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FINANCIAL STATEMENT ANALYSIS UNIT 12

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Analysing financial statements involves evaluating three characteristics of a company: 1. its liquidity 2. its profitability 3. its solvency BASICS OF FINANCIAL STATEMENT ANALYSIS

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COMPARATIVE ANALYSIS Three types of comparisons: –Intracompany basis-compare previous years data with current year within the company. –Intercompany basis – compare data with specific competitors. –Industry averages - compare overall industry data.

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COMPARATIVE ANALYSIS Three tools: –Horizontal analysis –Vertical analysis –Ratio analysis

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HORIZONTAL ANALYSIS 127%121%119%112%100% ANY COMPANY INC. Assumed Net Sales For the Year Ended December 31 (in millions) 20032002200120001999 $ 6,562.8$ 6,295.4$ 6,190.6$ 5,786.6$ 5,181.4 Change since base period

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VERTICAL ANALYSIS VERTICAL ANALYSIS Expresses each item in a financial statement as a percent of a base amount (total assets or net sales) ANY COMPANY, INC. Condensed Balance Sheets (Partial) December 31 (in millions) 2002 2001. AssetsAmountPercent AmountPercent Current assets$1,496.5 29.6 $1,467.7 30.1 Capital assets 2,888.8 57.2 2,733.3 56.9 Other assets 666.2 13.2 636.6 13.0 Total assets$5,051.5100.0% $4,837.6 100.0%

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VERTICAL ANALYSIS VERTICAL ANALYSIS

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RATIO ANALYSIS Liquidity Ratios Measure short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash. Profitability Ratios Measure the income or operating success of an enterprise for a given period of time. Solvency Ratios Measure the ability of the enterprise to survive over a long period of time. Ratios may be expressed as percentages (50%), proportions (1:2), Days (32 days), or rate (3.23)

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LIQUIDITY RATIOS LIQUIDITY RATIOS Current ratio Acid test ratio Receivables turnover Collection period Inventory turnover Days sales in inventory

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CURRENT RATIO Measures short-term debt-paying ability Current ratio =Current assets Current liabilities (Discussed in Chapter 4)

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ACID TEST RATIO Measures immediate short-term debt- paying ability Acid test ratio = Cash + temporary investments + net receivables Current liabilities (Discussed in Chapter 9)

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RECEIVABLES TURNOVER Measures liquidity of receivables Receivables turnover = Net credit sales Average net receivables (Discussed in Chapter 9)

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COLLECTION PERIOD Measures number of days receivables are outstanding Collection period = 365 days Receivables turnover (Discussed in Chapter 9)

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INVENTORY TURNOVER INVENTORY TURNOVER Measures liquidity of inventory Inventory turnover = Cost of goods sold Average inventory (Discussed in Chapter 5)

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DAYS SALES IN INVENTORY Measures number of days inventory is on hand Days in inventory = 365 days Inventory turnover (Discussed in Chapter 5)

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PROFITABILITY RATIOS Profit margin Gross profit margin Return on assets Return on common shareholders’ equity Book value per share Earnings per share (EPS) Price-earnings (PE) ratio Dividend yield

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PROFIT MARGIN Measures net income generated by each dollar of sales (Discussed in Chapter 5) Profit margin = Net income Net sales

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GROSS PROFIT MARGIN Measures margin between selling price and cost of goods sold generated by each dollar of sales (Discussed in Chapter 5) Gross profit margin = Gross profit Net sales

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RETURN ON ASSETS Measures overall profitability of assets Return on assets = Net income Average total assets (Discussed in Chapter 10)

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RETURN ON COMMON SHAREHOLDERS’ EQUITY Measures profitability of common shareholders’ investment Return on common shareholders’ equity = Net income Average common shareholders’ equity (Discussed in Chapter 14)

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BOOK VALUE PER SHARE Measures the equity (net assets) per common share Book value per share = Common shareholders’ equity Number of common shares (Discussed in Chapter 14)

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EARNINGS PER SHARE (EPS) Measures net income earned on each common share (Discussed in Chapter 15) Earnings per share = Net income Number of common shares

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PRICE-EARNINGS (PE) RATIO Measures relationship between market price per share and earnings per share (Discussed in Chapter 15) Price-earnings ratio = Share price Earnings per share

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DIVIDEND YIELD Measures rate of return earned from dividends (Discussed in Chapter 15) Dividend yield = Cash dividends per share Share price

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SOLVENCY RATIOS SOLVENCY RATIOS Debt to total assets Cash total debt coverage

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DEBT TO TOTAL ASSETS Measures % of total assets provided by creditors Debt to total assets = Total liabilities Total assets (Discussed in Chapter 16)

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CASH TOTAL DEBT COVERAGE Measures long-term debt-paying ability (cash basis) Cash total debt coverage ratio = Net cash provided by operating activities Average total liabilities (Discussed in Chapter 18)

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Estimates Historical cost Alternative accounting methods Atypical data Diversification LIMITATIONS OF FINANCIAL ANALYSIS

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