Financial Statement Analysis chapter-3.ppt

In finance it is very important to have proper knowledge about all the financial statement and after that ratio analysis so that we can easily understand the position or condition of the firm at the particular time or moment.so in this slides i have tried to explain those thing ,

1. Chapter 3:
Financial Statement and Ratio Analysis
Chapter

2. Businesses report information in the form of financial
statements issued on a periodic basis. GAAP requires the
following four financial statements.
Balance Sheet-statement of financial position at a given point in
time.
Income Statement-revenues minus expenses for a given time
period ending at a specified date.
Statement of Owner's Equity-also known as Statement of
Retained Earnings or Equity Statement.
Statement of Cash Flows-summarizes sources and uses of cash;
indicates whether enough cash is available to carry on routine
operations.

3. Financial Statements
The Income Statement
The income statementprovides a financial
summary of a company’s operating results
during a specified period.
Although they are prepared annually for reporting
purposes, they are generally computed monthly
by management and quarterly for tax purposes.

4. Financial Statements

5. Financial Statements

6. Financial Statements
The Balance Sheet
The balance sheetpresents a summary of a firm’s
financial position at a given point in time.
Assets indicate what the firm owns, equity
represents the owners’ investment, and liabilities
indicate what the firm has borrowed.

7. Financial Statements

8. Financial Statements

9. Financial Statements
Statement of Retained Earnings
The statement of retained earningsreconciles
the net income earned and dividends paid during
the year with the change in retained earnings.

10. Financial Statements
Table 8.3

11. Statement of Cash Flows
The statement of cash flowsprovides a summary
of the cash flows over the period of concern,
typically the year just ended.
This statement not only provides insight into a
company’s investment and financing and operating
activities, but also ties together the income statement
and previous and current balance sheets .For a given
period, the cash flow statement provides the following
information:
Sources of cash
Uses of cash
Change in cash balance

12. The cash flow statement is a cash basisreport
on three types of financial activities:
Operating Cashflow are directly related to sale
and production of firm’s product and services.
Investment Cashflow associated with purchase
and sale of both fixed asset and business
interest.
Financing Cashflow resulting from debt and
equity financing structure.

13. Operating cash flows include:
Receipts from the sale of goods or services
Receipts for the sale of loans, debt or equity instruments
in a trading portfolio
Interest received on loans
Dividends received on equity securities
Payments to suppliers for goods and services
Payments to employees or on behalf of employees
buying Merchandise
Depreciation
Deferred tax
Amortization (loss of intangible asset value over time)
Any gains or losses associated with the sale of a non-
current asset, because associated cash flows do not
belong in the operating section.

14. Investing activities are
Purchase or Sale of an asset (assets can be land,
building, equipment, marketable securities, etc.)
Loans made to suppliers or received from customers
Payments related to mergers and acquisitions
Financing activities
Proceeds from issuing short-term or long-term debt
Payments of dividends
Payments for repurchase of company shares
Repayment of debt principal, including capital leases
For non-profit organizations, receipts of donor-restricted
cash that is limited to long-term purposes

15. Table 8.4

16. Financial Performance analysis serves the
following purposes :
Analysis of financial statements is an attempt to assess the
efficiency and performance of an enterprise.
The analysis and interpretation of financial statements is very
essential to measure the efficiency, profitability, financial
soundness and future prospects of the business units.
-Measuring the profitability
-Indicating the trend of Achievements
-Assessing the growth potential of the business
-Comparative position in relation to other firms
-Assess overall financial strength
-Assess solvency of the firm

17. Using Financial Ratios
Interested Parties
Ratio analysisinvolves methods of calculating
and interpreting financial ratios to assess a firm’s
financial condition and performance.
It is of interest to shareholders, creditors,
and the firm’s own management.

18. Types of Ratio Comparisons
Trend or Time-Series Analysis
Used to evaluate a firm’s performance over time.
Cross-Sectional Analysis
Used to compare different firms at the same point in time.
Industry comparative analysis
One specific type of cross sectional analysis. Used to compare
one firm’s financial performance to the industry’s average
performance.
Combined Analysis
Combined analysis simply uses a combination
of both time-series analysis and cross-sectional analysis.

19. Types of Ratio Comparisons
Figure 8.1

20. Cautions for Doing Ratio Analysis
Ratios must be considered together;
a single ratio by itself means relatively little.
Financial statements that are being compared
should be dated at the same point in time.
Use audited financial statements when possible.
The financial data being compared should have
been developed in the same way.
Be wary of inflation distortions.

21. Ratio Analysis Example
Using Daton Company Financial Statements
Liquidity ratios
Activity ratios
Financial leverage ratio
Market ratios
Profitability ratios

22. Ratio Analysis
Liquidity Ratios
Current Ratio
Current ratio =
Total current assets
Total current liabilities
Current ratio =
$1,233,000
$620,000
= 1.97

23. Liquidity Ratios
Quick ratio
Ratio Analysis
Quick ratio =
Total current assets -Inventory
Total current liabilities
Quick ratio =
$1,233,000 -$289,000
$620,000
= 1.51

24. Ratio Analysis
Activity Ratios
Inventory Turnover
Inventory turnover =
Cost of goods sold
Inventory
Inventory turnover =
$2,088,000
$289,000
= 7.2

25. Ratio Analysis
Activity Ratios
Average collection period
ACP =
Accounts receivable
Net sales/360
ACP =
$503,000
$3,074,000/360
= 58.9 days

26. Ratio Analysis
Activity Ratios
Average payment period
APP =
Accounts payable
Annual purchases/360
APP =
$382,000
(.70 x$2,088,000)/360
= 94.1 days

27. Activity Ratios
Total asset turnover
Ratio Analysis
Total asset turnover =
Net sales
Total assets
Total asset turnover =
$3,074,000
$3,579,000
= .85

28. Financial Leverage Ratio
Debt ratio
Ratio Analysis
Debt ratio =
Total liabilities
Total assets
Debt ratio =
$1,643,000
$3,579,000
= 45.7%

29. Leverage Ratios
Times interest earned ratio
Ratio Analysis
Times interest earned =
EBIT
Interest Expense
Times interest earned =
$418,000
$93,000
= 4.5

30. Leverage Ratios
Fixed-payment coverage ratio (FPCR)
Ratio Analysis
FPCR =
EBIT + Lease pymts
Interest + Lease pymts + {(Princ pymts + PSD) x[1/(1 -t)]}
FPCR =
$418,000 + $35,000
$93,000 + $35,000 + {($71,000 + $10,000) x[1/(1 -.29)]}
= 1.9

31. Profitability Ratios
Gross profit margin
Ratio Analysis
GPM =
Gross profit
Net sales
GPM =
$986,000
$3,074,000
= 32.1%

32. Profitability Ratios
Operating profit margin
Ratio Analysis
OPM =
EBIT
Net sales
OPM =
$418,000
$3,074,000
= 13.6%

33. Profitability Ratios
Net profit margin
Ratio Analysis
NPM =
Net profits after taxes
Net sales
NPM =
$231,000
$3,074,000
= 7.5%

34. Profitability Ratios
Return on total assets (ROA)
Ratio Analysis
ROA =
Net profits after taxes or EACS
Total assets
ROA =
$231,000
$3,597,000
= 6.4%

35. Profitability Ratios
Return on equity (ROE)
Ratio Analysis
ROE =
Net profits after taxes or EACS
Stockholders’ equity
ROE =
$231,000
$1,954,000
= 11.8%

36. Profitability Ratios
Earnings per share (EPS)
Ratio Analysis
EPS =
Earnings available to common stockholder
Number of shares outstanding
EPS =
$221,000
76,262
= $2.90

37. Market Ratios
Price earnings (P/E) ratio
Ratio Analysis
P/E =
Market price per share of common stock
Earnings per share
P/E =
$32.25
$2.90
= 11.1

38. Market Ratios
Market/book (M/B) ratio
Ratio Analysis
M/B =
Market price per share of common stock
Book value per share of common stock
M/B =
$32.25
$23.00
= 1.40

39. Summarizing All Ratios

40. Summarizing All Ratios
Table 8.7 (Panel 2)

41. Profitability Ratios
Common-size income statements
Ratio Analysis

42. DuPont System of Analysis
The DuPont systemis used to dissect the firm’s
financial statements and to assess its financial
condition.
It merges the income statement and balance sheet
into two summary measures of profitability: ROA
and ROE as shown in Figure 8.2 on the following
slide.
The top portion focuses on the income statement,
and the bottom focuses on the balance sheet.
The advantage of the DuPont system is that it
allows
you to break ROE into a profit-on-sales component,
an efficiency-of-asset-use component, and a use-of-
leverage component.

43. DuPont Analysis
A method of performance measurement that was started by the
DuPont Corporation in the 1920s. With this method, assets are
measured at their gross book value rather than at net book value in
order to produce a higher return on equity (ROE).It is also known as
"DuPont identity".
DuPont analysistells us that ROE is affected bythree things:
-Operating efficiency, which ismeasured by profit margin
-Asset use efficiency, which is measured by total asset turnover
-Financial leverage, which ismeasured by the equity multiplier
ROE = Profit Margin (Profit/Sales)* Total Asset Turnover
(Sales/Assets)* Equity Multiplier (Assets/Equity)

44. DuPont Analysis
Utilizing all three ratios, the DuPont Analysis provides deeper
insight into the health of the organization versus the simple
ROE calculation (annual earnings/ shareholder's equity).
For instance, if a company's return on equity increases
because of an improved net profit margin (net income/sales)
or due to increased asset turnover (sales/assets), this is a
very positive sign. But, if the assets to equity result is the
reason for the increase, the company could very well be over
leveraged (too much debt), which puts the company in a more
risky situation.
While the DuPont Analysis is a good starting point when
analyzing the creditworthiness of an organization, the result is
not meaningful unless compared to an industry benchmark. If
such a benchmark is not available, you should at least do a
trend analysis of the same company's return on equity over 3
or more years.

45. DuPont System of Analysis
Figure 8.2

46. DuPont System of Analysis
Figure 8.2 (Panel 1)

47. DuPont System of Analysis
Figure 8.2 (Panel 2)