1. 4-1 Business Finance (MGT 232) Lecture 20

2. 4-2 Financial Statement Analysis

3. 4-3 Cash Management Cash management System Collection float Mail float Processing float Availability float Deposit float Lock Box system Cash Budget Overview of the Last Lecture

4. 4-4 Financial Statement Analysis Financial Statements A Possible Framework for Analysis Ratio Analysis Trend Analysis Common-Size and Index Analysis Financial Statements A Possible Framework for Analysis Ratio Analysis Trend Analysis Common-Size and Index Analysis

5. 4-5 Examples of External Uses of Statement Analysis Trade Creditors Trade Creditors -- Focus on the liquidity of the firm. Bondholders Bondholders -- Focus on the long-term cash flow of the firm. Shareholders Shareholders -- Focus on the profitability and long-term health of the firm. Trade Creditors Trade Creditors -- Focus on the liquidity of the firm. Bondholders Bondholders -- Focus on the long-term cash flow of the firm. Shareholders Shareholders -- Focus on the profitability and long-term health of the firm.

6. 4-6 Examples of Internal Uses of Statement Analysis Plan Plan -- Focus on assessing the current financial position and evaluating potential firm opportunities. Control Control -- Focus on return on investment for various assets and asset efficiency. Understand Understand -- Focus on understanding how suppliers of funds analyze the firm. Plan Plan -- Focus on assessing the current financial position and evaluating potential firm opportunities. Control Control -- Focus on return on investment for various assets and asset efficiency. Understand Understand -- Focus on understanding how suppliers of funds analyze the firm.

7. 4-7 Primary Types of Financial Statements Income Statement – A summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period. Income Statement – A summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period. Balance Sheet u A summary of a firm’s financial position on a given date that shows total assets = total liabilities + owners’ equity. Balance Sheet u A summary of a firm’s financial position on a given date that shows total assets = total liabilities + owners’ equity.

8. 4-8 Basket Wonders’ Balance Sheet (Asset Side) a. How the firm stands on a specific date. b. What BW owned. c. Amounts owed by customers. d. Future expense items already paid. e. Cash/likely convertible to cash within 1 year. f. Original amount paid. g. Acc. deductions for wear and tear. a. How the firm stands on a specific date. b. What BW owned. c. Amounts owed by customers. d. Future expense items already paid. e. Cash/likely convertible to cash within 1 year. f. Original amount paid. g. Acc. deductions for wear and tear. Cash and C.E. Rs. 90 c Acct. Rec. c 394 Inventories 696 d Current Assets e Rs. 1,195 f g Net Fix. Assets Rs. 701 Total Assets b Rs.2,169 Prepaid Exp d 5 Accum Tax Prepay 10 Current Assets e Rs. 1,195 Fixed Assets (@Cost) f 1030 Less: Acc. Depr. g (329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223 Total Assets b Rs.2,169 Basket Wonders Balance Sheet (thousands) Dec. 31, 2013 Basket Wonders Balance Sheet (thousands) Dec. 31, 2013 a

9. 4-9 Basket Wonders’ Balance Sheet (Liability Side) a. Note, Assets = Liabilities + Equity. b. What BW owed and ownership position. c. Owed to suppliers for goods and services. d. Unpaid wages, salaries, etc. e. Debts payable < 1 year. f. Debts payable > 1 year. g. Original investment. h. Earnings reinvested. a. Note, Assets = Liabilities + Equity. b. What BW owed and ownership position. c. Owed to suppliers for goods and services. d. Unpaid wages, salaries, etc. e. Debts payable < 1 year. f. Debts payable > 1 year. g. Original investment. h. Earnings reinvested. c d d Current Liab. e Rs. 500 f g g h Total Equity Rs. 1,139 Notes Payable Rs. 290 Acct. Payable c 94 Accrued Taxes d 16 Other Accrued Liab. d 100 Current Liab. e Rs. 500 Long-Term Debt f 530 Shareholders’ Equity Com. Stock (Rs.1 par) g 200 Add Pd in Capital g 729 Retained Earnings h 210 Total Equity Rs. 1,139 Total Liab/Equity a,b Rs.2,169 Basket Wonders Balance Sheet (thousands) Dec. 31, 2013

10. 4-10 Basket Wonders’ Income Statement a. Measures profitability over a time period. b. Received, or receivable, from customers. c. Sales comm., adv., officers’ salaries, etc. d. Operating income. e. Cost of borrowed funds. f. Taxable income. g. Amount earned for shareholders. a. Measures profitability over a time period. b. Received, or receivable, from customers. c. Sales comm., adv., officers’ salaries, etc. d. Operating income. e. Cost of borrowed funds. f. Taxable income. g. Amount earned for shareholders. b c f Increase in RE Rs. 53 Net Sales Rs. 2,211 Cost of Goods Sold b 1,599 Gross Profit Rs. 612 SG&A Expenses c 402 EBIT d Rs. 210 Interest Expense e 59 EBT f Rs. 151 Income Taxes 60 EAT g Rs. 91 Cash Dividends 38 Increase in RE Rs. 53 Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2013 Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2013 a

11. 4-11 Framework for Financial Analysis Analytical Tools Used Sources and Uses Statement Statement of Cash Flows Cash Budgets Analytical Tools Used Sources and Uses Statement Statement of Cash Flows Cash Budgets 1. Analysis of the funds needs of the firm. needs of the firm. Trend / Seasonal Component How much funding will be required in the future? Is there a seasonal component? Trend / Seasonal Component How much funding will be required in the future? Is there a seasonal component?

12. 4-12 Framework for Financial Analysis Health of a Firm Financial Ratios 1. Individually 2. Over time 3. In combination 4. In comparison Health of a Firm Financial Ratios 1. Individually 2. Over time 3. In combination 4. In comparison 1. Analysis of the funds needs of the firm. 2. Analysis of the financial condition and profitability condition and profitability of the firm. of the firm.

13. 4-13 Framework for Financial Analysis Examples: Volatility in sales Volatility in costs Proximity to break-even point Examples: Volatility in sales Volatility in costs Proximity to break-even point 1. Analysis of the funds needs of the firm. 2. Analysis of the financial condition and profitability of the firm. 3. Analysis of the business risk of the firm. risk of the firm. Business risk Business risk relates to the risk inherent in the operations of the firm.

14. 4-14 Framework for Financial Analysis A Financial Manager must consider all three jointly when determining the financing needs of the firm. Determiningthefinancing needs of the firm. 1. Analysis of the funds needs of the firm. needs of the firm. 2. Analysis of the financial condition and profitability condition and profitability of the firm. of the firm. 3. Analysis of the business risk of the firm. risk of the firm.

15. 4-15 Framework for Financial Analysis Negotiationswith suppliers of capital. Determiningthefinancing needs of the firm. 1. Analysis of the funds needs of the firm. needs of the firm. 2. Analysis of the financial condition and profitability condition and profitability of the firm. of the firm. 3. Analysis of the business risk of the firm. risk of the firm.

16. 4-16 Use of Financial Ratios Types of Comparisons Internal Comparisons External Comparisons Types of Comparisons Internal Comparisons External Comparisons A Financial Ratio is an index that relates two accounting numbers and is obtained by dividing one number by the other.

17. 4-17 What are the five major categories of ratios, and what questions do they answer? Liquidity: Can we make required payments in the short run? Asset management: right amount of assets vs. sales? Debt management, leverage: Right mix of debt and equity? Profitability: Do sales prices exceed unit costs, and are sales high enough as reflected in PM, ROE, and ROA? Market value: Do investors like what they see as reflected in P/E and M/B ratios?

18. 4-18 External Comparisons and Sources of Industry Ratios similar This involves comparing the ratios of one firm with those of similar firms or with industry averages. Similarity Similarity is important as one should compare “apples to apples.”

19. 4-19 Summary Financial Statements A Possible Framework for Analysis Ratio Analysis – Liquidity Ratios » Current ratio » Quick-asset ratio » Net working Capital