Professional Documents
Culture Documents
Financial Statement
Analysis
Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Created by: Gregory A. Kuhlemeyer, Ph.D.
Carroll College, Waukesha, WI
6-1
After studying Chapter 6,
you should be able to:
Understand the purpose of basic financial statements and their
contents.
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
6-2 gain additional insights into a firm's performance.
Financial
Statement Analysis
Financial Statements
A Possible Framework for Analysis
Balance Sheet Ratios
IncomeStatement and Income
Statement/Balance Sheet Ratios
Trend Analysis
Common-Size and Index Analysis
6-3
Financial Statements are like a fine
perfume to be sniffed but not
swallowed. Abraham Brilloff
The firm itself and the outside
providers of capital-creditors and
investors all undertake financial
statement analysis.
The type of analysis varies
according to the specific interest of
the party involved.
6-4
Examples of External Uses
of Statement Analysis
Trade Creditors -- Focus on the
liquidity of the firm.
Trade creditors are the (suppliers
owed money for goods and services)
their claims are short-term and so are
interested in the short-term liquidity of
the firm.
6-5
Examples of External Uses
of Statement Analysis
Bondholders -- Focus on the long-
term cash flow of the firm.
Bondholders are the providers of long-term
debt to the firm, so are interested in the
firms ability to generate regular cash flows
over a longer period of time.
They evaluate this ability through the analysis of the firms
capital structure, its profitability and future projections.
6-6
Examples of External Uses
of Statement Analysis
Shareholders -- Focus on the
profitability and long-term health of
the firm.
Investors are concerned with present and
future earnings as well as the stability of
these earnings.
They are interested in the capital gain and
dividends both -focus on profitability more.
6-7
Examples of Internal (Mngt)
Uses of Statement Analysis
Income Statement
A summary of a firms revenues and
expenses over a specified period, ending
with net income or loss for the period.
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Basket Wonders
Balance Sheet (Asset Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007a
Cash and C.E. $ 90 a. How the firm stands on
Acct. Rec.c 394 a specific date.
Inventories 696 b. What BW owned.
Prepaid Exp d 5 c. Amounts owed by
Accum Tax Prepay 10 customers.
Current Assetse $1,195 d. Future expense items
Fixed Assets (@Cost)f 1030 already paid.
Less: Acc. Depr. g (329) e. Cash/likely convertible
Net Fix. Assets $ 701 to cash within 1 year.
Investment, LT 50 f. Original amount paid.
Other Assets, LT 223 g. Acc. deductions for
6-10 Total Assets b $2,169 wear and tear.
Basket Wonders
Balance Sheet (Liability Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007
Notes Payable $ 290 a. Note, Assets =
Acct. Payablec 94 Liabilities + Equity.
Accrued Taxes d 16 b. What BW owed and
Other Accrued Liab. d 100 ownership position.
Current Liab. e $ 500 c. Owed to suppliers for
Long-Term Debt f 530 goods and services.
Shareholders Equity d. Unpaid wages,
Com. Stock ($1 par) g 200 salaries, etc.
Add Pd in Capital g 729 e. Debts payable < 1 year.
Retained Earnings h 210 f. Debts payable > 1 year.
Total Equity $1,139 g. Original investment.
a,b
6-11 Total Liab/Equity $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 a. Measures profitability
Cost of Goods Sold b 1,599 over a time period.
Gross Profit $ 612 b. Received, or receivable,
SG&A Expenses c 402 from customers.
EBITd $ 210 c. Sales comm., adv.,
Interest Expensee 59 officers salaries, etc.
EBT f $ 151 d. Operating income.
Income Taxes 60 e. Cost of borrowed funds.
EATg $ 91 f. Taxable income.
Cash Dividends 38 g. Amount earned for
Increase in RE
6-12
$ 53 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?
Health of a Firm
6-14
Framework for
Financial Analysis
6-17
Significance
Nature of the needs for funds requirement,
determine the type of financing.
Seasonal component short-term financing
Greater the business risk less desirable is
debt financing equity financing is safer as
there are no contractual obligations.
Greater liquidity and profitability risky
financing can be incurred (Debt)
6-18
Significance
It is not sufficient to determine the
best plan from viewpoint of the firm it
has to be sold to the supplier of funds
also.
The interaction of the firm with the
supplier of capital determines the
amount, terms and price of financing.
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Use of Financial Ratios
6-20
External Comparisons and
Sources of Industry Ratios
This involves Examples:
comparing the ratios Risk Management
of one firm with those Association
of similar firms or with
industry averages.
Dun & Bradstreet
Almanac of
Similarity is important Business and
as one should Industrial
compare apples to Financial Ratios
6-21
apples.
Liquidity Ratios
Balance Sheet Ratios Current
Current Assets
Liquidity Ratios Current Liabilities
2.5
2.3
Ratio Value
2.1
BW
1.9 Industry
1.7
1.5
2005 2006 2007
Analysis Year
6-27
Acid-Test Ratio -- Trend
Analysis Comparison
Trend Analysis of Acid-Test Ratio
1.5
1.3
Ratio Value
1.0 BW
Industry
0.8
0.5
2005 2006 2007
Analysis Year
6-28
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.
6-29
Financial Leverage Ratios
Balance Sheet Ratios Debt-to-Equity
Total Debt
Financial Leverage Shareholders Equity
Ratios
For Basket Wonders
December 31, 2007
Shows the extent to
which the firm is $1,030 = .90
financed by debt. $1,139
6-30
Financial Leverage
Ratio Comparisons
Debt-to-Equity Ratio
Year BW Industry
2007 .90 .90
2006 .88 .90
2005 .81 .89
BW has average debt utilization
6-31
relative to the industry average.
Financial Leverage Ratios
Balance Sheet Ratios Debt-to-Total-Assets
Total Debt
Financial Leverage Total Assets
Ratios
For Basket Wonders
Shows the percentage December 31, 2007
of the firms assets
that are supported by $1,030 = .47
debt financing. $2,169
6-32
Financial Leverage
Ratio Comparisons
Debt-to-Total-Asset Ratio
Year BW Industry
2007 .47 .47
2006 .47 .47
2005 .45 .47
BW has average debt utilization
6-33
relative to the industry average.
Financial Leverage Ratios
Balance Sheet Ratios Total Capitalization
(i.e., LT-Debt + Equity)
9.0
Ratio Value
7.0 BW
Industry
5.0
3.0
2005 2006 2007
Analysis Year
6-38
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.
6-39
Activity Ratios
Income Statement / Receivable Turnover
(Assume all sales are credit sales.)
Balance Sheet
Ratios Annual Net Credit Sales
Receivables
Activity Ratios
For Basket Wonders
Indicates quality of December 31, 2007
receivables and how
successful the firm is in $2,211 = 5.61
its collections. $394
6-40
Activity Ratios
Income Statement / Avg Collection Period
Balance Sheet
Days in the Year
Ratios
Receivable Turnover
3.5
Ratio Value
3.0 BW
Industry
2.5
2.0
2005 2006 2007
Analysis Year
6-48
6-49
6-50
Activity Ratios
Income Statement / Total Asset Turnover
Balance Sheet
Ratios Net Sales
Total Assets
Activity Ratios
For Basket Wonders
December 31, 2007
Indicates the overall
effectiveness of the firm $2,211 = 1.02
in utilizing its assets to $2,169
6-51
generate sales.
Activity
Ratio Comparisons
Total Asset Turnover Ratio
Year BW Industry
2007 1.02 1.17
2006 1.03 1.14
2005 1.01 1.13
BW has a weak total asset turnover ratio.
6-52
Why is this ratio considered weak?
Profitability Ratios
Income Statement / Gross Profit Margin
Balance Sheet
Ratios Gross Profit
Net Sales
Profitability Ratios
For Basket Wonders
December 31, 2007
Indicates the efficiency
of operations and firm $612 = .277
pricing policies. $2,211
6-53
Profitability
Ratio Comparisons
Gross Profit Margin
Year BW Industry
2007 27.7% 31.1%
2006 28.7 30.8
2005 31.3 27.6
BW has a weak Gross Profit Margin.
6-54
Gross Profit Margin --
Trend Analysis Comparison
Trend Analysis of Gross Profit Margin
35.0
Ratio Value (%)
32.5
30.0 BW
Industry
27.5
25.0
2005 2006 2007
Analysis Year
6-55
Profitability Ratios
Income Statement / Net Profit Margin
Balance Sheet
Ratios Net Profit after Taxes
Net Sales
Profitability Ratios
For Basket Wonders
December 31, 2007
Indicates the firms
profitability after taking $91 = .041
account of all expenses $2,211
6-56
and income taxes.
Profitability
Ratio Comparisons
Net Profit Margin
Year BW Industry
2007 4.1% 8.2%
2006 4.9 8.1
2005 9.0 7.6
BW has a poor Net Profit Margin.
6-57
Net Profit Margin --
Trend Analysis Comparison
Trend Analysis of Net Profit Margin
10
9
Ratio Value (%)
8
7 BW
Industry
6
5
4
2005 2006 2007
Analysis Year
6-58
Profitability Ratios
Income Statement / Return on Investment
Balance Sheet
Ratios Net Profit after Taxes
Total Assets
Profitability Ratios
For Basket Wonders
Indicates the December 31, 2007
profitability on the
assets of the firm (after $91 = .042
all expenses and taxes). $2,160
6-59
Profitability
Ratio Comparisons
Return on Investment
Year BW Industry
2007 4.2% 9.8%
2006 5.0 9.1
2005 9.1 10.8
BW has a poor Return on Investment.
6-60
Return on Investment
Trend Analysis Comparison
Trend Analysis of Return on Investment
12
Ratio Value (%)
10
8 BW
Industry
6
4
2005 2006 2007
Analysis Year
6-61
Profitability Ratios
Income Statement / Return on Equity
Balance Sheet
Ratios Net Profit after Taxes
Shareholders Equity
Profitability Ratios
For Basket Wonders
Indicates the profitability December 31, 2007
to the shareholders of
the firm (after all $91 = .08
expenses and taxes). $1,139
6-62
Profitability
Ratio Comparisons
Return on Equity
Year BW Industry
2007 8.0% 17.9%
2006 9.4 17.2
2005 16.6 20.4
BW has a poor Return on Equity.
6-63
Return on Equity --
Trend Analysis Comparison
Trend Analysis of Return on Equity
21.0
Ratio Value (%)
17.5
14.0 BW
Industry
10.5
7.0
2005 2006 2007
Analysis Year
6-64
Return on Investment and
the Du Pont Approach
Earning Power = Sales profitability X
Asset efficiency
ROI = Net profit margin X
Total asset turnover
ROI2007 = .041 x 1.02 = .042 or 4.2%
ROIIndustry = .082 x 1.17 = .098 or 9.8%
6-65
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
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.
6-69
Basket Wonders Common
Size Balance Sheets
Regular (thousands of $) Common-Size (%)
Assets 2005 2006 2007 2005 2006 2007
Cash 148 100 90 12.10 4.89 4.15
AR 283 410 394 23.14 20.06 18.17
Inv 322 616 696 26.33 30.14 32.09
Other CA 10 14 15 0.82 0.68 0.69
Tot CA 763 1,140 1,195 62.39 55.77 55.09
Net FA 349 631 701 28.54 30.87 32.32
LT Inv 0 50 50 0.00 2.45 2.31
Other LT 111 223 223 9.08 10.91 10.28
Tot Assets 1,223 2,044 2,169 100.0 100.0 100.0
6-70
Basket Wonders Common
Size Balance Sheets
Regular (thousands of $) Common-Size (%)
Liab+Equity 2005 2006 2007 2005 2006 2007
Note Pay 290 295 290 23.71 14.43 13.37
Acct Pay 81 94 94 6.62 4.60 4.33
Accr Tax 13 16 16 1.06 0.78 0.74
Other Accr 15 100 100 1.23 4.89 4.61
Tot CL 399 505 500 32.62 24.71 23.05
LT Debt 150 453 530 12.26 22.16 24.44
Equity 674 1,086 1,139 55.11 53.13 52.51
Tot L+E 1,223 2,044 2,169 100.0 100.0 100.0
6-71
Basket Wonders Common
Size Income Statements
Regular (thousands of $) Common-Size (%)
2005 2006 2007 2005 2006 2007
Net Sales 1,235 2,106 2,211 100.0 100.0 100.0
COGS 849 1,501 1,599 68.7 71.3 72.3
Gross Profit 386 605 612 31.3 28.7 27.7
Adm. 180 383 402 14.6 18.2 18.2
EBIT 206 222 210 16.7 10.5 9.5
Int Exp 20 51 59 1.6 2.4 2.7
EBT 186 171 151 15.1 8.1 6.8
EAT 112 103 91 9.1 4.9 4.1
Cash Div 50 50 50 4.0 2.4 2.3
6-72
Index Analyses
6-74
Basket Wonders
Indexed Balance Sheets
Regular (thousands of $) Indexed (%)
Liab+Equity 2005 2006 2007 2005 2006 2007
Note Pay 290 295 290 100.0 101.7 100.0
Acct Pay 81 94 94 100.0 116.0 116.0
Accr Tax 13 16 16 100.0 123.1 123.1
Other Accr 15 100 100 100.0 666.7 666.7
Tot CL 399 505 500 100.0 126.6 125.3
LT Debt 150 453 530 100.0 302.0 353.3
Equity 674 1,086 1,139 100.0 161.1 169.0
Tot L+E 1,223 2,044 2,169 100.0 167.1 177.4
6-75
Basket Wonders Indexed
Income Statements
Regular (thousands of $) Indexed (%)
2005 2006 2007 2005 2006 2007
Net Sales 1,235 2,106 2,211 100.0 170.5 179.0
COGS 849 1,501 1,599 100.0 176.8 188.3
Gross Profit 386 605 612 100.0 156.7 158.5
Adm. 180 383 402 100.0 212.8 223.3
EBIT 206 222 210 100.0 107.8 101.9
Int Exp 20 51 59 100.0 255.0 295.0
EBT 186 171 151 100.0 91.9 81.2
EAT 112 103 91 100.0 92.0 81.3
Cash Div 50 50 50 100.0 100.0 100.0
6-76