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