Chapter 1, Slide 1
Financial Reporting, Financial Statement Analysis, and Valuation:A Strategic Perspective
Sixth Edition
Stickney/Brown/Wahlen
Copyright © 2007 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.
Chapter 1Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
Slides Prepared by
Karen Foust
Tulane University
Chapter 1, Slide 2
Six-Step Process
1. Identify the industry’s economic characteristics
2. Identify company strategy3. Assess financial statement quality—adjust
if necessary4. Analyze risk and profitability5. Prepare forecasted financial statements6. Value the firm
Chapter 1, Slide 3
STEP 1: Industry’s Economic Characteristics
Profit Margin
Asset T/O
ROA
LTD/TA
Grocery 3.5% 2.9 10.15% 29.8% Pharmaceutical 12.1% .678 8.2% 25.3% Utility 10.5% .495 5.2% 65.6% Bank 13.0% .09 1.2% 8.7%
Chapter 1, Slide 4
Industry’s Economic Characteristics
• Can use:– Value chain analysis
– Porter’s Five Forces
– Economic Attributes Framework
Chapter 1, Slide 5
Value Chain Analysis
PepsiCo Bottlers
Chapter 1, Slide 6
Value Chain Analysis
• BY PEPSICO:
– New beverage product development
– Manufacture of concentrate
• BY BOTTLERS
– Mixing to produce beverage or syrup
– Containerizing
– Distribution to retail outlets
Chapter 1, Slide 7
Porter’s Five Forcesapplied to soft drink/beverage industry
• Buyer power - relative bargaining power
– LOW
• Supplier power
– LOW
• Rivalry among existing firms
– MODERATE
Chapter 1, Slide 8
Porter’s Five Forcesapplied to soft drink/beverage industry (cont’d)
• Threat of new entrants– LOW
• Threat of substitutes– LOW
• Implies profitability is– HIGH
Chapter 1, Slide 9
Economic Attributes Framework
• Demand
• Supply
• Manufacturing
• Marketing
• Investing & Financing
Chapter 1, Slide 10
Economic Attributes Framework
applied to soft drink/beverage industry
• Demand– Relatively insensitive to price
– Low growth in U.S. but high growth elsewhere
– Not cyclical
– Higher in warmer weather
Chapter 1, Slide 11
Economic Attributes Framework
applied to soft drink/beverage industry
• Supply– Two principal suppliers
– High brand recognition
– Domination of distribution channels
– High barriers to entry
Chapter 1, Slide 12
Economic Attributes Framework
applied to soft drink/beverage industry
• Manufacturing– Manufacture of concentrate/syrup not
capital intensive
– Bottling/distribution IS capital intensive
– Simple process
Chapter 1, Slide 13
Economic Attributes Framework
applied to soft drink/beverage industry
• Marketing– Brand recognition, established demand;
advertising can stimulate• Investing/Financing
– Bottling/distribution require long-term financing
– Profitability high, growth slow (in U.S.) leads to excess cash flow
– Other countries growth requires financing
Chapter 1, Slide 14
STEP 2: Company Strategy
• Nature of product or service
– niche market? Unique product?
• Integration within value chain
• Geographical diversification
• Industry diversification
Chapter 1, Slide 15
STEP 3: Financial Statement Quality
• Income Statement
• Balance Sheet
• Statement of Cash Flows
• Statement of Shareholders’ Equity
First three required; most companies include all four.
Chapter 1, Slide 16
Financial Statement Quality
BALANCE SHEETalso called Statement of Financial Position:Assets = Liabilities + Owners’ Equity
Assets: Monetary or Non
Current assets M (most)
Investments M (debt)
Non (equity)
Property, Plant & Equipment Non
Intangibles Non
Chapter 1, Slide 17
Financial Statement Quality
BALANCE SHEET continued
Liabilities
Current
NoncurrentLong-term debt
Other
Deferred income taxes
Executory contracts?
Chapter 1, Slide 18
Financial Statement Quality
BALANCE SHEET continued
Owners’ Equity: residual interest
Common stock
Other classes of stock
Additional paid in capital
Retained earnings (increased by net income, decreased by dividends)
Accumulated other comprehensive income
Chapter 1, Slide 19
Financial Statement Quality
INCOME STATEMENT -- accrual basis
Income from continuing operationsIncome, gains/losses from discontinued
operations
Extraordinary gains/lossesCumulative effect of a change in accounting
principle NOTE: Should not appear after 2005 due to change in GAAP.
Comprehensive Income
Quality of Earnings? Persistence?
Chapter 1, Slide 20
STATEMENT OF CASH FLOWS
free cash flows
Categories:
Operating
Investing
FinancingInvesting/financing activities not involving cash
Financial Statement Quality
Chapter 1, Slide 21
STEP 4: Profitability and Risk Analysis
• TOOLS:
– Common-size financial statements
– Percentage change statements
– Financial Statement Ratios• Profitability: EPS, ROCE• Risk: CR, Debt to Equity
Chapter 1, Slide 22
STEP 5: Forecast Financial Statements
• Earnings forecasts
• Operating cash flow forecasts
• Other key metrics
Chapter 1, Slide 23
STEP 6: Value the Firm
Valuation based on:
• Dividends
• Earnings
• Cash flows
All three methods will give same value
Chapter 1, Slide 24
Sources of Financial Statement Information
• Annual Report to Shareholders
• Form 10-K Annual Report
• Form 10-Q Quarterly Report
• Prospectus or Registration Statement
• Form 20-F Annual Report (for non-U.S. firms)