Return on Net Income Equity Average Shareholders’ Equity This ratio measures the effectiveness at managing capital provided by the shareholders... Return on Net Income + Interest Expens
Trang 2Chapter 5:
Using Financial Statement
Information
Trang 3Control and Prediction
Financial accounting numbers are
useful in two fundamental ways:
– They help investors and creditors
influence and monitor the business
decisions of a company’s managers.
– They help to predict a company’s
future earnings and cash flows.
Trang 4Book Value vs True Value
Financial statements do not reflect the
company’s prospects within its business
environment
– Statements are backward looking, not focusing
on the future prospects.
Financial statements are inherently limited
– Statements leave out some current and
historical information such as human
resources and the effects of inflation.
Management prepares the financial statements in
a biased manner
– Managers often choose accounting methods
Trang 5Framework for Financial Statement Analysis
Book Value
Book Value
Add adjustments for:
(1) business environment (2) unrecorded events
(3) management bias
Add adjustments for:
(1) business environment (2) unrecorded events
(3) management bias
Trang 6Five Steps of Financial Statement Analysis
Assessing the business environment.
Reading and studying the financial
statements and footnotes.
Assessing earnings quality.
Analyzing the financial statements.
Predicting future earnings and/or cash
flow.
Trang 7Assessing the Business
What is the company’s industry?
Who are the major players? Competition?
What are the relationships between the
company and its customers and suppliers?
How are the company’s sales and profits
affected by changes in the economy?
Trang 8Reading and Studying the Financial
Statements and Notes
Read the audit report.
Identify significant transactions
– major acquisitions, discontinuance or
disposal of a business segment, unresolved litigation, major write-downs of receivables or inventories, etc.
Read the financial statements and
footnotes.
Trang 9Assessing Earnings Quality
Earnings quality may be affected by a
number of strategies managers use to
influence accounting numbers Four
major strategies are discussed:
– Overstating operating performance
– “Taking a bath”
– Creating hidden reserves
– Employing off-balance-sheet
financing
Trang 10Assessing Earnings Quality
Overstating operating performance
through the acceleration of recognition
of revenue - shift the timing of revenue
from a future period to the current
period, through legitimate or
questionable activities.
Overstating operating performance
through the allocation and estimation of
expenses - shift the recognition of
expenses through the use of “taking a
bath” and “creating hidden reserves.”
Trang 11Assessing Earnings Quality
Taking a bath (also called “big bath”) - large losses and expenses this year may increase income in future years.
Rationale: if the current year is going to be
disappointing to investors anyway, increase
the loss to make next year look better For
example:
– Excessive write-downs of equipment will
lead to lower depreciation expense in future years.
– Excessive write-downs of inventory will
lead to lower cost of goods sold next year.
Trang 12Assessing Earnings Quality
Creating hidden reserves - expenses
may be shifted from one year to another
year by overestimating expense accrual.
Excessive bad debt expense or warranty
expense in the current year will lead to
reduced estimates in future years, as the
“reserve” is used up.
Note that these “reserves” have nothing to
do with cash reserves; they simply reserve some of the “income” to future periods.
Trang 13Assessing Earnings Quality
Employing off-balance-sheet financing - this relates to certain economic transactions that are not reflected in the balance sheet.
Managers prefer to keep certain liabilities off the balance sheet when GAAP permits it, primarily
because of potential debt covenant violations,
and because of the effect on certain ratios.
Examples include:
– treatment of leases as operating leases (Radio Shack)
– unconsolidated investments (Enron’s
“partnerships”) which do not separate assets
from liabilities.
Trang 14Analyzing the Financial Statements
Comparisons across time
Comparisons within the industry
Comparisons across different countries
Comparisons within the financial statements:
common-size statements and ratio analysis
Trang 15Comparisons Across Time
Financial accounting numbers can be
made more meaningful if they are
compared across time.
GAAP require side-by-side comparison
of the current and the preceding years
in published financial reports.
Trang 16Comparisons Within the Industry
Financial accounting numbers can also be
made more meaningful if they are compared
to those of similar companies.
Comparison of financial accounting numbers
with industry averages is also helpful.
Sources of industry information include:
– Dun & Bradstreet
– Robert Morris Associates
– Moody
Trang 17Common-Size Financial Statements
Trang 18Comparisons Within the Financial Statements
Common-size financial statements
Trang 19Common-Size Income Statement
for La-Z-Boy, Inc (Figure 5-2)
Income Statement (in millions) 2008 % 2007 %
Cost of sales (888) 72 (1,057) 73
Expenses and charges (460) 37 (408) 28
Net income $ (121) (9) $ (14) (1)
On the income statement, cost of goods sold,
expenses, and net income are often expressed
as percentages of net sales.
On the balance sheet, assets and liabilities can
be expressed as percentages of total assets.
Trang 20Profitability Ratios
These ratios are designed to measure a
firm’s earnings power.
Net income, the primary measure of the
overall success of a company, is compared
to other measures of financial activity or
condition to assess performance as a
percent of some level of activity or
investment.
Trang 21Return on Net Income
Equity Average Shareholders’ Equity
This ratio measures the effectiveness at
managing capital provided by the shareholders.
Profitability Ratios
Trang 22Return on Net Income + Interest Expense (1-tax rate) Assets Average Total Assets
This ratio measures the effectiveness at managing capital provided by all investors (stockholders and creditors).
Profitability Ratios
Trang 23Profitability Ratios
Return on Net Income + Interest Expense (1-tax rate)
Sales Net Sales
This ratio provides an indication of a company’s ability to generate and market profitable products and control its costs; also called the Profit Margin.
Trang 24Leverage Ratios
Leverage refers to using borrowed
funds to generate returns for
stockholders.
Leverage is desirable because it
creates returns for shareholders without
using any of their money.
Leverage increases risk by committing
the company to future cash obligations.
Trang 25Leverage Ratios
Common Net Income
Equity Net Income + Interest Expense (1-tax rate)
Leverage
This ratio compares the return available to the
shareholders to returns available to all capital providers.
Trang 26Leverage Ratios
Capital Average Total Assets
Structure Average Stockholders’ Equity
Leverage
This ratio measures the extent to which a company
relies on borrowings (liabilities).
Trang 27Debt to Equity Average Total Liabilities
Ratio Average Shareholders’ Equity
This ratio compares liabilities to shareholders’ equity
and is another measure of capital structure leverage.
Leverage Ratios
Trang 28Leverage Ratios
Long-term Long-Term Debt
Debt Ratio Total Assets
This ratio measures the importance of long-term
debt as a source of asset financing.
Trang 29Solvency Ratios
Solvency refers to a company’s ability
to meet its current debts as they come
due.
There is pressure on companies with
high levels of leverage to manage their
solvency.
Trang 30Solvency Ratios
Current Current Assets
Ratio Current Liabilities
This ratio measures solvency in the sense that current assets can be used to meet current liabilities.
Trang 31Solvency Ratios
Quick Cash + Marketable Securities + A/R
Ratio Current Liabilities
Similar to the current ratio, this ratio provides a more stringent test of a company’s solvency.
Trang 32Solvency Ratios
Interest Net Income + Tax Expense + Interest Expense Coverage Interest Expense
This ratio compares the annual funds available to meet
interest to the annual interest expense.
Trang 33Solvency Ratios
Accounts Cost of Goods Sold
Payable Average Accounts Payable
Turnover
This ratio measures the extent to which accounts
payable is used as a form of financing.
Trang 34Asset Turnover Ratios
Asset turnover ratios are typically
computed for total assets, accounts
receivable, inventory, and fixed assets.
These ratios measure the speed with
which assets move through operations
or reflect the number of times during a
given period that these specific assets
are acquired, used, and replaced.
Trang 35Asset Turnover Ratios
Receivables Net Credit Sales
Turnover Average Accounts Receivable
This ratio reflects the number of times the trade
receivables were recorded, collected, and recorded
again during the period.
Trang 36Asset Turnover Ratios
Inventory Cost of Goods Sold
Turnover Average Inventory
This ratio measures the speed with which
inventories move through operations.
Trang 37Asset Turnover Ratios
Fixed Assets Sales
Turnover Average Fixed Assets
This ratio measures the speed with which fixed assets are used up.
Trang 38Asset Turnover Ratios
Total Asset Sales
Turnover Average Total Assets
This ratio measures the speed with which all assets are used up in operations.
Trang 39Market Ratios
These additional ratios are used by the
financial community to assess company
performance.
Trang 40Market Ratios
Earnings Net Income
per Average Number of Common Shares
Share Outstanding
This ratio, according to the financial press, is the
primary measure of a company’s performance It
calculates the amount of income that is earned for
each shareholder.
Trang 41Market Ratios
Price/Earnings Market Price per Share
Ratio Earnings per Share
This ratio is used by many analysts to assess the
investment potential of common stocks.
Trang 42Market Ratios
Dividend Yield Dividends per Share
Ratio Market Price per Share
This ratio indicates to cash return on the
shareholders’ investment.
Trang 43Market Ratios
Stock Market Price 1 - Market Price 0 + Dividends
Price Market Price 0
Return
This ratio measures the pretax performance of an
investment in a share of common stock.
Trang 44Comparisons Across Different Countries
Investors interested in comparing the financial
performance and condition of companies from different
countries often must contend with two difficult issues:
– If the companies use different accounting standards
(e.g., U.S GAAP vs IFRS), the reported values must
be adjusted to a common basis so that reasonable
comparisons can be made
– Adjusting financial statements to a common basis by itself may not be sufficient to achieve meaningful
comparisons In other words, not only must the
financial statements of a foreign-based company be
adjusted, but the resulting numbers can only be
Trang 45Appendix 5A
DuPont (ROE) Model:
Return On Equity = Return on Assets X Capital Structure
Leverage X Common Equity Leverage
Return on Assets = Profit margin X Asset Turnover
Trang 46Solvency Assessment (Figure 5A-6)
Trang 47Copyright © 2011 John Wiley & Sons, Inc All rights reserved
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