Upload
others
View
0
Download
0
Embed Size (px)
Citation preview
1-1
Overview of Financial
Statement Analysis
1-2
Financial Statement Analysis
• Financial Statement Analysis is an integral
and important part of the business
analysis.
• Business analysis?
– Process of evaluating a company’s economic
prospects and risks.
– The purpose is to improve business
decisions.
1-3
Business Analysis
Evaluate Prospects Evaluate Risks
Business Decision Makers
Equity investors
Creditors
Managers
Merger and Acquisition Analysts
External Auditors
Regulators
Board of Directors
Employees & Unions
Lawyers
Equity Analysis
Credit Analysis
Strategic Analysis: inter-firm; strength / weakness
Identify the value of target etc.
The quality of the financial reporting
The accuracy of financial report
The analysis on shareholders’ interests and responsibility
The analysis which are useful in collective bargaining negotiations.
The analysis about the humanity, legality etc.
1-4
Business Analysis
• These business decisions extend to equity and debt
valuation, credit risk assessment, earnings predictions,
audit testing, compensation negotiations, and countless
other decisions.
• Business analysis aids in making informed decisions by
helping structure the decision task through an evaluation
of a company’s business environment, its strategies, and
its financial position and performance.
1-5
Component Processes of Business Analysis
1-6
Industry Analysis
1-7
Strategic Analysis
Encompass (includes) evaluation of:
•Business decision
•Success in achieving competitive advantage
•This includes assessing a company’s expected strategic responses to
its business environment and the impact of these responses on its
future success and growth.
•Strategy analysis requires scrutiny of a company’s competitive
strategy for its product mix and cost structure.
1-8
Accounting Analysis
Comparability problems — across firms and across time
Manager estimation error
Distortion problems Earnings management
Accounting Standards
Accounting
Risk
Process to evaluate and adjust financial
statements to better reflect economic reality
1-9
Financial Analysis
Profitability analysis — Evaluate return
on investments
Risk analysis ——— Evaluate riskiness
& creditworthiness
Analysis of — Evaluate source &
cash flows deployment of funds
Common tools
Ratio
analysis
Cash
flow
analysis
Process to evaluate financial position and
performance using financial statements
1-10
Prospective Analysis
Intrinsic Value
Business Environment
& Strategy Analysis
Accounting Analysis
Financial Analysis
Process to forecast future payoffs
1-11
Information Sources for Business
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
1-12
Financial Statement Analysis
Application of Tools & Techniques
Using Financial Statements
To derive estimates & Inferences
Other Related Data
1-13
Dynamics of Business Activities
End of period
Beginning of period
Business Activities Time
Investing
Operating
FinancingPlanning
Planning
FinancingInvesting
1-14
Business Activities
Planning
Activities:
Goals
& Objectives
Competition Pricing
Market demandsTactics
Promotion
Managerial performance
Opportunities
Projections
Distribution
Obstacles
1-15
Business Activities
Financing
Financing activities
• Owner (equity)
• Nonowner (liabilities)
1-16
Investing activities
• Buying resources
• Selling resources
Investing = Financing
Business Activities
FinancingInvesting
1-17
Investing Activities
• Operating assets: Investments in land, buildings, equipment,
legal rights (patents, licenses, copyrights), inventories, human capital,
information systems, and similar assets are for the purpose of conducting
the company’s business operations.– Operating activities are a company’s primary source of earnings. Earnings reflect a
company’s success in buying from input markets and selling in output markets.
– Analysis of earnings figures, and their component parts, reflects a company’s success in
efficiently and effectively managing business activities.
• Financial assets: invest excess cash in securities such as
other companies 'equity stock, corporate and government bonds, and
money market funds.
• Current assets: short-term
• Non-current assets: long-term
1-18
Types of
Business
Analysis
Credit Analysis Equity Analysis
Management &
Control
Mergers, Acquisitions
& Divestitures
Director OversightRegulation
External Auditing
Labor Negotiations
Financial
Management
Types of Business Analysis
1-19
Credit Analysis
Trade Creditors
Provide goods or services
Most short-term
Usually implicit interest
Bear risk of default
Non-trade Creditors
Provide major
financing
Most long-term
Usually explicit interest
Bear risk of default
payables which are
related directly to the
company's primary
operations.
payables which are not
related directly to the core
operating business of the
company
1-20
Credit Analysis
Liquidity
Ability to meet short-
term obligations
Focus:
• Current cash flows
• Make up of current
assets and liabilities
• Liquidity of assets
Solvency
Ability to meet long-
term obligations
Focus:
• Long-term profitability
• Capital structure
Credit worthiness: Ability to honor credit obligations
(downside risk)
1-21
Credit Analysis
• Liquidity ratios:
– Current ratio: measures current assets available to
satisfy current liabilities.
• Current ratio =
– Acid-test ratio: a more stringent test of short-term
liquidity, uses only the most liquid current assets:
cash, short-term investments, and accounts receivable.
• Acid-test ratio =
1-22
1-23
Analysis and Interpretation: Mixon's short-term liquidity position has weakened over this
two-year period. Both the current and acid-test ratios show declining trends. Although
we do not have information about the nature of the company's business, the acid-test
ratio shift from ‘1.7 to 1’ down to ‘0.9 to 1’ and the current ratio shift from ‘2.9 to 1’ down
to ‘1.9 to 1’ indicate a potential liquidity problem. Still, we must recognize that industry
standards may show that the 2004 ratios were too high (instead of 2006 ratios as too
low).
1-24
Equity Analysis
• Equity investors provide funds to a company in return for
the risks and rewards of ownership. Equity investors are
major providers of company financing.
• Unlike credit analysis, equity analysis is symmetric in
that it must assess both downside risks and upside
potential. Because equity investors are affected by all
aspects of a company’s financial condition and
performance, their analysis needs are among the most
demanding and comprehensive of all users.
1-25
Equity Analysis
Technical analysis / Charting
• Patterns in price or volume history of a stock
• Predict future price movements
Fundamental Analysis
Determine Intrinsic value
without reference to
market price
• Analyze and interpret
key factors
– Economy
– Industry
– Company
Assessment of downside risk and upside potential
1-26
Intrinsic value
• Intrinsic value (also called fundamental value) refers
to the value of a company, stock, currency or product
determined through fundamental analysis without
reference to its market value.
• It is ordinarily calculated by summing the discounted
future income generated by the asset to obtain the
present value.
• It is worthy to note that this term may have different
meanings for different assets.
1-27
Planning
ActivitiesInvesting
Activities
Financial
Activities
Operating ActivitiesRevenues and expenses from providing
goods and services
Business Activities
1-28
Financial Statements
Balance Sheet
Income Statement
Statement of Shareholders’ Equity
Statement of Cash Flows
1-29
Financial Statements Reflect Business Activities
PlanningInvesting
Current:
• Cash
• Accounts Receivable
• Inventories
• Marketable Securities
Noncurrent:
• Land, Buildings, &
Equipment
• Patents
• Investments
Assets
Balance Sheet
FinancingCurrent:
• Notes Payable
• Accounts Payable
• Salaries Payable
• Income Tax Payable
Noncurrent:
• Bonds Payable
• Common Stock
• Retained Earnings
Liabilities & Equity
Balance Sheet
Statement of
Shareholders’ Equity
Operating
• Sales
• Cost of Goods Sold
• Selling Expense
• Administrative Expense
• Interest Expense
• Income Tax Expense
Net Income
Income statement
Cash Flow
Statement of
Cash Flows
1-30
Balance Sheet
Total Investing (Assets) = Total Financing
= Creditor Financing (Liabilities)
+ Owner Financing (Equity)• Liabilities:
– Funding from creditors
– represent obligations of a company / claims of creditors on assets
• Equity:
– 1. Funding invested by owners
– 2. Accumulated retained earnings
Colgate Financing = ?
(in $billions)
1-31
Total
Financing =?
1-32
1-33
Balance Sheet
Total Investing = Total Financing
= Creditor Financing + Owner Financing
Colgate Financing
(in $billions)
$9.138 = $7.727 + $1.410
1-34
Income Statement
Revenues – Cost of goods sold = Gross Profit
Gross profit – Operating expenses = Operating Profit
Colgate’s Profitability =?
(in $billions)
1-35
Gross Profit =?
Operating profit =?
1-361-36
Revenues – Cost of goods sold = Gross Profit
Gross profit – Operating expenses = Operating Profit
$12.238 - $5.536 = $6.701 Gross Profit
$6.701 - $4.5411 = $2.160 Operating profit
1-37
The Three Major Profits
Source: http://www.investopedia.com/articles/investing/062113/understanding-profit-metrics-gross-operating-and-net-profits.asp
1-38
Statement of Cash Flows
Net Cash Flows from Operating Activities
Net Cash Flows from Investing Activities
Net Cash Flows from Financing Activities
1-391-39
Note: Additional paid-in-capital represents
the excess paid by an investor over and
above the par-value price of a stock issue
and is often included in the contributed
surplus account in the shareholders'
equity section of a company's balance sheet.
1-40
1-41
Additional Information(Beyond Financial Statements)
Management’s Discussion & Analysis (MD&A)
Management Report
Auditor Report
Explanatory Notes to Financial Statements
Supplementary Information
Proxy Statement
1-42
Management’s Discussion & Analysis (MD&A)
• A portion of an organization's annual report that is written
for shareholders in which management explains how
the company performed the past year and projections for the coming
year. The report also highlights other aspects of the organization.
1-43
Management Report
• The purposes of this report are to reinforce:
1. senior management's responsibilities for the company’s
financial and internal control system and
2. the shared roles of management, directors, and the auditor in
preparing financial statements.
1-44
Auditor report
• An external auditor is an independent
certified public accountant hired by
management to provide an opinion on
whether or not the company’s financial
statements are prepared in conformity
with generally accepted accounting
principles.
• Financial statement analysis requires a
review of the auditor’s report to
ascertain whether the company
received an unqualified opinion.
Anything less than an unqualified
opinion increases the risk of analysis.
1-45
Explanatory Notes to Financial Statements
• Explanatory notes that accompany financial reports play an integral
part in financial statement analysis.
• Notes are a means of communicating additional information
regarding items included or excluded from the body of the
statements.
• Explanatory notes include information on:
1. accounting principles and methods employed,
2. detailed disclosures regarding individual financial statement items,
3. commitments and contingencies,
4. business combinations,
5. transactions with related parties,
6. stock option plans,
7. legal proceedings,
8. significant customers.
1-46
Supplementary Information
• Supplemental schedules to the financial
statement notes include information on:
1. business segment data,
2. export sales,
3. marketable securities,
4. valuation accounts,
5. short-term borrowings,
6. quarterly financial data.
1-47
Proxy Statement
• Shareholder votes are solicited for the election of directors and for
corporate actions such as mergers, acquisitions, and authorization of
securities.
• A proxy is a means whereby a shareholder authorizes another person to
actor him or her at a meeting of shareholders.
• A proxy statement contains information necessary for shareholders in
voting on matters for which the proxy is solicited.
• Proxy statements contain a wealth of information regarding a company
including the identity of shareholders owning 5% or more of outstanding
shares, biographical information on the board of directors, compensation
arrangements with officers and directors, employee benefit plans, and
certain transactions with officers and directors.
• Proxy statements are not typically part of the annual report.
1-48
Analysis Preview
Purpose: Evaluation of consecutive
financial statements
Output: Direction, speed, & extent of any
trend(s)
Types: Year-to-year Change Analysis (Y2Y)
Index-Number Trend Analysis
Comparative Analysis
Yr2Yr1 Yr3
Analysis Preview
1-49
Y2Y analysis is
straightforward.
Be attention when:
1. Negative value
2. Missing value
1-50
Analysis Preview
Purpose : Evaluation of internal makeup
of financial statements
Evaluation of financial statement
accounts across companies
Output: Proportionate size of assets,
liabilities, equity, revenues, &
expenses
Common-Size Analysis
1-51
Analysis Preview
• In analyzing a balance sheet:– It is common to express total assets (or liabilities plus
equity) as 100%.
• In analyzing an income statement:– Sales are often set at 100% with the remaining income
statement accounts expressed as a percentage of
sales.
Common-Size Analysis
1-52
Analysis Preview
1-53
Analysis Preview
1-54
Exercise
1-55
Exercise
2006 2005
Sales 100.0% 100.0%
Cost of goods sold 66.0 52.4
Gross profit 34.0% 47.6%
Operating expenses 21.0 19.4
Net income 13.0% 28.2%
Analysis and Interpretation: This situation appears to be unfavorable.
Both cost of goods sold and operating expenses are taking a larger
percent of each sales dollar in year 2006 compared to the prior year.
Also, even though sales volume increased, net income both
decreased in absolute terms and declined to only 13.0% of sales as
compared to 28.2% in the year before.
1-56
Exercise
• Express the Mixon Company’s balance sheets in common-size
percents. (Round to the nearest one-tenth of a percent.)
1-57
Exercise
Mixon Company
Common-Size Comparative Balance Sheet
December 31, 2004-2006
2006 2005* 2004*
Cash 5.9% 8.0% 9.9%
Accounts receivable, net 17.1 14.0 13.2
Merchandise inventory 21.5 18.5 14.2
Prepaid expenses 1.9 2.1 1.1
Plant assets, net 53.6 57.3 61.6
Total assets 100.0% 100.0% 100.0%
Accounts payable 24.9% 16.9% 13.2%
Long-term notes payable secured by
mortgages on plant assets 18.8 23.0 22.1
Common stock, $10 par value 31.4 36.5 43.6
Retained earnings 24.9 23.5 21.0
Total liabilities and equity 100.0% 100.0% 100.0%
* Column does not equal 100.0 due to rounding.
1-58
Analysis Preview
Purpose : Evaluate relation between two or more
economically important items (one
starting point for further analysis)
Output: Mathematical expression of relation
between two or more items
Cautions: Prior Accounting analysis is important
Interpretation is key
Ratio Analysis
1-59
Analysis Preview
Purpose: Estimate intrinsic value of a
company (or stock)
Basis: Present value theory (time value of
money)
ValuationValuation - an important goal of many types
of business analysis
1-60
Analysis Preview
Annuity & its Present Value (PV)
An annuity is a series of payments made at fixed intervals of time.
1-61
PV formula for Annuity
Analysis Preview
① * (1+i)
②-①
(1 + i)P − P = A − A(1 + i) − n
P(1 + i − 1) = A[1 − (1 + i) − n]
P = A [1 − (1 + i) − n] / i
The PV of an annuity is the summation of a Geometric sequence, the
discount factor is its common ratio.
①
②
1-62
Analysis Preview
Discount rate VS discount factor
• Discount rate: Assuming a discount rate (i) of 10%, the $1,000 in a
year's time would be equivalent to $909.09 to you today (1,000 /
[1.00 + 0.10]).
• Discount factor: for the same case, the discount factor is 1/(1+i)= 1
/ (1.00 + 0.10) = 10/11
PV factor for annuity
• PV factor for annuity:
1-63
Analysis Preview
Annuity & its Present Value (PV)
Use the formula to compute the PV of the annuity :
discount rate = 5%
PV = Annuity * PV factor (of annuity)
= 1000 * [ 1- 1.05^(-5) ] / 0.05
= 1000 * 4.32948
= 4329.48
1-64
Analysis Preview
Debt (Bond) Valuation
• A bond is a form of debt (i.e. a contractual liability;
basically just a certificate showing that a borrower
promises to repay interest and principal on specified
dates.
• Issued by both governments and corporations
1-65
Analysis Preview
Debt (Bond) Valuation
• Example: the Government of Canada issued a bond
with a face value of $1,000 in June 2002 which
matures in June 2022. The stated annual interest rate
is 8%:
• the face value (the principal or par value) is $1,000
• the annual coupon is $80
• the coupon rate is 8%
• the time to maturity is 20 years
• the maturity date is June 1, 2022
1-66
Analysis Preview
Debt (Bond) Valuation
Bt is the value of the bond at time t
It +n is the interest payment in period t+n
F is the principal payment (usually the debt’s face value)
r is the investor’s required interest rate (yield to maturity)
1-67
Exercise
1-68
Exercise
1-69
Exercise
1-70
Analysis Preview
Equity Valuation
– Dividend Discount Model
Vt is the value of an equity security at time t
Dt +n is the dividend in period t+n
k is the cost of capital
E refers to expected dividends
1-71
Analysis Preview
Equity Valuation
– Dividend Discount ModelExample:An investor plans to hold Newco's stock for 2 years. Newco expects to
pay its shareholders common equity, $0.25 per share over the next two
years. The investor anticipates Newco's stock will close the end of that
time period at $40 per share. Given a rate of return of 10%, what is the
value of Newco's common stock at the end of the two-year time
period?
Answer:Value of Newco's common stock
= $0.25/ (1.10)1 + $0.25/(1.10)2 + $40/(1.10)2
= $33.49
1-72
Analysis Preview
Equity Analysis and Valuation
– Earnings Persistence:
Recasting and adjusting earnings;
Determinants of Persistence;
Measuring persistence
– Earnings-Based Valuation:
Stock prices and accounting data
Valuation multiples
– Earning Power and Forecasting:
Earning power
Earnings forecasting Monitoring and revising
1-73
Intrinsic value
• Intrinsic value (also called fundamental value) refers
to the value of a company, stock, currency or product
determined through fundamental analysis without
reference to its market value.
• It is ordinarily calculated by summing the discounted
future income generated by the asset to obtain the
present value.
• It is worthy to note that this term may have different
meanings for different assets.
1-74
1-75
Intrinsic value
• Intrinsic value (also called fundamental value) refers
to the value of a company, stock, currency or product
determined through fundamental analysis without
reference to its market value.
• It is ordinarily calculated by summing the discounted
future income generated by the asset to obtain the
present value.
• It is worthy to note that this term may have different
meanings for different assets.
1-76
Analysis Preview
Equity Valuation
- Free Cash Flow to Equity Model
FCFt+n is the free cash flow 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
1-77
1-78
Analysis Preview
Equity Valuation
- Residual Income Model
BVt is the book value at the end of period t
Rit+n is the residual income in period t + n [defined as
net income, NI, minus a charge on beginning
book value, BV, or RIt = NIt - (k x BVt-1)]
k is the cost of capital
E refers to an expectation
1-79
1-80
Analysis in an Efficient Market
Three assumed forms of market efficiency
Weak Form - prices reflect information in
past prices
Semi-strong - prices reflect all public
Form information
Strong Form - prices reflect all public and
private information
1-81
Analysis in an Efficient Market
• EMH (Efficient Market Hypothesis) assumes the existence of
competent and well-informed analysts using tools of analysis like
those described in this book.
• It also assumes analysts are continually evaluating and acting on
the stream of information entering the marketplace.
• Extreme proponents of EMH claim that if all information is instantly
reflected in prices, attempts to reap consistent rewards through
financial statement analysis is futile.
• This extreme position presents a paradox.
– On one hand, financial statement analysts are assumed capable of keeping
markets efficient, yet these same analysts are assumed as unable to earn
excess returns from their efforts.
– Moreover, if analysts presume their efforts in this regard are futile, the efficiency
of the market ceases.