financial statements and cash flows. financial statements
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- Slide 1
- Financial Statements and Cash Flows
- Slide 2
- Financial Statements
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- Balance sheet Income statement Statement of cash flows
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- Balance Sheet Statement of financial position. The balance sheet is a financial statement that shows the firms assets, liabilities and equity at a given point in time. Balance Sheet Identity Assets = Liabilities + Shareholders Equity (Owners Equity)
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- Assets and Liquidity The speed and ease with which an asset can be converted to cash. Ease of conversion to cash. Without significant loss in value. Trade-off between the advantages of liquidity and foregone potential profits. The more liquid a firm is, the less likely it is to experience financial distress. The return on liquid assets is low.
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- Debt versus Equity Shareholders equity = Assets Liabilities Shareholders equity is the residual portion and equity owners are entitled to only the residual value. The use of debt in a firms capital is called financial leverage. The more debt a firm has, the greater of financial leverage.
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- Net Working Capital Net Working Capital = Current Assets Current Liabilities Positive when current assets exceed current liabilities. Positive when the cash that will become available over the next 12 months exceeds the cash that will be paid over the next 12 months. Usually positive in a healthy firm.
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- Market Value versus Book Value Book value the balance sheet Assets at historical costs. Market value - the price at which an item could be bought or sold Stockholder wealth maximization is to maximize the market value of the stock, not the book value.
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- Income Statement Profit and loss statement. Statement of financial performance. The income statement shows the revenue and expenses of a firm during a period of time. Revenue Expenses = Income Accounting net income is not the same as cash flow. Depreciation, a noncash expense, is deducted when net income is calculated.
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- Sources and Uses of Cash Sources of cash Cash inflows Decrease in assets other than cash Increase in liabilities or equity Uses of cash Cash outflows Increase in assets other than cash Decrease in liabilities or equity
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- Statement of Cash Flows The statement which summarizes the sources and uses of cash. Three categories Operating activities Investment activities Financing activities
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- Cash Flows
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- Cash Flow The difference between the number of money that came in and the number that went out. The actual net cash, as opposed to accounting net income, that flows into or out of a firm during a certain period. Free cash flow refers to the cash that the firm is free to distribute to creditors or stockholders because it is not needed for working capital or fixed asset investment.
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- Cash Flow Identity Cash Flow From Assets (CFFA) = Cash Flow to Creditors + Cash Flow to Stockholders Cash Flow From Assets = Operating Cash Flow Net Capital Spending Change in NWC Operating cash flow = Earnings before interest and equity (EBIT) + Depreciation Taxes Net capital spending = Ending net fixed assets Beginning net fixed assets + Depreciation Change in NWC = Ending NWC Beginning NWC Cash Flow to Creditors = Interest paid Net new borrowing Cash Flow to Stockholders = Dividends paid Net new equity raised
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- Example Current assets 2011: Current assets = 8,800 2010: Current assets = 7,000 Current liabilities 2011: Current liabilities = 3,000 2010: Current liabilities = 2,400 Fixed assets 2011: Net fixed assets = 6,800; 2010: Net fixed assets = 6,200 Depreciation Expense = 800 Long-term debt and Equity 2011: Long-term debt = 8,000; Common stock = 800 2010: Long-term debt = 7,900; Common stock = 800 Income Statement EBIT = 4,000; Taxes = 600 Interest expense = 700; Dividends = 1000 Calculate the CFFA
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- Solution OCF = $4,000 + 800 600 = $4,200 Net capital spending = $ 6,800 6,200 + 800 = $1,400 Change in NWC = ($8,800 3,000) ($7,000 2,400) = $1,200 CFFA = $4,200 1,400 - 1,200 = $1,600 CF to Creditors = $700 ($8,000 7,900) = $600 CF to Stockholders = $1,000 CFFA = $600 + 1,000 = $1,600
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- Working with Financial Statements
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- Standardized Financial Statements Common-size balance sheets Express each item as a percent of total assets Common-size income statements Express each item as a percent of sales Common-size statements of cash flows Express each item as a percent of total sources or uses Standardized financial statements are useful for comparing companies of different sizes.
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- Trend Analysis Common base-year statements Choose a base year and express each item relative to the base amount. Combined common-size base-year analysis As the assets grow, most of the other accounts must grow as well. By forming the common-size statements, the effect of the overall growth would be eliminated.
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- Ratio Analysis Ratio analysis are useful for comparing through time or between companies. Categories of financial ratios Short-term solvency or liquidity ratios Long-term solvency or financial leverage ratios Asset management or turnover ratios Profitability ratios Market value ratios
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- Short-Term Solvency Ratios Current ratio = Current assets / Current liabilities Quick ratio = (Current assets Inventory) / Current liabilities Cash ratio = Cash / Current liabilities Net working capital to total assets = Net working capital / Total assets Interval measure = Current assets / average daily operating costs
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- Long-Term Solvency Ratios Total debt ratio = (Total assets Total equity) / Total assets Debt-equity ratio = Total debt / Total equity Equity multiplier = Total assets / Total equity = 1 + Debt-equity ratio Long-term debt ratio = Long-term debt / (Long- term debt + Total equity) Times interest earned ratio = EBIT / Interest Cash coverage ratio = (EBIT + Depreciation) / Interest
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- Asset Management Ratios Inventory turnover = Cost of goods sold / Inventory Days sales in inventory = 365 / Inventory turnover Receivables turnover = Sales / Accounts receivable Days sales in receivables = 365 / Receivables turnover NWC Turnover = Sales / NWC Fixed asset turnover = Sales / Net fixed assets Total asset turnover = Sales / Total assets
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- Profitability Ratios Profit margin = Net income / Sales Return on assets (ROA) = Net income / Total assets Return on equity (ROE) = Net income / Total equity
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- Market Value Ratios Price-earnings ratio = Price per share / Earnings per share Price-sales ratio = Price per share / Sales per share Market-to-book ratio = Market value per share / Book value per share Tobins Q = Market value of the firms assets / Replacement cost of the firm s assets = Market value of the firms debt and equity / Replacement cost of the firm s debt and equity
- Slide 26
- The Du Pont Identity ROE = Net income / Total equity ROE = (Sales / Sales)(Net income/ Total assets)(Total assets / Total equity) ROE = (Net income / Sales)(Sales / Total assets)(Total assets / Total equity) ROE = (ROA)(Equity multiplier) ROE = (Profit margin)(Total asset turnover )(Equity multiplier)
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- The Du Pont Identity ROE = (Profit margin)(Total asset turnover)(Equity multiplier) Profit margin profitability ratio, operating efficiency Total asset turnover asset management ratio, asset use efficiency Equity multiplier long-term solvency ratio, financial leverage
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- Why Evaluate Financial Statements? Internal uses Performance evaluation Planning for the future External uses Creditors Suppliers Customers Credit-rating agencies
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- Choosing a Benchmark Time-trend analysis Compared to history Peer group analysis Compare to the peer group
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- Limitations The results of ratio analysis depend on the quality of financial statements. It is difficult for diversified firms to find a benchmark. Factors such as inflation, different operating and accounting practices, seasonal factors can distort comparisons. It is difficult to judge whether a particular ratio is good or bad. It is difficult to judge whether a firm is good or bad if some ratios look good and some ratios look bad.
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