Materi Tambahan (Financial Statement Analysis

Chapter 6
Financial Statement Analysis

6.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
After Studying Chapter 6, you should be able to:

1. 2. 3. 4.
Understand the purpose of basic financial statements and their contents. Understand what is meant by convergence in accounting standards. Explain why financial statement analysis is important to the firm and to outside suppliers of capital. Define, calculate, and categorize (according to liquidity, financial leverage, coverage, activity, and profitability) the major financial ratios and understand what they can tell us about the firm. Define, calculate, and discuss a firms operating cycle and cash cycle. Use ratios to analyze a firm's health and then recommend reasonable alternative courses of action to improve the health of the firm. Analyze a firms return on investment (i.e., earning power) and return on equity using a DuPont approach. Understand the limitations of financial ratio analysis. Use trend analysis, common-size analysis, and index analysis to gain additional insights into a firm's performance.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
5. 6. 7. 8. 9.
6.2
Financial Statement Analysis

Financial Statements A Possible Framework for Analysis Balance Sheet Ratios Income Statement and Income/Balance Sheet Ratios
Trend Analysis
Common-Size and Index Analysis
Examples of External Uses of Statement Analysis

Trade Creditors Focus on the liquidity of the firm.
Bondholders Focus on the long-term cash flow of the firm. Shareholders Focus on the profitability and long-term health of the firm.
Examples of Internal Uses of Statement Analysis

Plan Focus on assessing the current financial position and evaluating potential firm opportunities. Control Focus on return on investment for various assets and asset efficiency.
Understand Focus on understanding how suppliers of funds analyze the firm.
Global Accounting Standards

Convergence of Accounting Standards: Aims to
narrow or remove differences so that investors can better understand financial statements prepared under different accounting frameworks
IASB International Accounting Standards Board has the responsibility of IFRS IFRS International Financial Reporting Standards (EU countries adopted) US GAAP US Generally Accepted Accounting Principles determined by FASB FASB Financial Accounting Standards Board determines accounting standards for financial statements
Primary Types of Financial Statements

Balance Sheet
A summary of a firms financial position on a given date that shows total assets = total liabilities + owners equity.
Income Statement
A summary of a firms revenues and expenses over a specified period, ending with net income or loss for the period.
Basket Wonders Balance Sheet (Asset Side)

Basket Wonders Balance Sheet (thousands) Dec. 31, 2007a
Cash $ 90 Acct. Rec.c 394 Inventories 696 Prepaid Exp d 5 Accum Tax Prepay 10 Current Assetse $1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g (329) Net Fix. Assets $ 701 Investment, LT 50 Other Assets, LT 223 Total Assets b $2,169
6.8
a. How the firm stands on a specific date. b. What BW owned. c. Amounts owed by customers. d. Future expense items already paid. e. Cash/likely convertible to cash within 1 year. f. Original amount paid. g. Acc. deductions for wear and tear.
Basket Wonders Balance Sheet (Liability Side)

Basket Wonders Balance Sheet (thousands) Dec. 31, 2007
Notes Payable Acct. Payablec Accrued Taxes d Other Accrued Liab. d Current Liab. e Long-Term Debt f Shareholders Equity Com. Stock ($1 par) g Add Pd in Capital g Retained Earnings h Total Equity Total Liab/Equitya,b
6.9
$ 290 94 16 100 $ 500 530
a. Note, Assets = Liabilities + Equity. b. What BW owed and ownership position. c. Owed to suppliers for goods and services. d. Unpaid wages, 200 salaries, etc. 729 e. Debts payable < 1 year. 210 f. Debts payable > 1 year. $1,139 g. Original investment. $2,169 h. Earnings reinvested.
Basket Wonders Income Statement

Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2007a Net Sales $ 2,211 Cost of Goods Sold b 1,599 Gross Profit $ 612 SG&A Expenses c 402 EBITd $ 210 Interest Expensee 59 EBT f $ 151 Income Taxes 60 EATg $ 91 Cash Dividends 38 Increase in RE $ 53
6.10
a. Measures profitability over a time period. b. Received, or receivable, from customers. c. Sales comm., adv., officers salaries, etc. d. Operating income. e. Cost of borrowed funds. f. Taxable income. g. Amount earned for shareholders.
Framework for Financial Analysis

Trend/Seasonal Component
How much funding will be required in the future?
1. Analysis of the funds needs of the firm.
Is there a seasonal component?
Analytical Tools Used

Sources and Uses Statement
Statement of Cash Flows

Cash Budgets

Health of a Firm
1. Analysis of the funds needs of the firm. 2. Analysis of the financial condition and profitability of the firm.
Financial Ratios 1. 2. 3. 4. Individually Over time In combination In comparison
6.12

1. Analysis of the funds needs of the firm. 2. Analysis of the financial condition and profitability of the firm. 3. Analysis of the business risk of the firm.
Business risk relates to the risk inherent in the operations of the firm. Examples: Volatility in sales
Volatility in costs Proximity to break-even point
6.13

Determining the financing needs of the firm.
A Financial Manager must consider all three jointly when determining the financing needs of the firm.
6.14
Determining the financing needs of the firm.
Negotiations with suppliers of capital.
6.15
Use of Financial Ratios

A Financial Ratio is an index that relates two accounting numbers and is obtained by dividing one number by the other.
6.16
Types of Comparisons
Internal Comparisons External Comparisons
External Comparisons and Sources of Industry Ratios

This involves comparing the ratios of one firm with those of similar firms or with industry averages. Similarity is important as one should compare apples to apples.
6.17
Examples: Risk Management Association
Dun & Bradstreet

Almanac of Business and Industrial Financial Ratios
Liquidity Ratios
Balance Sheet Ratios
Liquidity Ratios
Current
Current Assets Current Liabilities For Basket Wonders December 31, 2007 $1,195 = 2.39 $500
Shows a firms ability to cover its current liabilities with its current assets.
6.18
Liquidity Ratio Comparisons

Current Ratio
Year 2007 2006 BW 2.39 2.26 Industry 2.15 2.09
2005
6.19
1.91
2.01
Ratio is stronger than the industry average.

Liquidity Ratios
Liquidity Ratios
Acid-Test (Quick)
Current Assets - Inv Current Liabilities For Basket Wonders December 31, 2007 $1,195 $696 = 1.00 $500
Shows a firms ability to meet current liabilities with its most liquid assets.
6.20
Liquidity Ratio Comparisons

Acid-Test Ratio
Year 2007 2006 BW 1.00 1.04 Industry 1.25 1.23
2005
6.21
1.11
1.25
Ratio is weaker than the industry average.

Summary of the Liquidity Ratio Comparisons

Ratio Current Acid-Test BW 2.39 1.00 Industry 2.15 1.25
Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account. Note that this industry has a relatively high level of inventories.
Current Ratio Trend Analysis Comparison

Trend Analysis of Current Ratio
2.5 Ratio Value 2.3 2.1 1.9 1.7 1.5 2005
BW Industry
2006 Analysis Year
2007
6.23
Acid-Test Ratio Trend Analysis Comparison

Trend Analysis of Acid-Test Ratio
1.5 Ratio Value 1.3 1.0 0.8 0.5 2005
6.24
BW Industry
2006 Analysis Year
2007
Summary of the Liquidity Trend Analyses

The current ratio for BW has been rising at the same time the acid-test ratio has been declining.
The current ratio for the industry has been rising slowly at the same time the acid-test ratio has been relatively stable. This indicates that inventories are a significant problem for BW.
Financial Leverage Ratios

Debt-to-Equity
Total Debt Shareholders Equity For Basket Wonders December 31, 2007 $1,030 = 0.90 $1,139
Shows the extent to which the firm is financed by debt.

6.26
Financial Leverage Ratio Comparisons

Debt-to-Equity Ratio
Year 2007 2006 BW 0.90 0.88 Industry 0.90 0.90
2005
6.27
0.81
0.89
BW has average debt utilization relative to the industry average.


Debt-to-Total-Assets
Total Debt Total Assets For Basket Wonders December 31, 2007 $1,030 = 0.47 $2,169
Shows the percentage of the firms assets that are supported by debt financing.
6.28

Debt-to-Total-Asset Ratio
Year
2007
BW
0.47
Industry
0.47
2006
2005
6.29
0.47
0.45
0.47
0.47
BW has average debt utilization relative to the industry average.


Financial Leverage Ratios Shows the relative importance of long-term debt to the long-term financing of the firm.
6.30
Total Capitalization
(i.e., LT-Debt + Equity)
Total Debt Total Capitalization For Basket Wonders December 31, 2007 $1,030 = 0.62 $1,669

Total Capitalization Ratio
Year 2007 2006 BW 0.62 0.62 Industry 0.60 0.61
2005
6.31
0.67
0.62
BW has average long-term debt utilization relative to the industry average.

Coverage Ratios
Income Statement Ratios Coverage Ratios
Interest Coverage
EBIT Interest Charges For Basket Wonders December 31, 2007 $210 = 3.56 $59
Indicates a firms ability to cover interest charges.

6.32
Coverage Ratio Comparisons

Interest Coverage Ratio
Year 2007 2006 2005
6.33
BW 3.56 4.35 10.30
Industry 5.19 5.02 4.66
BW has below average interest coverage relative to the industry average.

Coverage Ratio Trend Analysis Comparison

Trend Analysis of Interest Coverage Ratio
11.0 9.0
Ratio Value 7.0 5.0 3.0 2005 2006 Analysis Year
BW Industry
2007
Summary of the Coverage Trend Analysis

The interest coverage ratio for BW has been falling since 2005. It has been below industry averages for the past two years. This indicates that low earnings (EBIT) may be a potential problem for BW.
Note, we know that debt levels are in line with the industry averages.
Activity Ratios
Income Statement/ Balance Sheet Ratios
Activity Ratios Indicates quality of receivables and how successful the firm is in its collections.
6.36
Receivable Turnover
(Assume all sales are credit sales.)
Annual Net Credit Sales Receivables For Basket Wonders December 31, 2007 $2,211 = 5.61 $394
Activity Ratios
Income Statement/ Balance Sheet Ratios Activity Ratios Average number of days that receivables are outstanding. (or RT in days)
6.37
Avg Collection Period

Days in the Year Receivable Turnover For Basket Wonders December 31, 2007 365 5.61
= 65 days
Activity Ratio Comparisons

Average Collection Period
Year 2007 2006 BW 65.0 71.1 Industry 65.7 66.3
2005
6.38
83.6
69.2
BW has improved the average collection period to that of the industry average.
Activity Ratios
Activity Ratios Indicates the promptness of payment to suppliers by the firm.
6.39
Payable Turnover (PT)

(Assume annual credit purchases = $1,551.)
Annual Credit Purchases Accounts Payable For Basket Wonders December 31, 2007 $1551 = 16.5 $94
Activity Ratios
Activity Ratios Average number of days that payables are outstanding.
6.40
PT in Days
Days in the Year Payable Turnover For Basket Wonders December 31, 2007 365 16.5 = 22.1 days

Payable Turnover in Days
Year 2007 2006 BW 22.1 25.4 Industry 46.7 51.1
2005
6.41
43.5
Is this good?
48.5
BW has improved the PT in Days.

Activity Ratios
Activity Ratios Indicates the effectiveness of the inventory management practices of the firm.
6.42
Inventory Turnover
Cost of Goods Sold Inventory For Basket Wonders December 31, 2007 $1,599 = 2.30 $696

Inventory Turnover Ratio
Year 2007 2006 BW 2.30 2.44 Industry 3.45 3.76
2005
6.43
2.64
3.69
BW has a very poor inventory turnover ratio.

Inventory Turnover Ratio Trend Analysis Comparison

Trend Analysis of Inventory Turnover Ratio
4.0 3.5 3.0 2.5 2.0 2005 BW Industry
Ratio Value
2006 Analysis Year
2007
6.44
Activity Ratios
Activity Ratios Indicates the overall effectiveness of the firm in utilizing its assets to generate sales.
6.45
Total Asset Turnover

Net Sales Total Assets For Basket Wonders December 31, 2007 $2,211 = 1.02 $2,169

Total Asset Turnover Ratio
Year 2007 2006
BW
1.02
Industry
1.17
1.03
1.01
1.14
1.13
2005
6.46
BW has a weak total asset turnover ratio.
Why is this ratio considered weak?

Profitability Ratios
Income Statement/ Balance Sheet Ratios Profitability Ratios Indicates the efficiency of operations and firm pricing policies.
6.47
Gross Profit Margin

Gross Profit Net Sales For Basket Wonders December 31, 2007 $612 = 0.277 $2,211
Profitability Ratio Comparisons

Gross Profit Margin
Year 2007 2006 BW 27.7% 28.7 Industry 31.1% 30.8
2005
6.48
31.3
27.6
BW has a weak Gross Profit Margin.

Gross Profit Margin Trend Analysis Comparison

Trend Analysis of Gross Profit Margin
35.0 Ratio Value (%) 32.5 30.0 27.5 25.0 2005 BW Industry
2006 Analysis Year
2007
6.49
Income Statement/ Balance Sheet Ratios Profitability Ratios Indicates the firms profitability after taking account of all expenses and income taxes.
6.50
Net Profit Margin

Net Profit after Taxes Net Sales For Basket Wonders December 31, 2007 $91 = 0.041 $2,211

Net Profit Margin
Year 2007 2006 BW 4.1% 4.9 Industry 8.2% 8.1
2005
6.51
9.0
7.6
BW has a poor Net Profit Margin.

Net Profit Margin Trend Analysis Comparison

Trend Analysis of Net Profit Margin
10 9
Ratio Value (%)
7
6 5 4 2005
BW Industry
2006 Analysis Year
2007
6.52
Income Statement/ Balance Sheet Ratios Profitability Ratios Indicates the profitability on the assets of the firm (after all expenses and taxes).
6.53
Return on Investment
Net Profit after Taxes Total Assets For Basket Wonders December 31, 2007 $91 = 0.042 $2,160

Return on Investment
Year 2007 2006 BW 4.2% 5.0 Industry 9.6% 9.1
2005
6.54
9.1
10.8
BW has a poor Return on Investment.

Return on Investment Trend Analysis Comparison

Trend Analysis of Return on Investment
12
Ratio Value (%)
10 8 6 4 2005 BW Industry
2006 Analysis Year
2007
6.55
Profitability Ratios Indicates the profitability to the shareholders of the firm (after all expenses and taxes).
6.56
Return on Equity
Net Profit after Taxes Shareholders Equity For Basket Wonders December 31, 2007 $91 = 0.08 $1,139

Return on Equity
Year 2007 2006 BW 8.0% 9.4 Industry 18.0% 17.2
2005
6.57
16.6
20.4
BW has a poor Return on Equity.

Return on Equity Trend Analysis Comparison

Trend Analysis of Return on Equity
21.0 Ratio Value (%) 17.5 14.0 10.5 7.0 2005 BW Industry
2006 Analysis Year
2007
6.58
Return on Investment and the Du Pont Approach

Earning Power = Sales profitability Asset efficiency ROI = Net profit margin Total asset turnover
ROI2007 = 0.041 1.02 = 0.042 or 4.2%
(Note: values are rounded)
ROIIndustry = 0.082 1.17 = 0.096 or 9.6%
Return on Equity and the Du Pont Approach

Return On Equity = Net profit margin X Total asset turnover X Equity Multiplier
Total Assets Equity Multiplier = Shareholders Equity
ROE2007
= 0.041 1.02 1.90 = 0.080

(Note: values are rounded)
ROEIndustry = 0.082 1.17 1.88 = 0.180

Summary of the Profitability Trend Analyses
The profitability ratios for BW have ALL been falling since 2005. Each has been below the industry averages for the past three years.
This indicates that COGS and administrative costs may both be too high and a potential problem for BW. Note, this result is consistent with the low interest coverage ratio.
6.61
Summary of Ratio Analyses

Inventories are too high.
May be paying off creditors (accounts payable) too soon.
COGS may be too high.

Selling, general, and administrative costs may be too high.
Common-Size Analysis
An analysis of percentage financial statements where all balance sheet items are divided by total assets and all income statement items are divided by net sales or revenues.
6.63
Basket Wonders Common Size Balance Sheets

Regular (thousands of $) Assets Cash AR Inv Other CA Tot CA Net FA LT Inv Other LT Tot Assets
6.64
Common-Size (%) 2005 12.10 23.14 26.33 0.82 62.39 28.54 0.00 9.08 100.0 2006 4.89 20.06 30.14 0.68 55.77 30.87 2.45 10.91 100.0 2007 4.15 18.17 32.09 0.69 55.09 32.32 2.31 10.28 100.0
2005 148 283 322 10 763 349 0 111 1,223
2006 100 410 616 14 1,140 631 50 223 2,044
2007 90 394 696 15 1,195 701 50 223 2,169
Basket Wonders CommonSize Balance Sheets

Regular (thousands of $) Liab+Equity Note Pay Acct Pay Accr Tax Other Accr Tot CL LT Debt Equity Tot L+E 2005 290 81 13 15 399 150 674 1,223 2006 295 94 16 100 505 453 1,086 2,044 2007 290 94 16 100 500 530 1,139 2,169 Common-Size (%) 2005 23.71 6.62 1.06 1.23 32.62 12.26 55.11 100.0 2006 14.43 4.60 0.78 4.89 24.71 22.16 53.13 100.0 2007 13.37 4.33 0.74 4.61 23.05 24.44 52.51 100.0
6.65
Basket Wonders CommonSize Income Statements

Regular (thousands of $) 2005 Net Sales COGS Gross Profit Adm. EBIT Int Exp EBT EAT Cash Div
6.66
Common-Size (%) 2005 100.0 68.7 31.3 14.6 16.7 1.6 15.1 9.1 4.0 2006 100.0 71.3 28.7 18.2 10.5 2.4 8.1 4.9 2.4 2007 100.0 72.3 27.7 18.2 9.5 2.7 6.8 4.1 2.3
2006 2,106 1,501 605 383 222 51 171 103 50
2007 2,211 1,599 612 402 210 59 151 91 50
1,235 849 386 180 206 20 186 112 50
Index Analyses
An analysis of percentage financial statements where all balance sheet or income statement figures for a base year equal 100.0 (percent) and subsequent financial statement items are expressed as percentages of their values in the base year.
Basket Wonders Indexed Balance Sheets

Regular (thousands of $) Assets Cash AR Inv Other CA Tot CA Net FA LT Inv Other LT Tot Assets
6.68
Indexed (%) 2005 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 2006 67.6 144.9 191.3 140.0 149.4 180.8 inf. 200.9 167.1 2007 60.8 139.2 216.1 150.0 156.6 200.9 inf. 200.9 177.4
2005 148 283 322 10 763 349 0 111 1,223
2006 100 410 616 14 1,140 631 50 223 2,044
2007 90 394 696 15 1,195 701 50 223 2,169
Basket Wonders Indexed Balance Sheets

Regular (thousands of $) Liab+Equity Note Pay Acct Pay Accr Tax Other Accr Tot CL LT Debt Equity Tot L+E 2005 290 81 13 15 399 150 674 1,223 2006 295 94 16 100 505 453 1,086 2,044 2007 290 94 16 100 2005 100.0 100.0 100.0 100.0 Indexed (%) 2006 101.7 116.0 123.1 666.7 126.6 302.0 161.1 167.1 2007 100.0 116.0 123.1 666.7 125.3 353.3 169.0 177.4
500 100.0 530 100.0 1,139 100.0 2,169 100.0
6.69
Basket Wonders Indexed Income Statements

Regular (thousands of $) 2005 Net Sales COGS Gross Profit Adm. EBIT Int Exp 1,235 849 386 180 206 20 2006 2,106 1,501 605 383 222 51 2007 2,211 1,599 612 402 210 59 2005 100.0 100.0 100.0 100.0 100.0 100.0 Indexed (%) 2006 170.5 176.8 156.7 212.8 107.8 255.0 2007 179.0 188.3 158.5 223.3 101.9 295.0
EBT
EAT Cash Div
6.70
186
112 50
171
103 50
151
91 50
100.0
100.0 100.0
91.9
92.0 100.0
81.2
81.3 100.0

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Chapter 6

Financial Statement Analysis

After Studying Chapter 6, you should be able to:

Financial Statement Analysis

Examples of External Uses of Statement Analysis

Examples of Internal Uses of Statement Analysis

Global Accounting Standards

Primary Types of Financial Statements

Basket Wonders Balance Sheet (Asset Side)

Basket Wonders Balance Sheet (Liability Side)

$ 290 94 16 100 $ 500 530

Basket Wonders Income Statement

Framework for Financial Analysis

Is there a seasonal component?

Analytical Tools Used

Statement of Cash Flows

Framework for Financial Analysis

Financial Ratios 1. 2. 3. 4. Individually Over time In combination In comparison

Framework for Financial Analysis

Framework for Financial Analysis

Determining the financing needs of the firm.

Framework for Financial Analysis

Determining the financing needs of the firm.

Negotiations with suppliers of capital.

Use of Financial Ratios

External Comparisons and Sources of Industry Ratios

Examples: Risk Management Association

Dun & Bradstreet

Liquidity Ratio Comparisons

Ratio is stronger than the industry average.

Liquidity Ratio Comparisons

Ratio is weaker than the industry average.

Summary of the Liquidity Ratio Comparisons

Current Ratio Trend Analysis Comparison

2006 Analysis Year

Acid-Test Ratio Trend Analysis Comparison

2006 Analysis Year

Summary of the Liquidity Trend Analyses

Financial Leverage Ratios

Shows the extent to which the firm is financed by debt.

Financial Leverage Ratio Comparisons

BW has average debt utilization relative to the industry average.

Financial Leverage Ratios

Financial Leverage Ratio Comparisons

BW has average debt utilization relative to the industry average.

Financial Leverage Ratios

Financial Leverage Ratio Comparisons

BW has average long-term debt utilization relative to the industry average.

Indicates a firms ability to cover interest charges.

Coverage Ratio Comparisons

BW 3.56 4.35 10.30

Industry 5.19 5.02 4.66

BW has below average interest coverage relative to the industry average.

Coverage Ratio Trend Analysis Comparison

Summary of the Coverage Trend Analysis

Avg Collection Period

Activity Ratio Comparisons

Payable Turnover (PT)

Activity Ratio Comparisons

BW has improved the PT in Days.

Activity Ratio Comparisons

BW has a very poor inventory turnover ratio.

Inventory Turnover Ratio Trend Analysis Comparison

2006 Analysis Year