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    financial analysis financial analysis Presentation Transcript

    • 17-1 ANALYSIS AND INTERPRETATION OFFINANCIAL STATEMENTS
    • 17-2Financial Statement Analysis Financial Statement Analysis will help business owners and other interested people to analyse the data in financial statements to provide them with better information about such key factors for decision making and ultimate business survival.
    • 17-3Financial Statement AnalysisWho analyzes financial statements? Internal users (i.e., management) External users (emphasis of chapter) Examples? Investors, creditors, regulatory agencies & … stock market analysts and auditors
    • 17-4Financial Statement Analysis What do internal users use it for? Planning, evaluating and controlling company operations What do external users use it for? Assessing past performance and current financial position and making predictions about the future profitability and solvency of the company as well as evaluating the effectiveness of management
    • 17-5Financial Statement AnalysisInformation is available from Published annual reports (1) Financial statements (2) Notes to financial statements (3) Letters to shareholders (4) Auditor’s report (5) Management’s discussion and analysis Reports filed with the government e.g., Form 10-K, Form 10-Q and Form 8-K
    • 17-6Financial Statement AnalysisInformation is available from Other sources (1) Newspapers (e.g., Journal ledger ) (2) Periodicals (e.g. Forbes, Fortune) (3) Financial information organizations such as: Moody’s, Standard & Poor’s, Dun & Bradstreet, Inc., and Robert Morris
    • Methods of 17-7Financial Statement Analysis Horizontal Analysis Vertical Analysis Common-Size Statements Trend Percentages Ratio Analysis
    • 17-8 Horizontal Analysis Using comparative financial Using comparative financialstatements to calculate amountstatements to calculate amount or percentage changes in a or percentage changes in a financial statement item from financial statement item from one period to the next one period to the next
    • 17-9Vertical AnalysisFor a single financial For a single financialstatement, each itemstatement, each item is expressed as a is expressed as a percentage of a percentage of a significant total, significant total, e.g., all income e.g., all income statement items are statement items are expressed as a expressed as a percentage of sales percentage of sales
    • 17-10Common-Size Statements Financial statements that show Financial statements that show only percentages and no only percentages and no absolute amounts absolute amounts
    • 17-11 Trend Percentages Show changes over time in Show changes over time ingiven financial statement itemsgiven financial statement items (can help evaluate financial (can help evaluate financial information of several years) information of several years)
    • 17-12 Ratio AnalysisExpression of logical relationshipsExpression of logical relationships between items in a financial between items in a financial statement of a single period statement of a single period (e.g., percentage relationship (e.g., percentage relationshipbetween revenue and net income) between revenue and net income)
    • 17-13Horizontal Analysis Example The management of Clover Company provides you with comparative balance sheets of the years ended December 31, 1999 and 1998. Management asks you to prepare a horizontal analysis on the information.
    • 17-14
    • 17-15Horizontal Analysis ExampleCalculating Change in Rupees Amounts Rupees Current Year Base Year = – Change Figure Figure
    • 17-16Horizontal Analysis ExampleCalculating Change in Dollar Amounts Dollar Current Year Base Year = – Change Figure Figure Since we are measuring the amount of the change between 1998 and 1999, the Rupees amounts for 1998 become the “base” year figures.
    • 17-17Horizontal Analysis Example Calculating Change as a PercentagePercentage Rupees Change Change = Base Year Figure × 100%
    • 17-18Horizontal Analysis Example $12,000 – $23,500 = $(11,500)
    • 17-19Horizontal Analysis Example ($11,500 ÷ $23,500) × 100% = 48.9%
    • 17-20Horizontal Analysis Example
    • 17-21Horizontal Analysis Example Let’s apply the same procedures to the liability and shareholders’ equity sections of the balance sheet.
    • 17-22 CLOVER CORPORATION Comparative Balance Sheets December 31, 1999 and 1998 Increase (Decrease) 1999 1998 Amount % Liabilities and Stockholders EquityCurrent liabilities: Accounts payable $ 67,000 $ 44,000 $ 23,000 52.3 Notes payable 3,000 6,000 (3,000) (50.0) Total current liabilities 70,000 50,000 20,000 40.0Long-term liabilities: Bonds payable, 8% 75,000 80,000 (5,000) (6.3) Total liabilities 145,000 130,000 15,000 11.5Stockholders equity: Preferred stock 20,000 20,000 - 0.0 Common stock 60,000 60,000 - 0.0 Additional paid-in capital 10,000 10,000 - 0.0 Total paid-in capital 90,000 90,000 - 0.0Retained earnings 80,000 69,700 10,300 14.8 Total stockholders equity 170,000 159,700 10,300 6.4Total liabilities and stockholders equity $ 315,000 $ 289,700 $ 25,300 8.7
    • 17-23Horizontal Analysis Example Now, let’s apply the procedures to the income statement.
    • 17-24 CLOVER CORPORATION Comparative Income Statements For the Years Ended December 31, 1999 and 1998 Increase (Decrease) 1999 1998 Amount %Net sales $ 520,000 $ 480,000 $ 40,000 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net operating income 31,400 39,000 (7,600) (19.5)Interest expense 6,400 7,000 (600) (8.6)Net income before taxes 25,000 32,000 (7,000) (21.9)Less income taxes (30%) 7,500 9,600 (2,100) (21.9)Net income $ 17,500 $ 22,400 $ (4,900) (21.9)
    • 17-25 CLOVER CORPORATION Comparative Income Statements For the Years Ended December 31, 1999 and 1998 Increase (Decrease) 1999 1998 Amount %Net sales $ 520,000 $ 480,000 $ 40,000 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net operating income 31,400 39,000 (7,600) (19.5)Interest expense 6,400 7,000 (600) (8.6)Net income before taxes 25,000 32,000 (7,000) (21.9)Less income taxes (30%) 7,500 9,600 (2,100) (21.9)Net income $ 17,500 $ 22,400 $ (4,900) (21.9) Sales increased by 8.3% while net income decreased by 21.9%.
    • 17-26 There were increases in both cost of goodssold (14.3%) and operating expenses (2.1%). These increased costs more than offset the CLOVER CORPORATION increase in sales, yielding an overall Comparative Income Statements decrease in net income. For the Years Ended December 31, 1999 and 1998 Increase (Decrease) 1999 1998 Amount %Net sales $ 520,000 $ 480,000 $ 40,000 8.3Cost of goods sold 360,000 315,000 45,000 14.3Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1Net operating income 31,400 39,000 (7,600) (19.5)Interest expense 6,400 7,000 (600) (8.6)Net income before taxes 25,000 32,000 (7,000) (21.9)Less income taxes (30%) 7,500 9,600 (2,100) (21.9)Net income $ 17,500 $ 22,400 $ (4,900) (21.9)
    • 17-27 Vertical Analysis ExampleThe management of Sample Company asks you to prepare a vertical analysis for the comparative balance sheets of the company.
    • 17-28Vertical Analysis Example
    • 17-29Vertical Analysis Example $82,000 ÷ $483,000 = 17% rounded $30,000 ÷ $387,000 = 8% rounded
    • 17-30Vertical Analysis Example $76,000 ÷ $483,000 = 16% rounded
    • 17-31Trend Percentages Example Wheeler, Inc. provides you with the following operating data and asks that you prepare a trend analysis.
    • 17-32Trend Percentages Example Wheeler, Inc. provides you with the following operating data and asks that you prepare a trend analysis. $1,991 - $1,820 = $171
    • 17-33Trend Percentages ExampleUsing 1995 as the base year, we develop the following percentage relationships. $1,991 - $1,820 = $171 $171 ÷ $1,820 = 9% rounded
    • 17-34Trend linefor Sales
    • 17-35 RatiosRatios can be expressed in three different ways:1. Ratio (e.g., current ratio of 2:1)2. % (e.g., profit margin of 2%)3. $ (e.g., EPS of $2.25) CAUTION! “Using ratios and percentages without considering the underlying causes may be hazardous to your health!” lead to incorrect conclusions.”
    • 17-36 Categories of RatiosLiquidity Ratios Indicate a company’s short-term debt-paying abilityEquity (Long-Term Solvency) Ratios Show relationship between debt and equity financing in a companyProfitability Tests Relate income to other variablesMarket Tests Help assess relative merits of stocks in the marketplace
    • 17-3710 Ratios You Must Know Liquidity RatiosCurrent (working capital) ratioAcid-test (quick) ratioCash flow liquidity ratioAccounts receivable turnoverNumber of days’ sales in accounts receivableInventory turnoverTotal assets turnover
    • 17-38 10 Ratios You Must KnowEquity (Long-Term Solvency) Ratios Equity (stockholders’ equity) ratio Equity to debt
    • 17-3910 Ratios You Must Know Profitability TestsReturn on operating assetsNet income to net sales (return onsales or “profit margin”) margin” $Return on average common stockholders’ equity (ROE) ROECash flow marginEarnings per shareTimes interest earnedTimes preferred dividends earned
    • 17-4010 Ratios You Must Know Market TestsEarnings yield on common stockPrice-earnings ratioPayout ratio on common stockDividend yield on common stockDividend yield on preferred stockCash flow per share of commonstock
    • 17-41 Now, let’s look at NortonCorporation’s 1999and 1998 financial statements.
    • 17-42
    • 17-43
    • 17-44
    • 17-45 Now, let’s calculate the 10 ratios basedon Norton’s financial statements.
    • 17-46 NORTON CORPORATION 1999 Cash $ 30,000 Accounts receivable, net We will Beginning of year 17,000 use this End of year 20,000information Inventoryto calculate Beginning of year 10,000 the liquidity End of year 12,000 ratios for Total current assets 65,000 Norton. Total current liabilities 42,000 Sales on account 494,000 Cost of goods sold 140,000
    • 17-47 Working Capital* The excess of current assets over current liabilities. 12/31/99Current assets $ 65,000Current liabilities (42,000)Working capital $ 23,000 * While this is not a ratio, it does give an indication of a company’s liquidity.
    • 17-48Current (Working Capital) Ratio #1 Current Current Assets = Ratio Current Liabilities Current $65,000 = = 1.55 : 1 Ratio $42,000 Measures the ability of the company to pay current debts as they become due.
    • 17-49Acid-Test (Quick) Ratio #2Acid-Test Quick Assets = Ratio Current Liabilities Quick assets are Cash, Marketable Securities, Accounts Receivable (net) and current Notes Receivable.
    • 17-50Acid-Test (Quick) Ratio #2Acid-Test Quick Assets = Ratio Current Liabilities Norton Corporation’s quick assets consist of cash of $30,000 and accounts receivable of $20,000.
    • 17-51Acid-Test (Quick) Ratio #2Acid-Test Quick Assets = Ratio Current LiabilitiesAcid-Test $50,000 = = 1.19 : 1 Ratio $42,000
    • 17-52Accounts Receivable Turnover Net, credit sales #3 Average, net accounts receivable Accounts Sales on Account Receivable = Average Accounts Receivable Turnover Accounts $494,000 Receivable = = 26.70 times ($17,000 + $20,000) ÷ 2 Turnover This ratio measures how many times a company converts its receivables into cash each year.
    • Number of Days’ Sales 17-53 in Accounts Receivable #4Days’ Sales 365 Daysin Accounts = Accounts Receivable TurnoverReceivablesDays’ Sales 365 Daysin Accounts = = 13.67 days 26.70 TimesReceivablesMeasures, on average, how many days it takes to collect an account receivable.
    • 17-54 Inventory Turnover #5 Inventory Cost of Goods Sold = Turnover Average Inventory Inventory $140,000 = = 12.73 times Turnover ($10,000 + $12,000) ÷ 2Measures the number of times inventory is sold and replaced during the year.
    • Equity, or Long–Term 17-55 Solvency Ratios This is part of the information to calculate the equity, or long-termsolvency ratios of Norton Corporation. NORTON CORPORATION 1999Net operating income $ 84,000Net sales 494,000Interest expense 7,300Total stockholders equity 234,390
    • 17-56 NORTON CORPORATION 1999 Common shares outstanding Beginning of year 17,000 End of year 27,400 Net income $ 53,690 Here is the Stockholders equity rest of the Beginning of year 180,000information we will End of year 234,390 use. Dividends per share 2 Dec. 31 market price/share 20 Interest expense 7,300 Total assets Beginning of year 300,000 End of year 346,390
    • 17-57 Equity Ratio #6 Equity Stockholders’ Equity = Ratio Total Assets Equity $234,390 = = 67.7% Ratio $346,390 Measures the proportionof total assets provided by shareholders.
    • 17-58Net Income to Net Sales on Sales or Profit Margin #7 Net Income Net Income to = Net Sales Net Sales Net Income $53,690 to = = 10.9% $494,000 Net Sales Measures the proportion of the sales which is retained as profit.
    • Return on Average Common 17-59 Shareholders’ Equity (ROE) #8 Return on Net IncomeStockholders’ = Average Common Equity Stockholders’ Equity Return on $53,690Stockholders’ = = 25.9% ($180,000 + $234,390) ÷ 2 Equity Important measure of the income-producing ability of a company.
    • 17-60 Earnings Per Share #9 Earnings Available to Common ShareholdersEarnings = Weighted-Average Number of Commonper Share Shares OutstandingEarnings $53,690 = = $2.42per Share (17,000 + 27,400) ÷ 2 The financial press regularly publishes actual and forecasted EPS amounts.
    • 17-61 Price-Earnings Ratio #10Price-Earnings Market Price Per Share = Ratio EPSPrice-Earnings $20.00 = = 8.3 : 1 Ratio $ 2.42 Provides some measure of whether the stock is under or overpriced.
    • 17-62 Important ConsiderationsNeed for comparable data Data is provided by Dun & Bradstreet, Standard & Poor’s etc. Must compare by industry Is EPS comparable?Influence of external factors General business conditions Seasonal nature of business operationsImpact of inflation
    • No more ratios, please! 17-63
    • 17-64 Question The current ratio is a measure of The current ratio is a measure of liquidity that is computed by dividing liquidity that is computed by dividing total assets by total liabilities. total assets by total liabilities.a. Truea. Trueb. Falseb. False
    • 17-65 Question The current ratio is a measure of The current ratio is a measure of liquidity that is computed by dividing liquidity that is computed by dividing total assets by total liabilities. total assets by total liabilities.a. Truea. Trueb. Falseb. False The current ratio is a measure of The current ratio is a measure of liquidity, but is computed by liquidity, but is computed by dividing current assets by dividing current assets by current liabilities current liabilities
    • 17-66 Question Quick assets are defined as Cash, Quick assets are defined as Cash, Marketable Securities and net Marketable Securities and net receivables. receivables.a.a. True Trueb.b. False False
    • 17-67 Question Quick assets are defined as Cash, Quick assets are defined as Cash, Marketable Securities and net Marketable Securities and net receivables. receivables.a.a. True Trueb.b. False False
    • 17-68 Question Accounting Ratios are important tools Accounting Ratios are important tools used by. used by.a. Managersa. Managers c. Investors, c. Investors,b. Researchersb. Researchers d. All of the above d. All of the above Ans: d Ans: d
    • 17-69 Question Working Capital Turnover measures the Working Capital Turnover measures the relationship of Working Capital with. relationship of Working Capital with.a. Fixed Assetsa. Fixed Assetsb. Salesb. Salesc. Purchasec. Purchased. Stockd. Stock Ans; a Ans; a
    • 17-70 Question In Current Ratio, Current Assets are In Current Ratio, Current Assets are compared with:. compared with:.a. Current Profita. Current Profitb. Current Liabilities,b. Current Liabilities,c. Fixed Assets,c. Fixed Assets,d. Equity Share Capital.d. Equity Share Capital. Ans:b Ans:b
    • 17-71 Question Ratio of Net Income to Number of Equity Ratio of Net Income to Number of Equity Shares known as. Shares known as.a. Price Earnings Ratio,a. Price Earnings Ratio,b. Net Profit Ratio,b. Net Profit Ratio,c. Earnings per Share,c. Earnings per Share,d. Dividend per Share.d. Dividend per Share. Ans: c Ans: c
    • 17-72 Question Gross Profit Ratio for a firm remains Gross Profit Ratio for a firm remainssame but the Net Profit Ratio is same but the Net Profit Ratio isdecreasing. The reason for such decreasing. The reason for suchbehavior could be: behavior could be:(a)Increase in Costs of Goods Sold, (a)Increase in Costs of Goods Sold,(b)If Increase in Expense, (b)If Increase in Expense,(c)Increase in Dividend, (c)Increase in Dividend,(d)Decrease in Sales. (d)Decrease in Sales. Ans: b Ans: b
    • 17-73 Which of the Question Which of the following statements is following statements iscorrect? correct?(a)A Higher Receivable Turnover is not (a)A Higher Receivable Turnover is notdesirable, desirable,(b)Interest Coverage Ratio depends upon (b)Interest Coverage Ratio depends uponTax Rate, Tax Rate,(c) Increase in Net Profit Ratio means (c) Increase in Net Profit Ratio meansincrease in Sales, increase in Sales,(d) Lower Debt-Equity Ratio means (d) Lower Debt-Equity Ratio meanslower Financial Risk. lower Financial Risk. Ans:d Ans:d
    • 17-74 Question Which of the following helps analysing Which of the following helps analysingreturn to equity Shareholders? return to equity Shareholders?(a) Return on Assets, (a) Return on Assets,(b) Earnings Per Share, (b) Earnings Per Share,(c) Net Profit Ratio, (c) Net Profit Ratio,(d)Return on Investment. (d)Return on Investment. Ans: b Ans: b
    • 17-75 Question Trend Analysis helps comparing Trend Analysis helps comparingperformance of a firm performance of a firm(a)With other firms, (a)With other firms,(b)Over a period of firm, (b)Over a period of firm,(c)With other industries, (c)With other industries,(d) None of the above (d) None of the above Ans: b Ans: b
    • 17-76 Question Ratio Analysis can be used to study Ratio Analysis can be used to studyliquidity, turnover, profitability, etc. of a liquidity, turnover, profitability, etc. of afirm. What does Debt-Equity Ratio help firm. What does Debt-Equity Ratio helpto study? to study?(a)Solvency, (a)Solvency,(b)Liquidity, (b)Liquidity,(c)Profitability, (c)Profitability,(d) Turnover, (d) Turnover, Ans: a Ans: a
    • 17-77 Question In Inventory Turnover calculation, what In Inventory Turnover calculation, whatis taken in the numerator? is taken in the numerator?(a) Sales, (a) Sales,(b)Cost of Goods Sold, (b)Cost of Goods Sold,(c)Opening Stock, (c)Opening Stock,(d) Closing Stock. (d) Closing Stock. Ans: b Ans: b
    • 17-78Thank you!!!Ganesh.S.Uppin