Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Financial Statement Analysis K R Subramanyam John J Wild

6-2 1 CHAPTER Overview of Financial Statement Analysis

6-3 Information Sources for Analysis Trade reports Regulatory filings Economic Indicators Industry Statistics Financial Statements Quantitative Web sites Vision/Mission Statement Financial press Press Releases Chairperson’s Letter Management discussion & Analysis Qualitative

6-4 Operating Activities Revenues and expenses from providing goods and services Business Activities

6-5 Financial Statements Reflect Business Activities

6-6 Major aspects of financial statement analysis 4.Market measures 5.Financial distress and bankruptcy analysis Special analysis topics 1.Profitability analysis 2.Credit analysis 3.Cash flow analysis Basic analysis 6.Financial forecast 7.Equity valuation Prospective analysis

6-7 Analysis Process STEP 1 Identify analysis purposes STEP 2 Identify analysis aspects STEP 3 Collect data STEP 4 Process data STEP 5 Summarize & discuss results

6-8 Comparative analysis Why we need to compare? What we need to compare? –Period-to-period –Firm-to-firm –Division-to-division Difference types: –In dollars: ∆A = A 1 – A 0 –In percentages: A1A1 A0A0 x 100 (%) 8

6-9 Time To compare a company’s financial position and performance between periods. Horizontal analysis

Trend analysis is used for comparison of the same item over a significantly long period to detect general pattern of a relationship between associated factors and project the future direction of this pattern. Trend analysis

Trend analysis

6-12 Technique for identifying relationship between items in the same financial statement by expressing all amounts as the percentage of the total amount taken as 100 (a common-size financial statement). Vertical analysis

6-13 Common-size graph 13

6-14 Common-size Balance sheets

6-15 Common-size balance sheets

6-16 In mil. US$ … Account receivables Inventories Total assets

6-17

6-18 Ratio analysis To evaluate relationships among financial statement items Four groups: –Liquidity –Solvency –Efficiency –Profitability

6-19 Equity Valuation Purpose: Estimate intrinsic value of a company (or stock) Basis: Present value theory (time value of money) Purpose: Estimate intrinsic value of a company (or stock) Basis: Present value theory (time value of money) Valuation - an important goal of many types of business analysis Valuation - an important goal of many types of business analysis

6-20 (1 + r) n P = F n 1 Present value theory P = A x x 1 - (1 + r) n 1 r1 P: Present value Fn: Future value at period n A: Annual cash flows (from period 1 to period n) r: discounted rate

6-21 Equity valuation – Residual Income Model Expected Income = Required rate of equity x Book value of equity Residual Income = Actual Income – Expected Income Fair value of Equity = Book value of Equity + PV{Expected Residual Incomes} Investors should pay more than book value if actual income is higher than expected and less than book value if actual income is lower than expected.

6-22 Equity valuation – Residual Income Model BV t is the book value at the end of period t Ri t+n is the residual income in period t + n [defined as net income, NI, minus a charge on beginning book value, BV, or RI t = NI t - (k x BV t-1 )] k is the cost of capital E refers to an expectation BV t is the book value at the end of period t Ri t+n is the residual income in period t + n [defined as net income, NI, minus a charge on beginning book value, BV, or RI t = NI t - (k x BV t-1 )] k is the cost of capital E refers to an expectation

Example In VND mil Net income Dividends Beginning book value of equity Cost of equity 13%

Example Beginning book value of equity BV E 2. Required Income (r E = 13%) 3. Projected Income 4. Residual Income 5. Discounted factor (r E = 13%) 6. PV {RI 2013→2018 } Fair value of equity V E =

6-25 Equity valuation – Dividend model V t is the value of an equity security at time t D t +n is the dividend in period t+n k is the cost of capital E refers to expected dividends V t is the value of an equity security at time t D t +n is the dividend in period t+n k is the cost of capital E refers to expected dividends

6-26 Equity Valuation – Free cash flow to equity model FCFE t+n is the free cash flow to equity in the period t + n [often defined as cash flow from operations less capital expenditures] k is the cost of capital E refers to an expectation FCFE t+n is the free cash flow to equity in the period t + n [often defined as cash flow from operations less capital expenditures] k is the cost of capital E refers to an expectation