financial statement analysis unit 12 analysing financial statements involves evaluating three...
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FINANCIAL STATEMENT FINANCIAL STATEMENT ANALYSISANALYSIS
UNITUNIT
1212
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• Analysing financial statements involves evaluating three characteristics of a company:
1. its liquidity
2. its profitability
3. its solvency
BASICS OF BASICS OF FINANCIAL STATEMENT FINANCIAL STATEMENT
ANALYSISANALYSIS
BASICS OF BASICS OF FINANCIAL STATEMENT FINANCIAL STATEMENT
ANALYSISANALYSIS
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COMPARATIVE ANALYSISCOMPARATIVE ANALYSIS
• Three types of comparisons:– Intracompany basis-compare
previous years data with current year within the company.
– Intercompany basis – compare data with specific competitors.
– Industry averages - compare overall industry data.
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COMPARATIVE ANALYSISCOMPARATIVE ANALYSIS
• Three tools:– Horizontal analysis
– Vertical analysis
– Ratio analysis
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HORIZONTAL ANALYSISHORIZONTAL ANALYSIS
127% 121% 119% 112% 100%
ANY COMPANY INC.Assumed Net Sales
For the Year Ended December 31 (in millions)
2003 2002 2001 2000 1999
$ 6,562.8 $ 6,295.4 $ 6,190.6 $ 5,786.6 $ 5,181.4
Change since base
period
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VERTICAL ANALYSISVERTICAL ANALYSIS
• Expresses each item in a financial statement as a percent of a base amount (total assets or net sales)
ANY COMPANY, INC.Condensed Balance Sheets (Partial)
December 31 (in millions)
2002 2001 .
Assets Amount Percent Amount PercentCurrent assets $1,496.5 29.6 $1,467.7 30.1Capital assets 2,888.8 57.2 2,733.3 56.9Other assets 666.2 13.2 636.6 13.0 Total assets $5,051.5 100.0% $4,837.6 100.0%
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VERTICAL ANALYSISVERTICAL ANALYSIS
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RATIO ANALYSISRATIO ANALYSISRATIO ANALYSISRATIO ANALYSISLiquidity Ratios
Measure short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash.
Profitability Ratios
Measure the income or operating success of an enterprise for a given period of time.
Solvency Ratios
Measure the ability of the enterprise to survive over a long period of time.
Ratios may be expressed as percentages (50%), proportions (1:2), Days (32 days), or rate (3.23)
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LIQUIDITY RATIOSLIQUIDITY RATIOS
• Current ratio
• Acid test ratio
• Receivables turnover
• Collection period
• Inventory turnover
• Days sales in inventory
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CURRENT RATIOCURRENT RATIO
• Measures short-term debt-paying ability
Current ratio =Current assetsCurrent liabilities
(Discussed in Chapter 4)
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ACID TEST RATIOACID TEST RATIO
• Measures immediate short-term debt-paying ability
Acid test ratio =Cash + temporary investments + net
receivablesCurrent liabilities
(Discussed in Chapter 9)
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RECEIVABLES TURNOVERRECEIVABLES TURNOVER
• Measures liquidity of receivables
Receivables turnover =Net credit sales
Average net receivables
(Discussed in Chapter 9)
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COLLECTION PERIODCOLLECTION PERIOD
• Measures number of days receivables are outstanding
Collection period =365 days
Receivables turnover
(Discussed in Chapter 9)
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INVENTORY TURNOVERINVENTORY TURNOVER
• Measures liquidity of inventory
Inventory turnover =Cost of goods soldAverage inventory
(Discussed in Chapter 5)
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DAYS SALES IN INVENTORYDAYS SALES IN INVENTORY
• Measures number of days inventory is on hand
Days in inventory =365 days
Inventory turnover
(Discussed in Chapter 5)
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PROFITABILITY RATIOS PROFITABILITY RATIOS
• Profit margin
• Gross profit margin
• Return on assets
• Return on common shareholders’ equity
• Book value per share
• Earnings per share (EPS)
• Price-earnings (PE) ratio
• Dividend yield
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PROFIT MARGINPROFIT MARGIN
• Measures net income generated by each dollar of sales
(Discussed in Chapter 5)
Profit margin =Net incomeNet sales
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GROSS PROFIT MARGINGROSS PROFIT MARGIN
• Measures margin between selling price and cost of goods sold generated by each dollar of sales
(Discussed in Chapter 5)
Gross profit margin =Gross profit
Net sales
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RETURN ON ASSETSRETURN ON ASSETS
• Measures overall profitability of assets
Return on assets =Net income
Average total assets
(Discussed in Chapter 10)
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RETURN ON COMMON RETURN ON COMMON SHAREHOLDERS’ EQUITYSHAREHOLDERS’ EQUITY
• Measures profitability of common shareholders’ investment
Return on common shareholders’ equity =Net income
Average common shareholders’ equity
(Discussed in Chapter 14)
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BOOK VALUE PER SHAREBOOK VALUE PER SHARE
• Measures the equity (net assets) per common share
Book value per share =Common shareholders’ equity
Number of common shares
(Discussed in Chapter 14)
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EARNINGS PER SHARE (EPS)EARNINGS PER SHARE (EPS)
• Measures net income earned on each common share
(Discussed in Chapter 15)
Earnings per share =Net income
Number of common shares
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PRICE-EARNINGS (PE) RATIOPRICE-EARNINGS (PE) RATIO
• Measures relationship between market price per share and earnings per share
(Discussed in Chapter 15)
Price-earnings ratio =Share price
Earnings per share
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DIVIDEND YIELDDIVIDEND YIELD
• Measures rate of return earned from dividends
(Discussed in Chapter 15)
Dividend yield =Cash dividends per share
Share price
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SOLVENCY RATIOSSOLVENCY RATIOS
• Debt to total assets
• Cash total debt coverage
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DEBT TO TOTAL ASSETSDEBT TO TOTAL ASSETS
• Measures % of total assets provided by creditors
Debt to total assets =
Total liabilities Total assets
(Discussed in Chapter 16)
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CASH TOTAL DEBT COVERAGECASH TOTAL DEBT COVERAGE
• Measures long-term debt-paying ability (cash basis)
Cash total debt coverage ratio =Net cash provided by operating
activitiesAverage total liabilities
(Discussed in Chapter 18)
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• Estimates
• Historical cost
• Alternative accounting methods
• Atypical data
• Diversification
LIMITATIONS OF FINANCIAL LIMITATIONS OF FINANCIAL ANALYSISANALYSIS