Analysis of business financial statements.pptx

Analysis of financial statements

1. Analyzing Financial Statements - pt2

2. Key Idea Just as with the Income Statement, firms can similarly use vertical analysis with their Balance Sheet (b/s)… it just makes things easier to compare (both to yourself over time, as well as against your competitors and the industry average).

3. Breakdown of Assets This pie chart shows the various classes of assets as a percentage of total assets , thereby showing us the percentage of its investment in each type of asset.

4. Breakdown of Liabilities The liabilities and owners equity can also be broken down to determine where the firm is obtaining most of its financial support. This pie chart shows the various classes of liabilities as a percentage of total liabilities . Are you primarily debt financed or equity financed? How does that compare to your competitors? Your industry?

5. Key Idea As with the income statement, the use of percentages helps you to analyze changes over time, and against competitors and the industry as a whole (industry averages).

6. Comparative Balance Sheet 21% 25% 30% 76% 24% 100% 19% 25% 22% 67% 33% 54% 50% 19% 22% 100% 100% 100% 27% 46% 28% 50%

7. Key Idea Now, we’ll take a look at the balance sheet using ratio analysis ….

8. Ratio Analysis We’ve already used ratio analysis with the Income Statement: Profitability ratios Gross profit margin, Operating profit margin, Net profit margin It must be noted that sometimes a company can be showing a profit on the Income Statement, yet still fail because they run out of cash… So….. we also need to analyze the b/s.

9. Working Capital The b/s provides info that will indicate whether a company may have a cash flow problem . Working capital = Total current assets – Total current liabilities If the current assets exceed the current liabilities, then the company has “working capital”, and should be able to pay it’s obligations.

10. Ratio Analysis We can also use ratio analysis with the Balance Sheet: Financial Condition ratios measure the firm’s ability to pay its current bill, and to determine whether its debt load is reasonable. Current ratio Debt-to-equity ratio

11. Current Ratio looks at a company’s ability to meet current obligations and examines the relationship between a company’s current assets and its current liabilities. A Current Ratio below 1 indicates negative Working Capital and is a signal that the company may be in trouble!! A Current Ratio between 1.2 and 2 is generally assumed to be satisfactory. If the Current Ratio is too high , it could indicate problems such as: the company has too much inventory or they are not investing their excess cash in a productive way. Current Ratio

12. Current Ratio Y1 current ratio indicated that The College Shop had $3 of current assets for every $1 of current liabilities. In Y2 it had $4 of current assets for every $1.00 of current liabilities. So…. It appears that the College Shop should have no trouble meeting its current obligations….but wait! The average current ratio for the industry is 2.42.….

13. What does it mean??? The College Shop current ratio might actually be too high!! We need to look very closely at each of the current assets… Perhaps they have too much cash on hand that might otherwise be used for paying down a loan or buying other assets that can generate revenue for the firm. What do their accounts receivables consist of? This is $$ we expect to come in. Are we correct in assuming it will???

14. What does it mean??? How about the inventory? Do we have too much? How liquid is it? Is it mostly raw materials, work in process, or finished goods? It matters because things like wip cannot easily be turned into cash. How old is it? Is it as valuable as you think? Although you may “appear” to have have a healthy current ratio, you can still not be able to pay your bills on time.

15. The Profit show…. A. Stein Meats

16. Debt-to-Equity Ratio Debt-to-equity ratio examines a company’s financial “leverage”( basically,the riskiness of a company’s capital structure). It indicates the relationship between funds acquired from creditors (debt) and funds invested by owners (equity). It answers the question “how much debt is a company using to finance its assets relative to the value of the shareholder's equity.

17. Debt-to-Equity Ratio In Y1, the ratios of 1 indicates that The College Shop has an equal amount of equity and debt (for every $1 of equity, it has $1 of debt) In Y2, the company has more equity than debt. For every $1 in equity, it now has $.85 in debt.

18. What does it mean??? In Y1, the ratios of 1 indicates that The College Shop has an equal amount of equity and debt (for every $1 of equity, it has $1 of debt) In Y2, the company has more equity than debt. For every $1 in equity, it now has $.85 in debt. Capital-intensive industries (like the auto industry) tend to have a D/E ratio above 2, while companies that are not particularly capital intensive may often have a D/E ratio of under .50 … In the case of The College Shop, the industry average was .49 , so we would say that their ratio was too high !!!

19. What does it mean??? A high D/E ratio generally means that a company has been aggressive in financing its growth with debt! Both investors and lenders prefer to deal with firms whose owners have invested enough of their own money to avoid overreliance on borrowing. Think about it this way.. If you had 2 friends that wanted to borrow money from you and one had a substantial amount of debt already, who would you be more likely to loan money to?