Chapter 13 Financial Statement Analysis 1
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Transcript Chapter 13 Financial Statement Analysis 1
Chapter 13
Financial Statement
Analysis
Financial Accounting, Alternate 4e by Porter and Norton
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Financial Statement Analysis
Will I
be paid?
Creditors
How
good is our
investment?
How are we
performing?
Stockholders
Management2
Limitations of Financial
Statement Analysis
Use of different accounting methods
Changes in accounting methods
LIFO
FIFO
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Limitations of Financial
Statement Analysis
Failure to understand trends or
use industry ratios
Difficulty of making industry
comparisons (i.e., conglomerates)
????
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Limitations of Financial
Statement Analysis
Nonoperating items on income
statement
Effects of inflation
=
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Horizontal Analysis
Wm. Wrigley Jr. Company
(in millions)
2002
Net Sales
Gross Profit
Net Earnings
2001
$2,746 $2,401
1,596 1,404
402
363
Increase (Decrease)
Dollars
Percent
$345
192
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14.4 %
13.7
10.7
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Trend Analysis
Wm. Wrigley Jr. Company
2002
2001
2000
1999
1998
Return on
Avg. Equity 28.7% 30.1% 29.0% 26.8% 28.4%
Tracking items over a series of years
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Vertical Analysis
Common-size statements recast
items as a percentage of a
selected item
%
Allows comparisons of
companies of different size
%
Compares percentages across
years to identify trends
%
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Common-Size Statements
Sales revenue
Cost of goods sold
Gross profit
Selling & admin. exp.
Operating income
Interest expense
Income before tax
Income tax expense
Net income
Dollars
$24,000
18,000
$ 6,000
3,000
$ 3,000
140
$ 2,860
1,140
$ 1,720
Percent
100.0%
75.0
25.0%
12.5
12.5%
0.6
11.9%
4.8
7.1%
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Liquidity Analysis
Nearness to cash
Ability to pay debts as they become due
Working
Capital
Ratios
Turnover
Ratios
Cash
Ratios
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Working Capital
Excess of current assets over current
liabilities
Lacks meaningful comparisons for
companies of different size
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Current Ratio
Measure of short-term financial health
Consider composition of current assets
Rule of thumb
2:1
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Acid-Test (Quick) Ratio
Stricter test of ability to pay debts
Excludes inventories and prepaid assets
Quick Assets
Current Liabilities
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Cash Flow from Operations to
Current Liabilities Ratio
Focuses on cash only
Covers period of time
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SERIES
1985
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Net Cash Provided by Operating Activities
Average Current Liabilities
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Accounts Receivable Turnover
Ratio
Net Credit Sales
Average Accounts Receivable
Indicates how quickly a
company is collecting (i.e.,
turning over) its receivables
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Accounts Receivable Turnover
Ratio
Too fast
Credit policies too
stringent; may be
losing sales
Too slow
Credit department
not operating
effectively; possible
quality problems
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Number of Days’ Sales in
Receivables
360 Days*
.
Accts. Receivable Turnover
Represents the average # of days
accounts are outstanding
*Some analysts use 365 days.
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Number of Days’ Sales in
Receivables
Example:
360 Days
= 75 days
4.8 Times
If this company’s credit terms are net 30,
what would this tell you about the efficiency
of the collection process?
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Inventory Turnover
Ratio
Cost of Goods Sold
Average Inventory
Represents the number of times
per period inventory is turned
over (i.e., sold).
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Inventory Turnover Ratio
Circuit City
Safeway
5.8 times per year
9.2 times per year
Can you compare the two ratios?
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# of Days’ Sales in Inventory
1
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# of Days in Period
Inventory Turnover Ratio
Represents the average # of days
inventory is on hand before it’s sold
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# of Days’ Sales in Inventory
Circuit City
62 days
Safeway
39 days
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Do these averages seem reasonable?
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Cash Operating Cycle
Time between purchase of merchandise
and collection from the sale
# of days sales in receivables
+
# of days sales in inventory
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Solvency Analysis
Ability to stay in business over the
long-term
Times
Interest
Earned
Debt-toEquity
Ratio
Debt
Service
Coverage
Cash Flow
to Capital
Expenditures
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Debt-to-Equity Ratio
Total Liabilities
Total Stockholders’ Equity
How much
have creditors
contributed
compared to
owners?
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Debt-to-Equity Ratio
Total Liabilities
Total Stockholders’ Equity
= .60
For every dollar
contributed by
owners, creditors
have loaned $.60
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Times Interest Earned Ratio
Measures ability to meet current
interest payments
The greater the coverage the better
Net Income + Interest Expense + Income Tax Expense
Interest Expense
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Debt Service Coverage Ratio
Measures amount of cash from
operations available to service the debt
Cash Flow from Operations before Interest & Taxes
Interest and Principal Payments
P+ i
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Cash Flow from Operations to
Capital Expenditures Ratio
Measures company’s ability to use
operations (vs. creditors and owners) to
finance acquisitions of productive assets
Cash Flow from Operations – Dividends Paid
Cash Paid for Capital Acquisitions
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Profitability Analysis
Rate of Return on Assets
Return on Common S/E
EPS
P/E Ratio
Dividend Ratios
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Return on Assets Ratio
Measures return to all providers of
capital (creditors and owners)
Net Income + Interest Expense, Net of Tax
Average Total Assets
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Return on Common
Stockholders’ Equity
Net Income - Preferred Dividends
Average Common Stockholders’ Equity
The owners
earned 15%
on their investment
in ABC Co...
Not bad!
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Earnings per Share
Presents profits on a per-share basis
Net Income - Preferred Dividends
Weighted Avg. # of Common Shares Outstanding
Certificate of Stock
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Price/Earnings Ratio
Relates earnings to the market price of
the stock
Current Market Price
Earnings per Share
very high P/E
very low P/E
possibly overvalued
possibly undervalued
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Price/Earnings Ratio
P/E Ratios
Co. A
Co. B
= 10 to 1
= 7 to 1
Both companies
have earnings of $2
per share. So why
the different P/E
ratios?
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Dividend Payout Ratio
Common Dividends per Share
Earnings per Share
We need to
decide what % of
the firm’s income
we can return to
owners.
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Dividend Yield Ratio
Investors willing to forgo dividends in
lieu of price appreciation
Common Dividends per Share
Market Price per Share
=
usually
< 5%
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Appendix
Accounting Tools:
Reporting and Analyzing
Other Income Statement Items
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Common Characteristics
All
such items are reported after
income from continuing operations
Reported separately
Shown net of tax effects
Most analysts ignore these items,
since they are not likely to reoccur
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Discontinued Operations
Any gain or loss from disposal of a
division or segment of the business
Any net income or loss from operating
this portion until the date of disposal
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Extraordinary Items
Gain or loss due to an event that is
Unusual in nature AND
Infrequent in occurrence
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Cumulative Effect of a Change
in Accounting Principle
Reflects a change in a company’s
accounting principles, practices, or
methods
Reports the difference in income in all
prior years between the old method and
the new method
Sometimes such a change is dictated by
new accounting standards
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End of Chapter 13
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