Lecture Fundamentals of corporate finance: Lecture 1b - Ross, Westerfield, Jordan

Lecture 1b - Working with financial statements. The following will be discussed in this chapter: Statement of cash flows, standardized financial statements, ratio analysis, the du pont identity, using financial statement information.

Lecture 1b Chapter 3 Working With Financial Statements © 2003 The McGraw­Hill Companies, Inc. All rights reserved 3.2 Lecture Outline • • • • • Statement of Cash Flows Standardized Financial Statements Ratio Analysis The Du Pont Identity UsingFinancialStatementInformation McGrawưHill/Irwin â2003TheMcGrawưHillCompanies,Inc.Allrightsreserved 3.3 Review of Lecture Organization of Business Enterprise  • Main Goal – Maximizing Equity Value • Financial information about the firm is in – Balance Sheets – Income Statements – Cash Flow Statements McGraw­Hill/Irwin © 2003 The McGraw­Hill Companies, Inc. All rights reserved 3.4 Sample Balance Sheet Numbers in thousands Cash &  Equivalents A/R 2000 1999 2000 1999 3,171 6,489 A/P 313,286 340,220 1,095,118 1,048,991 N/P 227,848 86,631 Inventory 388,947 295,255 Other CL 1,239,651 1,098,602 Other CA 314,454 232,304 Total CL 1,780,785 1,525,453 Total CA 1,801,690 1,583,039 LT Debt 1,389,615 871,851 Net FA 3,129,754 2,535,072 C/S 1,761,044 1,648,490 4,118,111 Total Liab.  & Equity 4,931,444 4,118,111 Total Assets 4,931,444 McGraw­Hill/Irwin © 2003 The McGraw­Hill Companies, Inc. All rights reserved 3.5 Sample Income Statement Numbers in thousands, except EPS & DPS Revenues 4,335,491 Cost of Goods Sold 1,762,721 Expenses 1,390,262 Depreciation 362,325 EBIT 820,183 Interest Expense 52,841 Taxable Income Taxes 767,342 Net Income 471,916 295,426 EPS 2.41 Dividends per share 0.93 McGraw­Hill/Irwin © 2003 The McGraw­Hill Companies, Inc. All rights reserved 3.6 Sources and Uses • Sources – Cash inflow – occurs when we “sell” something – Decrease in asset account (Sample B/S) – Increase in liability or equity account • Uses – Cash outflow – occurs when we “buy” something – Increase in asset account – Decrease in liability or equity account McGrawưHill/Irwin â2003TheMcGrawưHillCompanies,Inc.Allrightsreserved 3.7 Statement of Cash Flows Statementthatsummarizesthesourcesand uses of cash • Changes divided into three major categories – Operating Activity – includes net income and  changes in most current accounts – Investment Activity – includes changes in fixed  assets – Financing Activity – includes changes in notes  payable, long­term debt and equity accounts as  well as dividends McGraw­Hill/Irwin © 2003 The McGraw­Hill Companies, Inc. All rights reserved 3.8 Sample Statement of Cash Flows Numbers in thousands Cash, beginning of year 6,489 Financing Activity Operating Activity      Increase in Notes Payable 141,217      Net Income 471,916      Increase in LT Debt 517,764      Plus: Depreciation 362,325      Decrease in C/S ­36,159               Increase in Other CL 141,049      Dividends Paid ­395,521      Less: Increase in A/R ­46,127        Net Cash from Financing                Increase in Inventory ­93,692 Net Decrease in Cash ­3,319                Increase in Other CA ­82,150 Cash End of Year 3,170*                Decrease in A/P ­26,934       Net Cash from Operations 726,387 227,301 Investment Activity      Fixed Asset Acquisition ­957,007        Net Cash from Investments ­957,007 *Difference due to rounding of dividends McGraw­Hill/Irwin © 2003 The McGraw­Hill Companies, Inc. All rights reserved 3.9 Standardized Financial Statements • Common­Size Balance Sheets – Compute all accounts as a percent of total  assets • Common­Size Income Statements – Compute all line items as a percent of sales • Standardizedstatementsmakeiteasierto comparefinancialinformation,particularlyas thecompanygrows Theyarealsousefulforcomparingcompanies ofdifferentsizes,particularlywithinthesame industry McGrawưHill/Irwin â2003TheMcGrawưHillCompanies,Inc.Allrightsreserved 3.10 Ratio Analysis • Ratios also allow for better comparison  through time or between companies • As we look at each ratio, ask yourself what the  ratio is trying to measure and why is that  information important • Ratios are used both internally and externally McGraw­Hill/Irwin © 2003 The McGraw­Hill Companies, Inc. All rights reserved 3.12 Computing Liquidity Ratios • Current Ratio = CA / CL – 1,801,690 / 1,780,785 = 1.01 times • Quick Ratio = (CA – Inventory) / CL – (1,801,690 – 388,947) / 1,780,785 = .793 times • Cash Ratio = Cash / CL – 3,171/1,780,785=.002times McGrawưHill/Irwin â2003TheMcGrawưHillCompanies,Inc.Allrightsreserved 3.13 Computing Long-term Solvency Ratios Total Debt Ratio = (TA – TE) / TA – (4,931,444 – 1,761,044) / 4,931,444 = .6429 times  or 64.29% – The firm finances a little over 64% of its assets  with debt • Debt/Equity = TD / TE – (4,931,4441,761,044)/1,761,044=1.800 times EquityMultiplier=TA/TE=1+D/E 1+1.800=2.800 McGrawưHill/Irwin â2003TheMcGrawưHillCompanies,Inc.Allrightsreserved 3.14 Computing Coverage Ratios • Times Interest Earned = EBIT / Interest – 820,183 / 52,841 = 15.5 times • Cash Coverage = (EBIT + Depreciation) /  Interest (820,183+362,325)/52,841=22.38times McGrawưHill/Irwin â2003TheMcGrawưHillCompanies,Inc.Allrightsreserved 3.15 Computing Inventory Ratios Inventory Turnover = Cost of Goods Sold /  Inventory – 1,762,721 / 388,947 = 4.53 times • Days’ Sales in Inventory = 365 / Inventory  Turnover – 365 / 4.53 = 81 days McGraw­Hill/Irwin © 2003 The McGraw­Hill Companies, Inc. All rights reserved 3.16 Computing Receivables Ratios • Receivables Turnover = Sales / Accounts  Receivable – 4,335,491/1,095,118=3.96times DaysSalesinReceivables=365/ ReceivablesTurnover 365/3.96=92days McGrawưHill/Irwin â2003TheMcGrawưHillCompanies,Inc.Allrightsreserved 3.17 Computing Total Asset Turnover • Total Asset Turnover = Sales / Total Assets – 4,335,491 / 4,931,444 = .88 times • Measure of asset use efficiency • Not unusual for TAT