Presentation on theme: "1 Introduction to Financial Statement Analysis smartwomansecurities October 25, 2006 Carolyn Clark Harvard Business School These materials are made for."— Presentation transcript:
1 Introduction to Financial Statement Analysis smartwomansecurities October 25, 2006 Carolyn Clark Harvard Business School These materials are made for educational purposes and should not be distributed. All materials are for SWS members use only
3 Industry Teams –Meet your team members; talk about your company s business and its competitors Industry Mentors –Your Industry Mentor will be ed to you this week; correspondence with Industry Mentors should be made as a group. For more details about Industry Mentors, check out the Mentor sheet you received last week!
4 Senior Mentors –Senior Mentors are another optional resource for SWS members. –We currently have several Senior Mentors that we want to pair up with interested members; Senior Mentors are senior-level executives and professionals that have been highly successful in their various fields. –We will send out information about Senior Mentors in an after this seminar; in order to get a Senior Mentor, you will have to write a short paragraph detailing why you would like to have that person as your Senior Mentor. –Depending on demand, we will likely only have 1-2 mentees per Senior Mentor.
5 Senior Mentors Jodi Tan, Chief Financial Officer, Chimay Capital Management Emily Grimes Wood, Financial Advisor, Grimes and Company Eva Valentine, Principal Executive Officer, Aegis Financial Strategies –We will you the bios of these women after the seminar in order for you to get a better sense of what they do. –We will update you as more opportunities to get Senior Mentors arise!
8 Accessing Financial Statements How do investors get access to financial statements? –A public company s financial statements MUST be available to the public (further requirements as mandated by Sarbanes-Oxley, an act passed by Congress in 2002 to fight fraud in corporations) –Look at your company s website and find their 10K (annual report) or 10-Q (quarterly report) – this is usually found under SEC Filings or something similar
9 Accessing Financial Statements Public Companies:
14 Balance Sheet: Its Components Assets: A company s resources Liabilities: Claims against the company s resources Owner s Equity: Remaining Claims accruing to owners Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
15 Assets Assets generate probable future economic benefits (value) for the company Examples: Cash, Accounts Receivable, Supplies, Inventory, Property and Equipment, Furniture, etc. Current Assets: Assets that can be converted to cash within one year or the operating cycle, whichever is longer (ie. cash, receivables, inventory) Non-Current Assets: Assets that are not expected to be converted to cash within that time period: property, plants, equipment, investments and funds Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
16 Liabilities Liabilities are obligations to deliver something of value (usually cash or services) in the future Examples: Accounts Payable, Salaries Payable, Interest Payable, Note Payable Current Liabilities: Obligations that are expected to be paid within one year (ie. notes payable, accounts payable, etc) Non-Current Liabilities: Obligations that are not expected to be paid within one year or the operating cycle, whichever is longer (ie. bonds payable, long-term notes payable, pension liabilities, capital leases) Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
17 Shareholder s Equity Equity is the residual interest in the assets of an entity that remains after its liabilities are deducted Stock and Paid-in Capital Retained Earnings Treasury Stock Other Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
18 How we can read balance sheets Its usefulness –Gives information about the liquidity of a company –Long-term solvency information (the ability of a corporation to meet its long-term fixed expenses and to accomplish long-term expansion and growth) Its limitations –Assets are recorded at historical cost rather than at market value (what you paid, not what it s worth ) –Resources such as employee skills and reputation are NOT recorded on balance sheet Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001; Investopedia.com
19 An investor s look at balance sheets Current Ratio: a measure of short- term liquidity risk Current Assets/Current Liabilities –Want to see a Current Ratio > 1 (ideally between 1.5 and 2) A ratio less than 1 means that a company cant pay its bills! Anything over 2 means that the company can easily fund its current liabilities, but may be keeping cash for other purposes. Sources: What is a Strong Balance Sheet, Chris Cather, Motley Fool, fool.com, February 2, 2005
20 An investor s look at balance sheets Return on Equity: Measure of the efficiency with which a company employs its owners capital Net Income / Owners Equity –Measures the percentage return to owners on their investment (earnings per dollar invested) –Helps managers and investors gauge where to allocate their capital
21 An investor s look at balance sheets Debt-to-Equity: This ratio measures the amount of long-term debt financing relative to equity in a firm s capital structure Long-term Debt / Owners Equity –Firms typically have a target debt-to-equity ratio; the degree of leverage varies across industries Note: Dont try to compare debt-to-equity ratios across different industries; in order to truly understand this ratio, must look at close peers to the company youre covering Sources: What is a Strong Balance Sheet, Chris Cather, Motley Fool, fool.com, February 2, 2005
22 Example: Balance Sheet (AEOS) American Eagle Outfitters In Millions of USD (except for per share items) 2Q061Q064Q05 Cash & Equivalents Short Term Investments Cash and Short Term Investments Accounts Receivable - Trade, Net Total Receivables, Net Total Inventory Prepaid Expenses Other Current Assets, Total Total Current Assets 1, , , Property/Plant/Equipment, Total - Gross Goodwill, Net 9.95 Long Term Investments Other Long Term Assets, Total Total Assets 1, , , Accounts Payable Accrued Expenses Notes Payable/Short Term Debt 0.00 Other Current liabilities, Total Total Current Liabilities Total Long Term Debt 0.00 Total Debt 0.00 Other Liabilities, Total Total Liabilities Common Stock, Total Additional Paid-In Capital Retained Earnings (Accumulated Deficit) 1, , Treasury Stock - Common Other Equity, Total Total Equity 1, , , Total Liabilities & Shareholders' Equity 1, , , Total Common Shares Outstanding From Google Finance
23 Income Statement
24 Income Statement Flow in a given period (vs. a given point in time) Basic equation: Net Income = Revenues – Expenses –Revenues: sources of income –Expenses: uses of income Net Income = earnings to be divided among the firm s shareholders (EPS)
25 Revenues and Expenses Revenues are inflows of resources as a result of providing goods or services to customers –Examples: Sales, interest income, gain on sale of plant assets Expenses are outflows of resources incurred in generating revenues –Examples: Cost of goods sold, selling expenses, general and administrative expenditures, depreciation, interest, income taxes Source: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
27 An investor s look at income statements Gross Profit = Revenue – Cost of Goods Sold ( COGS ) Gross Margin = Gross Profit/Revenue Operating Profit = Revenues – COGS – Remaining costs involved in operations (ie. employee compensation, advertising, expenses, etc.) Operating Margin = Operating Profit/Revenue –Operating margin measures the proportion of a company s revenue that is left over after paying for costs of operating, such as labor, raw materials, etc.) –A healthy gross margin is important for a company to pay its operating costs. The higher the margin the better! Note: Margins vary widely by industry. For example, software companies (ie, Microsoft) tend to have high margins, whereas retailers (ie, Wal-Mart) tend to have low margins –Why? (Hint: think about the value-add each company offers its customers. How replicable are the goods/services each company is offering?) Lower-margin companies like Wal-Mart can still be very profitable because they make up for their margins through selling large volumes of products Sources: Foolish Fundamentals: The Income Statement, Motley Fool, fool.com, August 25, 2006; Investopedia
28 Income Statement (AEOS) In Millions of USD (except for per share items)2Q06 1Q064Q05 Revenue Other Revenue, Total Total Revenue Cost of Revenue, Total Gross Profit Selling/General/Admin. Expenses, Total Research & Development Depreciation/Amortization Total Operating Expense Operating Income Other, Net Income Before Tax Income After Tax Net Income Before Extra. Items Net Income Preferred Dividends Income Available to Common Excl. Extra Items Income Available to Common Incl. Extra Items Basic Weighted Average Shares Basic EPS Excluding Extraordinary Items Basic EPS Including Extraordinary Items Dilution Adjustment 0.00 Diluted Weighted Average Shares Diluted EPS Excluding Extraordinary Items Diluted EPS Including Extraordinary Items Dividends per Share - Common Stock Primary Issue Diluted Normalized EPS From Google Finance
29 Statement of Cash Flows
30 Cash Flows Statement of cash flows provides relevant information about a company s cash inflows and outflows Net Income Cash!! –Net income is an accounting concept (GAAP rules); cash is king Cash flows help investors (and creditors) assess –Future funding needs –Liquidity (cash to run daily/annual operations) –Long-term solvency (ability to pay bills and service debt) Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
31 Cash Flows Cash flows come from –Operating Activities How much cash do the firms core operations generate? –Investing Activities Buying and selling non-current assets –Financing Activities How does the company buy its assets and pay its debts?
32 Cash Flows from Operating Activities Inflows –Cash received from customers –Interest income on receivables –Dividends from investments Outflows –Purchasing inventory –Salaries, wages, and other operating expenses –Interest on debt –Income taxes Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
33 Cash Flows from Investing Activities Inflows –Cash received from sales of PP&E –Sale of investments Outflows –Purchasing long-term assets (PP&E) –Purchasing investments –Acquisitions of other companies, divisions, etc. Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
34 Cash Flows from Financing Activities Inflows –Cash received from sale of equity securities –Cash received from borrowing, through bonds, loans, mortgages, etc. Outflows –Repaying debt –Paying out dividends to shareholders –Repurchasing stock in the market Sources: Intermediate Accounting; Spiceland., Sepe, Tomassini; 3rd edition; Irwin/McGraw-Hill Publishing Company, 2001
36 An investor s look at cash flows Net Operating Cash Flow: This represents the company s true cash profit. Net Investing Cash Flow: Investing activities let us know what a company may to aiming to do in the future; high investing outflow means a company may be expanding to grow a business. Free Cash Flow = Operating Cash Flow – Capital Expenditures (represents the cash that a company is able to generate after laying out the money required to maintain/expand its basset base) Net Financing Cash Flow: Financing activities let us know what a company is doing to get more cash. Note: It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run. Sources: Vince Hanks, Motley Fool, fool.com; Investopedia
37 Cash Flows (AEOS) In Millions of USD (except for per share items) 2Q06 1Q06 4Q05 Net Income/Starting Line Depreciation/Depletion Amortization Deferred Taxes Non-Cash Items Changes in Working Capital Cash from Operating Activities Capital Expenditures Other Investing Cash Flow Items, Total Cash from Investing Activities Financing Cash Flow Items Total Cash Dividends Paid Issuance (Retirement) of Stock, Net Issuance (Retirement) of Debt, Net Cash from Financing Activities Foreign Exchange Effects Net Change in Cash Cash Interest Paid, Supplemental Cash Taxes Paid, Supplemental From Google Finance
38 Key Takeaways
39 Key Points Use balance sheets to assess a company s financial position at a point in time –Look at key ratios to analyze a company s business Income statements measure performance –Look at the company s performance over time in terms of profits, margins, etc. Use statement of cash flows to follow the money –Look at where cash is going; free cash flow is a key metric!