Bài giảng Financial Management - Chapter 6: Financial Statement Analysis

Chapter 6Financial Statement AnalysisAfter Studying Chapter 6, you should be able to:Understand the purpose of basic financial statements and their contents. Understand what is meant by “convergence” in accounting standards.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 firm’s 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 firm’s 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 gain additional insights into a firm's performance.Financial StatementsA Possible Framework for AnalysisBalance Sheet RatiosIncome Statement and Income/Balance Sheet RatiosTrend AnalysisCommon-Size and Index AnalysisFinancial Statement AnalysisTrade Creditors – Focus on the liquidity of the firm.Bondholders – Focus on the long-term cash flow of the firm.Shareholders – Focus on the profitability and long-term health of the firm.Examples of External Uses of Statement AnalysisPlan – Focus on assessing the current financial position and evaluating potential firm opportunities.Control – Focus on return on investment for various assets and asset efficiency.Understand – Focus on understanding how suppliers of funds analyze the firm.Examples of Internal Uses of Statement AnalysisConvergence of Accounting Standards: Aims to narrow or remove differences so that investors can better understand financial statements prepared under different accounting frameworks IASB – International Accounting Standards Board has the responsibility of IFRSIFRS – International Financial Reporting Standards (EU countries adopted)US GAAP – US Generally Accepted Accounting Principles determined by FASBFASB – Financial Accounting Standards Board determines accounting standards for financial statementsGlobal Accounting StandardsIncome StatementA summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period.Balance SheetA summary of a firm’s financial position on a given date that shows total assets = total liabilities + owners’ equity.Primary Types of Financial Statementsa. How the firm stands on a specific date.b. What BW owned. c. Amounts owed by customers.d. Future expense items already paid.e. Cash/likely convertible to cash within 1 year.f. Original amount paid.g. Acc. deductions for wear and tear. Cash $ 90 Acct. Rec.c 394 Inventories 696 Prepaid Exp d 5 Accum Tax Prepay 10 Current Assetse $1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g (329) Net Fix. Assets $ 701 Investment, LT 50 Other Assets, LT 223 Total Assets b $2,169Basket Wonders Balance Sheet (thousands) Dec. 31, 2007aBasket Wonders’ Balance Sheet (Asset Side)a. Note, Assets = Liabilities + Equity.b. What BW owed and ownership position. c. Owed to suppliers for goods and services.d. Unpaid wages, salaries, etc.e. Debts payable 1 year.g. Original investment. h. Earnings reinvested.Notes Payable $ 290 Acct. Payablec 94 Accrued Taxes d 16 Other Accrued Liab. d 100 Current Liab. e $ 500 Long-Term Debt f 530 Shareholders’ Equity Com. Stock ($1 par) g 200 Add Pd in Capital g 729 Retained Earnings h 210 Total Equity $1,139 Total Liab/Equitya,b $2,169Basket Wonders Balance Sheet (thousands) Dec. 31, 2007Basket Wonders’ Balance Sheet (Liability Side)a. Measures profitability over a time period.b. Received, or receivable, from customers. c. Sales comm., adv., officers’ salaries, etc.d. Operating income.e. Cost of borrowed funds.f. Taxable income.g. Amount earned for shareholders. Net Sales $ 2,211 Cost of Goods Sold b 1,599 Gross Profit $ 612 SG&A Expenses c 402 EBITd $ 210 Interest Expensee 59 EBT f $ 151 Income Taxes 60 EATg $ 91 Cash Dividends 38 Increase in RE $ 53Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2007aBasket Wonders’ Income StatementAnalytical Tools UsedSources and Uses StatementStatement of Cash FlowsCash Budgets1. Analysis of the funds needs of the firm.Trend/Seasonal ComponentHow much funding will be required in the future?Is there a seasonal component?Framework for Financial AnalysisHealth of a FirmFinancial Ratios 1. Individually 2. Over time 3. In combination 4. In comparison1. Analysis of the funds needs of the firm.2. Analysis of the financial condition and profitability of the firm.Framework for Financial AnalysisExamples:Volatility in salesVolatility in costsProximity to break-even point1. Analysis of the funds needs of the firm.2. Analysis of the financial condition and profitability of the firm.3. Analysis of the business risk of the firm.Business risk relates to the risk inherent in the operations of the firm.Framework for Financial AnalysisA Financial Manager must consider all three jointly when determining the financing needs of the firm.Determiningthe financingneeds of the firm.1. Analysis of the funds needs of the firm.2. Analysis of the financial condition and profitability of the firm.3. Analysis of the business risk of the firm.Framework for Financial AnalysisNegotiationswithsuppliers ofcapital.Determiningthe financingneeds of the firm.1. Analysis of the funds needs of the firm.2. Analysis of the financial condition and profitability of the firm.3. Analysis of the business risk of the firm.Framework for Financial AnalysisTypes of ComparisonsInternal ComparisonsExternal ComparisonsA Financial Ratio is an index that relates two accounting numbers and is obtained by dividing one number by the other.Use of Financial RatiosExamples:Risk Management AssociationDun & BradstreetAlmanac of Business and Industrial Financial RatiosThis involves comparing the ratios of one firm with those of similar firms or with industry averages.Similarity is important as one should compare “apples to apples.”External Comparisons and Sources of Industry RatiosCurrentCurrent AssetsCurrent LiabilitiesFor Basket Wonders December 31, 2007Shows a firm’s ability to cover its current liabilities with its current assets.Balance Sheet RatiosLiquidity Ratios$1,195$500= 2.39Liquidity RatiosBW Industry2.39 2.152.26 2.091.91 2.01Year200720062005Current RatioRatio is stronger than the industry average.Liquidity Ratio ComparisonsAcid-Test (Quick)Current Assets - InvCurrent LiabilitiesFor Basket Wonders December 31, 2007Shows a firm’s ability to meet current liabilities with its most liquid assets.Balance Sheet RatiosLiquidity Ratios$1,195 – $696$500= 1.00Liquidity RatiosBW Industry1.00 1.251.04 1.231.11 1.25Year200720062005Acid-Test RatioRatio is weaker than the industry average.Liquidity Ratio ComparisonsStrong current ratio and weak acid-test ratio indicates a potential problem in the inventories account.Note that this industry has a relatively high level of inventories. Ratio BW IndustryCurrent 2.39 2.15Acid-Test 1.00 1.25Summary of the Liquidity Ratio Comparisons Trend Analysis of Current Ratio1.51.71.92.12.32.5200520062007Analysis YearRatio ValueBWIndustryCurrent Ratio – Trend Analysis ComparisonTrend Analysis of Acid-Test Ratio0.50.81.01.31.5200520062007Analysis YearRatio ValueBWIndustryAcid-Test Ratio – Trend Analysis ComparisonThe 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.The current ratio for BW has been rising at the same time the acid-test ratio has been declining.Summary of the Liquidity Trend AnalysesDebt-to-EquityTotal DebtShareholders’ EquityFor Basket Wonders December 31, 2007Shows the extent to which the firm is financed by debt.Balance Sheet RatiosFinancial LeverageRatios$1,030$1,139= 0.90Financial Leverage RatiosBW Industry 0.90 0.90 0.88 0.90 0.81 0.89Year200720062005Debt-to-Equity RatioBW has average debt utilizationrelative to the industry average.Financial Leverage Ratio ComparisonsDebt-to-Total-AssetsTotal DebtTotal AssetsFor Basket Wonders December 31, 2007Shows the percentage of the firm’s assets that are supported by debt financing.Balance Sheet RatiosFinancial LeverageRatios$1,030$2,169= 0.47Financial Leverage RatiosBW Industry 0.47 0.47 0.47 0.47 0.45 0.47Year200720062005Debt-to-Total-Asset RatioBW has average debt utilizationrelative to the industry average.Financial Leverage Ratio ComparisonsTotal CapitalizationTotal DebtTotal CapitalizationFor Basket Wonders December 31, 2007Shows the relative importance of long-term debt to the long-term financing of the firm.Balance Sheet RatiosFinancial LeverageRatios$1,030$1,669= 0.62(i.e., LT-Debt + Equity)Financial Leverage RatiosBW Industry 0.62 0.60 0.62 0.61 0.67 0.62Year200720062005Total Capitalization RatioBW has average long-term debt utilizationrelative to the industry average.Financial Leverage Ratio ComparisonsInterest CoverageEBITInterest ChargesFor Basket Wonders December 31, 2007Indicates a firm’s ability to cover interest charges.Income StatementRatiosCoverage Ratios$210$59= 3.56Coverage Ratios BW Industry 3.56 5.19 4.35 5.0210.30 4.66Year200720062005Interest Coverage RatioBW has below average interest coveragerelative to the industry average.Coverage Ratio Comparisons Trend Analysis of Interest Coverage Ratio3.05.07.09.011.0200520062007Analysis YearRatio ValueBWIndustryCoverage Ratio – Trend Analysis ComparisonThis 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.The interest coverage ratio for BW has been falling since 2005. It has been below industry averages for the past two years.Summary of the Coverage Trend AnalysisReceivable TurnoverAnnual Net Credit SalesReceivablesFor Basket Wonders December 31, 2007Indicates quality of receivables and how successful the firm is in its collections.Income Statement/Balance SheetRatiosActivity Ratios$2,211$394= 5.61(Assume all sales are credit sales.)Activity RatiosAvg Collection PeriodDays in the YearReceivable TurnoverFor Basket Wonders December 31, 2007Average number of days that receivables are outstanding.(or RT in days)Income Statement/Balance SheetRatiosActivity Ratios3655.61= 65 daysActivity RatiosBW Industry65.0 65.771.1 66.383.6 69.2Year200720062005Average Collection PeriodBW has improved the average collection period to that of the industry average.Activity Ratio ComparisonsPayable Turnover (PT)Annual Credit PurchasesAccounts PayableFor Basket Wonders December 31, 2007Indicates the promptness of payment to suppliers by the firm.Income Statement/Balance SheetRatiosActivity Ratios$1551$94= 16.5(Assume annual credit purchases = $1,551.)Activity RatiosPT in DaysDays in the YearPayable TurnoverFor Basket Wonders December 31, 2007Average number of days that payables are outstanding. Income Statement/Balance SheetRatiosActivity Ratios36516.5= 22.1 daysActivity RatiosBW Industry22.1 46.725.4 51.143.5 48.5Year200720062005Payable Turnover in DaysBW has improved the PT in Days.Is this good?Activity Ratio ComparisonsInventory TurnoverCost of Goods SoldInventoryFor Basket Wonders December 31, 2007Indicates the effectiveness of the inventory management practices of the firm. Income Statement/Balance SheetRatiosActivity Ratios$1,599$696= 2.30Activity RatiosBW Industry2.30 3.452.44 3.762.64 3.69Year200720062005Inventory Turnover RatioBW has a very poor inventory turnover ratio.Activity Ratio Comparisons Trend Analysis of Inventory Turnover Ratio2.02.53.03.54.0200520062007Analysis YearRatio ValueBWIndustryInventory Turnover Ratio –Trend Analysis ComparisonTotal Asset TurnoverNet SalesTotal AssetsFor Basket Wonders December 31, 2007Indicates the overall effectiveness of the firm in utilizing its assets to generate sales.Income Statement/Balance SheetRatiosActivity Ratios$2,211$2,169= 1.02Activity RatiosBW Industry1.02 1.171.03 1.141.01 1.13Year200720062005Total Asset Turnover RatioBW has a weak total asset turnover ratio.Why is this ratio considered weak?Activity Ratio ComparisonsGross Profit MarginGross ProfitNet SalesFor Basket Wonders December 31, 2007Indicates the efficiency of operations and firm pricing policies.Income Statement/Balance SheetRatiosProfitability Ratios$612$2,211= 0.277Profitability RatiosBW Industry27.7% 31.1%28.7 30.831.3 27.6Year200720062005Gross Profit MarginBW has a weak Gross Profit Margin.Profitability Ratio Comparisons Trend Analysis of Gross Profit Margin25.027.530.032.535.0200520062007Analysis YearRatio Value (%)BWIndustryGross Profit Margin –Trend Analysis ComparisonNet Profit MarginNet Profit after TaxesNet SalesFor Basket Wonders December 31, 2007Indicates the firm’s profitability after taking account of all expenses and income taxes. Income Statement/Balance SheetRatiosProfitability Ratios$91$2,211= 0.041Profitability RatiosBW Industry4.1% 8.2%4.9 8.19.0 7.6Year200720062005Net Profit MarginBW has a poor Net Profit Margin.Profitability Ratio Comparisons Trend Analysis of Net Profit Margin45678910200520062007Analysis YearRatio Value (%)BWIndustryNet Profit Margin – Trend Analysis ComparisonReturn on InvestmentNet Profit after TaxesTotal AssetsFor Basket Wonders December 31, 2007Indicates the profitability on the assets of the firm (after all expenses and taxes). Income Statement/Balance SheetRatiosProfitability Ratios$91$2,160= 0.042Profitability RatiosBW Industry4.2% 9.6%5.0 9.19.1 10.8Year200720062005Return on InvestmentBW has a poor Return on Investment.Profitability Ratio Comparisons Trend Analysis of Return on Investment4681012200520062007Analysis YearRatio Value (%)BWIndustryReturn on Investment –Trend Analysis ComparisonReturn on EquityNet Profit after TaxesShareholders’ EquityFor Basket Wonders December 31, 2007Indicates the profitability to the shareholders of the firm (after all expenses and taxes). Income Statement/Balance SheetRatiosProfitability Ratios$91$1,139= 0.08Profitability Ratios BW Industry 8.0% 18.0% 9.4 17.216.6 20.4Year200720062005Return on EquityBW has a poor Return on Equity.Profitability Ratio Comparisons Trend Analysis of Return on Equity7.010.514.017.521.0200520062007Analysis YearRatio Value (%)BWIndustryReturn on Equity – Trend Analysis ComparisonROI2007 = 0.041 × 1.02 = 0.042 or 4.2%ROIIndustry = 0.082 × 1.17 = 0.096 or 9.6%(Note: values are rounded)ROI = Net profit margin × Total asset turnoverEarning Power = Sales profitability × Asset efficiencyReturn on Investment and the Du Pont ApproachROE2007 = 0.041 × 1.02 × 1.90 = 0.080ROEIndustry = 0.082 × 1.17 × 1.88 = 0.180(Note: values are rounded)Return On Equity = Net profit margin X Total asset turnover X Equity MultiplierEquity Multiplier = Total AssetsShareholders’ EquityReturn on Equity and the Du Pont ApproachThe profitability ratios for BW have ALL been falling since 2005. Each has been below the industry averages for the past three years.This indicates that COGS and administrative costs may both be too high and a potential problem for BW.Note, this result is consistent with the low interest coverage ratio.Summary of the Profitability Trend AnalysesInventories are too high.May be paying off creditors (accounts payable) too soon.COGS may be too high.Selling, general, and administrative costs may be too high.Summary of Ratio AnalysesAn 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.Common-Size AnalysisBasket Wonders’ Common Size Balance SheetsBasket Wonders’ Common- Size Balance SheetsBasket Wonders’ Common- Size Income StatementsAn analysis of percentage financial statements where all balance sheet or income statement figures for a base year equal 100.0 (percent) and subsequent financial statement items are expressed as percentages of their values in the base year.Index AnalysesBasket Wonders’ Indexed Balance SheetsBasket Wonders’ Indexed Balance Sheets 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 Basket Wonders’ Indexed Income Statements