2. financial statements & analysis

8/3/2019 2. Financial Statements & Analysis

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Financial Statements and

Analysis


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Dr Mazila Md Yusuf Financial Statements & Analysis 2

Understanding Financial

Statements


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The Annual Report

Income statement (Profit and Loss Account)A statement that summarizes a firms revenues,expenses , and profit or loss over a given period oftime.

Balance sheetA statement that provides a snapshot of a firmsfinancial position at one point in time, detailing thefirms assets, liabilities, and owners equity.

Statement of cash flowsA statement that provides a summary of the cashflows of a firm over a given period of time.


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SALES

- EXPENSES= PROFIT

Income Statement


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SALES

- EXPENSES= PROFIT

Income Statement

Revenue


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Income Statement

SALES

- EXPENSES= PROFIT

Cost of Goods Sold

Operating Expenses

(marketing, administrative)Financing Costs

Taxes


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SALES

- Cost of Goods Sold

GROSS PROFIT

- Operating Expenses

OPERATING PROFIT (EBIT)

- Interest Expense

EARNINGS BEFORE TAXES (EBT)

- Income Taxes

EARNINGS AFTER TAXES (EAT)

- Preferred Stock Dividends

- NET INCOME AVAILABLE

TO COMMON STOCKHOLDERS

Income Statement


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SALES


GROSS PROFIT

- Operating Expenses

OPERATING INCOME(EBIT)

- Interest Expense


- Income Taxes



- NET INCOME AVAILABLE

TO COMMON STOCKHOLDERS

Income Statement


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SALES


GROSS PROFIT

- Operating ExpensesOPERATING INCOME (EBIT)

- Interest Expense


- Income Taxes



- NET INCOME AVAILABLETO COMMON STOCKHOLDERS

Income Statement


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Balance Sheet

Consists of:

1. Assets

2. Financing:Liabilities (Debt)

Equity


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Assets

Current Assets: assets that are relatively liquid,and are expected to be converted to cash within ayear. Cash, marketable securities, accounts receivable, inventories,

prepaid expenses.

Fixed Assets: asset with long-term use or value

-machinery and equipment, buildings, and land.

Other Assets: any asset that is not a current assetor fixed asset. Intangible assets, such as patents and copyrights.


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FinancingDebt Capital: financing provided by a

creditor.Short-term debt: borrowed money thatmust be repaid within the next 12 months.

Accounts payable, other payables such asinterest or taxes payable, accrued expenses,short-term notes.

Long-term debt: loans from banks orother sources that lend money for longerthan 12 months.


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Financing

Equity Capital: shareholders investment in thefirm.

Preferred Stock: holders receive fixeddividends, have higher priority than common

stockholders in event of liquidation of thefirm.

Common Stock: holders are residual owners

of the firm. They receive whatever is left aftercreditors and preferred stockholders are paid.


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Common or Owners Equity

Capital

Refers to equity excluding preferred stock

Owners equity components are:

1. Common stock

2. Paid-in capital additional money paid directlyto a firm by its owner

3. Share premiumdifference between market

price and par value when new stock are issued4. Retained earnings net profits that are

retained by a firm for its use rather than paid asdividends


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Balance SheetAssets Liabilities (Debt) & Equity

Current Assets

Cash

Marketable Securities

Accounts Receivable

InventoriesPrepaid Expenses

Fixed Assets

Machinery &

Equipment

Buildings and Land

Other Assets

Investments & patents

Current LiabilitiesAccounts PayableAccrued ExpensesShort-term notes

Long-TermLiabilities

Long-term notesMortgages

EquityPreferred StockCommon StockPaid in CapitalRetained Earnings


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Cash Flow Statement

Shows how funds are generated and used during a certainperiod. (Refer to Figure 3.1 on page 109) Provides answers to questions such as:

- Why was money borrowed during the period?- Why did firm issue additional shares?- What was done to firm's net profits?- How did firm retire long-term debt?- How did firm finance additional plants & equipments?

Provides insight into companys investment, financing &operating activities and reconciles them with changes in itscash and marketable securities during the period.


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Cash Flow Statement

Cash flows from Operations Net cash flows from operations after taxesand interest expenses

Cash Flows from InvestingIncludes acquisition of real assets (capital

expenditures) and disposal and purchase of

financial assets.

Cash flows from Financing Net cash flow from the issue and repurchaseof equity, from the issue & repayment ofdebt and after dividend payments

= Net Change in Cash Balance


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*Note: Net increase (decrease) in cash + MS should be equal

to difference between cash & MS on the balance sheet at thebeginning and end of year.

Total Operating CF + Total Investment CF+ Total Financing CF = Net change in

Cash & MS*

Cash Flow Statement


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Cash Flow Statement

Basic Inflows (Sources) and Outflows (Uses) of cash


Inflows (Sources) Outflows (Uses)

Decrease in any asset Increase in any asset

Increase in any liability Decrease in any liability

Net profits after taxes Net loss

Depreciation & noncash charges Dividends paid

Sale of stock Repurchase or retirement ofstock


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Financial Analysis

Process of analyzing financial statementsto enable managers to evaluateperformance & whether objectives are

being met or not.Enables weaknesses & strengths to beidentified.

Indicates how a firm has performed &likely to perform in the future

Tool for analysis - financial ratios


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Ratios- an attempt to standardize financial information tofacilitate meaningful comparisons

ratios answer questions concerning well-being of a firm:

has the firm been able to meet its debt obligations?

is management making enough profits from firms

assets?

how does management finance its investment?

are owners getting enough returns on theirinvestment?

ratios are of interest to shareholders, creditors and firms

own management

Financial ratios


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comparing ratios of a single firm in

a single year against the

benchmark (industry average) for

the same year.

Types of comparison

Cross-sectionalanalysis

comparing ratios of a single firm

over a period of time, usually 5years

Trend or

Time-Series analysis


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Cautions when doing ratioanalysis

ratios must be considered together, a single ratio byitself means relatively little.

financial statements being compared should be

dated at the same point in time.

use audited financial statements when possible

financial data being compared should have beendeveloped in the same way.

be wary of inflation especially when comparing oldfirms and new firms.


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Limitations of Ratio Analysis

Ratios are not useful for analyzing operations of acompany involved in various industrial sectors

Seasonal factors may distort ratios and thus fail toprovide a true picture of firms condition

Different operating policies and accountingpractices can distort comparison betweencompanies

Ratio analysis has to be comprehensive (not just asingle ratio) in order to reflect true performance ofa company



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Categories of Financial Ratios

1. Liquidity Ratios

2. Efficiency/Activity Ratios

3. Leverage/Debt Ratios4. Profitability Ratios

5. Market Ratios



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1. Liquidity Ratios

Measure solvency of firms overall

financial position

Measure ability to meet short-termobligations on time

Higher liquidity ratios are better for theyindicate that firm has a margin of safety

after fulfilling its short-term obligations



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1. Liquidity Ratios

Current ratio = Current assets

Current liabilities

Quick or Acid-test ratio = Current assets - Inventories

Current liabilities


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2. Efficiency/Activity ratios

Measure the speed with which specificcurrent accounts are converted into salesor cash (inflows and outflows)

Due to liquidity ratios are inadequate toassess the activity of specific currentaccounts due to different composition of

the accountsAlso important to look beyond liquidity ofassets to assess their activity



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Inventory turnover = Cost of Goods SoldInventory

* Measures activity or liquidity of firms inventory

Ave. Collection Period = Acc. Receivables x 365

Annual Credit Sales

* Measures amount of time needed to collect accounts receivable

Ave. Payment Period = Accounts Payable x 365Annual Credit Purchases

* Measures amount of time needed to pay accounts payable

Total Assets Turnover = SalesTotal Assets

* Measures firms efficiency of using its assets to generate sales


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3. Leverage Ratios

Measure amount of debt a firm uses togenerate profits

Higher debt means higher financialleverage and thus greater potential riskand return to the firm

Also measure ability to service debts

(payment of the fixed charges)



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Debt ratio = Total LiabilitiesTotal Assets

Measures proportion of total assets financed by creditors

Debt-Equity ratio = Long-term debtOwners equity

* Indicates relationship between funds provided by long-term creditors versus those provided by owners

Times Interest Earned = EBIT / Interest expenseMeasures ability to meet contractual interest payments

Fixed Payment Coverage Ratio (FPCR)FPCR=

EBIT + Lease pmtsInt. + Lease pmts + {(Pcipal pmts + PS div.) x [1/(1-T)]}

* Measures ability to meetall fixed payment obligations


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4. Profitability Ratios

Measure ability to generate profits withrespect to sales, assets or owners funds



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Gross profit margin = Gross profits

Sales* profits after payment of raw material costs

Operating profit margin = Operating Profits

Sales* profits after all operating costs and expenses arededucted

Net profit margin = Net profitsSales

* profits after deducting all operating costs, expenses,interest and taxes


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Return on Total Assets (ROA) = Net profitsTotal assets

* Measures managements effectiveness in generating

profits with available assets

Return on Common Equity (ROE) = Net profits

Common equity

* Measures return earned on owners investment

Earnings per Share (EPS)EPS = Earnings Available to Common Holders

Unit of common shares outstanding* Amount of profits earned for every unit of shares ofcommon stock outstanding and not amount of profitsactually obtained or distributed to stockholders


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5. Market Ratios

Relate a firms market value to certain

accounting values

Measure how well investors in themarketplace feel the firm is doing in termsof risk and return



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Price/Earnings (P/E) Ratio = Market price per share

EPS

* Amount investors are willing to pay for every dollar of companys

earnings

* Used to assess investors confidence in a company

Can be used as basis for share valuation; higher ratio greaterconfidence on the firm

Market/Book (M/B) Ratio = Market price per shareBook value per share

* Provides an assessment of how investors view the firms performance* It relates the market value of firms shares to their book value

Enable comparison made with other firms.

Market/Book (M/B) Ratio = Market price per shareBook value per share

2. financial statements & analysis

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