry average.
28Financial Leverage RatiosFinancial Leverage RatiosTotal CapitalizationTotal CapitalizationTotal DebtTotal DebtTotal CapitalizationTotal CapitalizationFor Basket WondersDecember 31, 2003Shows the relativeimportance of long-termdebt to the long-termfinancing of the firm.Balance Sheet RatiosFinancial LeverageRatios$1,030$1,030$1,669$1,669= .62.62(i.e., LT-Debt + Equity)
29Financial LeverageFinancial LeverageRatio ComparisonsRatio ComparisonsBW Industry.62 .60.62 .61.67 .62Year200320022001Total Capitalization RatioTotal Capitalization RatioBW has average long-term debt utilizationrelative to the industry average.
30Coverage RatiosCoverage RatiosInterest CoverageInterest CoverageEBITEBITInterest ChargesInterest ChargesFor Basket WondersDecember 31, 2003Indicates a firm’sability to coverinterest charges.Income StatementRatiosCoverage Ratios$210$210$59$59= 3.563.56
31CoverageCoverageRatio ComparisonsRatio ComparisonsBW Industry3.56 5.194.35 5.0210.30 4.66Year200320022001Interest Coverage RatioInterest Coverage RatioBW has below average interest coveragerelative to the industry average.
32Coverage Ratio -- TrendCoverage Ratio -- TrendAnalysis ComparisonAnalysis ComparisonTrend Analysis of Interest Coverage Ratio3.05.07.09.011.02001 2002 2003Analysis YearRatioValueBWIndustry
33Summary of the CoverageSummary of the CoverageTrend AnalysisTrend AnalysisThis indicates that low earningslow earnings (EBIT)may be a potential problem for BWBW.Note, we know that debt levelsdebt levels are inline with the industryindustry averages.The interest coverage ratio for BWBW hasbeen falling since 2001. It has beenbelow industryindustry averages for the pasttwo years.
34Activity RatiosActivity RatiosReceivable TurnoverReceivable TurnoverAnnual Net Credit SalesAnnual Net Credit SalesReceivablesReceivablesFor Basket WondersDecember 31, 2003Indicates quality ofreceivables and howsuccessful the firm is inits collections.Income Statement /Balance SheetRatiosActivity Ratios$2,211$2,211$394$394= 5.615.61(Assume all sales are credit sales.)
35Activity RatiosActivity RatiosAvg Collection PeriodAvg Collection PeriodDays in the YearDays in the YearReceivable TurnoverReceivable TurnoverFor Basket WondersDecember 31, 2003Average number of daysthat receivables areoutstanding.(or RT in days)Income Statement /Balance SheetRatiosActivity Ratios3653655.615.61= 65 days65 days
36ActivityActivityRatio ComparisonsRatio ComparisonsBW Industry65.0 65.771.1 66.383.6 69.2Year200320022001Average Collection PeriodAverage Collection PeriodBW has improved the average collectionperiod to that of the industry average.
38Activity RatiosActivity RatiosPT in DaysPT in DaysDays in the YearDays in the YearPayable TurnoverPayable TurnoverFor Basket WondersDecember 31, 2003Average number of daysthat payables areoutstanding.Income Statement /Balance SheetRatiosActivity Ratios36536516.516.5= 22.1 days22.1 days
39ActivityActivityRatio ComparisonsRatio ComparisonsBW Industry22.1 46.725.4 51.143.5 48.5Year200320022001Payable Turnover in DaysPayable Turnover in DaysBW has improved the PT in Days.Is this good?Is this good?
40Activity RatiosActivity RatiosInventory TurnoverInventory TurnoverCost of Goods SoldCost of Goods SoldInventoryInventoryFor Basket WondersDecember 31, 2003Indicates theeffectiveness of theinventory managementpractices of the firm.Income Statement /Balance SheetRatiosActivity Ratios$1,599$1,599$696$696= 2.302.30
41ActivityActivityRatio ComparisonsRatio ComparisonsBW Industry2.30 3.452.44 3.762.64 3.69Year200320022001Inventory Turnover RatioInventory Turnover RatioBW has a very poor inventory turnover ratio.
43Activity RatiosActivity RatiosTotal Asset TurnoverTotal Asset TurnoverNet SalesNet SalesTotal AssetsTotal AssetsFor Basket WondersDecember 31, 2003Indicates the overalleffectiveness of the firmin utilizing its assets togenerate sales.Income Statement /Balance SheetRatiosActivity Ratios$2,211$2,211$2,169$2,169= 1.021.02
44ActivityActivityRatio ComparisonsRatio ComparisonsBW Industry1.02 1.171.03 1.141.01 1.13Year200320022001Total Asset Turnover RatioTotal Asset Turnover RatioBW has a weak total asset turnover ratio.Why is this ratio considered weak?Why is this ratio considered weak?
48Profitability RatiosProfitability RatiosNet Profit MarginNet Profit MarginNet Profit after TaxesNet Profit after TaxesNet SalesNet SalesFor Basket WondersDecember 31, 2003Indicates the firm’sprofitability after takingaccount of all expensesand income taxes.Income Statement /Balance SheetRatiosProfitability Ratios$91$91$2,211$2,211= .041.041
49ProfitabilityProfitabilityRatio ComparisonsRatio ComparisonsBW Industry4.1% 8.2%4.9 8.19.0 7.6Year200320022001Net Profit MarginNet Profit MarginBW has a poor Net Profit Margin.
50Net Profit Margin --Net Profit Margin --Trend Analysis ComparisonTrend Analysis ComparisonTrend Analysis of Net Profit Margin456789102001 2002 2003Analysis YearRatioValue(%)BWIndustry
51Profitability RatiosProfitability RatiosReturn on InvestmentReturn on InvestmentNet Profit after TaxesNet Profit after TaxesTotal AssetsTotal AssetsFor Basket WondersDecember 31, 2003Indicates theprofitability on theassets of the firm (afterall expenses and taxes).Income Statement /Balance SheetRatiosProfitability Ratios$91$91$2,160$2,160= .042.042
52ProfitabilityProfitabilityRatio ComparisonsRatio ComparisonsBW Industry4.2% 9.8%5.0 9.19.1 10.8Year200320022001Return on InvestmentReturn on InvestmentBW has a poor Return on Investment.
53Return on Investment –Return on Investment –Trend Analysis ComparisonTrend Analysis ComparisonTrend Analysis of Return on Investment46810122001 2002 2003Analysis YearRatioValue(%)BWIndustry
54Profitability RatiosProfitability RatiosReturn on EquityReturn on EquityNet Profit after TaxesNet Profit after TaxesShareholders’ EquityShareholders’ EquityFor Basket WondersDecember 31, 2003Indicates the profitabilityto the shareholders ofthe firm (after allexpenses and taxes).Income Statement /Balance SheetRatiosProfitability Ratios$91$91$1,139$1,139= .08.08
55ProfitabilityProfitabilityRatio ComparisonsRatio ComparisonsBW Industry8.0% 17.9%9.4 17.216.6 20.4Year200320022001Return on EquityReturn on EquityBW has a poor Return on Equity.
56Return on Equity --Return on Equity --Trend Analysis ComparisonTrend Analysis ComparisonTrend Analysis of Return on Equity7.010.514.017.521.02001 2002 2003Analysis YearRatioValue(%)BWIndustry
57Return on Investment andReturn on Investment andthe Du Pont Approachthe Du Pont ApproachROIROI2003 = .041 x 1.02 = .042.042 or 4.2%4.2%ROIROIIndustry = .082 x 1.17 = .098.098 or 9.8%9.8%ROIROI = Net profit margin XTotal asset turnoverEarning PowerEarning Power = Sales profitability XAsset efficiency
58Return on Equity andReturn on Equity andthe Du Pont Approachthe Du Pont ApproachROEROE2003 = .041 x 1.02 x 1.90 = .080.080ROEROEIndustry = .082 x 1.17 x 1.88 = .179179Return On EquityReturn On Equity = Net profit margin XTotal asset turnover XEquity MultiplierEquity MultiplierEquity Multiplier =Total AssetsShareholders’ Equity
59Summary of the ProfitabilitySummary of the ProfitabilityTrend AnalysesTrend AnalysesThe profitability ratios for BWBW have ALLbeen falling since 2001. Each has beenbelow the industryindustry averages for the pastthree years.This indicates that COGSCOGS andadministrative costsadministrative costs may both be toohigh and a potential problem for BWBW.Note, this result is consistent with thelow interest coverage ratio.
60Summary of Ratio AnalysesSummary of Ratio AnalysesInventories are too high.May be paying off creditors(accounts payable) too soon.COGS may be too high.Selling, general, andadministrative costs may be toohigh.
61Common-size AnalysisCommon-size AnalysisAn analysis of percentagefinancial statements where allbalance sheet items are dividedby total assets and all incomestatement items are divided bynet sales or revenues.
65Index AnalysesIndex AnalysesAn analysis of percentage financialstatements where all balance sheetor income statement figures for abase year equal 100.0 (percent) andsubsequent financial statementitems are expressed as percentagesof their values in the base year.