McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Financial Statement Analysis K R Subramanyam John J Wild 1-2 1 CHAPTER Overview of Financial Statement Analysis 1-3 Business Analysis Evaluate Prospects Evaluate Prospects Evaluate Risks Evaluate Risks 1-4 Information Sources for Business Analysis 1-5 1-6 Credit Analysis 1-7 Credit Analysis Liquidity Ability to meet short- term obligations Focus: • Current cash flows • Make up of current assets and liabilities • Liquidity of assets Liquidity Ability to meet short- term obligations Focus: • Current cash flows • Make up of current assets and liabilities • Liquidity of assets Solvency Ability to meet long- term obligations Focus: • Long-term profitability • Capital structure Solvency Ability to meet long- term obligations Focus: • Long-term profitability • Capital structure Credit worthiness: Ability to honor credit obligations (downside risk) Credit worthiness: Ability to honor credit obligations (downside risk) 1-8 Equity Analysis Technical analysis / Charting • Patterns in price or volume history of a stock • Predict future price movements Technical analysis / Charting • Patterns in price or volume history of a stock • Predict future price movements Fundamental Analysis Determine Intrinsic value without reference to price • Analyze and interpret key factors – Economy – Industry – Company Fundamental Analysis Determine Intrinsic value without reference to price • Analyze and interpret key factors – Economy – Industry – Company Assessment of downside risk and upside potential Assessment of downside risk and upside potential 1-9 1-10 Accounting Analysis Accounting Risk Process to evaluate and adjust financial statements to better reflect economic reality Process to evaluate and adjust financial statements to better reflect economic reality [...]...1-11 Financial Analysis Process to evaluate financial position and Process to evaluate financial position and performance using financial statements performance using financial statements Profitability analysis — Evaluate return on investments Risk analysis ——— Evaluate riskiness & creditworthiness Analysis of — cash flows Evaluate source & deployment of funds Common tools Common tools Ratio analysis. .. Operating profit 1-24 1-25 Statement of Cash Flows 1-26 1-27 Additional Information (Beyond Financial Statements) 1-28 Analysis Preview Yr1 Yr2 Yr3 Comparative Analysis Purpose: Evaluation of consecutive financial statements Output: Direction, speed, & extent of any trend(s) Types: • Year-to-year Change Analysis • Index-Number Trend 1-29 Analysis Preview 1-30 Analysis Preview Common-Size Analysis Purpose :... Evaluation of internal makeup of financial statements • Evaluation of financial statement accounts across companies Output: Proportionate size of assets, liabilities, equity, revenues, & expenses 1-31 Analysis Preview 1-32 Analysis Preview 1-33 Analysis Preview Ratio Analysis Purpose : Evaluate relation between two or more economically important items (one starting point for further analysis) Output: Mathematical... creditworthiness Analysis of — cash flows Evaluate source & deployment of funds Common tools Common tools Ratio analysis Cash flow analysis 1-12 Prospective Analysis Process to forecast future payoffs Business Environment & Strategy Analysis Accounting Analysis Financial Analysis Intrinsic Value 1-13 Dynamics of Business Activities Business Activities Time 1-14 Business Activities 1-15 Business Activities... 1-17 Business Activities Operating Activities Revenues and expenses from providing goods and services 1-18 Financial Statements Reflect Business Activities 1-19 Financial Statements 1-20 1-21 Balance Sheet Total Investing = Total Financing = Creditor Financing + Owner Financing 1-22 1-23 Income Statement Revenues – Cost of goods sold = Gross Profit Gross profit – Operating expenses = Operating Profit... between two or more items Cautions: • Prior Accounting analysis is important • Interpretation is key - long vs short term & benchmarking 1-34 Analysis Preview Valuation Valuation - an important goal of many types of business analysis Purpose: Estimate intrinsic value of a company (or stock) Basis: Present value theory (time value of money) 1-35 Analysis Preview Debt (Bond) Valuation Bt is the value... the value of the bond at time t It +n is the interest payment in period t+n F is the principal payment (usually the debt’s face value) r is the investor’s required interest rate (yield to maturity) 1-36 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 expected dividends . tools Ratio analysis Cash flow analysis Process to evaluate financial position and performance using financial statements Process to evaluate financial position and performance using financial statements 1-12 Prospective. Analysis Intrinsic Value Intrinsic Value Business Environment & Strategy Analysis Business Environment & Strategy Analysis Accounting Analysis Accounting Analysis Financial Analysis Financial. Companies, Inc. All rights reserved. Financial Statement Analysis K R Subramanyam John J Wild 1-2 1 CHAPTER Overview of Financial Statement Analysis 1-3 Business Analysis Evaluate Prospects Evaluate