Financial Statements & AnalysisFinancial Statement FundamentalsSlide 3The Balance SheetSlide 5Slide 6Market versus Book ValueIncome StatementRatio AnalysisSlide 10Categories of Financial RatiosLiquidity RatiosSlide 13Asset Management RatiosSlide 15Slide 16Slide 17Debt RatiosLeverage RatiosCoverage RatiosSlide 21Profitability - StandardizingProfitability RatiosSlide 24Slide 25Slide 26Slide 27Slide 28Using the Du Pont IdentityMarket Value RatiosSlide 31BenchmarkingTime-Series AnalysisInterpretationFinancial Statements & AnalysisFinancial Statements & AnalysisFIL 240Prepared by Keldon BauerFinancial Statement Financial Statement FundamentalsFundamentals•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 FundamentalsFinancial Statement Fundamentals•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 marketingFinancial Sections Include:The Balance SheetThe 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 SheetThe 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 SheetThe 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 ValueMarket 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 decision-making process?Income StatementIncome 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 AnalysisRatio 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 AnalysisRatio 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 externallyCategories of Financial RatiosCategories of Financial Ratios•Short-term solvency or liquidity ratios•Activity Ratios•Debt Ratios•Profitability ratios•Market value ratiosLiquidity RatiosLiquidity Ratios•Relate short-term sources of and uses for cash.•Current Ratio:sLiabilitieCurrent AssetsCurrent RatioCurrent 51.412,78857,666 RatioCurrent Liquidity RatiosLiquidity Ratios•Quick (Acid Test) Ratio:sLiabilitieCurrent Inventory - AssetsCurrent RatioQuick 62.112,78837,009)-(57,666 RatioQuick Asset Management RatiosAsset Management Ratios•Purpose is to assess how well the firm is managing assets•Inventory turnover ratio (IT):56.3009,37924,131InventoryGoods ofCost IT days 0213.56365IT365 DaysInventory Asset Management RatiosAsset Management Ratios•Accounts receivable turnover (ART):05.9735,18565,169Rec. Acct.Sales ART days 0405.9365ART365 Period Collection Average Asset Management RatiosAsset Management Ratios•Accounts payable turnover (APT):22.24448,5924,131Payable Accts.Goods ofCost APT days 5122.24365APT365 PeriodPayment Average Asset Management RatiosAsset Management Ratios•Total Asset Turnover (TAT):•Measure of asset use efficiency•Interpret in industry context.90.1259,89565,169Assets TotalSales TAT Debt RatiosDebt Ratios•Relate debt to equity sources of investment funds .•Debt Ratio:Assets TotalsLiabilitie Total RatioDebt %59.1889,25916,597 RatioDebt Leverage RatiosLeverage Ratios•Equity Multiplier:Equity TotalAssets Total MultiplierEquity 23.1662,72259,89 MultiplierEquity Coverage RatiosCoverage Ratios•Measure of ability to meet debt contracts.•Times Interest Earned (TIE) Ratio:ExpenseInterest EBIT Ratio TIE 75.1475311,110 Ratio TIE Leverage RatiosLeverage Ratios•EBITDA Ratio:CMLTDExpenseInterest on)AmortizationDepreciati(EBIT RatioEBITDA •Can’t calculate example, CMLTD is not disclosed.Profitability - StandardizingProfitability - 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 industryProfitability RatiosProfitability Ratios•What’s the bottom line?•Gross Profit Margin (GPM):%20.22565,169641,37Revenue TotalProfit Gross GPM Profitability RatiosProfitability Ratios•Operating Profit Margin (OPM):%55.6565,169110,11Revenue TotalProfits Operating OPM Profitability RatiosProfitability Ratios•What’s the bottom line?•Net Profit Margin (NPM):%27.4565,169245,7Revenue TotalIncomeNet NPM Profitability