Financial

Statement
Analysis

K R Subramanyam
John J Wild

McGraw-Hill/Irwi Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights

n reserved.
 1-2

Overview of Financial
Statement Analysis

1
CHAPTE
R
 1-3

Business Analysis

Evaluate Prospects Evaluate Risks

 1-4

Information Sources for Business

Analysis
1-5
 1-6

Credit Analysis
 1-7

Credit Analysis
Credit worthiness: Ability to honor credit obligations
(downside risk)

Liquidity Solvency
Ability to meet Ability to meet
short-term obligations long-term obligations
Focus: Focus:
• Current cash flows • Long-term profitability
• Make up of current • Capital structure
assets and liabilities
• Liquidity of assets
 1-8

Equity Analysis
Assessment of downside risk and upside potential

Technical analysis / Fundamental Analysis

Charting Determine Intrinsic value
• Patterns in price or without reference to
volume history of a price
stock
• Analyze and interpret
• Predict future price
movements key factors
– Economy
– Industry
– Company
1-9
 1-10

Accounting Analysis

Process to evaluate and adjust financial

statements to better reflect economic reality

Acco
unting
Risk
 1-11

Financial Analysis

Process to evaluate financial position and

performance using financial statements

Profitability analysis — Evaluate return

on investments Common tools

Risk analysis ——— Evaluate riskiness Cash

& creditworthiness Ratio
flow
analysi
analysi
s
Analysis of — Evaluate source & s
cash flows deployment of funds
 1-12

Prospective Analysis

Process to forecast future payoffs

Business Environment
& Strategy Analysis

Accounting Analysis

Financial Analysis

Intrinsic Value
 1-13

Dynamics of Business Activities

Business Activities Time
 1-14

Business Activities
 1-15

Business Activities

Financing activities
• Owner (equity)
• Nonowner (liabilities)

Financing
 1-16

Business Activities

Investing activities
• Buying resources
• Selling resources

Investing Financing

Investing = Financing
 1-17

Business Activities

Operating Activities
Revenues and expenses from providing
goods and services
 1-18

Financial Statements Reflect Business Activities

 1-19

Financial Statements
1-20
 1-21

Balance Sheet

Total Investing = Total Financing

= Creditor Financing + Owner Financing
1-22
 1-23

Income Statement
Revenues – Cost of goods sold = Gross Profit
Gross profit – Operating expenses = Operating Profit

Colgate’s Profitability
(in $billions)

$12.238 - $5.536 = $6.701 Gross Profit

$6.701 - $4.5411 = $2.160 Operating profit
1-24
 1-25

Statement of Cash Flows

1-26
 1-27

Additional Information
(Beyond Financial Statements)
 1-28

Analysis Preview
Yr1 Yr2 Yr3
Comparative
Analysis
Purpose: Evaluation of consecutive
financial statements
Output: Direction, speed, & extent of any
trend(s)
Types: ∙ Year-to-year Change Analysis
∙ Index-Number Trend Analysis
 1-29

Analysis Preview
 1-30

Analysis Preview
Common-Size Analysis

Purpose : ∙ Evaluation of internal makeup

of financial statements
∙ Evaluation of financial statement
accounts across companies
Output: Proportionate size of assets,
liabilities, equity, revenues, &
expenses
 1-31

Analysis Preview
 1-32

Analysis Preview
 1-33

Analysis Preview
Ratio Analysis

Purpose : Evaluate relation between two or more

economically important items (one
starting point for further analysis)
Output: Mathematical expression of relation
between two or more items
Cautions: ∙ Prior Accounting analysis is important
∙ Interpretation is key - long vs short term &
benchmarking
 1-34

Analysis Preview
Valuation
Valuation - an important goal of many types
of business analysis

Purpose: Estimate intrinsic value of a

company (or stock)
Basis: Present value theory (time value of
money)
 1-35

Analysis Preview
Debt (Bond) Valuation

Bt is the value of the bond at time t

It +n is the interest payment in period t+n
F is the principal payment (usually the debt’s face value)
r is the investor’s required interest rate (yield to maturity)
 1-36

Analysis Preview
Equity Valuation

Vt is the value of an equity security at time t

Dt +n is the dividend in period t+n
k is the cost of capital
E refers to expected dividends
 1-37

Analysis Preview
Equity Valuation - Free Cash Flow to
Equity
Model

FCFt+n is the free cash flow in the period t + n [often

defined as cash flow from operations less capital
expenditures]
k is the cost of capital
E refers to an expectation
 1-38

Analysis Preview
Equity Valuation - Residual Income
Model

BV is the book value at the end of period t

t

Rit+n is the residual income in period t + n [defined as

net income, NI, minus a charge on beginning
book value, BV, or RIt = NIt - (k x BVt-1)]
k is the cost of capital
E refers to an expectation
 1-39

Analysis in an Efficient Market

Three assumed forms of market
efficiency
Weak Form - prices reflect information in
past prices
Semi-strong - prices reflect all public
Form information
Strong Form - prices reflect all public and
private information
 1-40

Book Organization