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# Financial Statement Analysis F F M

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### Financial Statement Analysis F F M

1. 1. FINANCE FOR MANAGERS COURSE LECTURER Shumaila Paracha Assistant Professor Course Code: 0387 MBA Program Academic Year Fall 2010
2. 2. Financial Statement Analysis • A thorough financial statement analysis include: • Ratio Analysis • Trend Analysis – Common Size Analysis – Percent Change Analysis • Du Pont Analysis
3. 3. TREND ANALYSIS • Trend analysis is about plotting ratio over time. • Trends give clues as to whether a firms financial condition is likely to improve or to deteriorate.
4. 4. TREND ANALYSIS • This graph shows that MicroDrive’s ROE has been declining since 1998, even though the industry average has been relatively stable. • All the other ratios can be analyzed similarly. ROE (%) Rate of Return on Equity 1997-2001 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 1997 1998 1999 2000 2001 Industry MicroDrive
5. 5. Common Size Analysis • Common Size analysis is used to identify trends in financial statements. • Common size is also useful in comparative analysis. • In common size analysis all income statement items are divided by sales ( common size income statement shows each item as % of sales) and all balance sheet items are divided by total assets (common size balance shows each item as a % of total assets).
6. 6. Common Size Analysis • The advantage of common size analysis is : – It facilitates comparisons of balance sheets and income statements over time and across companies.
7. 7. Percent Change Analysis • Percent Change analysis is also used to identify trends in financial statements. • In this type of analysis, growth rates are calculated for all income statement items and balance sheet accounts.
8. 8. Du Pont Analysis • The profit margin times the total asset turnover is called Du Pont equation and it gives rate of return on assets. • ROA= Profit margin X Total asset turnover = (Net income/Sales) X (Sales/Total assets) If the company is financed only with common equity, the ROA and ROE would be same because total assets equal total equity.
9. 9. Du Pont Analysis • However if a company use debt than ROE must be greater than ROA. Specifically the ROA can be multiplied by the equity multiplier. • Equity Multiplier (EM) = total assets / equity • Firms that use large amounts of debt financing (more leverage) will have a high EM-the more the debt the less the equity, hence the higher the EM.
10. 10. Du Pont Analysis • ROE depends on its ROA and its use of leverage • ROE = ROA x EM • ROE = (net income/total assets) x (total assets/equity) • So the extended Du Pont Equation is: • ROE = (Profit Margin)(Total Assets t/o)(EM)
11. 11. Comparative ratios and Benchmarking • Ratio analysis involves comparisons – a company’s ratios are compared with those of other firms in the same industry, that is to industry average figures. • However some firms go a step further – they also compare their ratios with those of a smaller set of leading companies in that industry. This technique is called Benchmarking. • The bench marking setup makes it easier for company’s to see exactly where the company stands relative to its competition.
12. 12. Follow up Task! • Read chapter – 3 “Analysis of financial Statements” from Book : Fundamentals of Financial Management (Brigham)Ed-10 or Ch-4 in Ed 11. • Read lecture slides. • Hear audio recording of lecture. • Solve the relevant questions at the end of chapter. – You can access lecture slides and audio recording from file server. – Written quiz from lec-1 till end of this lecture in the following class