Financial Statement Analysis

• Sustainable Income• Comparative Analysis• Ratio Analysis• Limitations

Sustainable Income

• Value of company = present value of future cash flows– Cash flow from

• Dividends• Increase in stock value

• As rough approximation of cash flows, accountants use net income– Finance types would disagree

• Sustainable income = expected future net income

• Exclude irregular items

Irregular items

• Extraordinary items– Unusual in nature

• For that area– Earthquake in Los Angeles vs. New York City

– Not expected to recur in forseeable future• Mount St. Helens

Irregular items

• Extraordinary items– Acts of God seldom occur in the area

• Cost of snow removal in Charleston versus Miami

– New regulations• NCAA ban of Rawlings bats for collegiate use

– Expropriation• Shell in Mexico

Irregular items

• Change in accounting principle• Remember…want consistency• Must

– Provide better information– Impact of change is shown separately

• Executive stock options

Irregular items

• Discontinued operations– Disposal of a large segment of business

• Tribune Company sells Chicago Cubs

– Show separately gain (loss) from business and gain (loss) from sale

– Will not happen again in the future

Comparative Analysis

• Intracompany analysis– Compare company trends over time

• Valid comparison• Competitors: how do we measure up?

• Intercompany analysis– Compare with a competitor

• Industry leader???• Competitor: comparable?

Comparative Analysis

• Comparison with industry averages– Which industry?– Better than “mediocre”?

---- Horizontal Analysis -2009 2010

Sales $100,000 $110,000

A/R 10,000 15,000

Inventory 30,000 60,000

Calculating percentage change: (New – Old)/(Old)

Want A/R to grow faster than Sales???

Want Inventory to grow faster than Sales???

Vertical AnalysisPercent

Cash 10,000 10%

A/R 12,000 12%

Total Assets 100,000 100%

Liabilities, equity and asset accounts are all calculated as a percent of Total Assets… Not Total Liabilities or Equity.

Vertical Analysis

Percent

Sales 100,000 100%

Cost of goods sold 60,000 60%

Gross profit 40,000 40%

Selling and admin expenses 25,000 25%

Net income 15,000 15%Prefer to see COGS increase as a percent of sales???

Prefer to see selling and admin expense increase???

FINANCIAL RATIOS

TYPES

LIQUIDITY SOLVENCY PROFITABILITY MARKET VALUE

PAY BILLS??? PAY LONG-TERM DEBT? MAKING $$$$? OWNERS WEALTHY??

Short-termCreditors

Long-termcreditors

Owners ,long-termcreditors

Owners

Further Look At Financial Statements

• Financial ratios – Liquidity:

• Current ratio: CA/CL– What is current asset? Current liability?

• Working capital: CA – CL• Quick: (CA – Inv)/CL

– Solvency• Debt: Debt/Assets• Free cash flow: Operating cash flow – capital

expenditures – dividends– Profitability:

• ROA: Net income/Assets• ROE: Net income/Stockholders Equity• Profit Margin = Net income/Sales

Further Look At Financial Statements

• Financial ratios – Market

• P/E ratio = Stock Price / Earnings Per Share– Average– High– Low

• PEG ratio = P/E ratio / Growth rate EPS• Beta

– Average– Change over years?

– Growth ratios• Payout = Dividends / Net Income• Retention = 100% - Payout