chapter01-10e alk

8/10/2019 Chapter01-10e ALK

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McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Financial

Statement

Analysis

K R Subramanyam

John J Wi ld


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1CHAPTER

Overview of Financial

Statement Analysis


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Business Analysis

Evaluate Prospects Evaluate Risks

Business Decision Makers

Equity investors

Creditors

Managers

Merger and Acquisition Analysts

External Auditors

Directors

Regulators

Employees & Unions

Lawyers


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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

Chairpersons Letter

Management discussion & Analysis

Qualitative


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Types ofBusiness

Analysis

Credit Analysis Equity Analysis

Management &

Control

Mergers, Acquisitions

& Divestitures

Director OversightRegulation

External Auditing

Labor Negotiations

Financial

Management


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Credit Analysis

TradeCreditors

Providegoods orservices

Most short-term

Usuallyimplicitinterest

Bear risk ofdefault

Non-tradeCreditors

Providemajor

financing

Most long-term

Usuallyexplicitinterest

Bear risk ofdefault


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Credit Analysis

Liquidity

Ability to meet short-

term obligations

Focus:

Current cash flowsMake up of current

assets and liabilities

Liquidity of assets

Solvency

Ability to meet long-

term obligations

Focus:

Long-term profitabilityCapital structure

Credit worthiness: Ability to honor credit obligations

(downside risk)


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Equity Analysis

Technical analysis /

Charting Patterns in price or

volume history of astock

Predict future pricemovements

Fundamental Analysis

Determine Intrinsic value

without reference to

price

Analyze and interpret

key factors

Economy

Industry

Company

Assessment of downside risk and upside potential


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Prospective

AnalysisAccounting

Analysis

Business

Environment &

Strategy Analysis

Industry

Analysis

Strategy

Analysis

Financial

Analysis

Analysis

of cash

flowsProfitability

Analysis

Risk

Analysis

Cost of Capital Estimate Intrinsic Value

Component Processes of

Business Analysis


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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


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Financial Analysis

Profitability analysisEvaluate returnon investments

Risk analysisEvaluate riskiness

& creditworthiness

Analysis of Evaluate source &

cash flows deployment of funds

Common tools

Ratioanalysis

Cash

flowanalysis

Process to evaluate financial position and

performance using financial statements

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Prospective Analysis

Intrinsic Value

Business Environment

& Strategy Analysis

Accounting Analysis

Financial Analysis

Process to forecast future payoffs

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Dynamics of Business Activities

End of period

Beginning of period

Business Activities Time

Investing

Operating

Financing

Planning

Planning

FinancingInvesting

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Business Activities

Planning

Activities:

Goals

& Objectives

Competition Pricing

Market demandsTactics

Promotion

Managerial performance

Opportunities

Projections

Distribution

Obstacles

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Business Activities

Financing

Financing activities

Owner (equity)

Nonowner (liabilities)

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Investing activities

Buying resourcesSelling resources

Investing = Financing

Business Activities

FinancingInvesting

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Planning

ActivitiesInvesting

Activities

Financial

Activities

Operating ActivitiesRevenues and expenses from providing

goods and services

Business Activities

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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

ShareholdersEquity

Operating

SalesCost of Goods Sold

Selling ExpenseAdministrative Expense

Interest Expense

Income Tax Expense

Net Income

Income statement

Cash Flow

Statement of

Cash Flows

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Financial Statements

Balance Sheet

Income Statement

Statement of ShareholdersEquity

Statement of Cash Flows

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Balance Sheet

Total Investing = Total Financing

= Creditor Financing + Owner

Financing

Colgate Financing

(in $billions)

$9.138 = $7.727 + $1.410

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Income Statement

RevenuesCost of goods sold = Gross Profit

Gross profitOperating expenses = Operating Profit

Colgates Profitability

(in $billions)

$12.238 - $5.536 = $6.701 Gross Profit

$6.701 - $4.5411 = $2.160 Operating profit

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Statement of Cash Flows

Net Cash Flows fromOperating Activities

Net Cash Flows fromInvesting Activities

Net Cash Flows fromFinancing Activities

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Additional Information(Beyond Financial Statements)

Managements Discussion & Analysis (MD&A)

Management Report

Auditor Report

Explanatory Notes to Financial Statements

Supplementary Information

Proxy Statement

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Analysis Preview

Purpose: Evaluation of consecutivefinancial statements

Output: Direction, speed, & extent of any

trend(s)

Types: Year-to-year Change Analysis

Index-Number Trend Analysis

Comparative Analysis

Yr2Yr1 Yr3

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Analysis Preview

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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

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Analysis Preview

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Analysis Preview

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Analysis Preview

Purpose : Evaluate relation between two or more

economically important items (onestarting point for further analysis)

Output: Mathematical expression of relation

between two or more items

Cautions: Prior Accounting analysis is important

Interpretation is key - long vs short

term & benchmarking

Ratio Analysis

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Analysis Preview

Purpose: Estimate intrinsic value of a

company (or stock)

Basis: Present value theory (time value ofmoney)

ValuationValuation - an important goal of many types

of business analysis

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Analysis Preview

Debt (Bond) Valuation

Bt is the value of the bond at time t

It +n is the interest payment in period t+nF is the principal payment (usually the debts face value)

ris the investors required interest rate (yield to maturity)

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Analysis Preview

Equity Valuation

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 expecteddividends

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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 capitalexpenditures]


E refers to an expectation

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Analysis Preview

Equity Valuation - Residual Income Model

BVtis 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)]


E refers to an expectation

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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 andprivate information

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Book Organization

Financial Statement Analysis

Part I

Introduction and Overview

Part III

Financial Analysis

Part II

Accounting Analysis

Chapter 1: Overview of

Financial Statement

Analysis

Chapter 2: Financial

Reporting and

Analysis

Chapter 3: Analyzing

Financial Activities


Investing Activities


Investing Activities:

Special topic


Operating Activities

Chapter 7: Cash Flow

Analysis

Chapter 8: Return on

Invested Capital

Chapter 9: ProfitabilityAnalysis

Chapter 10: Prospective

Analysis

Chapter 11: Credit

Analysis

Chapter 12: Equity

A l i d V l ti

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