91814 basics of analysis
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Basics of Analysis
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Ratio Analysis
Liquidity Measures a firms ability to meet its current obligations
Leverage (borrowing capacity) Measures the degree of protector for long-term creditors
Profitability Measures the earning ability of a firm
Investor-focused
Cash flow Indicate liquidity, borrowing capacity, and profitability
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Ratio Analysis
Interpreted in comparison with Prior ratios Competitor ratios Industry ratios
Predetermined standards
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Complexities and Context
Use of average data from balance sheetaccounts Necessary when comparing against income
statement data Does not Eliminate cyclical or seasonal variations Capture changes that occur unevenly throughout the year
Analysis must be performed and understood
within the context of Native accounting principles Native business practices and culture
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Common-Size Analysis
The use of percentages is usually preferable tothe use of absolute amounts
Vertical analysis
All amounts of a year expressed as a percentage ofa base amount (e.g., net sales revenue, totalassets)
Horizontal analysis
Amounts for comparative years are expressed as apercentage of the base year amount
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Vertical Analysis
Sales revenue 100,000$ 100.0% 95,000$ 100.0% 91,000$ 100.0%
Cost of goods sold 65,000 65.0% 60,800 64.0% 56,420 62.0%
Gross profit 35,000 35.0% 34,200 36.0% 34,580 38.0%
Operating expenses:
Selling expense 14,000 14.0% 11,400 12.0% 10,000 11.0%General expense 16,000 16.0% 15,200 16.0% 13,650 15.0%
Total operating expense 30,000 30.0% 26,600 28.0% 23,650 26.0%
Operating Income before taxes 5,000 5.0% 7,600 8.0% 10,930 12.0%
Taxes related to operations 1,500 1.5% 2,280 2.4% 3,279 3.6%
Net Income 3,500$ 3.5% 5,320$ 5.6% 7,651$ 8.4%
Melcher Company
Income Statement
2005 2004 2003
For the Years Ended December 31
Each financial statement element is presented asa percentage of a designated base.
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Horizontal Analysis
2005 2004 2003 2005 2004 2003
Sales revenue 100,000$ 95,000$ 91,000$ 109.9% 104.4% 100.0%
Cost of goods sold 65,000 60,800 56,420 115.2% 107.8% 100.0%
Gross profit 35,000 34,200 34,580 101.2% 98.9% 100.0%
Operating expenses:
Selling expense 14,000 11,400 10,000 140.0% 114.0% 100.0%General expense 16,000 15,200 13,650 117.2% 111.4% 100.0%
Total operating expense 30,000 26,600 23,650 126.8% 112.5% 100.0%
Operating Income before taxes 5,000 7,600 10,930 45.7% 69.5% 100.0%
Taxes related to operations 1,500 2,280 3,279 45.7% 69.5% 100.0%
Net Income 3,500$ 5,320$ 7,651$ 45.7% 69.5% 100.0%
Melcher Company
Income StatementFor the Years Ended December 31
Each financial statement element is presented as apercentage of a base amount from a selected year.
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Year-to-Year Change Analysis
Use both absolute and percentages
Guidelines:
When an item has value in the base year and none
in the next period, the decrease is 100% A meaningful percent change cannot be computed
when one number is positive and the other numberis negative
A percent change is incomputable when there is nofigure for the base year.
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Industry Variations
Financial components vary by type of industry
Merchandising
Inventory is a principal asset
Sales may be primarily for cash or on credit
Service
Inventory is low or nonexistent
Manufacturing Large inventory holdings
Substantial investment in plant assets
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Descriptive Information
Narrative data
Annual report
Trade periodicals
Industry reviews Further explains the financial position of a firm
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Comparisons
Provides context for analysis of ratios andfinancial data
Common types
Trend analysis SIC: Standard Industrial Classification
NAICS: North American Industry ClassificationSystem
Industry averages; competitor comparisons
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Comparisons: Trend Analysis
A study of the financial history of a firm
Longitudinal ratio comparison
Falling
Rising
Relatively constant
Highlight
Effective management Evidence of problems
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Comparisons: SIC
Classifies business by industry Defines industries in accordance with the
composition and structure of the economy
Coding structure Division
Major group
Industry group
Industry
Reported in SEC registrant filings
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Comparisons: NAICS
Joint creation of NAFTA partners: Canada,U.S., and Mexico
Industry is defined by similar productionprocesses
Coding structure
Sector
Sub-sector
Industry group NAICS industry
National industry
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Comparisons: Industry
Industry comparison complicated by highlydiversified companies
Financial services
Base their analysis on industry placement Provide composite industry data
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Financial Services Publications
Publication Service Coverage Data ClassificationThe Departmentof CommerceFinancial Report
EconomicSurveys Division,Bureau of theCensus
Manufacturing,mining, and tradecorporations
Incomestatement andbalance sheetdata andratios
NAICS
Annual StatementStudies
RiskManagementAssociation
Manufacturing,wholesaling,retailing, service,agriculture, andconstruction
Common-sizefinancialstatementsand ratios
NAICS and SIC
Standard &
Poors IndustrySurveys
Standard &
Poors
50 North
American andglobal industries
Industry write-
ups andstatistics
NAICS
Almanac ofBusiness andIndustrialFinancial Ratios
CCH, Inc. 192 industries Corporate taxreturn data
NAICS
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Financial Services Publications (contd)
Publication Service Coverage Data ClassificationIndustry Normsand Key BusinessRatios
Dun & Bradstreet 800 businesslines; 5 segments
Condensedfinancialstatements;ratios
SIC
[various] Value Line
InvestmentService
98 industries Longitudinal
financialinformation
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Comparisons: Caution
Ratios are subject to variance from:
Differing data
Inconsistent formula construction
Optional (elective) accounting treatment
Different fiscal year-ends
Varying financial policies
Inconsistent basis (before or after tax)
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Relative Size of Firm
Comparison of disparate size firms
Capital market access
Economy of scale (purchasing)
Wider customer base Information
Absolute: amplifies comparison difficulty
Common-size: eliminates some of the difficulty
Percent of market helps to define relative size
O h R
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Other Resources:Wards Business Directory
Domestic and public companies
8-volume set
V1, 2, 3 Alphabetical listing
V4 State and ZIP code V5 SIC code
V6-7 State then SIC code
V8 NAICS code then revenue
Oth R
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Other Resources:Standard & Poors Stock Reports
Companies listed on various stock exchanges
Alphabetical by exchange
NYSE
American Stock Exchange NASDAQ stock market
Regional exchanges
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Other Resources:Standard & Poors Register Of Corporations, Directors, And Executives
3-volumes
V1 Alphabetical by firm name
V21 Alphabetical listing of key individuals
V22 Industries in 7 subsections
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Other Resources:Standard & Poors Analysts Handbook
Selected income statement and balance sheetitems
Related ratios
Applicable to Standard & Poors industry groupstock price indexes
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Other Resources:Standard & Poors Corporation Records
U.S. corporations
Background information
Detailed financial statistics
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Other Resources:Americas Corporate Families:The Billion Dollar Directory
Corporate family listings
Alphabetical
Geographical
SIC Cross-reference divisions, subsidiaries, and
ultimate parent companies
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Other Resources:D&BMillion Dollar Directory
Company listings
Alphabetical
Geographically
SIC
Other Reso rces
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Other Resources:Directory Of Corporate Affiliates
Corporate information
Divisions
Subsidiaries
Affiliates Indexes
Alphabetical
Geographical
SIC
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Other Resources:Thomas Register Of American Manufacturers
Comprehensive reference
Products
Services
Company profiles Catalog file
Other Resources:
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Other Resources:Mergent Industrial Manual
New York and American Stock Exchanges
History
Business
Properties Subsidiaries
Financial statements
SIC codes
Other Resources:
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Other Resources:Security Owners Stock Guide
Published by Standard & Poors
Survey of 5,300 stocks
Trading activity
Price range Dividends
etc.
Other Resources:
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Other Resources:Standard & Poors Statistical Service
Industry statistics
Agriculture
Metals
Building Transportation
etc.
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Other Resources: Dividend Records
Mergent Dividend Record
Standard & Poors Annual Dividend Record
Provide dividend records of virtually publicly ownedAmerican and some foreign companies
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Other Resources:D&B Reference Book of Corporate Managements
Principle corporate officers
Year of birth
Education
Military service
Present business position
Previous positions
Other Resources:
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Other Resources:Compact Disclosure
Database of textual and financial information
Annual and periodic reports filed with the SEC
Contents
Major financial statements Financial ratios
Institutional holdings
Insider ownership
Presidents letter Financial notes
Other Resources:
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Other Resources:Lexis-Nexis
Accounting, legal, newspaper, and periodicalinformation
Financial statements from annual reports
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The Users of Financial Statements
Management
Analyze information from the perspective of bothinvestors and creditors
Investors Analysis of past and present information to project
the future prospects of the entity
Creditors
Short-term: focus is on current resources
Long-term: consider the future prospects of the firm
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