Chapter 14 investments financial statement analysis

Chapter 14 Financial Statement Analysis 14.1 The Major Financial Statements  Income statement  Balance sheet  Statement of cash flows 14-2 Income Statement • Four broad types of accounts: - Cost of goods sold - General and administrative expenses - Interest expense - Taxes on earnings • Common Size income statements - Divide each account by net sales - Eliminates size distortions 14-3 Table 14.1 Consolidated Statement of Income 14-4 Balance Sheet • Assets - Current: Converted into cash within 1 year. - Long-term • Liability (current and long term) and stockholders’ equity • Common size balance sheet - Divide each account by total assets - Each account presented as a percent of the total 14-5 Table 14.2 Consolidated Balance Sheet A 14-6 Table 14.2 Consolidated Balance Sheet B 14-7 Statement of Cash Flows • A financial statement showing a firm’s cash receipts and cash payments during a specified pe riod. - Recognizes transactions only if cash changes hands. - “Undoes” much of accrual accounting to get at cash changes. - Does not allocate capital expenditures through time via depreciation as income statement does. 14-8 Statement of Cash Flows Three main sections • Cash flow related to operations • Cash flow related to investing • Cash flow related to financing • Allows the analyst to understand which of the firm’s activities are using and which generating cash. 14-9 Statement of Cash Flows • Not all sources of cash are equally sustainable. • Would you rather invest in a firm that is primarily generating cash through operations or through financing? • It is difficult to evaluate whether the amount of cash flow related to investing is ‘good’ or ‘bad.’ What else woul d we need to know? • Rate of return on the investment • Comparable data over time or from competitors 14-10 [...]... good investments Firm with low ROEs can be good investments if the price is low enough 14- 30 Choosing a Benchmark Figure 14. 1 DuPont Decomposition for Hewlett-Packard 14- 31 Choosing a Benchmark Table 14. 10 Ratios for Major Industries 14- 32 14. 7 Value Investing: The Graham Technique 14- 33 Benjamin Graham • Founder of modern fundamental analysis • Graham believed careful analysis of a firm’s financial statements... that depends on the debt/equit y 14- 16 Financial Leverage and ROE Nodett: All equity financed; Total assets of $100M; 40% Somdett: 40% debt financing of $100M assets; Interest rate of of corporate tax 8% 14- 18 14. 4 Ratio Analysis 14- 19 Ratio Analysis • Purpose of Ratio Analysis - Understand the factors that affect performance • Methods - Trend analysis - Comparative analysis - Combination of the two...Table 14. 3 Consolidated Statement of Cash Flows 14- 11 14. 2 Accounting Versus Economic Earnings 14- 12 Accounting Versus Economic Earnings • Accounting earnings • Earnings of a firm as reported on its income statement • Economic earnings • The real flow of cash that firm could pay out to its stockholders without impairing its productive capacity 14- 13 14. 3 Profitability Measures 14- 14 Past Versus... more debt? 14- 25 Sample ROE Decomposition Compare two firms, Nodett and Somdett 14- 26 More on Ratios Table 14. 8 Growth Industries (GI) financial statements ($thousands) 14- 27 Ratio Analysis using GI Industry Average Asset Utilization Ratios (2010 data for GI): Evaluate efficiency 1 Total Asset Turnover 2 Fixed Asset Turnover 3 Inventory Turnover Sales Avg Assets Sales Avg Fixed Asset s $144 ,000 = 303... community - Important for credit markets 14- 20 DuPont Decomposition of ROE ROE can be decomposed into various ratios that reflect different aspects of a firm’s performance: ROE = Net Profit Pretax Profit EBIT Sales Assets × × × × Pretax Profit EBIT Sales Assets Equity (1) × (2) × (3) × (4) × (5) Tax × Interest × Margin × Turnover × Leverage Burden Burden 14- 21 Type of Financial Ratios • Net Profit Pretax... administrative expenses and depreciation • Ratio (4) Asset Turnover Ratio (ATO) - Measures the efficiency of the firm at generating sales per dollar invested in assets - Note: Margin x ATO = ROA 14- 23 Type of Financial Ratios ROE = • Net Prof it Pret ax Prof it EBIT Sales Assets × × × × Pret ax Profit EBIT Sales Assets Equity (1) Tax Burden × × (2) × (3) × (4) × (5) Interest × Margin × Turnover × Leverage... of the percentage of debt in total capitalization Note that it appears that using more debt as a percent of capital will increase ROE, but using more debt also reduces the interest burden ratio 14- 24 Type of Financial Ratios ROE = • Ratio (5) Leverage ratio Net Prof it Pret ax Prof it EBIT Sales Assets × × × × Pret ax Profit EBIT Sales Assets Equity (1) × (2) × (3) × (4) × (5) Tax × Interest × Margin... Data from recent past may provide information regarding future ROE • Analysts should always keep an eye on the future • Expectations of future dividends and earnings determine intrinsic value of stock 14- 15 Financial Leverage and ROE • • • • Pay careful attention to the firm’s debt-equity mix and to the interest rate on its debt • • If ROAROE borrowing rate,rate)  ROA + ( ROA −money than it pays out to... Assets Sales Avg Fixed Asset s $144 ,000 = 303 ($518,400 + 432,000)/2 0.40 $144 ,000 = 606 ($259,200 + 216, 000)/2 0.70 Cost of Goods Sold $79,200 = 485 Average Inventory ($129,600 + 108,000)/2 0.50 4 Average collection period or days sales in receivables Avg Accounts Receivables Sales × 365 ($43,200 + $36,000)/2 = 100.4 days $144 ,000× 365 60 days • Lower fixed-asset turnover and investor turnover • Higher... Higher average days receivables  Higher investment in working capital and thus lower ROA  Have problems with excess plant capacity along with poor inventory and receivables management practices 14- 28 Ratio Analysis using GI Industry Average Liquidity Ratios (2010 data for GI): Evaluate riskiness Current Assets Current Liabilities 1.Current Ratio 2.Quick Ratio 2.0 Cash + Marketable Securities + Receivables . Chapter 14 Financial Statement Analysis 14. 1 The Major Financial Statements  Income statement  Balance sheet  Statement of cash flows 14- 2 Income Statement • Four broad. presented as a percent of the total 14- 5 Table 14. 2 Consolidated Balance Sheet A 14- 6 Table 14. 2 Consolidated Balance Sheet B 14- 7 Statement of Cash Flows • A financial statement showing a firm’s cash. Interest rate of 8% 14. 4 Ratio Analysis 14- 19 Ratio Analysis • Purpose of Ratio Analysis - Understand the factors that affect performance • Methods - Trend analysis - Comparative analysis - Combination