Chapter6FinancialStatementAnalysis

1、 ?Study objectives Chapter 6: Financial Statement Analysis -Review finan cial stateme nts -A possible framework for an alysis -Balance sheet ratios -Income statement and income statement/balance sheet ratios -Trend analysis -Common size and index analysis 1.What is financial analysis ?Analysis is to

2、 interpret certain information for decision purpose ?Financial analysis involves analyzing financial statements prepared in accordance with generally accepted accounting principles to ascertain information concerning the magnitude, timing, and riskness of future cash flows Different purpose of finan

3、cial analysis ?The firm itself and outside providers of capital-creditors and investors-all undertake financial analysis. The type of analysis varies according to the specific interests of the party involved ?Trade creditors (suppliers) are interested in the liquidity of a firm ?The claims of bondho

4、lders (bankers or other creditors) are more interested in the cash-flow ability of the firm to service debt over a long period of time ?Investors in a companys common stock are principally concerned with present and expected future earnings as well as with the stability of these earnings about a tre

5、nd line ?Management also employ financial analysis for the purpose of internal control and to better provide what capital suppliers seek in financial condition Financial statements ?See page 128 -129 balance sheet and income statement ?The probable defect of financial statements analysis: window dre

6、ss (see page 135) 3.Use of financial ratios ?Financial ratio is an index that relates two accounting numbers and is obtained by dividing one number by the other -Financial statements give the analyst a lot of accounting numbers, so why bother with a ratio? For the reason of comparison among firms 3.

7、1Internal comparisons ?The analysis of financial ratios involves two types of comparison. - the comparison of a present ratio with past and expected future ratio for the same company -comparing the ratios of one firm with those of similar firms or with industry averages at the same point in time ?Th

8、e meaning of internal comparison -when financial ratios are arrayed over a period of years, the analyst can study the composition of change and determine whether there has been an improvementor deterioration in the firms financial condition and performance overtime 3.2External comparisons ?The purpo

9、se of external comparison -gives insight into the relative financial condition and performance of the firm; helps us identify any significant deviation from any applicable industry average (or standard). 3.3Types of ratios ?The commonly used financial ratios are of essentially two kinds. at a point

10、in time. - The first kind summarizes some aspect of the firms “financial condition” We call these balance sheet ratios, because both the numerator and denominator in each ratio come directly from the balance sheet. The second kind of ratio summarizes some aspect of a firm s performanee over a period

11、 of time. These ratio are called either income statement or income statement/balance sheet ratios ?Income statement ratios compare one flow item from the income statement to another flow item from the income statement ?Income statement/balance sheet ratio compare a flow (income statement) item in th

12、e numerator to a stock item in the denominator -Compari ng a flow item to a stock item poses a pote ntial problem for the an alyst. We run the risk of a possible mismatch of variables. Therefore, where appropriate, we may need to use an “average ”balancesheet figure in the denominator of an income s

13、tatement/balance sheet ratio to make the denominator more representative of the entire period 3.4Types of ratios ?Additionally, we further subdivide our financial ratios into five distinct types: liquidity, financial leverage, coverage, activity, and profitability ratios (see figure 6-2 page 134) ?N

14、o one ratio gives us sufficient information by which to judge the financial condition and performance of the firm. 3.5Balance sheet ratios ?What is liquidity? the ability of an asset to b e converted into cash without a significant price concession ?Liquidity ratios: ratios that measure a firms abil

15、ity to m-teermtsohbolritgations -Liquidity ratios compare short-term obligati ons to short-term resources available to meet these obligations -Short-term creditors pay attention to these ratios, because they indicate the present cash solvency of the firm 3.6Liquidity ratios ?Current ratio: current a

16、ssets divided by current liabilities. -Assumption: the current liability will be due within a year, and current assets will change into cash within a year, so the current liabilities will be paid back by current assets -Example: Aldine Manufacturing company page 134, -Comparisons with industry avera

17、ges are meaningful in identifying companies that are out of line -The current ratio is regarded as a crude measure because it does not take into account the liquidity of the individual components of the current assets ?Acid-test (quick) ratio: current assets less inventories divided by current liabi

18、lities. -Assumption: the current liabilities will be due in a short time, so only those assets with strong liquidity could be used to meet the obligations -It shows a firm s ability to meet current liabilities with its most liquid assets -Example of Aldine Corporation and summary of its liquidity: p

19、age 136 3.7 Financial leverage ratios ?Financial leverage means that the use of debt financing can bring more earnings ability to firm, because the interest is fixed. ?If the firm s profitability surpasses the interesrtate, the firm will earn more with more debt financing. -We shall study it later i

20、n corporate finance. 3.8 Debt ratios ?Debt ratios show the extent to which the firm is financed by debt ?The bigger the debt ratios, the bigger is the firms finagnecial lever ?Debt-to-equity ratio is computed by simply dividing the total debt of the firm (including current liabilities) by its shareh

21、olders equity -The Ion g-term creditors will show great in terest i n this ratio, because the lower the ratio, the higher the lev el of the firm s financing is provided by shareholders, and the larger the creditor cushion in the event of shrinking asset values or outright losses -Depending on the pu

22、rpose for which the ratio is used , preferred stock is sometimes included as debt rather than as equity when debt ratios are calculated ?The ratio of debt to equity will vary according to the nature of the business and the variability of cash flows ?A comparison of the debt -to-equity ratio for a gi

23、ven company with those of similar firms gives us a general indication of the creditworthness and financial risk of the firm ?Debt-to-total- assets ratio is to divide a firms total debt by its total assets ?This ratio serves a similar purpose to the debt -to-equity ratio ?The computation of Aldine is

24、 on page 137. how to explain the results?3.9 Income statement and income statement/balance sheet ratios ?Coverage ratios: ratios that relate the financial charges of a firm to its ability to service or cover them -Bond rating service and creditors (such as banks) make extensive use of these ratios ?

25、Interest coverage ratio: earnings before interest and taxes divided by interest charges. - It indicates a firm s ability to cover interest charges. - It also sheds some light on the firms capacity to take odnenbet w ?For Aldine, in fiscal year 20 x2 this ratio is $400000/$85000=4.71. with an industr

26、y median average of 4.0, Aldine s ability to cover annual interest appears to provide a good margin of safety ?A broader type of analysis would evaluate the ability ofthe firm to cover all charges of a fixed nature. We shall discuss the topic later 3.10 Activity ratios ?Activity ratios, also known a

27、s efficiency or turnover ratios, measure how effectively the firm is using its assets -how effectively the firm is using its assets is measured by the recycling speed of assets, why? ?In computing activity ratios for the Aldine, we use year -end asset levels. However, an average of monthly, quarterl

28、y, or beginning and year-end balance is often employed (more representative of the entire period, not just year end) Receivables activity ?Receivable turnover ratio=annual net credit sales/average amount of receivables ?Assume that all 20 x2 sales for Aldine are credit sales, Receivable turnover rat

29、io is: $3992000/$678000=5.89. The median industry receivable turnover ratio is 8.1. So Aldine s receivables are considerably slower in turning over. ?This might be an indication of a lax collection policy and a number of past-due accounts. ?If receivables are far from being current, we may have to r

30、eassess the firm lisquidity ?When sales are season or have grown considerably over the year, using the year-end receivable balance may not be appropriate. -With seasonality, an average of the monthly closing balances may be the most appropriate. With growth, an average of receivables at the beginnin

31、g and end of the year might be appropriate ?Receivable turnover in days=days in the year/receivable turnover -Although too high an average collect ion period is usually bad, a very low average collection period may not be good (maybe a excessively restrictive credit policy) ?Aging accounts receivabl

32、es (see page140) -The purpose of this is to make out how much receivables is past due, to further understand the liquidity of the firm Payables activity ?Aging of accounts payable ?Payable turnover ratio=annual credit purchases/average of accounts payable ?Payable turnover in days=days in the year/p

33、ayable turnover ?The average payable period is valuable information in valuating the probability that a credit applicant will pay on time Inventory activity ?Inventory turnover ratio=cost of goods sold/inventory ?For Aldine, the ratio for 20 x2 is $2680000/$1329000=2.02, and the industry median is 3

34、.3. What does it mean? ?As with receivables, growth and seasonality, a verage amount is always favored Generally, the higher the inventory turnover, the more efficient the inventory management of the firm and“ fresher ” the inventory. However, sometimes a high inventory turnover may be a symptom of

35、maintaining too low a level of inventory and incurring frequent stockout ?Inventory turnover in days=days in the year/inventory turnover Operating cycle ?Operating cycle is the length of time from the commitment of cash for purchases until the collection of receivables resulting from the sale of goo

36、ds or services ?Mathematically, a firm osperating cycle is equal to inventory turnover in days plus receivable turnover in days ?If we want to measure the length of time from the actual outlay of cash for purchase until the collection of cash from sales, cash cycle equals to operating cycle less pay

37、able turnover in days ?Why worry about the firm s operating cycle? The length of the operating cycle is an important factor in determining a firm s current asset needs. A firm with a very short operating cycle can operate effectively with a relatively small amount of current assets and relatively lo

38、w current and acid-test ratios A second look at Aldine s liquidity?Aldines curren-tteasntdratcioids compared favorably to industry median ratios. However, the turnover ratios for both of these assets, and the resulting operating cycle, are significantly worse than the industry median values. These f

39、indings suggest that the two assets are not entirely current,this factor detracts from the favorable current and quick ratios Total asset (or capital) turnover ratio ?Total asset turnover= net sales/total assets ?Aldine tsotal asset turnover for fiscal -year 20 x2 is $3992000$3250000=1.23. The media

40、n total asset turnover for the industry is 1.66, so it is clear that Aldine generates less sales revenue per dollar of asset investment 3.11Profitability ratios ?Ratios that relate profits to sales and investment ?Is there a relation between profit and sales/investment? From the viewpoint of industr

41、y and the investors Profitability in relation to sales ?Gross profit margin=(net sales -cost of goods sold)/net sales ?A measure of the efficiency of the firm s operations (why). Price is fluctuate with the total demand and supply, while the cost is determined by internal operation ?An indication of

42、 how products are priced Example of Aldine ?For Aldine, the gross profit margin for fiscal -year 20 x2 is $1312000/$3992000=32.9%. ?It is significantly above the median of 23.8% of the industry, indicating that it is relativel y more efficient at producing and selling products above cost Profitabili

43、ty in relation to sales ?Net profit margin=(net profit after tax)/net sales ?A measure of the firm psrofitability of sales after taking account of all expenses and income taxes ?Why we “ make” this ratio? All the expenses aim at revenue, while net profit is the final goal of the firm Example of Aldi

44、neFor Aldine, this ratio for fiscal-year 20 x2 is $201000/$3992000=5.04%. It is above the median net profit margin (4.7%) for the industry, which indicates that it has a higher level of“ sales profitability ” than most of other firms in thePirnodfiutasbtriylity in relation to investment ?ROI=(net profit after tax)/total assets ?For Aldine, ROI for fiscal -year 20 x2 is $201000/$3250000=6.18%. This ratio compares unfavorably to a median value of 7.8% for the industry. What is the probable cause? ROI and Du Pont Approach ?ROI=Net Profit Marginxtotal asset turnover ?Why