Financial Statements Analysis FIL 240 Prepared by Keldon Bauer Financial Statement Fundamentals Publicly traded companies must file an annual 10 K report with the SEC The purpose of the 10 K is to report to owners on the status of their investment The 10 K report contains both verbal and quantitative information about the performance of the firm Financial Statement Fundamentals Financial Sections Include Income Statement usually 3 years Balance Sheet usually 2 years Statement of Retained Earnings Statement of Cash Flows Key operating statistics for 5 10 years The purpose is both informative and marketing The Balance Sheet The balance sheet is an attempt to show the sources of investment funds and their uses in the firm at the present time Accountants should be looking out for the interests of the investor Conservatism Lower of cost or market The Balance Sheet Assets are listed in order of liquidity Ease of conversion to cash Without significant loss of value The less liquid an item on the balance sheet is the less reliably it reflects its current value over time Standard practice of inventory accounting depreciation etc do not reflect actual value The Balance Sheet Balance Sheet Identity Assets Liabilities Stockholders Equity Uses Debt Sources Equity Sources The amount the firm owes on its liabilities is usually exactly what is on its balance sheet The value of the equity is never what appears on the balance sheet Equity is what is used to balance the identity Market versus Book Value The balance sheet provides the book value of the assets liabilities and equity Market value is the price at which the assets liabilities or equity can actually be bought or sold Market value and book value are often very different Why Which is more important to the decisionmaking process Income Statement The income statement acts as a basis of change in the equity section of the balance sheet You either pay equity investors back with income or increase their book value reinvest You generally report revenues first and then deduct any expenses for the period Matching principle GAAP requires revenue to be recognized when it accrues and match the expenses required to generate the revenue Ratio Analysis Financial ratios are the vital signs of the business They are used to assess the health of the business When they are off the norm they should be taken together with all known information to get a correct diagnosis Norms should be seen as a normal range not just one number Ratio Analysis Ratios also allow for better comparison through time or between companies As we look at each ratio ask yourself what the ratio is trying to measure and why is that information important Ratios are used both internally and externally Categories of Financial Ratios Short term solvency or liquidity ratios Activity Ratios Debt Ratios Profitability ratios Market value ratios Liquidity Ratios Relate short term sources of and uses for cash Current Ratio Current Assets Current Ratio Current Liabilities 57 666 Current Ratio 4 51 12 788 Liquidity Ratios Quick Acid Test Ratio Current Assets Inventory Quick Ratio Current Liabilities 57 666 37 009 Quick Ratio 1 62 12 788 Asset Management Ratios Purpose is to assess how well the firm is managing assets Inventory turnover ratio IT Cost of Goods 131 924 IT 3 56 Inventory 37 009 365 365 Inventory Days 102 days IT 3 56 Asset Management Ratios Accounts receivable turnover ART Sales 169 565 ART 9 05 Acct Rec 18 735 365 365 Average Collection Period 40 days ART 9 05 Asset Management Ratios Accounts payable turnover APT Cost of Goods 131 924 APT 24 22 Accts Payable 5 448 365 365 Average Payment Period 15 days APT 24 22 Asset Management Ratios Total Asset Turnover TAT Measure of asset use efficiency Interpret in industry context Sales 169 565 TAT 1 90 Total Assets 89 259 Debt Ratios Relate debt to equity sources of investment funds Debt Ratio Total Liabilities Debt Ratio Total Assets 16 597 Debt Ratio 18 59 89 259 Leverage Ratios Equity Multiplier Total Assets Equity Multiplier Total Equity 89 259 Equity Multiplier 1 23 72 662 Coverage Ratios Measure of ability to meet debt contracts Times Interest Earned TIE Ratio EBIT TIE Ratio Interest Expense 11 110 TIE Ratio 14 75 753 Leverage Ratios EBITDA Ratio EBIT Depreciati on Amortization EBITDA Ratio Interest Expense CMLTD Can t calculate example CMLTD is not disclosed Profitability Standardizing Common Size Balance Sheets Compute all accounts as a percent of total assets Common Size Income Statements Compute all line items as a percent of sales Standardized statements make it easier to compare financial information particularly as the company grows They are also useful for comparing companies of different sizes particularly within the same industry Profitability Ratios What s the bottom line Gross Profit Margin GPM Gross Profit 37 641 GPM 22 20 Total Revenue 169 565 Profitability Ratios Operating Profit Margin OPM Operating Profits 11 110 OPM 6 55 Total Revenue 169 565 Profitability Ratios What s the bottom line Net Profit Margin NPM Net Income 7 245 NPM 4 27 Total Revenue 169 565 Profitability Ratios Earnings per Share EPS Net Income 7 245 EPS 1 69 Total Revenue 4 277 Profitability Ratios Return on Total Assets ROA This is a measure of the return on assets owned Therefore it is a measure of return to all invested funds Net Income 7 245 ROA 8 12 Total Assets 89 259 Profitability Ratios Return on Common Equity ROE This is a measure of return to the equity holder whether or not they get a dividend Net Income 7 245 ROE 9 97 Total Equity 72 662 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 Market Value Ratios Price Earnings P E Ratio Market Price per Share P E Ratio Earnings per Share Market Value Ratios Market Book M B Ratio Market Price per Share M B Ratio Book Value per Share Benchmarking Ratios are not very helpful by themselves they need to be compared to something Time Trend Analysis Used to see how the firm s performance is changing through time Internal and external uses Peer Group Analysis Compare to similar companies or within industries SIC and NAICS codes Time Series Analysis Evaluation of the firm s financial performance over time using financial ratios Look for trends Interpretation