2 PreambleThe overview of Financial Statements reveals information about past and current performance of the firm.When combining this information with other sources, we might be able to form expectations about the firm’s future cash flows.
3 Outline The Balance Sheet The Income Statement The Statement of Cash FlowsOn ratio analysis
4 Balance SheetFinancial Statement showing a firm’s accounting value on a particular date.
6 Reminder Assets are listed in the order of decreasing liquidity Liquidity = the degree of ease to which an asset can be converted to cash without a substantial loss or price reduction.The balance sheet does not reflect the real value of firm's assets.The balance sheet reflects the historical cost of firm's assets.
7 The Income StatementReveals how profitable the firm is over a certain period of time.
9 Statement of cash flows Integrates the Balance Sheet and the Income StatementCF from operating activities + CF from investing + Cf from financingInterpretationNet increase or decrease in the firm’s cash
10 Cash flows identities In any given year: Cash flow from assets = CF to creditors + CF to shareholderswhere:CF to creditors = Interest paid - Net new debt raisedCF to shareholders = Dividends paid - Net new equity raisedCash flow from assets = OCF - NCS - Additions to NWCOperating CF = EBIT + Depr. - TaxesNCS = Ending Fixed Assets - (Beginning Fixed Assets - Depr.)Additions to NWC = NWCt - NWCt-1
12 Sources of cash: Increase in accounts payable Increase in common stock Increase in accounts payableIncrease in common stockIncrease in retained earnings
13 Uses of cash: Increase in accounts receivable Increase in inventory Increase in accounts receivableIncrease in inventoryDecrease in notes payableDecrease in long-term debtNet fixed asset acquisitions
14 Ratio analysis When analyzing a firm, we want to know: if the firm is able to meet its short-term financial obligations (is it solvent?);if the firm is able to meet its long-term financial obligations (going bankrupt in the future?);how well the assets of the firm are managed;how well the overall operations of the firm are managed (is it profitable?);how the market interprets accounting data and what expectations are factored in.
15 Ratio analysis Short-term solvency and liquidity ratios: Indicate the firm’s ability to pay its bills over the short run without undue stress.Financial leverage:Describe a firm’s long-term ability to meet its financial obligationsAsset utilization turnover ratios:Describe how efficiently (intensively) a firm uses its assets to generate sales.Profitability ratios:Describes how efficiently the firm manages its overall operations (the higher, the better !!!!!)Market ratiosDescribe how the market values the firm.
16 Short-term solvency and liquidity ratios Current ratio = Current assets/Current liabilitiesQuick ratio = (Current assets-Inventory)/Current liabilitiesCash ratio = Cash/Current liabilitiesNWC to total assets = (Current assets - Current liabilities)/Total assetsInterval measure = Current assets/Avg. daily op. costs
17 Short-term solvency and liquidity ratios Current ratio = $708/540 = 1.31Quick ratio =($708-$422)/$540 = 0.53Cash ratio = $98/$540 =NWC to total assets = ($ )/$3,588 = 0.047Interval measure = $708/[$1,344/365] = 192 days
18 Financial leverageTotal debt ratio = (Total assets-Total equity)/Total assetsDebt/equity ratio = Total debt/total equityEquity multiplier = Total assets/Total equity = 1 + Debt/EquityLong-term debt ratio = Long-term debt/(Total assets)Times interest earned = EBIT/InterestCash coverage ratio = (EBIT + Depreciation)/Interest
19 Financial leverage Total debt ratio = ($3,588 - $2,591)/$3,588 = 0.28 Debt/equity ratio = $997/$2,591 = 0.28/0.72 = 0.39Equity multiplier =Long-term debt ratio = $457/[$457 + $2,591] = 0.15Times interest earned = $691/$141 = 4.9 timesCash coverage ratio = ($691 +$276)/$141 = 6.9
26 Market ratiosPrice/Earnings ratios = Price per share/Earnings per shareMarket-to-book ratio = Market value per share/Book value per shareTobin’s QQ = (Mkt. value of debt + Mkt. value of equity)/Replacement value of assetsHigher Q’s indicate higher investment opportunities and/or comparative advantage)
27 Market ratios Assume: There are 33,000 shares outstanding and P = $88 P/E = $88/$11 = 8Market-to-book ratio = $88/($2,591/33) = 1.12P/E and Market-to-book are also measures of cheapness