financial statements & analysis resa lundkvist former financial analyst, standard & poor’s...
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Financial Statements & Analysis
Resa LundkvistFormer Financial Analyst, Standard & Poor’s
Retired Managing Director, JP MorganAdjunct Professor, Finance, SNHU
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Brady Inc. Balance Sheetas of 12/31/13
Assets = Liabilities + Stockholders Equity
Cash $100 Accounts Payable $300Accounts Receivable 200 Notes Payable 200Inventory 400 Current portion LTD 100 Current Assets 900 Current Liabilities 600
Equipment, net of Dep’n 800 Long-Term Debt 700Property 900 Total Liabilities 1,300 Noncurrent Assets 1,700 Common Stock 900 Retained Earnings 600 Stockholders Equity 1,500 Total Assets 2,800 Total Liab. & SE 2,800 ↓ ↓
Company’s Economic Resources Company’s Sources of Financing
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Balance Sheet
• The B/S is a financial snapshot on a specific date• The B/S doesn’t reflect amounts for which assets could
currently be sold (an asset’s market value). Instead, balance sheets report book values less any accumulated depreciation.
• Assets are listed in order of liquidity (closeness to cash)• Current assets will be turned into cash in < 1 year• Noncurrent assets will be turned into cash > 1 year
– Inventory is included as a Current Asset regardless of how long its cycle to cash
• Liabilities are listed in order of maturity, so obligations due within the next year are classified as current liabilities
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Key Liquidity Tests
Why is liquidity so important?
Because cash is king. You can’t repay debt with equipment or property – you need cash! A company can’t meet its ST obligations if all its assets are tied up long-term. Companies have failed more often for liquidity problems than for solvency problems. A profitable company that can’t meet its payroll obligations has liquidity problems.So, keep an eye on:• Net working capital = current assets – current liabilities• Current ratio = current assets/current liabilities
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Debt vs. Equity and Capital Structure• Debt/equity - describes a company’s capital structure.
Long-term asset purchases are financed either by debt capital, supplied by creditors, or by equity capital, supplied by owners. A company’s particular mix of debt and equity is called its capital structure. The capital structure is how a firm finances its operations and growth by using different sources of funds.
• Debt is typically a cheaper source of funding than equity, but debt has a major drawback:– it has to be serviced and repaid in full and on time. Debt
payments place a burden on the company that must be met, regardless of the company’s profitability. There is no flexibility.
• Equity is a permanent and more flexible source of funding
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Brady Inc. Income Statement (P&L)FYE 12/31/13
Sales $3,000Cost of Goods Sold (COGS) 1,000 Gross Profit 2,000Selling, General, & Admin Expenses (SG&A) 500Depreciation Expense 200 Earnings before Interest & Taxes (EBIT) 1,300Interest Expense 100 Pretax Income 1,200 Income taxes (25%) 300 Net Income 900
↓
Dividends +/or Retained Earnings
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Income Statement (P&L)
• If the B/S is a snapshot, then the P&L is a video, recording all of the company’s transactions
• Net Income is allocated to dividends (shows up in cash flow statement) +/or retained earnings (shows up in Stockholders’ Equity section of B/S)
• Good example of how the 3 main financial statements are connected and explains why all 3 have to be calculated to have a complete financial picture of a company
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P&L AnalysisRatios focus on operating or “core” profitability• How much of each $1 of sales is turned into gross
profit or EBIT?– Gross Profit Margin = Gross Profit/Sales– EBIT Margin = EBIT/Sales
• How much Net Income are the company’s assets or equity generating (return on invested capital)?– Return on Assets = Net Income/Total Assets– Return on Equity = Net Income/Equity
Ratios are industry specific: identify correct peer group
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P&L Analysis (#2)
• Depreciation – a non-cash allocation of an asset’s cost over its estimated useful life.
• Note that interest expense is deducted below core profitability measures, because it’s a consequence of capital structure, not operations.
• Interest expense is tax-deductible, thus reducing tax expense. No flexibility, but lower-cost.
• Dividends, however, are after-tax payments. More flexibility but also more expensive. – Payout Ratio = Dividends/Net Income– Plowback Ratio = Retained Earnings added/Net Income
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Cash Flow StatementCash Flow Statement is the summation of all the company’s transactions that had a direct impact on cash. It explains the change in the Cash account on the B/S from 1 year to the next. A giant Cash T-account.
• Cash from Operations – start with Net Income … then adjust• +/- Cash from Investing Activities – transactions with an
operational nature, like buying a new equipment, opening a new factory, closing a factory or selling land
• +/- Cash from Financing Activities – transactions related to capital structure, such as selling new shares, paying dividends, borrowing new debt, or repaying loans
--> Change in Cash on B/S from last year
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My income statement says I made money, so why doesn’t my bank account agree?
OR: Why isn’t net income = cash from operations? 2 reasons: 1 easy, 1 not-so-easy1. Depreciation is a non-cash expense that has been deducted on
the P&L but doesn’t affect cash, and must be added back.2. The P&L doesn’t capture changes in current assets and current
liabilities that result from accrual accounting and cause changes in cash.Example: Reported revenues don’t always equal cash collected from customers because some sales may be on credit, causing Accounts Receivable, a current asset, to increase. To calculate cash from operations, this increase must be deducted from Net Income. If a CA ↑, deduct from NI. If a CL ↑, add to NI.
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Example: Calculating Cash from Operations
Brady Inc.’s Net Income = $900 & Depreciation = $2002013 A/R = $200 & 2012 A/R = $150, using cash2013 A/P = $300 & 2012 A/P = $100, releasing cash
To calculate CFO: Start with Net Income $900 Add back Depreciation + 200 Subtract ↑ in Current Assets (A/R) - 50 Add ↑ in Current Liabilities (A/P) + 150 Cash from Operations $800