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1
TOPIC 10:
FINANCIAL STATEMENT ANALYSIS
2
Introduction
Interpretation is when users evaluate financial information to make judgements
It is the key to any in-depth understanding of an organisation’s performance.
Basically, the users evaluate an organisation’s performance and financial position using the information from INCOME STATEMENT and BALANCE SHEET.
The value of the analysis is depends on the value of the financial statements.
3
Techniques (types) of analysis:
1.Horizontal Analysis Comparing key figures in financial statement Evaluates a series of financial statement over a
period of time.
2. Vertical Analysis Evaluates financial statement by expressing each
item in a financial statement as a percent of the base amount (key figure)
Key-figure (such as sales in IS and total assets on BS) are set to 100%
Other items are then expressed as percentage of 100
4
Techniques (types) of analysis: (cont.)
3. Trend analysis Similar to horizontal analysis, except
that the first set of account in the series is given a base of 100
4.Ratio Analysis It expresses the relationship among
selected items of financial statement data.
5
Horizontal AnalysisHorizontal Analysis
What is horizontal analysis?
What is horizontal analysis?
It’s an analysis of the percentage increases and decreases of related items in comparative
financial statements.
It’s an analysis of the percentage increases and decreases of related items in comparative
financial statements.
6
HOME DEPOTComparative Balance Sheets (in Millions)
Dec 31, 2006 and Dec 31, 2007
AssetsCurrent assets $10,361 $ 7,777 $2,584 33.2%Property and equipment, net 15,375 13,068 2,307 17.7Other assets 658 540 118 21.9Total assets $26,394 $21,385 $5,009 23.4
LiabilitiesCurrent liabilities $ 6,501 $ 4,385 $2,116 48.3Long-term debt, excluding current installment 1,250 1,545 (295) (19.1)Other long-term liabilities 372 256 116 45.3Deferred income taxes 189 195 (6) (3.1)Total long-term liabilities $ 1,811 $ 1,996 $ (185) (9.3)Total liabilities $ 8,312 $ 6,381 $1,931 30.3
Increase (Decrease)
Dec 31, 2007 Dec 31, 2006 Amount Percent
14-7
The stockholders’ equity section is not displayed.The stockholders’ equity section is not displayed.
7
AssetsCurrent assets $10,361 $ 7,777 $2,584 33.2%Property and equipment, net 15,375 13,068 2,307 17.7Other assets 658 540 118 21.9Total assets $26,394 $21,385 $5,009 23.4
LiabilitiesCurrent liabilities $ 6,501 $ 4,385 $2,116 48.3Long-term debt, excluding current installment 1,250 1,545 (295) (19.1)Other long-term liabilities 372 256 116 45.3Deferred income taxes 189 195 (6) (3.1)Total long-term liabilities $ 1,811 $ 1,996 $ (185) (9.3)Total liabilities $ 8,312 $ 6,381 $1,931 30.3
14-8
Horizontal Analysis:
Difference $2,584
Base year $7,777= 33.2%
33.2%
HOME DEPOTComparative Balance Sheets (in Millions)Dec 31, 2006 and Dec 31, 2007 Increase (Decrease)
Dec 31, 2007 Dec 31, 2006 Amount Percent
8
HOME DEPOTComparative Balance Sheets (in Millions)
Dec 31, 2006 and Dec 31, 2007
14-9
Condensed
33.2% AssetsCurrent assets $10,361 $ 7,777 $2,584 33.2%Property and equipment, net 15,375 13,068 2,307 17.7Other assets 658 540 118 21.9Total assets $26,394 $21,385 $5,009 23.4
LiabilitiesCurrent liabilities $ 6,501 $ 4,385 $2,116 48.3Long-term debt, excluding current installment 1,250 1,545 (295) (19.1)Other long-term liabilities 372 256 116 45.3Deferred income taxes 189 195 (6) (3.1)Total long-term liabilities $ 1,811 $ 1,996 $ (185) (9.3)Total liabilities $ 8,312 $ 6,381 $1,931 30.3
17.733.2%
Horizontal Analysis:
Difference $2,307
Base year $13,068= 17.7%
Increase (Decrease)
Dec 31, 2007 Dec 31, 2006 Amount Percent
9
HOME DEPOTComparative Balance Sheets (in Millions)
Dec 31, 2006 and Dec 31, 2007
14-10
Condensed
AssetsCurrent assets $10,361 $ 7,777 $2,584 33.2%Property and equipment, net 15,375 13,068 2,307 17.7Other assets 658 540 118 21.9Total assets $26,394 $21,385 $5,009 23.4
LiabilitiesCurrent liabilities $ 6,501 $ 4,385 $2,116 48.3Long-term debt, excluding current installment 1,250 1,545 (295) (19.1)Other long-term liabilities 372 256 116 45.3Deferred income taxes 189 195 (6) (3.1)Total long-term liabilities $ 1,811 $ 1,996 $ (185) (9.3)Total liabilities $ 8,312 $ 6,381 $1,931 30.3
Increase (Decrease)
Dec 31, 2007 Dec 31, 2006 Amount Percent
10
HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
Sales (net) $53,553 $45,738 $7,815Cost of merchandise sold 37,406 32,057 5,349 Gross profit $16,147 $13,681 $2,466 Selling and store operating exp. 10,280 8,655 1,625General and administrative exp. 935 835 100 Total operating expenses $11,215 $ 9,490 $1,725Income from operations $ 4,932 $ 4,191 $ 741Other income and expenses:
Interest and investment inc. 53 47 6 Interest expense (28) (21) (7)Income before income tax $ 4,957 $ 4,217 $ 740 Income taxes 1,913 1,636 277 Net income $ 3,044 $ 2,581 $ 463
Horizontal Analysis:
Difference $7,815
Base year $45,738= 17.1%
17.1%
14-11
Increase (Decrease)
Dec 31, 2007 Dec 31, 2006 Amount Percent
11
HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
Sales (net) $53,553 $45,738 $7,815Cost of merchandise sold 37,406 32,057 5,349 Gross profit $16,147 $13,681 $2,466 Selling and store operating exp. 10,280 8,655 1,625General and administrative exp. 935 835 100 Total operating expenses $11,215 $ 9,490 $1,725Income from operations $ 4,932 $ 4,191 $ 741Other income and expenses:
Interest and investment inc. 53 47 6 Interest expense (28) (21) (7)Income before income tax $ 4,957 $ 4,217 $ 740 Income taxes 1,913 1,636 277 Net income $ 3,044 $ 2,581 $ 463
Horizontal Analysis:
Difference $5,349
Base year $32,057= 16.7
17.1%16.7
14-12
Increase (Decrease)
Dec 31, 2007 Dec 31, 2006 Amount Percent
12
HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
Sales (net) $53,553 $45,738 $7,815Cost of merchandise sold 37,406 32,057 5,349 Gross profit $16,147 $13,681 $2,466 Selling and store operating exp. 10,280 8,655 1,625General and administrative exp. 935 835 100 Total operating expenses $11,215 $ 9,490 $1,725Income from operations $ 4,932 $ 4,191 $ 741Other income and expenses:
Interest and investment inc. 53 47 6 Interest expense (28) (21) (7)Income before income tax $ 4,957 $ 4,217 $ 740 Income taxes 1,913 1,636 277 Net income $ 3,044 $ 2,581 $ 463
17.1%16.7
14-13
18.018.812.018.217.7
12.833.317.516.917.9
Increase (Decrease)
Dec 31, 2007 Dec 31, 2006 Amount Percent
13
Vertical AnalysisVertical Analysis
A percentage analysis can be used to show the relationship of each component to a total within
a single statement.
A percentage analysis can be used to show the relationship of each component to a total within
a single statement.
14
The total, or 100% item, on the balance sheet is “total
assets.”
The total, or 100% item, on the balance sheet is “total
assets.”
Vertical AnalysisVertical Analysis
The total, or 100% item, on the income statement is
“total sales.”
The total, or 100% item, on the income statement is
“total sales.”
15
14-18
AssetsCurrent assets $10,361 $ 7,777Property and equipment, net 15,375 13,068Other assets 58 540Total assets $26,394 $21,385
LiabilitiesCurrent liabilities $ 6,501 $ 4,385Long-term liabilities 1,811 1,996Total liabilities $ 8,312 $ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082 $15,004Total liabilities and SE $26,394 $21,385
Total assets is 100.0%
Total assets is 100.0%
100.0%
HOME DEPOTComparative Balance Sheets (in Millions)
December 31, 2007 and December 31, 2006
December 31, 2007 December 31, 2006 Amount Percent Amount Percent
14-18
Condensed
16
HOME DEPOTComparative Balance Sheets (in Millions)
December 31, 2007 and December 31, 2006
December 31, 2007 December 31, 2006 Amount Percent Amount Percent
14-19
Condensed
AssetsCurrent assets $10,361 $ 7,777Property and equipment, net 15,375 13,068Other assets 58 540Total assets $26,394 $21,385
LiabilitiesCurrent liabilities $ 6,501 $ 4,385Long-term liabilities 1,811 1,996Total liabilities $ 8,312 $ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082 $15,004Total liabilities and SE $26,394 $21,385
39.3%
100.0%
Vertical Analysis:
Current assets $10,361
Total assets $26,394= 39.3%
17
HOME DEPOTComparative Balance Sheets (in Millions)
December 31, 2007 and December 31, 2006
December 31, 2007 December 31, 2006 Amount Percent Amount Percent
14-20
Condensed
AssetsCurrent assets $10,361 $ 7,777Property and equipment, net 15,375 13,068Other assets 58 540Total assets $26,394 $21,385
LiabilitiesCurrent liabilities $ 6,501 $ 4,385Long-term liabilities 1,811 1,996Total liabilities $ 8,312 $ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082 $15,004Total liabilities and SE $26,394 $21,385
39.3%58.2
2.5100.0%
24.6% 6.9
31.5%
20.9% 47.6 68.5%100.0%
18
HOME DEPOTComparative Balance Sheets (in Millions)
December 31, 2007 and December 31, 2006
December 31, 2007 December 31, 2006 Amount Percent Amount Percent
14-21
Condensed
39.3%58.2
2.5100.0%
24.6% 6.9
31.5%
20.9% 47.6 68.5%100.0%
100.0%
AssetsCurrent assets $10,361 $ 7,777Property and equipment, net 15,375 13,068Other assets 58 540Total assets $26,394 $21,385
LiabilitiesCurrent liabilities $ 6,501 $ 4,385Long-term liabilities 1,811 1,996Total liabilities $ 8,312 $ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082 $15,004Total liabilities and SE $26,394 $21,385
Total assets is 100.0%
Total assets is 100.0%
19
December 31, 2007 December 31, 2006 Amount Percent Amount Percent
Condensed
AssetsCurrent assets $10,361 $ 7,777Property and equipment, net 15,375 13,068Other assets 58 540Total assets $26,394 $21,385
LiabilitiesCurrent liabilities $ 6,501 $ 4,385Long-term liabilities 1,811 1,996Total liabilities $ 8,312 $ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082 $15,004Total liabilities and SE $26,394 $21,385
39.3%58.2
2.5100.0%
24.6% 6.9
31.5%
20.9% 47.6 68.5%100.0%
100.0%
36.4%
Vertical Analysis:
Current assets $7,777
Total assets $21,385= 36.4%
HOME DEPOTComparative Balance Sheets (in Millions)
December 31, 2007 and December 31, 2006
14-22
20
December 31, 2007 December 31, 2006 Amount Percent Amount Percent
Condensed
AssetsCurrent assets $10,361 $ 7,777Property and equipment, net 15,375 13,068Other assets 58 540Total assets $26,394 $21,385
LiabilitiesCurrent liabilities $ 6,501 $ 4,385Long-term liabilities 1,811 1,996Total liabilities $ 8,312 $ 6,381 Stockholders’ EquityCommon stock/paid-in capital $ 5,529 $ 4,926RE & accumulated comp. loss 12,553 10,078Total stockholders’ equity $18,082 $15,004Total liabilities and SE $26,394 $21,385
39.3%58.2
2.5100.0%
24.6% 6.9
31.5%
20.9% 47.6 68.5%100.0%
100.0%
36.4%61.1
2.5
HOME DEPOTComparative Balance Sheets (in Millions)
December 31, 2007 and December 31, 2006
14-23
20.5% 9.3 29.8%
23.0% 47.1 70.2%100.0%
21
HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
Sales (net) $53,553 100.0% $45,738 100.0%Cost of merchandise sold 37,406 32,057Gross profit $16,147 $13,681Selling and store operating exp. 10,280 8,655General and administrative exp. 935 835Total operating expenses $11,215 $ 9,490Income from operations $ 4,932 $ 4,191Other income and expenses:
Interest and investment inc. 53 47 Interest expense (28) (21) Income before income tax $ 4,957 $ 4,217Income taxes 1,913 1,636Net income $ 3,044 $ 2,581
14-24
Amount Percent Amount Percent
2007 2006
Net sales is 100.0%
Net sales is 100.0%
Net sales is 100.0%
Net sales is 100.0%
22
HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
Sales (net) $53,553 100.0% $45,738 100.0%Cost of merchandise sold 37,406 32,057Gross profit $16,147 $13,681Selling and store operating exp. 10,280 8,655General and administrative exp. 935 835Total operating expenses $11,215 $ 9,490Income from operations $ 4,932 $ 4,191Other income and expenses:
Interest and investment inc. 53 47 Interest expense (28) (21) Income before income tax $ 4,957 $ 4,217Income taxes 1,913 1,636Net income $ 3,044 $ 2,581
14-25
Amount Percent Amount Percent
2007 2006
Vertical Analysis:
Cost of Merchandise Sold $32,057
Net Sales $45,738
= 70.1%
2006
70.1
23
Sales (net) $53,553 100.0% $45,738 100.0%Cost of merchandise sold 37,406 32,057Gross profit $16,147 $13,681Selling and store operating exp. 10,280 8,655General and administrative exp. 935 835Total operating expenses $11,215 $ 9,490Income from operations $ 4,932 $ 4,191Other income and expenses:
Interest and investment inc. 53 47 Interest expense (28) (21) Income before income tax $ 4,957 $ 4,217Income taxes 1,913 1,636Net income $ 3,044 $ 2,581
Vertical Analysis:
Cost of Merchandise Sold $37,406
Net Sales $53,553
= 69.9%
2007
HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
14-26
Amount Percent Amount Percent
2007 2006
69.9 70.1
24
HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
Sales (net) $53,553 100.0% $45,738 100.0%Cost of merchandise sold 37,406 32,057Gross profit $16,147 $13,681Selling and store operating exp. 10,280 8,655General and administrative exp. 935 835Total operating expenses $11,215 $ 9,490Income from operations $ 4,932 $ 4,191Other income and expenses:
Interest and investment inc. 53 47 Interest expense (28) (21) Income before income tax $ 4,957 $ 4,217Income taxes 1,913 1,636Net income $ 3,044 $ 2,581
14-27
Amount Percent Amount Percent
2007 2007
69.9 29.9%
18.9% 1.8
20.7%9.2%
0.1 (0.1)
9.2% 3.6
5.6%
70.1
25
HOME DEPOT INC. Income Statement (in millions)For Periods Ended December 31, 2007 and December 31, 2006
Sales (net) $53,553 100.0% $45,738 100.0%Cost of merchandise sold 37,406 32,057Gross profit $16,147 $13,681Selling and store operating exp. 10,280 8,655General and administrative exp. 935 835Total operating expenses $11,215 $ 9,490Income from operations $ 4,932 $ 4,191Other income and expenses:
Interest and investment inc. 53 47 Interest expense (28) (21) Income before income tax $ 4,957 $ 4,217Income taxes 1,913 1,636Net income $ 3,044 $ 2,581
14-28
Amount Percent Amount Percent
2007 2006
70.1 30.1%
19.2%
1.7
20.9%
9.2%
0.1
(0.0)
9.3%
3.6
5.7%
29.9%
18.9% 1.8
20.7%
9.2%
0.1 (0.1)
9.2% 3.6
5.6%
69.9
26
Types of ratio analysis
1. Profitability Ratio
2. Efficiency/activity/asset management Ratio
3. Liquidity Ratio
4. Solvency Ratio
5. Cash flow
6. Investment
27
1. Profitability
1. Return on capital
employed
2. Gross profit ratio
3. Net profit ratio
2. Liquidity
1. Current ratio
2. Quick ratio
3. Efficiency
1. Debtors turnover
2. Debtors collection period
3. Stock turnover ratio
4. Asset turnover ratio
4. Solvency/financial leverage management ratio
1. Debt to Equity ratio
2.Debt ratio
28
Continue………..
5. Cash Flow
1. Cash flow ratio
6. Investment 1. Dividend yield 2. Dividend cover 3. Earnings per share 4. Price/earnings ratio 5. Interest cover
29
Importance of Ratios
Quick and easy snapshot of an organisation’s achievements
Aid for comparisonsRatio provide benchmark to compare on
company with another (inter-firm comparison) or to compare the same company over period of time (intra-firm comparison).
30
PROFITABILITY RATIO
It measures the income or operating effectiveness of an organisation for a given period of time.
A low value of this ratio will affect the company ‘s ability to obtain debt, equity financing and the ability to grow or expand.
i Return on capital employed (ROCE)• measures effective use of capital• It measures the profitability from the
shareholder view point. It shows how many ringgit of the net income
were earned for each ringgit invested by the owner.
= Profit or earning after tax x 100%
Average capital employed
31
Continue…ii. Gross Profit Margin It measures the percentage of one ringgit of sales
that results in gross income.= Sales – Cost of Goods Sold x
100% Sales= Gross Profit x 100%
Sales
iii. Net Profit MarginIt measures the percentage of one ringgit of sales that results in net income.= Profit or earning after tax x 100%
Sales
32
LIQUIDITY RATIO
It measure the short term ability of the organisation to pay debt and to meet unexpected need for cash.
i. Current Ratio To measure the ability of current
asset that the company have to pay back the short term debt.
= Current Asset Current Liability
33
ii. Quick Ratio• It measures the company’s immediate short
term liquidity.
Current Asset – Stock – Prepayment
Current Liability
Continue…
This ratio indicates whether current liabilities could be paid without having to sell the inventory
This ratio is useful for companies which cannot convert inventory into cash quickly if necessary.
34
Cont…. This ratio indicates whether the business has
enough short-term assets to cover its short-term liabilities.
A ratio above 1 indicates that working capital is positive (Current assets exceed current liabilities)
A ratio below 1 indicates that working capital is negative.
Many large companies regularly operate with current ratio closer to 1 and 2
35
Generally the higher the ratio, the greater the financial stability and the lower the risk for both creditors and owners.
However, the ratio should not be too high because that may indicate that the business is not reinvesting in long-term assets to maintain future productivity.
High current ratio can actually indicate problems if inventories are getting larger than they should be or collections of receivables are slowing down.
36
EFFICIENCY RATIO
Debtors turnover Measures how many times it takes
customers to pay
Credit sales
Average debtors
37
EFFICIENCY RATIO1. Debtors collection period Measures how long it takes customers to pay
= Average debtors x 365 days OR 365 days Credit sales debtors turnover
This ratio indicates how many days it takes, on average to collect a day’s sale revenue.
The quicker a business collects and bank the money, the better it is to the company
Large numbers of days is a negative signal, raising questions about the company’s policies of granting credit such as; Unrestricted credit policies Longer credit limit Collection attempts is not very strength
38
Efficiency Ratio
3. Stock turnover ratio measures how quickly stock moves through business This ratio means that the average length of time that
the stocks are held before being sold.
= Cost of goods sold
Average stock
It can also be calculated in days
= Average stock x 365 days OR 365 days Cost of goods sold stock turnover
39
Efficiency Ratio
4. Asset turnover ratio compares sales to total assets employed Measures how efficient the assets in
generating sales
= Sales x 100%
Average total assets
40
SOLVENCY/FINANCIAL LEVERAGE MANAGEMENT RATIO
1. Debt to Equity ratio = Total liabilities
Total Equity
2. Debt ratio
Also call debt to assets ratio
= Total liabilities
Total Asset
41
SOLVENCY/FINANCIAL LEVERAGE MANAGEMENT RATIO
- This is to measure the ability of the company to survive over a long period of time
- The ability to pay interest as it come due/mature
42
Income Statement for the year ended 31 Dec 2007
Sales 200
Less: Cost of goods sold (100)
Gross profits 100
Less expenses
General 40
Interest 10 (50)
Profit before tax 50
Less: Taxation (15)
Profits after tax 35
Less: Dividends (15)
Retained profits 20
43
Balance Sheet as at 31 Dec 2007
Fixed AssetsCurrent Assets Stock Debtors CashCurrent Liabilities Creditors Proposed dividends and taxNet Current assetsTotal assets less current liabilities
Financed by/ capital employed:
Long-term liabilities Loan Preference share capital (50m, $1)
Owners Equity Ordinary Share capital (150m.$1)Other reserves Retained Earning
$ m
604020
(50)(10)
$ m
120
(60)
7050
150
65
$ m275
60335
120
215335
44
1. Profitability Ratiosa. Return on Capital Employed Profit after tax = 35 = 16.3% Average capital employed 215
b. Gross Profit RatioGross profit = 100 = 50% Sales 200
c. Net Profit RatioNet profit after taxation = 35 = 17.5% sales 200
45
2. Liquidity Ratiosa. Current Ratio
Current assets = 120 = 2:1
Current liabilities 60
b. Quick Ratio
Current assets - stock = 120-60 = 1:1
Current liabilities 60
46
3. Efficiency Ratios
Debtors Collection Period
Average debtors x 365 = 40 x 365 = 73 days
Credit sales 200
47
c. Stock TurnoverCOGS = 100 = 1.66 times
Average stock 60
d. Asset Turnover Ratio Sales x 100% = 200 x 100%Average total assets 395
= 51%
48
4. Financing ratio
a) Debt to equity ratio Total liabilities = 180 = 0.837
Total equity 215
b) Debt ratio
Total liabilities = 180 = 0.456
Total assets 395
49
Limitations of the Accounting Information1. Estimates
The financial statement contains numerous estimates. Eg. Provision for doubtful debt, depreciation and contingent loss.
2. CostThe traditional financial statements are based on historical cost, it is not adjusted for price-level change. Eg. Inflation affects the sales growth.
3. Alternative Accounting MethodA comparison may be misleading as different companies use different accounting method. Eg. FIFO and LIFO.
4. Diversification of firmsThis diversification of activities of companies limit the usefulness of financial analysis. (no specific industry).
50
CONCLUSION
Ratio analysis is a good way to overview an organisation’s activities
Ratio analysis must be compared with past result or industry norms, not in isolation
Things to be taken into account in using ratio analysis: size of the organisation Method used in accounting treatment Same industry Same country