Transcript Chapter 4 Financial Statements Analysis Tools

Chapter 4
Financial Statements
Analysis Tools
Outline
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Demand and supply of financial analysis
Basic analytical procedures
Analysis methods
Comprehensive analysis of financial ratios
The limitations of financial analysis
Demand and supply of financial
analysis
Demand
Investors
Managers
Employees
Customers
auditors
Government/regulatory
agencies
Supply
Internal analysts
Intermediaries
Financial analysts
Bond rating agencies
Basic Analytical Procedures
Determine
objective
Contrive
analysis
scheme
Collect
data
Analyze
data
Conclude
Techniques of Financial Statement
Analysis
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Horizontal analysis
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Trend analysis
Vertical analysis
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Comparative financial statements are presented side
by side
Common-size financial statement
Ratio analysis
Ratio Analysis
Financial ratio analysis is the calculation and comparison
of ratios which are derived from the information in a
company's financial statements
Liquidity
Analysis
Efficiency
Analysis
Leverage
Ratios
Coverage
Ratios
Profitability
Ratios
Liquidity Ratios analysis
Current ratio
Current Assets
Current Liabilities
Quick ratio
Current Assets- Inventory
Current Liabilities
Cash ratio
Cash
Current Liabilities
Activity or Efficiency Ratios Analysis
Fixed Asset
Turnover
Sales
Net Fixed Assets
Accounts
Receivable
Turnover
Sales
Accounts Receivable
Average collection
period
Accounts receivable turnover
Sales/360
Inventory turnover
Sales
Inventory
Activity or Efficiency Ratios Analysis
Total Assets
Turnover
Sales
Total Assets
Leverage Ratios
Total Debt Ratio
Total Debt
Total Assets
The Long-Term
Debt Ratio
Long Term Debt
Total Asset
LTD to Total
Capitalization
LTD
LTD + Total Equity
Leverage Ratios
Debt to Equity
Ratio
LTD to Equity
Ratio
Total Debt
Total Equity
LTD
Preferred Equity + Common Equity
Coverage Ratios
Times Interest
Earned Ratio
Cash Coverage
Ratio
EBIT
Interest Expense
EBIT + Non Cash Expenses
Interest Expense
Profitability analysis
Gross Profit
Margin
Gross Profit
Sales
Operating Profit
Margin
Net Operating Income
Sales
Net Income
Sales
Net Profit Margin
Profitability analysis
Return on Total
Assets
Net Income
Total Assets
Return on Equity
Net Income
Total Equity
Return on Common
Equity
Net Income Available to Common
Equity
Common Equity
Du Pond Analysis
ROE=Net Margin X Asset Turnover X Leverage Factor
Assets
Owner’s equity
Net income
Net Sales
Net income
owner’s equity
Sales
Assets
Trend Analysis
Comparing a company’s financial condition
and performance across time
Cash
1000000000
800000000
600000000
Cash
400000000
200000000
0
1999
2000
2001
Year
2002
2003
A Compare of Company’s Profitability
Return on net asset
Return on total assets
0.08
0.25
0.07
0.20
0.06
0.05
0.15
Company A
Company B
0.10
Company A
Company B
0.04
0.03
0.02
0.05
0.01
0.00
0.00
1999 2000 2001 2002 2003
1999 2000 2001 2002 2003
Why ratio analysis is useful?
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They facilitate inter-company comparison;
They downplay the impact of size and allow evaluation over
time or across entities without undue concern for the effects of
size difference;
They serve as benchmarks for targets such as financing ratios
and debt burden;
They help provide an informed basis for making investmentrelated decisions by comparing an entity’s financial performance
to another;
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How is ratio analysis limited?
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It is restricted to information reported in the
financial statements;
It is based on past performance.
Comparability is hampered when accounting
policies are not uniform across an industry;
The past may not predict the future;
How is ratio analysis limited? (cont)
Trends and relationships must be carefully
evaluated with reference to industry norms,
budgets, and strategic decisions;
 Because of some potential problems in
standard, comparison must be careful;
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Potential problems and limitations of
financial ratio analysis
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Comparison with industry averages is difficult
for a conglomerate firm that operates in many
different divisions.
“Average” performance is not necessarily
good, perhaps the firm should aim higher.
Seasonal factors can distort ratios.
“Window dressing” techniques can make
statements and ratios look better.
More issues regarding ratios
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Different operating and accounting practices can
distort comparisons.
Sometimes it is hard to tell if a ratio is “good”
or “bad”.
Difficult to tell whether a company is, on
balance, in strong or weak position.
What should an analyst keep in mind about
financial analysis?
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An overview of all ratios can provide important
information concerning the strategic decisions of
a company and the nature of its business;
However, accounting information can only
provide so much data. An analyst must proceed
with caution;
Qualitative factors to be considered
when evaluating a company’s future
financial performance
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Are the firm’s revenues tied to 1 key customer,
product, or supplier?
What percentage of the firm’s business is
generated overseas?
Competition
Future prospects
Legal and regulatory environment
Summary
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Users of financial statements often gain a clearer
picture of the economic condition of an entity
by the analysis of accounting information;
The analytical measures obtained from financial
statements are usually expressed as ratios or
percentages;
Summary
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Financial analysis techniques work best when
they are used to confirm or refute other
information. When using analytical tools to
evaluate a company, the analyst should keep in
mind the limitations of analysis
The End of Chapter 4