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Overview of Financial Analysis <ul><li>SPECIFY THE OBJECTIVES OF THE ANALYSIS </li></ul><ul><li>Focus on who is the financ...
Steps of a F/S Analysis <ul><li>Establish objectives of the analysis </li></ul><ul><li>Study the industry and relate indus...
Potential Financial Statement Users: <ul><li>Creditors </li></ul><ul><li>Investors </li></ul><ul><li>Managers </li></ul><u...
Data sources <ul><li>Financial statements (and notes) </li></ul><ul><li>Auditor’s report </li></ul><ul><li>MD&A </li></ul>...
Tools for analysis <ul><li>Common size financial statements </li></ul><ul><li>Financial ratios </li></ul><ul><li>Trend ana...
Financial Ratio Categories <ul><li>Liquidity Ratios </li></ul><ul><ul><li>measure a firm’s ability to meet cash needs as t...
Ratio Categories (continued) <ul><li>Leverage Ratios </li></ul><ul><ul><li>measure the extent of a firm’s financing with d...
Caution! <ul><li>Ratios are valuable, BUT….. </li></ul><ul><ul><li>They do not provide answers in an of themselves and are...
Profitability Ratios <ul><li>Gross Profit Margin </li></ul><ul><ul><li>Gross Profit/Net Sales </li></ul></ul><ul><li>Opera...
Profitability Ratios (continued) <ul><li>Return on Investment (or Return on Assets) </li></ul><ul><ul><li>Net Earnings/Tot...
Return on Investment <ul><li>Return on Investment (ROI) </li></ul><ul><ul><li>Net operating income </li></ul></ul><ul><ul>...
Understanding ROI 2005 KD Hatheway-Dial ROI = Margin X Turnover = Operating Margin = Turnover Net Operating Income Sales S...
Understanding ROI 2005 KD Hatheway-Dial 12.5% = X 2.5 = 5% = 2.5 $10,000 $80,000 $200,000 $200,000 X 100 5%
APPLYING ROI 2005 KD Hatheway-Dial 23.25% = 8.4545 X 2.75 = 8.4545 = 2.75 $18,600 $80,000 $220,000 $220,000 10% Increased ...
APPLYING ROI 2005 KD Hatheway-Dial 36.25% = 14.5% X 2.50 = 14.5% = 2.50 $29,000 $80,000 $200,000 $200,000 10% Decrease in ...
APPLYING ROI 2005 KD Hatheway-Dial 13.90% = 5.0% X 2.78 = 5.0% = 2.78 $10,000 $72,000 $200,000 $200,000 10% Decrease in op...
APPLYING ROI 2005 KD Hatheway-Dial 16.25% = 6.8% X 2.39 = 6.8% = 2.39 $14,300 $88,000 $210,000 $210,000 10% increase in op...
Profitability Ratios (continued) <ul><li>Cash Flow Margin </li></ul><ul><ul><li>Cash Flow from Operating Activities /Net S...
Profitability Ratios (continued) <ul><li>Cash Return on Assets </li></ul><ul><ul><li>Cash Flow from Operating Activities /...
Liquidity Ratios <ul><li>Current Ratio </li></ul><ul><ul><li>Current Assets/Current Liabilities </li></ul></ul><ul><ul><li...
Activity Ratios <ul><li>Average Collection Period </li></ul><ul><ul><li>Accounts Receivable/Average Daily Sales </li></ul>...
Activity Ratios (continued) <ul><li>Inventory Turnover </li></ul><ul><ul><li>Cost of Goods Sold/Inventory </li></ul></ul><...
Leverage: Debt Ratios <ul><li>Debt Ratio </li></ul><ul><ul><li>Total Liabilities/Total Assets </li></ul></ul><ul><li>Long-...
Leverage: Coverage Ratios <ul><li>Proportion and amount of debt in capital structure is important to analyst </li></ul><ul...
Coverage Ratios (continued) <ul><li>Times Interest Earned </li></ul><ul><ul><li>Operating Profit/Interest Expense </li></u...
Coverage Ratios (continued) <ul><li>Cash Flow Adequacy </li></ul><ul><ul><li>Cash Flow from Operating Activities/ Average ...
Other Ratios <ul><li>Earnings per Common Share </li></ul><ul><ul><li>Net Earnings/Average Common Shares Outstanding </li><...
Other Ratios (continued) <ul><li>Dividend Payout </li></ul><ul><ul><li>Dividends per Share/Earnings per Share </li></ul></...
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Financialanalysis.ppt

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Financialanalysis.ppt

  1. 1. Overview of Financial Analysis <ul><li>SPECIFY THE OBJECTIVES OF THE ANALYSIS </li></ul><ul><li>Focus on who is the financial statement user </li></ul><ul><li>The identity of the user helps define what information is needed </li></ul>Financial The company’s return on equity has dipped considerably over the last period I had better sell that stock ASAP!
  2. 2. Steps of a F/S Analysis <ul><li>Establish objectives of the analysis </li></ul><ul><li>Study the industry and relate industry climate to current and projected economic developments - </li></ul><ul><ul><ul><li>a growth industry? </li></ul></ul></ul><ul><ul><ul><li>a dying industry? </li></ul></ul></ul><ul><ul><ul><li>a changing industry? </li></ul></ul></ul><ul><li>Develop knowledge of firm and quality of management </li></ul><ul><li>Evaluate financial statements using basic tools </li></ul><ul><li>Summarize findings </li></ul><ul><li>Reach conclusions relevant to established objectives </li></ul>
  3. 3. Potential Financial Statement Users: <ul><li>Creditors </li></ul><ul><li>Investors </li></ul><ul><li>Managers </li></ul><ul><li>Who else? </li></ul><ul><li>What types of questions do each of these users seek answers to? </li></ul>
  4. 4. Data sources <ul><li>Financial statements (and notes) </li></ul><ul><li>Auditor’s report </li></ul><ul><li>MD&A </li></ul><ul><li>Supplementary schedules </li></ul><ul><li>10K and 10Q reports filed with SEC </li></ul><ul><li>Computerized data bases </li></ul><ul><ul><li>Info on industry norms/ratios </li></ul></ul><ul><ul><li>Info on particular companies/industries/mutual funds </li></ul></ul><ul><li>Articles in popular/business press </li></ul><ul><li>Websites </li></ul>
  5. 5. Tools for analysis <ul><li>Common size financial statements </li></ul><ul><li>Financial ratios </li></ul><ul><li>Trend analysis </li></ul><ul><li>Structural analysis </li></ul><ul><li>Industry comparisons </li></ul><ul><li>Common sense and judgment </li></ul>
  6. 6. Financial Ratio Categories <ul><li>Liquidity Ratios </li></ul><ul><ul><li>measure a firm’s ability to meet cash needs as they arise </li></ul></ul><ul><li>Activity Ratios </li></ul><ul><ul><li>measure the liquidity of specific assets and the efficiency of managing assets </li></ul></ul>
  7. 7. Ratio Categories (continued) <ul><li>Leverage Ratios </li></ul><ul><ul><li>measure the extent of a firm’s financing with debt relative to equity and its ability to cover interest and other fixed charges </li></ul></ul><ul><li>Profitability Ratios </li></ul><ul><ul><li>measure the overall performance of a firm and its efficiency in managing assets, liabilities and equity </li></ul></ul>
  8. 8. Caution! <ul><li>Ratios are valuable, BUT….. </li></ul><ul><ul><li>They do not provide answers in an of themselves and are not predictive </li></ul></ul><ul><ul><li>They should be used with other elements of financial analysis </li></ul></ul><ul><ul><li>There are no “rules of thumb” that apply to interpretation of ratios </li></ul></ul>
  9. 9. Profitability Ratios <ul><li>Gross Profit Margin </li></ul><ul><ul><li>Gross Profit/Net Sales </li></ul></ul><ul><li>Operating Profit Margin </li></ul><ul><ul><li>Operating Profit/Net Sales </li></ul></ul><ul><li>Net Profit Margin </li></ul><ul><ul><li>Net Earnings/Net Sales </li></ul></ul><ul><li>All measure firm’s ability to translate sales dollars into profits </li></ul>
  10. 10. Profitability Ratios (continued) <ul><li>Return on Investment (or Return on Assets) </li></ul><ul><ul><li>Net Earnings/Total Assets </li></ul></ul><ul><li>Return on Equity </li></ul><ul><ul><li>Net Earnings/Stockholders’ Equity </li></ul></ul><ul><li>Both measure overall efficiency of firm in managing investment in assets and generating return to stockholders </li></ul>
  11. 11. Return on Investment <ul><li>Return on Investment (ROI) </li></ul><ul><ul><li>Net operating income </li></ul></ul><ul><ul><ul><li>Income before interest and taxes </li></ul></ul></ul><ul><ul><li>Operating assets </li></ul></ul><ul><ul><ul><li>Assets held for operating purposes ONLY </li></ul></ul></ul><ul><ul><ul><li>i.e. cash, accounts receivable, inventory, plant and equipment </li></ul></ul></ul>2005 KD Hatheway-Dial Average Operating Assets Net Operating Income = ROI
  12. 12. Understanding ROI 2005 KD Hatheway-Dial ROI = Margin X Turnover = Operating Margin = Turnover Net Operating Income Sales Sales Average Operating Assets
  13. 13. Understanding ROI 2005 KD Hatheway-Dial 12.5% = X 2.5 = 5% = 2.5 $10,000 $80,000 $200,000 $200,000 X 100 5%
  14. 14. APPLYING ROI 2005 KD Hatheway-Dial 23.25% = 8.4545 X 2.75 = 8.4545 = 2.75 $18,600 $80,000 $220,000 $220,000 10% Increased Sales without Any Increase in Operating Assets (assume 6% increase in operating expenses) X 100 86% increase with 10% increase in sales
  15. 15. APPLYING ROI 2005 KD Hatheway-Dial 36.25% = 14.5% X 2.50 = 14.5% = 2.50 $29,000 $80,000 $200,000 $200,000 10% Decrease in operating expenses and no change in sales X 100 190% increase with 10% decrease in operating expenses
  16. 16. APPLYING ROI 2005 KD Hatheway-Dial 13.90% = 5.0% X 2.78 = 5.0% = 2.78 $10,000 $72,000 $200,000 $200,000 10% Decrease in operating assets and no change in sales or operating expenses X 100 11.2% increase with 10% decrease in operating assets
  17. 17. APPLYING ROI 2005 KD Hatheway-Dial 16.25% = 6.8% X 2.39 = 6.8% = 2.39 $14,300 $88,000 $210,000 $210,000 10% increase in operating assets and 5% change in sales and 3% operating expenses X 100 30% increase with 10% decrease in operating assets
  18. 18. Profitability Ratios (continued) <ul><li>Cash Flow Margin </li></ul><ul><ul><li>Cash Flow from Operating Activities /Net Sales </li></ul></ul><ul><ul><li>Measures ability to translate sales into cash (with which to pay bills) </li></ul></ul>
  19. 19. Profitability Ratios (continued) <ul><li>Cash Return on Assets </li></ul><ul><ul><li>Cash Flow from Operating Activities /Total Assets </li></ul></ul><ul><ul><li>Useful comparison to return on investment </li></ul></ul><ul><ul><li>Indicates firm’s ability to generate cash from utilizing its assets </li></ul></ul>
  20. 20. Liquidity Ratios <ul><li>Current Ratio </li></ul><ul><ul><li>Current Assets/Current Liabilities </li></ul></ul><ul><ul><li>Measures ability to meet short-term cash needs </li></ul></ul><ul><li>Quick or Acid Test Ratio </li></ul><ul><ul><li>Current Assets-Inventory/Current Liabilities </li></ul></ul><ul><ul><li>Measure ability to meet short-term cash needs more rigorously </li></ul></ul><ul><li>Cash Flow Liquidity Ratio </li></ul><ul><ul><li>Cash+Marketable Securities+Cash Flow from Operating Activities/Current Liabilities </li></ul></ul><ul><ul><li>Focuses on ability of the firm to generate operating cash flows as a source of liquidity </li></ul></ul>
  21. 21. Activity Ratios <ul><li>Average Collection Period </li></ul><ul><ul><li>Accounts Receivable/Average Daily Sales </li></ul></ul><ul><ul><li>Helps gauge liquidity of accounts receivable (ability to collect cash from customers) </li></ul></ul><ul><li>Accounts Receivable Turnover </li></ul><ul><ul><li>Net Sales/Accounts Receivable </li></ul></ul><ul><ul><li>Another measure of efficiency of firm’s collection and credit policies </li></ul></ul>
  22. 22. Activity Ratios (continued) <ul><li>Inventory Turnover </li></ul><ul><ul><li>Cost of Goods Sold/Inventory </li></ul></ul><ul><ul><li>Measures efficiency of inventory management </li></ul></ul><ul><li>Fixed Asset and Total Asset Turnover </li></ul><ul><ul><li>Net Sales/Net PP&E (Fixed Asset T/O) </li></ul></ul><ul><ul><li>Net Sales/Total Assets (Total Asset T/O) </li></ul></ul><ul><ul><li>Both assess effectiveness in generating sales from investment in assets </li></ul></ul>
  23. 23. Leverage: Debt Ratios <ul><li>Debt Ratio </li></ul><ul><ul><li>Total Liabilities/Total Assets </li></ul></ul><ul><li>Long-Term Debt to Total Capitalization </li></ul><ul><ul><li>Long-term Debt/Long-term Debt + Stockholders’ Equity </li></ul></ul><ul><li>Debt to Equity Ratio </li></ul><ul><ul><li>Total Liabilities/Stockholders’ Equity </li></ul></ul><ul><li>All three measure extent of firm’s financing with debt </li></ul>
  24. 24. Leverage: Coverage Ratios <ul><li>Proportion and amount of debt in capital structure is important to analyst </li></ul><ul><li>Tradeoff between risk and return </li></ul><ul><li>Use of debt involves risk -- commitment to fixed charges </li></ul><ul><li>Fixed charges must be COVERED -- following are some ratios to assess coverage </li></ul>
  25. 25. Coverage Ratios (continued) <ul><li>Times Interest Earned </li></ul><ul><ul><li>Operating Profit/Interest Expense </li></ul></ul><ul><ul><li>Indicates how well operating earnings cover fixed interest charges </li></ul></ul><ul><li>Fixed Charge Coverage </li></ul><ul><ul><li>Operating Profit + Lease Payments/Interest Expense + Lease Payments </li></ul></ul><ul><ul><li>Broader measure of how well operating earnings cover fixed charges </li></ul></ul>
  26. 26. Coverage Ratios (continued) <ul><li>Cash Flow Adequacy </li></ul><ul><ul><li>Cash Flow from Operating Activities/ Average Annual Long-Term Debt Maturities </li></ul></ul><ul><ul><li>Measures firm’s ability to cover long-term debt maturities each year </li></ul></ul><ul><ul><li>Rationale is that over the long-run operating cash flows must be adequate to cover investing activities financed with debt </li></ul></ul>
  27. 27. Other Ratios <ul><li>Earnings per Common Share </li></ul><ul><ul><li>Net Earnings/Average Common Shares Outstanding </li></ul></ul><ul><ul><li>Indicates return on a per share basis </li></ul></ul><ul><li>Price to Earnings </li></ul><ul><ul><li>Market Price of Common Stock/Earnings per Common Share </li></ul></ul><ul><ul><li>Expresses a multiple the stock market places on earnings </li></ul></ul>
  28. 28. Other Ratios (continued) <ul><li>Dividend Payout </li></ul><ul><ul><li>Dividends per Share/Earnings per Share </li></ul></ul><ul><ul><li>Shows percentage of earnings paid out to stockholders </li></ul></ul><ul><li>Dividend Yield </li></ul><ul><ul><li>Dividends per Share/Market Price of Common Share </li></ul></ul><ul><ul><li>Shows rate earned by shareholders from dividends relative to current stock price </li></ul></ul>

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