1 financial statement analysis. 2 financial statement analysis (objectives) a good working...

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Financial Statement Analysis

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Financial Statement Analysis(objectives)

A good working knowledge of financial statement is desirable because such a statement and number derived from those statement are primary means of communicating financial information both with the firm and out side the firm.

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Financial statement analysis is performance by:- Stockholders : to measure management’s

performance. Creditors : to make their investment decisions. Management: to plan and control operation. And it is also an important tool for accountants and

financial analysts to use to better understand their company's competitive position.

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• Financial statements can be analyzed to identify:-– Trends in key financial data. – Compare financial performance across

companies. – Calculate financial ratios which can be used to

assess a company's current performance as well as its prospects for the future.

• Financial statement users should be able to Financial statement users should be able to find and interpret information to answer find and interpret information to answer questions about a company.questions about a company.

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Financial Statement Analysis

• Balance Sheet.Balance Sheet.• Statement of Stockholders’ Equity.Statement of Stockholders’ Equity.• Income Statement or Earnings Statement. Income Statement or Earnings Statement. • Statement of Cash Flows.Statement of Cash Flows.

Annual reports contain four basic financial statements:-

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The Financial StatementsThe Financial StatementsThe Balance Sheet

• Also called the statement of condition or the statement of financial position.

• Shows the financial condition or financial position of a company on a particular date.– Prepared on a particular date at the end of an

accounting period– End of accounting period can be the end of a calendar

year, fiscal year, or interim period such as a year, a quarter, etc.

• Summarizes what the firm owns and what the firm owes to outsiders and to internal owners.

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The Financial StatementsThe Financial StatementsThe Balance Sheet

• AssetsAssets = = Liabilities Liabilities ++ Stockholders’ equity Stockholders’ equity

– Assets are what the firm owns.– Liabilities are what the firm owes to outsiders.– Stockholders’ equity is what the firm owes to

internal owners.

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Financial Statement : Balance Sheet

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Assets

Shareholders’ Equity

Current Liabilities

Long-Term Debt

Liabilities

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Financial Statement : Balance Sheet Assets

A. Current Assets: Include cash and assets expected to be converted to cash within one year or one operating cycle. Assets that are continually

1. Cash• Cash awaiting deposit• Cash in a bank account

2. Marketable Securities• Short-term investments of cash that is not needed.• Treasury bills, certificates, notes, bonds, commercial

paper

3. Accounts Receivable• Customer balances outstanding on credit sales.

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4. Inventories Items held for sale or used in the manufacture of products

that will be sold. Manufacturing Company (three types of inventory):-

Raw materials Work-in-process Finished goods

5. Prepaid Expenses Expenses paid in advance. Included in current assets if they

expire within one year or one operating cycle:- insurance rent utilities

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A. Fixed Assets

1)Tangible:

• Have physical substance. long-lived– Not used up during annual operations.– Produce economic benefits for more than one year.

• Fixed assets other than land are “depreciated” over the period of time they benefit the firm.

– Straight-line method allocates an equal amount of expense to each year of the depreciation period.

• Land refers to property used in business, not investment property.

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2 .Intangible• Goodwill recognized in business combinations• Patents• Trademarks• Copyrights• Brand Names• Franchises

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Financial Statement (Balance Sheet) Liabilities

Represent claims against assets and includeCurrent Liabilities & Non current liabilities.

A. Current liabilities must be satisfied in one year or one operating cycle and include.

1. Accounts payableShort-term obligations that arise from credit extended by suppliers for the

purchase of goods and services .Account is eliminated when bill is satisfied.

2. Notes payableShort-term obligations in the form of promissory notes. Lines of credit to

suppliers or financial institutions.

3. Accrued liabilitiesResult from recognition of an expense prior to actual payment of cash.

4. Unearned revenue Result from payments received in advance for services or products.

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Financial Statement (Balance Sheet) Liabilities

B. Long–term liabilities: Obligations with maturities beyond one year.

1. Long-term debt :Bonds, Long-Term Notes Payable.

2. Deferred Taxes: Result of temporary differences in the recognition of revenue and expense for taxable income relative to reported income.

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Financial Statement (Balance Sheet) Stockholders’ Equity

Stockholders’ Equity: Final section of balance sheet

Also called shareholders’ equity Residual interest in assets that remains after deducting liabilities

A. Common Stock Shareholders• Do not ordinarily receive a fixed return.• Have voting privileges in proportion to ownership interest.• Can benefit through price appreciation.• Can suffer through price depreciation.• Dividends are declared at the discretion of a company’s

board of directors.

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Financial Statement (Balance Sheet) Stockholders’ Equity

B. Additional paid-in capital : Reflects the amount by which the original sales price of the stock shares exceeded par value.

C. Retained Earnings: Funds a company has elected to reinvest in the operations of the business rather than pay out in stock.

D. Preferred stock : Carries a fixed annual dividend payments Carries no voting rights.

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2007 2006 2007 2006Current assets: Current Liabilities:

Cash and equivalents $140 $107 Accounts payable $213 $197 Accounts receivable 294 270 Notes payable 50 53

Inventories 269 280 Accrued expenses 223 205 Other 58 50 Total current liabilities $486 $455

Total current assets $761 $707Long-term liabilities:

Fixed assets: Deferred taxes $117 $104 Property, plant, and equipment $1,423 $1,274 Long-term debt 471 458

Less accumulated depreciation (550) (460) Total long-term liabilities $588 $562 Net property, plant, and equipment 873 814 Intangible assets and other 245 221 Stockholder's equity:

Total fixed assets $1,118 $1,035 Preferred stock $39 $39 Common stock ($1 per value) 55 32 Capital surplus 347 327 Accumulated retained earnings 390 347 Less treasury stock (26) (20) Total equity $805 $725

Total assets $1,879 $1,742 Total liabilities and stockholder's equity $1,879 $1,742

The assets are listed in order by the length of time it would normally take a firm with ongoing operations to convert them into cash.

Clearly, cash is much more liquid than property, plant, and equipment.

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The Financial StatementsThe Financial StatementsThe Income StatementThe Income Statement

Also called the earnings statement Also called the earnings statement Presents the results of operations for the Presents the results of operations for the accounting period. accounting period.

• revenues• expenses• net income• earnings per share

Reveals management’s ability to translate sales dollars into profits.

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• Sales (operating revenues) are the major revenue source for most companies.

• Cost of Goods Sold: Cost to seller of products or services sold to customers.

• Operating Expenses: Selling and administrative, Advertising.

• Depreciation Cost of assets other than land that will benefit a business enterprise for more than a year is allocated over the asset’s service life.

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• Operating Profit (Operating income) Also called earnings before interest and taxes (EBIT)

– Measures overall performance of company’s operations: sales revenue less expenses associated with generating sales.

– Provides a basis for assessing success of a firm apart from financing and investing activities and separate from tax considerations.

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• Other Income (Expense)

Revenues and costs other than from operations such as• dividend and interest income• interest expense• investment gains (losses)• equity earnings (losses)• gains (losses) from sale of fixed assets

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Financial Statement : Income Statement

Total operating revenuesCost of goods soldSelling, general, and administrative expensesDepreciationOperating incomeOther incomeEarnings before interest and taxesInterest expensePretax incomeTaxes Current: $71 Deferred: $13Net income Addition to retained earnings $43 Dividends: $43

The operations section of the income statement reports the firm’s revenues and expenses from principal operations.

$2,262 ( 1,655)

( 327) ( 90)

$190 29

$219( 49)

$170 ( 84)

$86

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Total operating revenues $2,262Cost of goods sold 1,655Selling, general, and administrative expenses 327Depreciation 90Operating income $190Other income 29

Earnings before interest and taxes $219Interest expense 49Pretax income $170Taxes 84 Current: $71 Deferred: $13Net income $86 Addition to retained earnings: $43 Dividends: $43

The non-operating section of the income statement includes all financing costs, such as interest expense.


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Total operating revenuesCost of goods soldSelling, general, and administrative expensesDepreciationOperating incomeOther incomeEarnings before interest and taxesInterest expensePretax incomeTaxes Current: $71 Deferred: $13Net income Addition to retained earnings: $43 Dividends: $43

Usually a separate section reports the amount of taxes levied on income.

$2,262 1,655

327 90

$19029

$219 49

$170 84

$86


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Total operating revenuesCost of goods soldSelling, general, and administrative expensesDepreciationOperating incomeOther incomeEarnings before interest and taxesInterest expensePretax incomeTaxes Current: $71 Deferred: $13Net income Retained earnings: $43 Dividends: $43

Net income is the “bottom line.”

$2,262 1,655

327 90

$19029

$219 49

$170 84

$86


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Short-Term Asset Management

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Long-Term Debt

Current Liabilities

Net Working Capital

How should short-term assets be managed and financed?

Shareholders’ Equity

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2007 2006 2007 2006Current assets: Current Liabilities: Cash and equivalents $140 $107 Accounts payable $213 $197 Accounts receivable 294 270 Notes payable 50 53 Inventories 269 280 Accrued expenses 223 205 Other 58 50 Total current liabilities $486 $455 Total current assets $761 $707

Long-term liabilities:Fixed assets: Deferred taxes $117 $104 Property, plant, and equipment $1,423 $1,274 Long-term debt 471 458 Less accumulated depreciation (550) (460 Total long-term liabilities $588 $562 Net property, plant, and equipment 873 814 Intangible assets and other 245 221 Stockholder's equity: Total fixed assets $1,118 $1,035 Preferred stock $39 $39

Common stock ($1 par value) 55 32 Capital surplus 347 327 Accumulated retained earnings 390 347 Less treasury stock (26) (20) Total equity $805 $725

Total assets $1,879 $1,742 Total liabilities and stockholder's equity $1,879 $1,742

Here we see NWC grow to $275 million in 2006 from $252 million in 2005. This increase of $23 million is an investment of the firm.

$23 million

$275m = $761m- $486m

$252m = $707- $455

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The Financial StatementsThe Financial StatementsThe Statement of Cash FlowsThe Statement of Cash Flows

Provides information about the cash Provides information about the cash inflows and outflows during an accounting inflows and outflows during an accounting periodperiod

• Operating activitiesOperating activities• Financing activitiesFinancing activities• Investing activitiesInvesting activities

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Financial Statement : Financial Cash Flow

Cash Flow of the FirmOperating cash flow $238 (Earnings before interest and taxes plus depreciation minus taxes)Capital spending -173 (Acquisitions of fixed assets minus sales of fixed assets)Additions to net working capital -23 Total $42

Cash Flow of Investors in the FirmDebt $36 (Interest plus retirement of debt minus long-term debt financing)Equity 6 (Dividends plus repurchase of equity minus new equity financing) Total $42

Operating Cash Flow:

EBIT $219

Depreciation $90

Current Taxes -$71

OCF $238

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Cash Flow of the FirmOperating cash flow $238 (Earnings before interest and taxes plus depreciation minus taxes)Capital spending (Acquisitions of fixed assets minus sales of fixed assets)Additions to net working capital Total

Cash Flow of Investors in the FirmDebt (Interest plus retirement of debt minus long-term debt financing)Equity (Dividends plus repurchase of equity minus new equity financing) Total

Capital Spending

Purchase of fixed assets $198

Sales of fixed assets -$25

Capital Spending $173

-173

-23$42

$36

6

$42

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NWC grew from $275 million in 2007 from $252 million in 2006.

This increase of $23 million is the addition to NWC.

-173

-23$42

$36

6

$42

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-173

-23$42

$36

6

$42

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Cash Flow to Creditors

Interest$49

Retirement of debt 73

Debt service 122

Proceeds from new debt sales -86

Total $36

-173

-23$42

$36

6

$42

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Cash Flow to Stockholders

Dividends $43

Repurchase of stock 6

Cash to Stockholders 49

Proceeds from new stock issue -43

Total $6

-173

-23$42

$36

6

$42

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)()(

)(

SCFBCF

ACF

The cash flow received from the firm’s assets must equal the cash flows to the firm’s creditors and stockholders:

-173

-23$42

$36

6

$42

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Financial Statement : Financial Cash Flow (Cash Flow from Operations)

To calculate cash flow from operations, start with net income, add back non-cash items like depreciation and adjust for changes in current assets and liabilities (other than cash).

OperationsNet Income

Depreciation

Deferred Taxes

Changes in Assets and Liabilities

Accounts Receivable

Inventories

Accounts Payable

Accrued Expenses

Notes Payable

Other

Total Cash Flow from Operations

$86

90

13

-24

11

16

18

-3

$199

-8

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Financial Statement : Financial Cash Flow (Cash Flow from Investing)

Cash flow from investing activities involves changes in capital assets: acquisition of fixed assets and sales of fixed assets (i.e., net capital expenditures).

Acquisition of fixed assetsSales of fixed assets

Total Cash Flow from Investing Activities

-$19825

-$173

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Financial Statement : Financial Cash Flow (Cash Flow from Financing)

Cash flows to and from creditors and owners include changes in equity and debt.

Retirement of debt (includes notes)

Proceeds from long-term debt sales

Dividends

Repurchase of stock

Proceeds from new stock issue

Total Cash Flow from Financing

-$73

86

-43

43

$7

-6

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The statement of cash flows is the addition of cash flows from operations, investing, and financing.

OperationsNet IncomeDepreciationDeferred TaxesChanges in Assets and Liabilities

Accounts ReceivableInventoriesAccounts PayableAccrued ExpensesNotes PayableOther

Total Cash Flow from Operations

$869013

-24111618-3

$199-8

Acquisition of fixed assetsSales of fixed assets

Total Cash Flow from Investing Activities

-$19825

-$173

Investing Activities

Financing ActivitiesRetirement of debt (includes notes)Proceeds from long-term debt salesDividendsRepurchase of stockProceeds from new stock issue

Total Cash Flow from Financing

-$7386-43

43$7

-6

Change in Cash (on the balance sheet) $33

1 financial statement analysis. 2 financial statement analysis (objectives) a good working...

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