Financial Statement

Analysis

1
 Vertical Analysis

Horizontal Analysis

Ratio Analysis

2
Financial Statement Analysis
Will I
be paid?
Creditors
How
good is our
investment? How are we
performing?
Stockholders

Management3
 Limitations of Financial
Statement Analysis
Use of different accounting methods
Changes in accounting methods

LIFO FIFO
4
Limitations of Financial
Statement Analysis
Failure to understand trends or
use industry ratios
Difficulty of making industry

???? comparisons (i.e., conglomerates)

5
 Limitations of Financial
Statement Analysis
Nonoperating items on income
statement
Effects of inflation

=
6
 Horizontal Analysis
Wm. Wrigley Jr. Company
(in millions) Increase (Decrease)
2001 2000 Dollars Percent
Net Sales $2,430 $2,146 $284 13.2 %
Gross Profit 1,433 1,242 191 15.4
Net Earnings 363 329 34 10.3

7
 Trend Analysis

Wm. Wrigley Jr. Company

2001 2000 1999 1998 1997

Return on
Avg. Equity 30.1% 29.0% 26.8% 28.4% 28.9%

Tracking items over a series of years

8
 Vertical Analysis
Common-size statements recast
items as a percentage of a %
selected item
Allows comparisons of %
companies of different size
Compares percentages across %
years to identify trends

9
Common-Size Statements
Dollars Percent
Sales revenue $24,000 100.0%
Cost of goods sold 18,000 75.0
Gross profit $ 6,000 25.0%
Selling & admin. exp. 3,000 12.5
Operating income $ 3,000 12.5%
Interest expense 140 0.6
Income before tax $ 2,860 11.9%
Income tax expense 1,140 4.8
Net income
$ 1,720 7.1% 10
 Liquidity Analysis
Nearness to cash
Ability to pay debts as they become due

Turnover
Working Cash
Ratios
Capital Ratios
Ratios
11
 Working Capital
Excess of current assets over current
liabilities
Lacks meaningful comparisons for
companies of different size

-
12
 Current Ratio
Measure of short-term financial health
Consider composition of current assets

Rule of thumb
2:1 13
 Acid-Test (Quick) Ratio
Stricter test of ability to pay debts
Excludes inventories and prepaid assets

Quick Assets
Current Liabilities

14
Cash Flow from Operations to
Current Liabilities Ratio
Focuses on cash only FEDERAL RESERVE NOTE

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

THE
THEUNITED
UNITEDSTATES
STATESOF
OFAMERICA
AMERICA

L70744629F

12

Covers period of time

WASHINGTON, D.C. 12
A
H 293

L70744629F

12 SERIES 12
1985

ONE
ONE DOLLAR
DOLLAR

Net Cash Provided by Operating Activities

Average Current Liabilities

15
Accounts Receivable Turnover
Ratio

Net Credit Sales

Average Accounts Receivable

Indicates how quickly a

company is collecting (i.e.,
turning over) its receivables
16
 Accounts Receivable Turnover
Ratio
Too fast Too slow

Credit policies too Credit department

stringent; may be not operating
losing sales effectively; possible
quality problems
17
Number of Days Sales in
Receivables

360 Days* .
Accts. Receivable Turnover

Represents the average # of days

accounts are outstanding

*Some analysts use 365 days.

18
 Number of Days Sales in
Receivables
Example:

360 Days
= 75 days
4.8 Times

If this companys credit terms are net 30,

what would this tell you about the efficiency
of the collection process?
19
Inventory Turnover
Ratio

Cost of Goods Sold

Average Inventory

Represents the number of times

per period inventory is turned
over (i.e., sold).
20
Inventory Turnover Ratio

Circuit City 5.9 times per year

Safeway 9.3 times per year

Can you compare the two ratios?

21
 1 2 3

4 5 6 7 8 9 10

# of Days Sales in Inventory

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 27 28 29 30 31

# of Days in Period
Inventory Turnover Ratio

Represents the average # of days

inventory is on hand before its sold

22
 1 2 3

4 5 6 7 8 9 10

# of Days Sales in Inventory

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 27 28 29 30 31

Circuit City 61 days

Safeway 39 days

Do these averages seem reasonable?

23
 Cash Operating Cycle
Time between purchase of merchandise
and collection from the sale
# of days sales in receivables
+
# of days sales in inventory

24
 Solvency Analysis
Ability to stay in business over the
long-term
Times
Interest
Debt-to- Earned
Equity
Ratio
Cash Flow
Debt
to Capital
Service
Expenditures
Coverage
25
 Debt-to-Equity Ratio
How much
have creditors
Total Liabilities contributed
Total Stockholders Equity compared to
owners?

26
 Debt-to-Equity Ratio

Total Liabilities
Total Stockholders Equity = .60
For every dollar
contributed by
owners, creditors
have loaned $.60

27
 Times Interest Earned Ratio
Measures ability to meet current
interest payments
The greater the coverage the better

Net Income + Interest Expense + Income Tax Expense

Interest Expense

28
 Debt Service Coverage Ratio

Measures amount of cash from

operations available to service the debt

Cash Flow from Operations before Interest & Taxes

Interest and Principal Payments

P+ i

29
 Cash Flow from Operations to
Capital Expenditures Ratio
Measures companys ability to use
operations (vs. creditors and owners) to
finance acquisitions of productive assets

Cash Flow from Operations Dividends Paid

Cash Paid for Capital Acquisitions

30
Profitability Analysis
Rate of Return on Assets
Return on Common S/E
EPS
P/E Ratio
Dividend Ratios

31
 Return on Assets Ratio
Measures return to all providers of
capital (creditors and owners)

Net Income + Interest Expense, Net of Tax

Average Total Assets

32
Return on Common
Stockholders Equity
Net Income - Preferred Dividends
Average Common Stockholders Equity

The owners
earned 15%
on their investment
in ABC Co...
Not bad!

33
 Earnings per Share
Presents profits on a per-share basis

Net Income - Preferred Dividends

Weighted Avg. # of Common Shares Outstanding

Certificate of Stock

34
 Price/Earnings Ratio
Relates earnings to the market price of
the stock

Current Market Price

Earnings per Share

very high P/E possibly overvalued

very low P/E possibly undervalued
35
 Price/Earnings Ratio

Both companies
P/E Ratios
have earnings of $2
Co. A = 10 to 1 per share. So why
Co. B = 7 to 1
the different P/E
ratios?

36
Dividend Payout Ratio
Common Dividends per Share
Earnings per Share

We need to
decide what % of
the firms income
we can return to
owners.

37
 Dividend Yield Ratio
Investors willing to forgo dividends in
lieu of price appreciation

Common Dividends per Share usually

Market Price per Share = < 5%

38
Appendix
Accounting Tools:
Reporting and Analyzing
Other Income Statement Items

39
 Common Characteristics
All such items are reported after
income from continuing operations
Reported separately
Shown net of tax effects
Most analysts ignore these items,
since they are not likely to reoccur

40
 Discontinued Operations
Any gain or loss from disposal of a
division or segment of the business
Any net income or loss from operating
this portion until the date of disposal

41
 Extraordinary Items
Gain or loss due to an event that is
Unusual in nature AND
Infrequent in occurrence

42
 Cumulative Effect of a Change
in Accounting Principle
Reflects a change in a companys
accounting principles, practices, or
methods
Reports the difference in income in all
prior years between the old method and
the new method
Sometimes such a change is dictated by
new accounting standards

43
End of Chapter 13

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