financial statement analysis
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Financial Statements
Balance Sheet
Income Statement
Managers and Analysts Use Financial Statement to Conduct:- Cash Flow Analysis
- Performance (Ratio) Analysis
The Link Between the Balance Sheets and the Income Statement.
1999 2000 2000
• Why Accounting Profits and Cash Flows Differ– Revenue Recognition– The Matching Principle– Depreciation
Accounting Profits andCash Flows
•Are Accounting Profits and cash Flows same?
Translating Accounting Profits intoCash Flows
• The statement is based on three cash flow categories:Cash flow from operations is net income
adjusted for depreciation and changes in receivables, payables, and inventories.
Translating Accounting Profits intoCash Flows
Cash flow from investing activities arise from the purchase and sale of marketable securities and productive assets such as machinery.
Cash flow from financing activities include the repayment of debt, the payment of dividends, and the issuance of new securities.
Sources And Uses Of Cash
• Sources of cash– Operations—customers pay invoices– Investing—firm sells assets– Financing—firm borrows or issues new shares
• Uses of cash– Operations—pay its suppliers– Investing—capital expenditures– Financing—interest and dividend payments
Sources of Cash Inflow and Cash Outflow.
The Sources and Uses of Corporate Cash
• Decrease in any asset
• Increase in any liability
• Net profits after taxes
• Depreciation and other non-cash charges
• Sale of stock
• Increase in any asset
• Decrease in any liability
• Net loss
• Dividends paid
• Repurchase or retirement of stock
SourcesSources UsesUses
Key Measures of Cash Flow
12
Cash Flow from
Operations
Operating Cash Flow
Free Cash Flow
• Total Cash Generated
• Cash Flow Before Repaying Lenders
• Cash Flow Firm Could Distribute to Investors
FINANCIAL STATEMENT ANALYSIS
Objectives of Analysis
• The adequacy or otherwise of the profits earned
• The adequacy or otherwise of the financial strength
• Its ability to generate enough cash and cash equivalents, their timing and certainty
• The future growth outlook
Why Evaluate Financial Statements?
• Internal uses– Performance evaluation – compensation and
comparison between divisions– Planning for the future – guide in estimating future
cash flows
• External uses– Creditors– Suppliers– Customers– Stockholders, Analysts
The Tool Kit
• Multi – Step Income Statement
• Horizontal Analysis
• Common-Sized Analysis
• Trend Analysis
• Analytical Balance Sheet
• Ratio Analysis
• Cash flow Analysis
Multi-step Income Statement
• GP
• PBDIT
• OP / PBIT
• PBTEOT
• PBT
• PAT
Analytical Balance Sheet
Ratio Analysis
• RoI Ratios
• Solvency Ratios
• Liquidity ratios
• Turnover Ratios
• Profitability Ratios
• Market Ratios
• Dupont Analysis
RoI Ratios
• RoNW = PAT – Preferred dividend / Networth (%)
• EPS (Rs)
• CEPS = PAT – Preferred dividend + non-cash charges / no. of equity shares o/s (Rs)
Solvency Ratios
• NAV / NWPS / BVPS (Rs)
• DER
• Interest cover = PAT + Int (LTD) + non-cash charges / int (LTD) – Times
• DSCR = PAT + Int (LTD) + non-cash charges / int (LTD) + principal repayment – Times
Liquidity ratios
• CR = CAs, loans and advances + ST Inv / CLs + provisions + ST debt
• QR• CP allowed to customers = receivables x 365 /
credit sales• Supplier’s credit = payables x 365 / credit
purchases• Inventory holding period = inventory x 365 /
COGS
Turnover Ratios
• FATO = Net sales / fixed assets
• NWTO = Net sales / NW
• Debtor turnover
• Inventory turnover
Profitability Ratios
• Multi-step profit margins
• Ratios of individual costs and expenses to sales
• Ratios of other income, extraordinary items and prior year adjustments to PBT and/or net sales
The DuPont Model
Brings together:
• Profitability
• Efficiency
• Leverage
Deriving the Du Pont Identity
• ROE = NI / TE• Multiply by 1 and then rearrange
– ROE = (NI / TE) (TA / TA)– ROE = (NI / TA) (TA / TE) = ROA * EM
• Multiply by 1 again and then rearrange– ROE = (NI / TA) (TA / TE) (Sales / Sales)– ROE = (NI / Sales) (Sales / TA) (TA / TE)– ROE = PM * TAT * EM
Du Pont Analysis
Net Income Sales Assets Return on equity =
Sales Asset Shareholder’s Equity
EquityMultiplier
TotalAsset
Turnover
NetProfit
Margin
Using the Du Pont Identity
• ROE = PM * TAT * EM– Profit margin is a measure of the firm’s
operating efficiency – how well does it control costs
– Total asset turnover is a measure of the firm’s asset use efficiency – how well does it manage its assets
– Equity multiplier is a measure of the firm’s financial leverage
Potential Problems• There is no underlying theory, so there is no way
to know which ratios are most relevant• Benchmarking is difficult for diversified firms• Globalization and international competition makes
comparison more difficult because of differences in accounting regulations
• Varying accounting procedures, i.e. FIFO vs. LIFO
• Different fiscal years• Extraordinary events
• Comparison with industry averages is difficult if the firm operates many different divisions.
• “Average” performance is not necessarily good.• Seasonal factors can distort ratios.
(More…)
• Window dressing techniques can make statements and ratios look better.
• Sometimes it is difficult to tell if a ratio value is “good” or “bad.”
• Often, different ratios give different signals, so it is difficult to tell, on balance, whether a company is in a strong or weak financial condition.
What are some qualitative factors analysts should consider when
evaluating a company’s likely future financial performance?
• Are the company’s revenues tied to a single customer?
• To what extent are the company’s revenues tied to a single product?
• To what extent does the company rely on a single supplier?
(More…)
• What percentage of the company’s business is generated overseas?
• What is the competitive situation?• What does the future have in store?• What is the company’s legal and
regulatory environment?
Non-Financial Measures of Operating Effectiveness
• Innovation
• Customer Service
• Product Quality
• Reputation
• Good Employee Relations
Balanced Scorecard• Organisational Learning and Growth
(Employee Training & Education, Innovation, Opportunities for Improvement, New Product Dev. Time)
• Business and Production Process Efficiency (Quality, Productivity, Cycle time)
• Customer Value (Customer Satisfaction and Loyalty)
• Financial Performance