Transcript Slide 1

Learning Objectives
1. Understand the nature of financial
statement analysis.
2. Calculate and interpret horizontal and
vertical analysis.
3. Assess profitability through the
calculation and interpretation of ratios.
Learning Objectives
4. Assess liquidity through the calculation
and interpretation of ratios.
5. Assess solvency through the calculation
and interpretation of ratios.
6. Calculate and interpret a DuPont
Analysis.
LOI
Financial Statement Analysis
All publicly traded companies must prepare
audited financial statements each year and
file them with the Securities and Exchange
Commission. These statements include the
income statement, the balance sheet, the
statement of stockholders’ equity, and the
statement of cash flows. Financial statements
contain multiple years of data for comparative
purposes and are the starting point for any
analysis.
Financial Analysis
Financial statement analysis is
the process of applying
analytical tools to a company’s
financial statements to
understand the company’s
financial health and requires:
Financial
information
Standards
of
comparison
Analysis
tools
Examples
In this chapter, the financial
information provided by Best Buy Co.,
Inc. will be used to illustrate the
process of financial analysis. For
financial ratios, Best Buy will be
compared to hhgregg’s ratios, since
both companies are in a similar
industry.
Standards of Comparison
Prior Year of • Often called
intracompany
the Same comparison
1
Company (horizontal analysis)
Benchmark • Often called
intercompany
2
Among
comparison (vertical
Competitors analysis)
• Industry benchmarks
3 Industry
can be obtained from
Standards financial websites.
Analysis Tools
Horizontal
1 Analysis
2
3
Vertical
Analysis
Ratio
Analysis
• comparison of a
company’s financial
results across time.
• comparison of
financial balances to a
base account from the
same company.
• comparison of
different balances
from the financial
statements.
LO2
Horizontal Analysis
Horizontal analysis is an analysis technique that calculates the
change in an account balance from one period to the next and
expresses that change in both dollar and percentage terms.
Balance Sheet – Horizontal – Best
Buy (2008)
Best Buy ($ in millions, except
per share amounts
2/28/09 3/1/08 $ Change
Current Assets:
Cash and cash equivalents
$498 $1,438
$(940)
Receivables
1,868
549
1,319
Merchandise Inventories
4,753
4,708
45
Other current assets
1,073
647
426
Total Current Assets
$8,192 $7,342
$850
$Property
Current
Year
- $ Basenet
Year = $1,868
and
Equipment,
4,174 – 549
3,306=
868
Goodwill $ Base Year
2,203
1,115
$549 1,088
Other Assets
$1,257 $1,022
$235
Assets= $1,868 – 549 = $1,319
$80,000 $67,000 $13,000
$Total
Change
% Change
-65.4%
240.3%
1.0%
65.8%
11.6%
26.3%
102.5%
23.0%
24.1%
240.3%
Income Statement Horizontal – Best Buy
(2008)
Vertical Analysis
Vertical analysis is an analysis technique that states each account
balance on a financial statement as a percentage of a base amount on
the statement.
Balance Sheet Vertical – Best Buy (2008)
Asset accounts are stated as a percentage of Total Assets
(set at 100%). For example, on 2/28/09, Receivables is
11.8% of Total Assets (calculated as $1,868 ÷ $15,826).
Income Statement Vertical– Best Buy
(2008)
Overall Best Buy was profitable in 2008, but it was less
profitable than in 2007 (3.5% in 2007 versus 2.2% in 2008).
One reason for this was the increase in operating expenses.
LO3
Profitability Analysis
Profitability Ratios
Creditors
• Indicates the ability to
make required
principal and interest
payments.
• Indicates related stock
Stockholders price increases or
dividends paid.
Managers
• Indicates potential for
bonuses and incentive
plans linked to
performance.
Profit Margin Ratio
The profit margin ratio compares net income to net sales and
measures the ability of a company to generate profits from sales. A
higher ratio indicates a greater ability to generate profits from sales.
Return on Equity
The return on equity ratio compares net income to the average
balance in stockholders’ equity during the year, showing how
effectively a company uses the equity provided by stockholders
during the year to generate additional equity for its owners.
Stockholders naturally want this ratio to be as high as possible.
Return on Assets
The return on assets ratio compares net income to average
total assets during the year, representing a company’s ability to
generate profits from its entire resource base (not just those
resources provided by owners). Like the return on equity, investors
would like the ratio as high as possible.
Earnings Per Share
Earnings per share compares a company’s net income to the
average number of shares of common stock outstanding during the
year. The ratio represents the return on each share of stock owned
by an investor.
Price to Earnings Ratio
The price to earnings ratio compares net income to the current
market price of the company’s common stock and provides an
indication of investor perceptions of the company. A higher price
to earnings ratio generally indicates that investors are more
optimistic about the future prospects of a company.
Profitability Summary
LO4
Liquidity Analysis
Liquidity Ratios
Liquidity ratios assess the ability of a company
to meet its immediate or short-term financial
obligations. Failing to do so can result in additional
expenses and, ultimately, bankruptcy.
Current Ratio
The current ratio is one of the most frequently used ratios in financial
analysis and compares current assets to current liabilities. As such, it
compares assets that should be turned into cash within one year to
liabilities that should be paid within one year. A higher ratio indicates
greater liquidity.
Quick Ratio
The quick ratio (sometimes called the acid-test ratio) compares a
company’s cash and near-cash assets, or quick assets, to its current
liabilities. Quick assets include cash, short-term investments, and accounts
receivable. Since the quick ratio measures the degree to which a company
could pay off its current liabilities immediately, a higher quick ratio
indicates greater liquidity.
Receivables Turnover Ratio
The receivables turnover ratio compares a company’s credit sales during
a period to its average accounts receivable balance during that period. A
higher ratio means that the company is better able to generate and
collect sales, leading to better liquidity.
Inventory Turnover Ratio
The inventory turnover ratio compares a company’s cost of goods sold
during a period to its average inventory balance during that period. It
reveals how many times a company is able to sell its inventory balance
in a period. A higher ratio is better because it indicates that the
company sold more inventory while maintaining less inventory on hand.
Liquidity Summary
Ethics and
Solvency
Ratios
Decision Making
Solvency
focusesenvironment,
on capitalcompanies
structure
and
In today’s business
have
to be
assesses
theofextent
of borrowing
needed.
aware not only
the economic
impact of their
decisions,
but also of their ethical impact.
• Solvency refers
Information
Debt to
to a company’s Good Ends?
Times
Assets
being
used
Bad Ends?
Interest
ability to remain
Ratio
Earned
for?
in business over
Debt to
the long term.
Equity
-
Solvency Analysis
Debt to Assets
The debt to assets ratio compares a company’s total liabilities to
its total assets and yields the percentage of assets provided by
creditors. As such, the ratio provides a measure of a company’s
capital structure. A decreasing ratio shows that a company is
taking on a less risky capital structure over time.
Debt to Equity
The debt to equity ratio compares a company’s total liabilities to
its total equity. Higher debt to equity ratios indicate a riskier
capital structure and therefore greater risk of insolvency.
Times Interest Earned
The times interest earned ratio compares a company’s net
income to its interest expense. It shows how well a company can
pay interest out of current-year earnings. A higher ratio indicates
a greater ability to make payments, and therefore less risk of
insolvency.
Solvency Summary
LO6
DuPont Analysis
A DuPont analysis
provides insight into how
a company’s return on
equity was generated by
decomposing the return
into three components:
•operating efficiency,
•asset effectiveness,
and
•capital structure.
DuPont Calculation
The higher the ratio, the more
efficient a company is in turning
sales into profits.
The higher the ratio, the more
effective a company is in generating
sales given its assets.
The higher the ratio, the more a
company is financing its assets with
debt rather than equity (riskier).
This is the leverage multiplier.
Best Buy’s DuPont Calculations
The analysis shows clearly why Best Buy’s return to
its owners decreased from 2007 to 2008.
Profits from sales were down
in 2008, resulting in a lower
return on equity.
Benefit of DuPont Analysis
One of the main benefits of a DuPont
analysis is the ability to ask what-if
questions.
???
What if Best Buy was able to
squeeze out another $.02 of
profit on each dollar of sales?
How would that affect the
return to owners?
Answer: 2008 return
would increase to 0.407 (0.042
X 2.84 X 3.41).
What if the market for electronics
took a significant downturn and
Best Buy was only able to generate
sales of 1.5 times assets on hand?
Would that significantly affect the
return to investors? Answer: 2008
return would fall almost in half to
0.113 (0.022 X 1.50 X 3.41).
End of Chapter 12