Day 3 - Financial Statement Analysis

8/8/2019 Day 3 - Financial Statement Analysis

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M.S. Ramaiah School of Advanced Studies - Bangalore

PEMP-MBA503

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Session 3

Financial Statement Analysis

Session Speaker Suman Yadav


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At the end of this session the student would have

understood:-

Explain the meaning, need and purpose of financialstatement analysis;

Identify the parties interested in analysis of financialstatements;

Explain the various techniques and tools of analysisof financial statements.

Session Objectives


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Session Contents

Introduction to Business Analysis

Introduction to Financial Statement Analysis

Requirement of having Financial Statement Analysis

Ratio Analysis

Difficulties Associated with Financial Statement Analysis

EVA

MVA

Inter Firm Comparison


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Business Analysis

Merger and AcquisitionAnalysts

Directors

Equity investors

CreditorsManagersExternal Auditors

Employees & UnionsLawyers

Regulators

Business Decision Makers


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Information Sources of BusinessAnalysis

QuantitativeTrade reports

Financial Statements

Industry StatisticsEconomic Indicators

Regulatory filings


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Qualitative

Web sites

Information Sources of BusinessAnalysis

Management Discussion& Analysis

Chairpersons LetterVision/Mission Statement

Financial Press

Press Releases


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Types of BusinessAnalysis

REGULATION

CREDITANALYSIS

EQUITYANALYSIS

LABOUR NEGOTIATIONS

MANAGEMENT

& CONTROLDIRECTOR OVERSIGHT

FINANCIALMANAGEMENT

EXTERNALAUDIT

MERGERS,ACQUITIONS &DIVETITURES


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Financial Statements

Financial Statement analysis is an integral andimportant part of the Business analysis.

Business analysis is the process of evaluating acompanys economic prospects and risks. Thisincludes analyzing a companys business

environment, its strategies, and its financial positionand performance.


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Financial Statement AnalysisIntroduction

Financial statement analysis is defined as:The process of identifying financial strengths andweaknesses of the firm by properly establishingrelationship between the items of the balance sheet

and the profit and loss account.


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Financial Statement Analysis

IntroductionFinancial statements are prepared to meet externalreporting obligations and also for decision making

purposes. They play a dominant role in setting theframework of managerial decisions.The information provided in the financial statementsis not an end in itself as no meaningful conclusionscan be drawn from these statements alone.The information provided in the financial statementsis of immense use in making decisions throughanalysis and interpretation of financial statements.


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Types of Financial Analysis

On the Basis of Material Used On the Basis of Modus Operandi

External Analysis

Internal Analysis

Horizontal Analysis

Vertical Analysis

Types of Financial Analysis

Long Term Analysis Short Term Analysis


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Methods of Analysis

There are various methods or techniques that areused in analyzing financial statements:

Comparative statementsSchedule of changes in working capitalCommon size percentagesFunds analysisTrend analysisRatios analysis


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Tools and Techniques of FinancialStatement Analysis:

Horizontal and Vertical Analysis

Ratios Analysis


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Horizontal Analysis

Horizontal Analysis or Trend Analysis:Comparison of two or more year's financial data is known ashorizontal analysis, or trend analysis. H orizontal analysis isfacilitated by showing changes between years in both dollar and percentage form.

Trend Percentage:Horizontal analysis of financial statements can also be carried

out by computing trend percentages.Trend percentage states several years' financial data in termsof a base year. The base year equals 100%, with all other yearsstated in some percentage of this base.


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Vertical Analysis

Vertical analysis is the procedure of preparing and presenting common size statements.

Common size statement is one that shows the itemsappearing on it in percentage form as well as in dollar form. Each item is stated as a percentage of sometotal of which that item is a part. Key financial

changes and trends can be highlighted by the use of common size statements.


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Ratio Analysis

Ratios simply means one number expressed interms of another.

A ratio is a statistical yardstick by means of which relationship between two or variousfigures can be compared or measured.


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Advantages of Financial StatementAnalysis

The major benefit is that the investors getenough idea to decide about the investmentsof their funds in the specific company.

Secondly, regulatory authorities like

International Accounting Standards Board canensure whether the company is followingaccounting standards or not.


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Advantages of Financial Statement

Analysis

Thirdly, financial statements analysis can helpthe government agencies to analyze thetaxation due to the company.Moreover, company can analyze its own

performance over the period of time throughfinancial statements analysis


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ong term debt ratio =long term debt

long term debt + equity

Debt equity ratio =long term debt + value of leases

equity

everage Ratios

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Total debt ratiototal liabilities

total assets

Times interest earnedEBIT

interest payments

ash coverage ratioEBIT + depreciation

interest payments

Leverage Ratios

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et orking capital

to total assets ratio=

et orking capitalTotal assets

urrent ratio =current assets

current liabilities

Liquidity Ratios

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Cash ratiocash marketable securities

current liabilities

Quick ratiocash marketable securities receivables

current liabilities

Interval measure cash marketable securities receivablesaverage daily expenditures from operations

Liquidity Ratios

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Asset turnover ratio =ales

Average total assets

W turnover =sales

average net orking capital

Efficiency Ratios

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ays sales in inventory =average inventory

cost o goods sold / 365

Inventory turnover ratio =cost o goods soldaverage inventory

Average collection period =average receivablesaverage daily sales

E iciency Ratios

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Return on assetsEBIT - tax

average total assets

Net profit marginEBIT - tax

sales

Return on equityearnings available for common stock

average equity

Profitability Ratios

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Plowback ratio earnings - dividendsearnings

1 - payout ratio

Payout ratiodividendsearnings

Growth in equity rom plowback earnings - dividendsearnings

Pro itability Ratios

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orecasted PE ratio = PaveEP

1r - g

0

1

=Div

EPSx1

1

PE Ratiostock price

earnings per share

ividend yielddividend per share

stock price

Market Value Ratios

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Market to book ratio = stock price book value per share

Price per share = P =iv

r - g01

Tobins =market value of assets

estimated replcement cost

Market Value Ratios

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ACC Growth

retained earningsInternal growth rate 9.85%

net assets!

retained earnings pro it a ter tax equityInternal gro th rate =

pro it a ter tax equity net assets

equity plo back ratio return on equity net assets

v v

! v v

=9.85%

G rowth and Retained Earnings

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Common Size Analysis = EntityTotal Entity

Indicates the proportion of an asset/liability/expense is asa function of total assets/liabilities/revenue.

Things to rememberCompares what proportion that an expense reduces sales,especially useful when comparing previous years.

It is also useful when comparing similar companies of different sizes to see if they have the same financialstructure.

Common Size Analysis

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A breakdown of ROE and ROA intocomponent ratios

equityinterest-tax-EBIT=ROE

assetstaxes-EBIT=ROA

The DUPONT System

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A =salesassets

xEBIT - taxes

sales

asset

turnover

profit

margin

The DUP NT System

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ROE =assetsequity

xsalesassets

xEBIT - taxes

salesx

EBIT - taxes - interestEBIT - taxes

leverage

ratio

assetturnover

profitmargin

debtburden

The DUPONT System

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An aspect of technical analysis that tries to predict the futuremovement of a stock based on past data. Trend analysis is basedon the idea that what has happened in the past gives traders anidea of what will happen in the future.There are three main types of trends: short-, intermediate- andlong-term.Trend analysis tries to predict a trend like a bull market run andride that trend until data suggests a trend reversal (e.g. bull to

bear market). Trend analysis is helpful because moving withtrends, and not against them, will lead to profit for an investor .

Trend Analysis

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Cash Flow AnalysisAnd

Fund Flow Analysis

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Acash flow statement is a statement which discloses thechanges in cash position between the two periods.The cash flow statement is an important planning tool inthe hands of management.This helps the management in formulating plans for immediate future cash needs.A cash flow statement is useful for short-term planning.

Advantages :Helps in efficient cash management.

Helps in internal financial management.Discloses the movements of cash.Discloses the success or failure of cash planning.

Cash Flow Analysis

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LIMITATIONSCash flow statement cannot be equated with theIncome Statement.

The cash balance as disclosed by the cash flowstatement may not represent the real liquid

position of the business since it can be easilyinfluenced by postponing purchases and other

payments.Cash flow statement cannot replace the IncomeStatement or the Funds Flow Statement.

Cash Flow Analysis

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The connection between two successive balance sheets & the statement of cash flowscan be shown :

a. Assets = Liabilities + Owners equity

b. Cash Noncash assets = Liabilities Owners equity

c. Cash = Liabilities Noncash assets Owners equity

d. ( Cash = ( Liab ( Noncash assets ( Owners equity

Statement of Cash Flows

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( Cash = ( Liab ( Noncash assets ( Owners equity

T he cash flow statement simultaneouslyprovides an explanation of why a firms cashposition has changed between successivebalance sheet dates and explains changes thathave taken place in the firms noncash asset,

liability, and stockholders equity accounts over the same time period.


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The change in a firms cash position betweensuccessive balance sheet dates will not equalthe reported earnings for that period .


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operating activitiesoperating activities,

investing activitiesinvesting activities, andfinancing activitiesfinancing activities.

operating activitiesoperating activities,

investing activitiesinvesting activities, andfinancing activitiesfinancing activities.

This statement reports cash inflowsinflows and outflowsoutflows based on the firms

A summary of a firms payments during a

period of time.


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Cash Flow from Operating Activities

Shows impact of transactions not defined as

investing or financing activities.

These cash flows are generally the cash effectsof transactions that enter into the determinationof net income.


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Cash InflowsCash InflowsFrom sales of goods or servicesFrom interest and dividend income

Cash OutflowsCash OutflowsTo pay suppliers for inventoryTo pay employees for servicesTo pay lenders (interest)

To pay government for taxesTo pay other suppliers for other operating

expenses

Cash Flow from Operating Activities

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Cash Flow from Financing ActivitiesCash Flow from Financing ActivitiesShows impact of all cash transactions withshareholders and the borrowing and repayingtransactions with lenders .

Cash Flow from Financing ActivitiesCash Flow from Financing ActivitiesShows impact of all cash transactions withshareholders and the borrowing and repayingtransactions with lenders .

Cash Flow from Investing ActivitiesCash Flow from Investing ActivitiesShows impact of buying and selling fixed assets anddebt or equity securities of other entities.

Statement of Cash Flow

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Cash OutflowsCash OutflowsTo acquire fixed assets (property, plant, equipment)

To purchase debt or equity securities (other thancommon equity) of other entities

Cash InflowsCash InflowsFrom sale of fixed assets (property, plant,

equipment)From sale of debt or equity securities (other than

common equity) of other entities

Cash Flow from Investing Activities

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Cash OutflowsCash OutflowsTo repay amounts borrowed

To repurchase the firms own equity securitiesTo pay shareholders dividends

Cash InflowsCash InflowsFrom borrowing

From the sale of the firms own equity securities

Cash Flow from Investing Activities

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Funds flow statement is based on the accrualaccounting system.Funds flow statement analyses the sources andapplication of funds of long-term nature and the netincrease or decrease in long-term funds will bereflected on the working capital of the firm.Funds Flow analysis is more useful for long range

financial planning.Funds flow statement tallies the funds generatedfrom various sources with various uses to whichthey are put.

Funds Flow Statements

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A summary of a firms changes in financialposition from one period to another; it is also

called a sources and uses of funds statementor a statement of changes in financial position.

A summary of a firms changes in financialposition from one period to another; it is also

called a sources and uses of funds statementor a statement of changes in financial position.

Flow of Funds Statements

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All of the firms investments and claims againstthose investments.Extends beyond beyond just just transactions involving cashcash.

All of the firms investments and claims againstthose investments.Extends beyond beyond just just transactions involving cashcash.

What are fundsfunds?

Flow of Funds Statements

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The letters labeling the boxes stand for UUsesses ,SSourcesources, AAssetsssets , andLLiabilitiesiabilities (broadlydefined). The pluses(minuses) indicateincreases (decreases) inassets or liabilities.

The letters labeling the boxes stand for UUsesses ,SSourcesources, AAssetsssets , andLLiabilitiesiabilities (broadlydefined). The pluses(minuses) indicateincreases (decreases) inassets or liabilities.

A A LL-

-

SS

UU

Sources and Uses of Statements

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Measurement problemsUncertaintyTemporal spread

Difficulties Associated with Financial

Statement Analysis

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It is a financial performance method to calculate the trueeconomic profit of a corporation.It can be calculated as net operating after taxes profit minus a

charge for a opportunity cost of the capital invested.It is an estimate of the amount by which earnings exceed or fall short of the required minimum rate of return for shareholders or lenders at comparable risks.It can be calculated at divisional level.It is a flow and can be used for performance evaluation over time.

Economic Value Added ( EVA)

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Setting organisational goals.Performance measurement.Determining Bonus.Communication with shareholders and investors.Motivation of Managers.Capital Budgeting.

Corporate Valuation.Analyzing equity securities .

Usage of EVA

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It is the difference between the equity market valuation of a listed / quotedcompany and the sum of the adjusted book value of debt and equity invested in acompany. In short it is a sum of all capital claims held against the company; themarket value of debt and the market value of equity.The higher the MVA, the better.

The high MVA indicates the company has created substantial wealth for theshareholders.MVA is equivalent to the present value of all future expected EVA.

Negative MVA means the value of the actions and investment of management isless than the value of the actions and investments of the management is less than

the value of capital contributed to the company by the capitalmarkets. This means that wealth or value has been destroyed.

Market Value Added ( MVA)

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Market Value Added ( MVA)

NOTE:The aim is to maximize MVA not to maximize the value of thefirm, since this can be easily accomplished by investing ever increasing amounts of capital.MVA does not take into account the opportunity costs of theinvested capital.MVA also does not take into account intermediate cash returnsto shareholders.MVA cannot be calculated at divisional (SBU) level andcannot be used for private held companies.

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Inter Firm Comparison

A technique for assessing the financial profitability of a veterinary practice by comparing it on the basis of anumber of criteria with other practices in similar

situations. The practices are rated according to their performance in each area, e.g. percentage of potentialincome written off as bad debts, percentage of annualincome on the sundry debtors ledger.

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Summary

Ratio Analysis were explainedG rowth and Retained Earnings were discussedCommon Size Analysis were discussed

Trend Analysis were explainedCash Flow and Fund Flow Analysis were explainedEconomic Value Added was explained

Market value Added explained

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Documents

Day 3 - Financial Statement Analysis