Slide 1Slide 2Business AnalysisInformation Sources for Business AnalysisSlide 5Credit AnalysisSlide 7Equity AnalysisSlide 9Accounting AnalysisFinancial AnalysisProspective AnalysisDynamics of Business ActivitiesSlide 14Business ActivitiesSlide 16Slide 17Financial Statements Reflect Business ActivitiesFinancial StatementsSlide 20Balance SheetSlide 22Income StatementSlide 24Statement of Cash FlowsSlide 26Additional Information (Beyond Financial Statements)Analysis PreviewSlide 29Slide 30Slide 31Slide 32Slide 33Slide 34Slide 35Slide 36Slide 37Slide 38Analysis in an Efficient MarketBook OrganizationMcGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.Financial Statement AnalysisK R SubramanyamJohn J Wild1-21CHAPTEROverview of Financial Statement Analysis1-3Business AnalysisEvaluate ProspectsEvaluate ProspectsEvaluate RisksEvaluate Risks1-4Information Sources for Business Analysis1-51-6Credit Analysis1-7Credit AnalysisLiquidity Ability to meet short-term obligations Focus: • Current cash flows• Make up of current assets and liabilities• Liquidity of assetsLiquidity Ability to meet short-term obligations Focus: • Current cash flows• Make up of current assets and liabilities• Liquidity of assetsSolvencyAbility to meet long-term obligations Focus:• Long-term profitability• Capital structureSolvencyAbility to meet long-term obligations Focus:• Long-term profitability• Capital structureCredit worthiness: Ability to honor credit obligations(downside risk)Credit worthiness: Ability to honor credit obligations(downside risk)1-8Equity AnalysisTechnical analysis / Charting•Patterns in price or volume history of a stock•Predict future price movementsTechnical analysis / Charting•Patterns in price or volume history of a stock•Predict future price movementsFundamental Analysis Determine Intrinsic value without reference to price•Analyze and interpret key factors–Economy–Industry–CompanyFundamental Analysis Determine Intrinsic value without reference to price•Analyze and interpret key factors–Economy–Industry–CompanyAssessment of downside risk and upside potentialAssessment of downside risk and upside potential1-91-10Accounting AnalysisAccountingRiskAccountingRiskProcess to evaluate and adjust financial statements to better reflect economic realityProcess to evaluate and adjust financial statements to better reflect economic reality1-11Financial AnalysisProfitability analysis — Evaluate return on investmentsRisk analysis ——— Evaluate riskiness & creditworthinessAnalysis of — Evaluate source & cash flows deployment of fundsProfitability analysis — Evaluate return on investmentsRisk analysis ——— Evaluate riskiness & creditworthinessAnalysis of — Evaluate source & cash flows deployment of fundsCommon toolsCommon toolsRatioanalysisRatioanalysisCash flowanalysisCash flowanalysisProcess to evaluate financial position and performance using financial statementsProcess to evaluate financial position and performance using financial statements1-12Prospective AnalysisIntrinsic ValueIntrinsic ValueBusiness Environment& Strategy AnalysisBusiness Environment& Strategy AnalysisAccounting AnalysisAccounting AnalysisFinancial AnalysisFinancial AnalysisProcess to forecast future payoffsProcess to forecast future payoffs1-13Dynamics of Business ActivitiesBusiness ActivitiesBusiness ActivitiesTimeTime1-14Business Activities1-15Business ActivitiesFinancingFinancing activities • Owner (equity)• Nonowner (liabilities)Financing activities • Owner (equity)• Nonowner (liabilities)1-16Investing activities • Buying resources• Selling resourcesInvesting activities • Buying resources• Selling resourcesInvesting = Financing Investing = Financing Business ActivitiesFinancingInvesting1-17Operating ActivitiesRevenues and expenses from providinggoods and servicesOperating ActivitiesRevenues and expenses from providinggoods and servicesBusiness Activities1-18Financial Statements Reflect Business Activities1-19Financial Statements1-201-21Balance Sheet Total Investing = Total Financing = Creditor Financing + Owner Financing Total Investing = Total Financing = Creditor Financing + Owner Financing1-221-23Income Statement Revenues – Cost of goods sold = Gross ProfitGross profit – Operating expenses = Operating Profit Revenues – Cost of goods sold = Gross ProfitGross profit – Operating expenses = Operating ProfitColgate’s Profitability(in $billions)$12.238 - $5.536 = $6.701 Gross Profit$6.701 - $4.5411 = $2.160 Operating profit1-241-25Statement of Cash Flows1-261-27Additional Information(Beyond Financial Statements)1-28Analysis PreviewPurpose: Evaluation of consecutive financial statementsOutput: Direction, speed, & extent of any trend(s)Types: - Year-to-year Change Analysis - Index-Number Trend AnalysisPurpose: Evaluation of consecutive financial statementsOutput: Direction, speed, & extent of any trend(s)Types: - Year-to-year Change Analysis - Index-Number Trend AnalysisComparative AnalysisComparative AnalysisYr2Yr1 Yr3Analysis Preview1-291-30Analysis PreviewPurpose : - Evaluation of internal makeup of financial statements- Evaluation of financial statement accounts across companiesOutput: Proportionate size of assets, liabilities, equity, revenues, & expensesPurpose : - Evaluation of internal makeup of financial statements- Evaluation of financial statement accounts across companiesOutput: Proportionate size of assets, liabilities, equity, revenues, & expensesCommon-Size AnalysisCommon-Size Analysis1-31Analysis Preview1-32Analysis Preview1-33Analysis PreviewPurpose : Evaluate relation between two or more economically important items (one starting point for further analysis)Output: Mathematical expression of relation between two or more itemsCautions: - Prior Accounting analysis is important- Interpretation is key - long vs short term & benchmarkingPurpose : Evaluate relation between two or more economically important items (one starting point for further analysis)Output: Mathematical expression of relation between two or more itemsCautions: - Prior Accounting analysis is important- Interpretation is key - long vs short term & benchmarkingRatio AnalysisRatio Analysis1-34Analysis PreviewPurpose: Estimate intrinsic value of a company (or stock)Basis: