Essentials of Managerial Finance

1
Chapter 11 Analysis of Financial Statements
2
Financial Statements and Reports
The Income Statement

• The income statement provides a financial summary
  of a companys 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.

3
Penny Ltd. Income Statement
Sales 80,000 Variable operating
costs (60,000) Fixed costs, excluding
depreciation (12,000) Depreciation ( 2,000) EBIT
NOI 6,000 Interest ( 1,000) Earnings before
taxes (EBT) 5,000 Taxes (40) ( 2,000) Net
income 3,000 Dividends 2,000 Addition to
retained earnings 1,000

4
Financial Statements and Reports
The Balance Sheet

• The balance sheet presents a summary of a firms
  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.

5
Penny Ltd. Balance Sheet
Current Current Year Year Cash
securities 2,000 Accounts payable
4,000 Accounts receivable 6,000 Accruals 5,000
Inventory 7,000 Notes payable 1,000
Current assets 15,000 Current
liabilities 10,000 Net fixed assets 10,000
Long-term debt 6,000 Total assets 25,000
Total liabilities 16,000 Common
stock 6,000 Retained earnings 3,000
Owners equity 9,000 Total liabilities
equity 25,000

6
Penny Ltd. Balance SheetChanges in Assets
Current Previous Year Year
Change Cash securities 2,000 1,000 Accou
nts receivable 6,000 5,000 Inventory 7,000
8,000 Current assets 15,000 14,000 Net fixed
assets 10,000 9,000 Total
assets 25,000 23,000
Source Use
1,000 (1,000) 1,000

X X X

Fixed assets if no purchases or sales 9,000 -
2,000 7,000 Depreciation 2,000 Change in
fixed assets 10,000 - 7,000 3,000
Sources of Cash Uses of Cash ? Asset Account ?
Asset Account
7
Penny Ltd. Balance SheetChanges in Liabilities
and Equity
Current Previous Year Year Accounts
payable 4,000
2,000 Accruals 5,000 4,000 Notes payable 1,000
2,000 Current liabilities 10,000 8,000 Long-term
debt 6,000 7,000 Total liabilities 16,000 15
,000 Common stock 6,000 6,000 Retained earnings
3,000 2,000 Owners equity 9,000 8,000 Total
liabilities equity 25,000 23,000
Change 2,000 (1,000) (1,000) 1,000
Source Use


X X X X

Sources of Cash Uses of Cash ? Liability/Equity
Account ? Liability/Equity Account
8
Financial Statements and Reports
Statement of Cash Flows

• The statement of cash flows provides a summary of
  the cash flows over the period of concern,
  typically the year just ended.
• This statement not only provides insight into a
  companys investment, financing and operating
  activities, but also ties together the income
  statement and previous and current balance sheets.

9
Penny Ltd. Statement of Cash Flows
Cash Flows from Operations Net income
(NI) 3,000 Adjustments to NI Depreciation
2,000 ? Inventory 1,000 ? Accounts payable
2,000 ? Accruals 1,000 ? Accounts
receivable (1,000) Net CF from operations
8,000 Cash Flows from Long-Term
Investing Acquisition of assets (3,000)
Cash Flows from Financing Activities ? Notes
payable (1,000) ? Long-term bonds (1,000)
Dividend payment (2,000) Net CF from
financing (4,000) Net Change in
cash 1,000 Cash at beginning of year 1,000 Cash
at end of year 2,000

10
Notes to the Financial Statements

• Notes to the financial statements provide
  detailed information on the accounting policies,
  procedures, calculations, and transactions
  underlying various entries in the financial
  statements.
• Common issues include revenue recognition, income
  taxes, breakdowns of fixed asset accounts, debt
  and lease terms, and contingencies.

11
Financial StatementsTime Dimension

• Balance sheeta snapshot of where the firm is
  at a specific point in time (stock statement).
• Income statement and statement of cash
  flowsshows the results of the firms activities
  over a period of time (flow statement).

12
Ratio (Financial Statement) Analysis

• General categories of analysis
• Liquidity
• Asset management
• Debt management
• Profitability
• Market value

13
Liquidity Ratios
Provide an indication of how well the firm can
meet its current obligations

• Help measure the liquidity position of the firm
• Too little, or too much liquidity could be
  considered a bad sign
• too little liquiditysuggests the firm will have
  problems paying its current obligations in the
  future
• too much liquiditymight suggest the firm is not
  investing its funds wisely

14
Liquidity Ratios
Current ratio total current assets
total current liabilities
Quick ratio Total Current Assets -
Inventory total current
liabilities

15
Asset Management Ratios

Provide an indication of how well the firm
manages its assets (efficiency)

• Show how often the firm is turning over its
  assets to generate funds
• Generally, when assets are not turned over
  quickly enough, it is because sales have slowed
  or current assets, such as inventory and
  receivables, are too high
• If assets are turned over too quickly, it could
  mean that the firm is not producing enough

16
Asset Management Ratios
Inventory Turnover Cost of Goods Sold
Inventory
DSO Days Sales Outstanding Receivables
Average sales per day
Fixed assets turnover ratio Sales
Net fixed assets
Total Asset Turnover Sales
Total Assets


17
Debt Management Ratios
Indicate how the firms financial position is
affected by the amount of debt it has

• financial leverage refers to the use of debt
• leverage helps to magnify returns, on both the
  positive and the negative sides, because debt
  represents a fixed obligation

18
Debt Management Ratios
Debt Ratio Total Liabilities/Total Assets

Times Interest Earned EBIT/Interest charges
Fixed charge coverage ratio EBIT Lease
Pymts Interest Lease Pymts (Princ
Pymts PSD) x 1/(1-t)




19
Profitability ratios

• Indicate how the firms management of its
  liquidity position, assets, and debt has affected
  normal operating activities.

20
Profitability Ratios
Profit Margin on Sales Net Income/ Sales

Return on Total Assets Net Income/ Total Assets
Return on Common Equity Net Income available to
common stockholders / Common equity




21
Market Value Ratios

• Measures that consider the value of the firms
  stock in the financial marketsthat is, how well
  investors perceive that the firm is creating
  value.

22
Market Value Ratios
P/E Market Price Per Share of Common Stock
Earnings Per Share
M/B Market Price Per Share of Common Stock
Book Value Per Share of Common Stock
23
Trend and Comparative Analyses

• Ratios should be evaluated
• At a point in time in comparison to a norm, such
  as an industry average, to determine the firms
  current financial position (comparative
  analysis).
• Over time to determine whether the firms current
  financial position is improving or deteriorating
  (trend analysis).

24
Using Financial Ratios
Types of Ratio Comparisons