PUTRABUSINESSSCHOOL

FINANCIALSTATEMENT
ANALYSIS:
CASESTUDY:IDENTIFY
THEINDUSTRIES
Instructor:Dr.AhmedRazman

GroupNo:05
NoorAhmedBrohi
PaschalOrijka
NinaHidayana
HazeemAzamDar
VanessaChin
Introduction:

FinancialStatementanalysisisaprocessofselecting,evaluating,
andinterpretingfinancialdata,alongwithotherpertinentinformation,
inordertoformulateanassessmentofacompanyspresentand
futurefinancialconditionandperformance.
FinancialStatementAnalysisTechniques:
RatioAnalysis:
TrendAnalysis:
Financialstatementanalysisusingratiomeasurementsandtrend
analysisassiststheuseroffinancialstatementsinmakinginformed
judgmentsanddecisionsaboutanentity`sfinancialconditionand
resultsofoperations.

FINANCIALSTATEMENTANALYSIS
FinancialRatioAnalysis
Financialratioanalysisistheuseofrelationshipsamongfinancial
statementaccountstogaugethefinancialconditionand
performanceofacompany.
Wecanclassifyratiosbasedonthetypeofinformationtheratio
provides:

4
Liquidity
Ratios
Abilityto
meetshort-
term,
immediate
obligations.
Activity
Ratios
Effectiveness
inputtingits
asset
investmentto
use.
Leverage
Ratios
Abilityto
satisfydebt
obligations.
Profitability
Ratios
Abilityto
manage
expensesto
produce
profitsfrom
sales.
LiquidityMeasures
A class of financial metrics that is used to determine a
company's ability to pay off its short-terms debts
obligations. Generally, the higher the value of the ratio,
the larger the margin of safety that the company
possessestocovershort-termdebts.
The Liquidity measures of Cash ratio, current ratio, and
acid-testratioaremajormeasureoffinancialhealth.
Currentratio.Thecurrentratioisthemostbasicliquidity
test.Itsignifiesacompany'sabilitytomeetitsshort-term
liabilities with its short-term assets. A current ratio
greaterthanorequaltooneindicatesthatcurrentassets
shouldbeabletosatisfynear-termobligations.Acurrent
ratio of less than one may mean the firm has liquidity
issues.
CurrentRatio=(CurrentAssets)/CurrentLiabilities
Foranexampleofhowtocalculatethecurrentratio,let'slookatthebalance
sheetforCompanyAli&Sons
BalanceSheetforCompanyAli&Sons
YearendingDecember31,2013
Assets
Cash1,000
AccountsReceivable500
Inventory500
TotalCurrentAssets2,000
Liabilities
AccountsPayable500
CurrentLong-TermDebt500
TotalCurrentLiabilities1,000
LongTermDebt500
TotalLiabilities1,500
Owners'Equity500
WecancalculateCompanyAli&Sonscurrentratioas:2,000/1,000=2.0
Asoftheendof2009,CompanyAli&Sonshad$2.00incurrentassetsforevery
dollarofcurrentliabilities.Thecompanyappearstobeabletoeasilyserviceits
short-termdebtobligations.

LiquidityMeasures
Acid-testRatio.TheAcidtest/quickratioisatoughertestof
liquidity than the current ratio. It eliminates certain current
assetssuchasinventoryandprepaidexpensesthatmaybe
more difficult to convert to cash. Like the current ratio,
having a quick ratio above one means a company should
have little problem with liquidity. The higher the ratio, the
more liquid it is, and the better able the company will be to
rideoutanydownturninitsbusiness.
Acid-test Ratio = (Cash + Accounts Receivable + Short-
TermorMarketableSecurities)/(CurrentLiabilities)
Todemonstrate,let'sassumethisinformationwaspulledfromthebalance
sheetofourtheoreticalfirmCompanyAli&Sons:

Usingtheprimaryquickratioformulaandtheinformationabove,wecan
calculateCompanyAli&SonsAcid-Testratioasfollows:
($60,000+$10,000+$40,000)/$65,000=1.7
ThismeansthatforeverydollarofCompanyAli&sonscurrentliabilities,
thefirmhas$1.70ofveryliquidassetstocoverthoseimmediate
obligations.

Cash $60,000 AccountsPayable $30,000

Marketable
Securities
$10,000 AccruedExpenses $20,000
Accounts
Receivable
$40,000 NotesPayable $5,000
Inventory $50,000
CurrentPortionofLong-Term
Debt
$10,000
TotalCurrentAssets$160,000 TotalCurrentLiabilities $65,000
LiquidityMeasures
CashRatio.Thecashratioisthemostconservativeliquidity
ratioofall.Itonlymeasurestheabilityofafirm'scash,along
withinvestmentsthatareeasilyconvertedintocash,topay
itsshort-termobligations.Alongwiththequickratio,ahigher
cashratiogenerallymeansthecompanyisinbetterfinancial
shape.
CashRatio=(Cash+Short-TermorMarketableSecurities)
/(CurrentLiabilities)
ActivityMeasures
Activitymeasuresfocusprimarilyonthe
relationshipbetweenassetlevelsand
sale(i.e.Turnover)
Turnover= Sales
Averageassets
*averageassetsareusedinturnovercalculation(ratherthan
year-endassets)becausetheamountinvestediscomparedto
sales,whicharegeneratedoveraperiodoftime.
*determinedbythebalancesheetamountatthebeginningand
endoftheperiod
TURNOVERiscalculatedfor:
1. Accountsreceivable
2. Inventories
3. Plantandequipment
4. Totaloperatingassets
5. Totalassets
AssetTurnoverCalculations(IntelCorporation)

Accountsreceivableturnoverfor2008($millions):
Sales(netrevenues)for2008$37,586
Accountsreceivable(net)12/27/08.1,712
Accountsreceivable(net)12/29/07.2,576
AccountsReceivableTurnover= Sales
Averageaccountsreceivable
= $37,586
($2,567+$1,712)/2
= 17.5times

InventoryTurnoverfor2008($millions):
Costofgoodssoldfor2008$16,742
Inventories12/27/08.3,744
Inventories12/29/07.3,370
InventoryTurnover = Costofgoodsold
Averageinventories
= 16,742
($3,370+$3,744)/2
= 4.7times

Plantandequipmentturnoverfor2008($millions):
Sales(netrevenues)for2008.$37,586
Plantandequipment(net)12/27/08.17,544
Plantandequipment(net)12/29/07.16,918

PlantandequipmentTurnover= Sales
Averageplantandequipment
=$37,586
($16,918+$17,544)/2
=2.2times

AssetTurnoverCalculations(IntelCorporation)cont.
TheEFFICIENCYofassetmanagementcanbe
seenthroughtheactivitymeasureof:

1. Numberofdayssalesinaccountsreceivable
2. Numberofdayssalesininventory
NumberofDaysSalesCalculations(IntelCorporation)

Numberofdayssalesinaccountsreceivablefor2008($millions):
Sales(netrevenues)for2008..$37,586
Accountsreceivable(net)at12/27/2008.1,712

Averagedayssales =AnnualSales/365
=$37,586/365
=$102,975
Dayssalesinaccountsreceivable =Accountsreceivable/Averagedayssales
=$1,712/$102,975
=$16.6days

Numberofdayssalesininventoryfor2008($millions):
:Costofgoodssoldfor2008...........$16,742
Inventoriesat12/27/2008........3,744

Averagedayscostofgoodssold =Annualcostofgoodssold/365
=$45,868
Dayssalesininventory =inventory/averagedaysCOGS
=81.6days

-Thesoonerthataccountsreceivablecanbe
collected,thesoonercashisavailabletouseinthe
business/permittemporaryinvestment.
-Thelowerinventoriescanbemaintainedrelativeto
sales,thelessinventoryneedstobefinancedwith
debtorownersequity,thushigherROI.

Riskswithlowinventories:
-----unanticipatedincreaseindemand
-----delayinreceivingrawmaterials/finished
products=out-ofstocksituation=lostofsales

Ingeneral,theHIGHERtheturnover/
fewerthenumberofdayssalesin
accountsreceivableandinventory,the
GREATERtheefficiency

TheTRENDoftheresultovertimeismost
meaningfulthanthecalculationbyitself
ProfitabilityMeasures
Amongthemostusedratiointhefinancial
world
TheprimaryGOAListofindouthowgood
isacompanyatgeneratingMONEY
RelatestoNETINCOMEandother
accountsonINCOMESTATEMENTwith
accountsonBALANCESHEET

ReturnonInvestment(ROI)
ROI=Return
Investment

- itisafinancialmeasurethatdeterminestheefficiencyofinvestment/the
efficiencyofmultipleinvestment.
- ROIbasedonoperatingincomebecomesanevaluationoftheoperating
activitiesofthefirm
- Operatingincomeisusedcomparedtonetincomebecauseitisamore
directmeasureoftheresultsofmanagementsactivities.
- Thisratiogivestherateofreturnthathasbeenearnedontheassets
investedandisthekeytomeasurePROFITABILITY
ReturnonEquity(ROE)

ROE=NetIncome
Averagetotalownersequity

- Measurestheabilityofacompanyatgettingmoreearningsusing
earningsthattheyalreadyhave.

Price/earningsratio(P/ERatio)

Price/earningsRatio=Marketpricepershare
(earningsmultiple)Earningspershare

- TherelativeEXPENSIVENESSofashareofafirmscommonstock
becauseitshowshowmuchinvestorsarewillingtopayforthestock
relativetoearnings.
- TheGREATERafirmsROIandrateofearningsgrowth,theHIGHER
theP/Eratioofitscommonstockwillbe.

Basedonmarketpricealone,
CompanyA CompanyB
Marketpricepershare $45.00 $63.00
*ItcanbeconcludedthatstockofCompanyBismoreexpensivethanthestock
ofcompanyA

Whenearningspershareareconsidered,
CompanyA CompanyB
Marketpricepershare $45.00 $63.00
Dilutedearningspershare 1.80 3.50

Thus,theP/Eratio,

CompanyA25(companysAstockismoreexpensivebecauseinvestorsare
willingtopay25timesearningsforit)
CompanyB18(investorsareonlywillingtopay18timesearningsforthe
stock)

DividendYield

DividendYield=Annualdividendpershare
Marketpricepershareofstock

- thedividendyieldexpressespartofthestockholdersROI,therateof
returnrepresentedbytheannualcashdividends
- TheotherpartofthestockholderstotalROIcomesfromthechangeinthe
marketvalueofthestockduringtheyear(preferredstockholders
decreasesasthemarketpricepershareincreases)
- Theaveragedividendyieldfor;
CommonStockintherangeof3percentto6percent
PreferredStock-intherangeof5percentto8percent
DividendPayoutRatio
DividendPayoutRatio=Annualdividendpershare
Earningspershare

- Thedividendpayoutratioexpressestheproportionofearningspaidas
dividendstocommonstockholders(reflectsthedividendpolicyofthe
company)
- Itcanbeusedtoestimatedividendsoffutureyearsifearningscanbe
estimated
- Thedividendpayoutratioisusuallyintherangeof30-50%,butitvary
significantly
- Afirmcanreferitsdividendin2ways;

1-Regulardividends(stableorgraduallychangingdividends)
2-Extradividends(maybepaidordeclaredafteranespeciallyprofitableyear)

PreferredDividendCoverageRatio

Preferreddividend=Netincome
coverageratio preferreddividendrequirement

- Expressestheabilityofthefirmtomeetitspreferredstockdividend
requirement.
- TheHIGHERthecoverageratio,theLOWERtheprobabilitythat
dividendsoncommonstockwillbediscontinuedbecauseoflow
earningsandfailuretopaydividendsonpreferredstock.
FinancialLeverageMeasures
Leverage-theuseofdebt(preferredstock)
tofinancetheassetsoftheentity

HigherDebt=HigherFinancial
Leverage

Highleveragewillleadtoahighinterest
paymentswhichwillnegativelyeffectthe
companysbottomlineearningspershare
(EPS).
WhichcanbeveryRISKY,ifthecompany
doesnothaveenoughmoneytopaythe
interest,theycouldgobankrupt.
Keepitsoptimalcapitalstructureinmind
whenmakingfinancingdecisionstoensure
anyincreaseindebtandpreferredstock
increasesthevalueofcompany.

WithoutFinancialLeverage
Balancesheet

Assets..$10,000

Liabilities..$ 0
Owners equity.....$10,000
Total L + OE.$10,000

Incomestatement
Earnings before
Interest & tax.$2,000
Interest...$ 0
Earnings before
Taxes$2,000
Income taxes(40%)...............$
800
Net Income
$1,200
ROI(assets)before =
interestandtaxes
=

=
ROEonequity,aftertaxes =

=

=
Earningsbeforeinterestandtaxes
TotalAssets
$2,000
$10,000
20%
NetIncome
OwnerEquity
$1,200
$10,000
12%
WithFinancialLeverage
Balancesheet

Assets...$10,000

Liabilities(9%)...$ 4,000
Owners equity......$ 6,000
Total L + OE..$10,000

Incomestatement
Earnings before
Interest & tax..$2,000
Interest$ 360
Earnings before Taxes.$1,640
Income taxes(40%)................$ 656
Net Income..$ 984
ROI(assets)before =
interestandtaxes
=

=
ROEonequity,aftertaxes =

=

=
Earningsbeforeinterestandtaxes
TotalAssets
$2,000
$10,000
20%
NetIncome
OwnerEquity
$984
$6,000
16.4%

- TheuseoffinancialleveragehasnotaffectedROI

- TheuseoffinancialleveragehascausedtheROEtoincreasefrom12%
to16.4%becauseROI(20%)exceedsthecostofthedebt(9%)usedto
financeaportionoftheassets.

FINANCIAL
LEVERAGE
MEASURES
DEBT/EQUITY
RATIO
DEBT
RATIO
Theratiosareusedtoindicatetheextenttowhichafirmis
usingfinancialleverage
Bothratioshowstherelationshipbetween
debtandequity
DEBTRATIO

=TOTAL
LIABILITIES
TOTALLIABILITIESAND
OWNERSEQUITY
DEBT/EQUITYRATIO

=TOTAL
LIABILITIES
TOTALOWNERSEQUITY
THUS, A DEBT RATIO OF 50% WOULD BE THE SAME AS A
DEBT/EQUITY RATIO OF 1 OR 1:1
LIABILITIES....$40,000
OWNERSEQUITY.$60,000
TOTALLIABILITY+OE................$10,000
DebtRatio

=TOTALLIABILITIES
TOTALLIABILITIESAND
OWNERSEQUITY

= $40,000
$100,000

= 40%
Debt/EquityRatio

=TOTAL
LIABILITIES
TOTALOWNERSEQUITY

= $40,000
$60,000

= 66.7%
TimesInterestEarnedRatio

Timeinterestearned= Earningsbeforeincome&taxes
Interestexpense

Generalruleofthumb,
Atimesinterestearnedratioof5orhigherisconsideredby
creditorstoindicatearelativelylowriskthatafirmwillnotbe
abletopayinterestinthefuture
- Measureofthefirmsabilitytoearnenoughtocoverits
annualinterestrequirements
- Itshowstherelationshipofearningsbeforeinterestand
taxes(operatingincome)tointerestexpense.
- TheGREATERtheratio,themoreconfidentthedebt
holderscanbeaboutthefirmsprospectsforcontinuingto
haveenoughearningstocoverinterestexpenseevenwitha
DECLINEindemandforproduct/services.
OtherAnalyticalTechniques
BookValueperShareofCommonStock
CommonSizeFinancialStatements
OtherOperatingStatistics

BookValueperShareofCommonStock

Alsoknownasnetassetvaluepershareofcommonstock
Whatifthecompanyhaspreferredshares?
Usedtocalculatethepersharevalueofacompanybasedonitsequityavailableto
commonshareholders.
Theterm"bookvalue"isacompany'sassetsminusitsliabilities
Thebookvaluepersharemaybeusedbysomeinvestorstodeterminetheequityina
companyrelativetothemarketvalueofthecompany,whichisthepriceofitsstock.
Forexample,acompanythatiscurrentlytradingfor$20buthasabookvalueof$10is
sellingattwiceitsequity.Thisexampleisreferredtoaspricetobookvalue(P/B)
Notaveryusefulmeasureincomparingtomarketvaluepershareofstock
CommonSizeFinancialStatements
1. Whatiscommonsizefinancialstatementsand
howisitpresentedtousers?

a) Expressingthebalancesheetandincomestatement
inpercentageformat
Incomestatementitems-expressedasa%oftotal
revenue
Balancesheetitems-expressedasa%oftotalassets
b)Canbeexpressedhorizontallyorvertically
2.Howisitprepared?
a) Selectthebaseyearforcomparison

i. Selectingthefirstyearofoperationsorthe
firstyearitmadeaprofitasthebaseyear,or
evenselectayearasrepresentativeof
"normal"performance.
ii. Calculateitemsin%andsumitupasatotal

3.WhatdoestheCSFSdo?
a) Spottrendsoverseveralyears
b) Easiercomparisoncomparedtorawfinancialstatementdata
c) Datain%canbeusedforgraphicaldisplay
Example:

2008 2007 2006 2005 2004

Net
revenue(Mi
l)
$37,586 $38,334 $35,382 $38,826 $34,209
Net
income(Mil)
5,292 6,976 5,044 8,664 7,516
2008 2007 2006 2005 2004
Net
revenues
(Sales)
110% 112% 103% 113% 100%
Netincome
(Earnings)
70% 93% 67% 115% 100%
HorizontalAnalysis(BalanceSheet)
VerticalAnalysis(BalanceSheet)
4.HowdowereadtheCSFS?
1. Lookatthebigpictureandmakequick
comparisons.Eg.Incomestatement:View
operatingincome,incomebeforetaxesand
netincometogetanoverviewofhowthe
companyisdoing.
2. Next,doaline-by-lineanalysistohelpreveal
moreinformationonthebigdata.
VerticalAnalysis(IncomeStatement)
UsingtheCSFSforCrossSectionalAnalysis
ofDifferentCompanies
Canbeusedtocomparemultiplecompanies
atthesamepointoftime
Usefulwhencomparingcompaniesofdifferent
sizes
Tocompareafirmtoitsindustryasa
whole,usingratios,allexpressedin%
Constructedincolumns,givesaquick
overviewofkeyitems
Limitations
Differencesinaccountingpolicies-adjust
Differencesinaccountingperiod
CASESTUDY:
IDENTIFYTHEINDUSTRIES
Introduction:
Common size financial statements are expressed in terms of
percentage,convertedfromthefinancialstatementsexpressed
indollarsandalsosomeselectedratios.Therearetwowaysof
presenting them; vertically or horizontally. Such financial
statements can be expressed individually, e.g. common size
balance sheet, common size income statement, common size
owners equity and common size cash flow statement. When
analysingsuchstatements,usersareabletodrawanoverview
of companies on how well the company is doing, compared to
playersofitsownindustriesorevenotherindustries.Usersare
alsoabletozoomintothedetailsbylookingatthepercentage
ofeachitem,tofurtherjustifybeforeanyconclusionsaremade.

12-Companiesaregiveninthecasestudy.Onthebasisof
financialstatementsinformationandfinancialratiosthe
industrieshavebeenidentifiedandpresentedbelow:

Company-A:isaserviceindustry.Itis
amajorpassangerairline.
1) Airlines will have high unearned
revenues, because People pay
airlines in advance way before the
daytheyrecieveairlineservice.
2) 2) Airlines Property, Plant and
Equipment account is high
considering the fact that airplanes
are expensive and they are
consideredPPE.

Company-B: is an upscale department

store.
1) Department stores always have high
inventory because they always need
thingsathandtosellthemimmediately.
2) They need high goodwill because these
stores are ususally very expensive and
theycanaffordtobeexpensivebecause
they are very popular and hence have
highgoodwill.
Company-C: is a manufacturer of oral,
personal,andhouseholdcareproducts.
1) Theyhaveveryhighturnover.
2) They have low inventory because they
sellproductsveryquickly.
3) They have huge PPE cause they need
machinery and factory to produce their
products.

Company-D:isdefencecontractor.Wecameto
thisconclusionbecauseoftheirveryhigh
inventoryastheyhavetosellalotofproductsat
thesametimetogovernmentsandother
securityorganizations.
Company-E:isaregionalbank.
1) Banksmusthaveahighcashandbanka/c
becausetheyoperatewithmoneyastheir
medium.
2) Theywillalsohaveveryhighaccounts
receivableastheylendmoneytootherparties,
whichthosepartieshavetoreturn.
Company-F:isawarehouseclub.
1) Theyhavethehighestinventorystockofall
whichmakessenseastheseshopsneed
manyproductsinhighquantityreadytobe
soldimmediately.
2) TheyhavehighPPEwhichcouldbebecause
ofthetransportaionvehiclesandthe
storeroomstheyhavepurchased.

Company-G:isfor-profithospitalchain.Thatis
so because of their very high PPE as they
needalotofspacetokeeppatients,medicine,
houseemergencystaffetc.
Company-H: is an international oil company.
We came to this conclusion because of their
very high goodwill. They are international
company and they work in a very competitive
business like oil industry at that, they need to
have a very high goodwill from customers to
succeed.
Company-I: is a major regional utility
company.
1) As they are major utility company, they will
have high PPE from which they will drive
utilitytoservecustomers.
2) They also have low inventory which makes
senseastheyprovideservicestocustomers.

Company-K:isatemporaryoffice
personalagency.
1) TheyhavelowPPEastheyhave
outsourcemostoftheirfunctions.
2) heyhavenoinventorywhich
supportsourideathatitisaservice
company.
Company-L:isadiscountdepartment
storechain.
1) Theyhaveveryhighinventory.
2) Theyhavehighturnoverbecause
theysellgoodsassoonasthey
purchasethem.Theydontkeep
stockforalongtime.

Hospital
BalanceSheet
MalaysianAirline
BalanceSheet