FINANCIAL ANALYSIS TYPES OF FINANCIAL STATEMENTS FINANCIAL RATIOS BASIC SOURCES AND USES OF FUNDS TOPIC PREVIEW LEARNING OBJECTIVE

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1 FINANCIAL ANALYSIS TOPIC PREVIEW TYPES OF FINANCIAL STATEMENTS FINANCIAL RATIOS BASIC SOURCES AND USES OF FUNDS LEARNING OBJECTIVE Students be able to: Distinguish the different types of financial statements in financial analysis Interpret company s performance based on ratios and cash flow analysis Construct the sources and uses of funds statement

2 Financial Statements Definitions Functions Note: Refer to Basic Financial Management by Scott, Jr Martin, Petty,Keown on page 79 to 92. Types of Financial Statements Income statements Balance sheet Statements of retained earnings Statements of cash flow Income Statements A financial summary Monthly, quarterly, annually

3 Income Statement Table 8.1 (Panel 1) Income statement Table 8.1 (Panel 2) Balance Sheet A summary at a given point in time Assets (what firm owns), equity (owner s investment) liabilities ( what firm borrowed)

4 Balance Sheet Table 8.2 (Panel 1) Balance Sheet Table 8.2 (Panel 2) Statement of Retained Earnings Reconcile net income earned and dividend paid during the year with the change in retained earnings

5 Statement of Retained Earnings Table 8.3 Statement of Cash Flows A summary of cash flows Provide insights on firm s investment, financing and operating activities using income statement and balance sheet (Refer to the text for example) Financial Ratios To assess firm s financial condition and performance by way of way of calculation and interpretation Of interest to shareholders, creditors and management

6 Types of Ratio Comparisons Trend or Time-Series Analysis Used to evaluate a firm s performance over time. Cross-Sectional Analysis Used to compare different firms at the same point in time. Industry comparative analysis One specific type of cross sectional analysis. Used to compare one firm s financial performance to the industry s average performance. Combined Analysis Combined analysis simply uses a combination of both time-series analysis and cross-sectional analysis. Types of Ratio Comparisons Figure 8.1 Cautions for Doing Ratios must be considered together; a single ratio by itself means relatively little. Financial statements that are being compared should be dated at the same point in time. Use audited financial statements when possible. The financial data being compared should have been developed in the same way. Be wary of inflation distortions.

7 Example Using Daton Company Financial Statements Liquidity ratios Activity ratios Financial leverage ratio Leverage ratios Profitability ratios Liquidity Ratios Current Ratio Current ratio = Total current assets Total current liabilities Current ratio = $1,233,000 $620,000 = 1.97 Liquidity Ratios Quick ratio Quick ratio = Total current assets - Inventory Total current liabilities Quick ratio = $1,233,000 - $289,000 $620,000 = 1.51

8 Activity Ratios Inventory Turnover Inventory turnover = Cost of goods sold Inventory Inventory turnover = $2,088,000 $289,000 = 7.2 Activity Ratios Average collection period ACP = Accounts receivable Net sales/360 ACP = $503,000 = 58.9 days $3,074,000/360 Activity Ratios Average payment period APP = Accounts payable Annual purchases/360 ACP = $382,000 (.70 x $2,088,000)/360 = 94.1 days

9 Activity Ratios Total asset turnover Total asset turnover = Net sales Total assets Total asset turnover = $3,074,000 $3,579,000 =.85 Financial Leverage Ratio Debt ratio Debt ratio = Total liabilities Total assets Debt ratio = $1,643,000 $3,579,000 = 45.7% Leverage Ratios Times interest earned ratio Times interest earned = EBIT Interest Times interest earned = $418,000 $93,000 = 4.5

10 Leverage Ratios Fixed-payment coverage ratio (FPCR) FPCR = EBIT + Lease pymts Interest + Lease pymts + {(Princ pymts + PSD) x [1/(1 - t)]} FPCR = $418,000 + $35,000 $93,000 + $35,000 + {($71,000 + $10,000) x [1/(1 -.29)]} = 1.9 Common-size income statements Table 8.6 Gross profit margin GPM = Gross profit Net sales GPM = $986,000 $3,074,000 = 32.1%

11 Operating profit margin OPM = EBIT Net sales OPM = $418,000 $3,074,000 = 13.6% Net profit margin NPM = Net profits after taxes Net sales NPM = $231,000 $3,074,000 = 7.5% Return on total assets (ROA) ROA = Net profits after taxes Total assets ROA = $231,000 $3,597,000 = 6.4%

12 Return on equity (ROE) ROE = Net profits after taxes Stockholders equity ROE = $231,000 $1,954,000 = 11.8% Earnings per share (EPS) EPS = Earnings available to common stockholder Number of shares outstanding EPS = $221,000 76,262 = $2.90 Price earnings (P/E) ratio P/E = Market price per share of common stock Earnings per share P/E = $32.25 $2.90 = 11.1

13 Market/book (M/B) ratio M/B = Market price per share of common stock Book value per share of common stock M/B = $32.25 $23.00 = 1.40 Summarizing All Ratios Table 8.7 (Panel 1) Summarizing All Ratios Table 8.7 (Panel 2)

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