chapter financial analysis2 financial analysis

7/28/2019 Chapter FINANCIAL ANALYSIS2 Financial Analysis

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CHAPTER 2

Financial Analysis

Definitions and functions offinancial statement

Financial ratios

Basic sources and uses of

funds


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What is Financial Analysis? Is a process of selecting, evaluating and

interpreting the past financial data of a firm.

It helps for making financial decision and canbe used to assess the strength and weaknesses

of management.


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Consists of:

Balance sheet,

Income Statement,

Cash flows statement,

Statement of retained earnings

Financial Statements


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Balance Sheet

Represent snapshot of firms financial

position at specific point in time

Consist of : Assets (i.e. current and fixed)

Liabilities (i.e. short and long term)

Owners equity (i.e. common equity)

Balance Sheet Equation

Assets = Liabilities + Owners Equity


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Format of Balance Sheet

ASSETS LIABILITIES AND EQUITIES

Current Assets Current Liabilities

Marketable Securities Account PayableAccount Receivable Notes Payable

Inventories Accruals

Prepaid expenses Total Current Liabilities

Total Current Assets

Fixed Assets Long Term Debt

Plant and MachineryLand and Buildings Common Equity

Total Fixed Assets Common Stock

Preferred Stock

Retained Earnings

TOTAL ASSETS TOTAL LIABILITIES AND EQUITY

Balance Sheet as at December 20XX


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Balance Sheet (cont..)

Types of Assets

Cash (i.e. cash balance from cash transaction)

Marketable securities (i.e. temporary investment) A/c receivables (i.e. debtors)

Inventories (i.e. materials, WIP & unsold product)

Prepaid (i.e. advance payment on expenses)

Fixed assets (subjected to depreciation)


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Types of Liabilities & Equities

A/c payables (i.e. creditors)

Notes payable (i.e. short term loan) Other payables (i.e. interest payment or income tax

payable)

Accrued expenses (i.e. unpaid expenses )

Capital stock (i.e. common or preferred stock)

Retained earnings (i.e. reserved)

Balance Sheet (cont..)


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It summarize the firms revenue and expenses

over an accounting period.

Operating activities

Income Statement

Profit = Sales - Expenses


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Income Statement (cont..)

Revenue/Net Sales

less: COGS

Gross Profitless: Operating Expenses

Depreciation

Operating Income/EBIT

plus: other income

less: Interest

Earnings Before Taxes

less: Corporate Taxes

Net Income

Dividend: Preferred

Common

Retained Earnings

Operating

Activities

Financing

Activities

Income Statement for the year ended December 20XX


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Income Statement (cont..)

Items in income statement:

Sales/Revenue (i.e. cash & credit sales)

COGS (i.e. cost to produce goods or services)

Operating exp (i.e. marketing, administration etc)

Interest (i.e. financing cost)

Tax expenses (i.e. payment to govt)

Net Income (i.e. to distribute to shareholders)


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Statement of Retained Earnings

It shows the firms earnings that have not

been distributed as dividends.

Statement of Retained Earnings for the year ended December 31, 20X2

Balanced of retained earnings, Dec 31, 20X1 XXX

add: Earning after tax 20X2 XXXless: Dividend, 20X2 XXX

Balanced of retained earnings, Dec 31, 20X2 XXXX


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Cash Flow Statement

Summarizes the inflows and outflows of

cash transactions for the year

Divided into 4 categories:

C/flow from Operations

C/flow from Investments

C/flow from financings

Reconciliation of cash


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As an Analysis tools to interpret andevaluate firms performance

Base on Financial Statement Users (i.e. Managers, investors, or

interested parties )

Two ways to interpret: Trend analysis (i.e. vertical or time

series)

Comparative analysis (i.e. horizontal)

Financial Ratios


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5 categories of financial ratio Liquidity ratios (i.e. how liquid the firms to meet

short-term obligation)

Activity ratios (i.e. to measure efficiency ofassets to generate sales)

Leverage ratios (i.e. how firms finance the itsassets, to determine the capital structure)

Profitability ratios (i.e. measure the efficiency offirms to generate profit)

Market/Equity ratios (i.e. concern toshareholders)

Financial Ratios (cont..)


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Current Ratio

Quick Ratio =

Current Assets

Current Liabilities

Current Asset - Inventory

Current Liabilities

=

Answer in X, higher ratio reflect the ability to pay its short term obligations

on time

Answer in X, higher ratio reflect the ability to pay its short term obligations

without rely on inventories


Liquidity Ratios


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Net Working

Capital

CA - CL=

Answer in $, higher (i.e. positive value), absolute measure in liquidity


Liquidity Ratios


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Inventory

Turnover

Average

Collection Period =

COGS or Sales

Inventory

A/c Receivables

Daily Sales

=

Answer in X, higher ratio reflect the effectiveness of inventory to generate

sales

Answer in Days, higher ratio indicates that firm has problem in collecting

debt


Activity Ratios


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A/C ReceivableTurnover

SalesA/C Receivable=

Answer in X, higher ratio reflect the effectiveness in collecting receivables


Activity Ratios


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Fixed Assets

Turnover

Total Assets

Turnover

Sales

Fixed Assets

Sales

Total Assets

=

Answer in X, higher ratio reflect the effectiveness of fixed assets to generate

sales


Activity Ratios

Answer in X, higher ratio reflect the effectiveness of total assets to generate

sales

=


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Debt

Ratio

Debt to

Equity

Total Debt

Total Assets

Total Debt

Equity

=

Answer in %, higher ratio reflect the higher amount of debt to finance assets


Leverage or Solvency Ratios

Answer in %, higher ratio reflect the higher amount of debt (i.e. capital

structure

=


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Time Interest

Earned

EBIT

Interest=

Answer in X, higher ratio indicates that firm can meet loan requirement and

lower risk of default




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Gross Profit

Margin

Operating

Profit Margin

Gross Profit

Sales

Operating Profit (EBIT)

Sales

=

Answer in %, higher ratio indicates higher contribution margin


Profitability Ratios

Answer in %, higher ratio indicates better productivity (i.e. operations)

=


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Net Profit

Margin

Return On

Assets

Earnings After Tax

Sales

Earnings After Tax

Total Assets

=

Answer in %, higher ratio indicates better income to shareholders



Answer in %, higher ratio indicates higher return on firms investment

=


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Return OnEquity

Earnings After TaxTotal Equity



Answer in %, higher ratio indicates higher return to shareholders

=


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Earning

Per Share

Price to

Earnings

Earnings After Tax

No. of common shares

Market Price p/share

EPS

=

Answer in $, higher ratio indicates better income per share


Market/Equity Ratios

Answer in X, higher ratio indicates the firms market price is overvalued

=


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Financial Ratio Analysis

RM'000

Revenue/Net Sales 1500

less: COGS 450

Gross Profit 1050less: Operating Expenses 450

Other operating expenses 300

Operating Income(EBIT) 300

plus: other income none

less: Interest 25Earnings Before Taxes 275

less: Corporate Taxes (40%) 110

Net Income 165

less: Dividend- Preferred none

Common 33

Retained Earnings 132

Income Statement for the year ended December 31, 2003


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Financial Ratio Analysis (cont..)

Balance Sheet as at December 31, 2000 &2003

ASSETS 2003 LIABILITIES AND EQUITIES 2003

Current Assets Current Liabilities

Cash 12 Account Payable 38

Account Receivable 44 Notes Payable 35

Inventories 82 Accruals 6

Prepaid expenses 8 Total Current Liabilities 79

Total Current Assets 146

Fixed Assets Long Term Debt 180

Plant and Machinery 170Land and Buildings 450 Common Equity

Total Fixed Assets 620 Common Stock 100

Preferred Stock 150

Retained Earnings 257

TOTAL ASSETS 766 TOTAL LIABILITIES AND EQUIT 766


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Liquidity Ratios Industry

1) Current ratio (times)

Current Assets 146 1.85 2X

Current Liabilities 79

2) Quick ratio (times)

Current Assets- Inventories 146 - 82 0.81 1.2X

Current Liabilities 79

3) Net working Capital

Current Asset - Current Liablities 146 - 79 67.00 none

2003

Liquidity Ratios


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Profitability Ratios Industry

1) Return on Equity (%)

Earning after tax 165 32.54 32%

Common Equity 507

2) Return on Asset(%)

Earnings after tax 165 21.54 45%

Total assets 766

3) Gross Profit Margin(%)

Gross Profit 1050 70.00 65%

Sales 1500

4) Operating Margin(%)

Operating Income 300 20.00 30%

Sales 1500

5) Net Profit Margin(%)

Net Profit 165 11.00 9%Sales 1500

2003



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Activity Ratios

Activity Ratio Industry

1) Asset Turnover (times/yr)

Sales 1500 1.96 5X

Total Assets 766

2) A/c Receivables Turnover (times/yr)

Sales 1500 34.09 40X

A/c Receivables 44

3) Average Collection Period (days)

A/c Receivables 44 10.22 6 days

Daily Sales (1550/360)

4) Inventory Turnover (times/yr)

COGS or Sales 1500 18.29 20X

Inventory 82

5) Fixed Assets Turnover

Sales 1500 2.42 none

Fixed Assets 620

2003


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Leverage (Solvency) Ratio Industry

1) Debt Ratio

Total Debt 259 33.81 30%

Total Assets 766

2) Debt to Equity

Total Debt 259 51.08 50%

Equity 507

3) Time Interest Earned (time)

EBIT 300 12.00 10X

Interest 25

2003


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Advantages of Financial Ratios

Easy to calculate

Allow comparison with industry average

Can identify problem areas of a firm Can be used to evaluate a firms financial

performance.


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Limitations of Financial Ratios

Does not provide useful information.

Can be easily misinterpreted.

Many firms window dress their financialstatement to make them look better for credit

analysis.


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Sources and Uses of Funds

Is a Statement of changes in financial position(i.e. assets, equity & liabilities)

Summarized all the new or additional Sourcesand Uses for investment purpose

Questions:

Where did firms get its funds during the year?

What did the firm do with available funds?

How does operations affect firms assets and

liabilities?


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Funds Flow Statement

Combine changes in B/Sheet with other relevant

financial figures (i.e. income statement) Funds inflow Sources

Funds outflow Uses

Sources and Uses of Funds

Total Sources of Funds = Total Uses of Funds


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Funds Flow Statement (cont..)

Sources of Funds

Decrease in Asset Increase in Liability &

Equity

EAT/Net profit

Depreciation

Uses Of Funds

Increase in Asset Decrease in Liability

&Equity

Net loss from operations

Dividend

How to Identify Sources and Uses of Funds?

Sources & Uses of Funds involve in Operations


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(RM'000) 20X1 20X2

Current Assets

Cash 28 97

Marketable Securities 42 10Account Receivable 93 128Inventories 65 85Total Current Assets 228 320

Fixed Assets

Gross Fixed Assets 887 1020less: depreciation 226 285

Total Fixed Assets 661 735TOTAL ASSETS 889 1,055

Current Liabilities

Account Payable 64 95Notes Payable 20 87Accrued Expenses 95 75Total Current Liabilites 179 257

Long Term Debt 297 318

Common Equity

Common Stock 140 160Paid in capital 108 120Retained Earnings 165 200

TOTAL LIABILITIES AND EQUITY 889 1,055

Mekar Inc Bhd

Balance Sheet as at 31 December 20X1 and 20X2

To Analyze the

Balance Sheet,Two BS is required


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(RM'000) 20X2Revenue/Net Sales 960

less: COGS 624Gross Profit 336less: Operating Expenses 167

Depreciation 19

Operating Income/EBIT 150less: Interest Expenses 30Earnings Before Taxes 120less: Corporate Taxes 48

Net Income 72

less: Dividend 37Retained Earnings 35

Mekar Inc BhdIncome statement for the year ended 31 December 20X2

Dividend isTransferred to the

Fund Flow

Statement

BUT

If there is no IS

Div = EAT- (RE1+RE0)

Analyze Income Statement


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All the items in

BS need to be

subtracted, X2-X1

And then transfer

To Funds Flow

Statement

Except

Retained Earnings

(RM'000) 20X1 20X2 X2-X1 S/U

Current Assets

Cash 28 97 69 UMarketable Securities 42 10 -32 S

Account Receivable 93 128 35 U

Inventories 65 85 20 U

Total Current Assets 228 320

Fixed Assets

Gross Fixed Assets 887 1020 133 U

less: depreciation 226 285 59 S

Total Fixed Assets 661 735TOTAL ASSETS 889 1,055

Current Liabilities

Account Payable 64 95 31 S

Notes Payable 20 87 67 S

Accrued Expenses 95 75 -20 U

Total Current Liabilites 179 257

Long Term Debt 297 318 21 S

Common Equity

Common Stock 140 160 20 S

Paid in capital 108 120 12 S

Retained Earnings 165 200 35 NA

TOTAL LIABILITIES AND EQUITY 889 1,055

Mekar Inc Bhd

Analysis for Funds Flow Statement for the year ended 31 Dec 20X2


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(RM'000)

Sources of Funds

Funds from operations

EAT 72

Depreciationa

19Total Funds from operations 91

Proceeds from the sale of:

New long-term debt 21

New common stock 20New paid in capital 12Total sources from long term funds 53

Proceeds from changes of WCSale in short-term securities 32Increase in acc payables 31Increase in notes payables 67Total sources from short-term funds 130

Total sources of funds 274

Uses of Funds

Long-term uses of fundsNet capital expenditure

b93

Dividend 37Total uses of long-term funds 130

Changes in WCIncrease in cash 69Increase Account Receivable 35Increase in Inventories 20

D i i li biliti 20

Mekar Inc Bhd

Funds Flow Statement for the year ended 31 Dec 20X2

Depreciation:

Extract from IS

or(Take the difference in BS)

Net Capex:

Net FA1 Net FA0+ Dep

or

(Gross FA1 Gross FA0 )

Parenthesis

If there is no ISavailable

chapter financial analysis2 financial analysis

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