FINANCIAL ANALYSIS AND REPORTING

Financial Analysis Involves:

1. Comparing a firms performance with that of other firms in the same industry.
2. Evaluating trends in the firms financial position over time.

Managers- for identifying situations needing attention

Potential lenders- to determine whether a company is creditworthy

Stockholders- to help predict future earnings, dividends and free cash flow.

1.1 Financial Analysis

a. Steps:
Gather Data
- Standardize format of Financial Statements
- There is no need to reinvent the wheel each time you analyze a company.
Examine Statement of Cash Flow
- Some can be done with virtually no calculators.
- Downward trends or negative net cash flow from the operations almost always
indicate problems.
- In investing, it shows whether the company has made a big acquisition,
especially when compared with prior years net cash flows from investing
activities.
- Reveals whether or not a company raising capital from investors or returning it
to them
Calculate and Examine the Return on Invested Capital
- ROIC provides the overall performance of the company.
- If greater than the companys weighted average cost of capital then the
company is adding a value. If less, then the company usually has a serious
problem.
- It is important to examine specific areas within the firm, and for that we use
ratio.
Begin Ratio Analysis
- To extract important information that might not be obvious simply from
examining a firms financial statement.

2.1 LIQUIDITY RATIOS = Sales

Current Ratio = Current Assets Inventories
Current Liabilities Days sales Outstanding
Quick, or Acid test, Ratio = Receivables
= Current Assets Inventories Annual Sales/365
Current Liabilities Fixed Assets Turnover
= Sales
3.1 ASSET MANAGEMENT Net Fixed Assets
Inventory Turnover
 Total Assets Turnover Total Assets
= Sales Return on Total Assets
Total Assets =Net income available to common stockholders
Total Assets
4.1 DEBT MANAGEMENT Return on Common Equity
Debt Ratio = Net income available to common stockholders
= Total Liabilities Common Equity
Total Assets
Times-interest-earned
= Earnings before interest and taxes
Interest Charges
EBITDA Coverage 6.1 MARKET VALUE
= EBITDA + Lease Payments Price/ Earnings (P/E)
Interest + Principal Payments + Lease = Price per Share
payments Earnings per Share
Price/Cash Flow
5.1 PROFITABILITY = Price per Share
Profit Margin on Sales Cash Flow per Share
= Net income available to common stockholders Market /Book (M/B)
Sales = Market price per Share
Basic Earning power Book value per Share
=Earnings before interest and taxes (EBIT)

SUMMARY
Liquidity ratios show the relationship of a firms current assets to its current liabilities
and thus its ability to meet maturing debts. Two commonly used liquidity ratios are the
current ratio and the quick, or acid test, ratio.
Asset management ratios measure how effectively a firm is managing its assets. These
ratios include inventory turnover, days sales outstanding, fixed assets turnover, and total
assets turnover.
Debt management ratios reveal (1) the extent to which the firm is financed with debt
and (2) its likelihood of defaulting on its debt obligations. They include the debt ratio,
the times-interest-earned ratio, and the EBITDA coverage ratio.
Profitability ratios show the combined effects of liquidity, asset management, and debt
management policies on operating results. They include the net profit margin (also
called the profit margin on sales), the basic earning power ratio, the return on total
assets, and the return on common equity.
Market value ratios relate the firms stock price to its earnings, cash flow, and book value
per share, thus giving management an indication of what investors think of the
companys past performance and future prospects. These include the price/earnings
ratio, the price/cash flow ratio, and the market/book ratio.
Trend analysis, in which one plots a ratio overtime, Is important because it reveals
whether the firms condition has been improving or deteriorating over time.
The Du Pont system is designed to show how the profit margin on sales, the assets
turnover ratio, and the use of debt all interact to determine the rate of
 o 110 Part 1: Fundamental Concepts of Corporate Finance return on equity. The firms
management can use the Du Pont system to analyze ways of improving performance
Benchmarking is the process of comparing a particular company with a group of similar
successful companies. Ratio analysis has limitations, but when used with care and
judgment it can be very helpful.

1) Liquidity Ratios - Liquidity ratios measure the company's ability to meet short term
debt obligations. To calculate the current ratio, divide current assets by current
liabilities. For example, if a company has current assets of $1,000,000 and current
liabilities of $500,000 (1000000/500000), it has a current ratio of 2. The quick ratio
measures if your more liquid assets could cover your short-term obligations. For the
quick ratio, sum your cash, marketable securities and accounts receivable, and then
divide by your current liabilities. If your liquidity ratios are higher than the industry
average, your company will probably have better luck getting short term loans from
lenders.

2) Debt Ratios - Debt ratios are similar to liquidity ratios, but they measure your
company's ability to pay back long-term debt. The basic debt ratio is total liabilities
divided by total assets. For example, if a company has total liabilities of $50,000 and
a total assets of $100,000 (50000/100000), it has a debt ratio of 0.5. Another
method of measurement is the debt-to-equity ratio, which is total liabilities divided
by total equity. Unlike the liquidity ratios, lower is better on debt ratios. Lower-than-
average debt ratios could help your company negotiate lower interest rates on long-
term loans.

3) Profitability Ratios - Profitability ratios focus on the general financial health of the
company, and are most useful to executives and board members. To calculate your
gross profit margin percentage, divide gross profit by revenue. This can help you
determine the profitability of current products and services. For example, if a
company has a gross profit of $15,000 and revenue of $75,000 (15000/75000), it
has a profit margin percentage of 20%. The operating profit margin percentage,
which is operating profit divided by revenue, measures manager performance
running the business. If your ratios are higher than the industry average, your
company is probably in a healthy financial position.

4) Market Value Ratios - Market ratios help investors determine if your company is a good
investment. Investors who want to estimate their return on investment may look at
the dividend payout ratio, which is dividends per share divided by net earnings per
share. For example, if a company has dividends of $1 per share and earnings of $2
per share (1/2), it has a dividend payout ratio of 0.5. The dividend yield ratio is
similar, but it expresses yield in a percentage form by dividing dividend per share by
the market value per share. Investors that want to invest in research and
development may utilize the price-to-research ratio, which is market capitalization
divided by R&D expenditures. Higher dividend ratios means that you are paying out
more than average, which will attract investors.