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FINANCIAL STATEMENT ANALYSIS

FINANCIAL STATEMENT ANALYSIS. Creditors Short term liquidity Long-term solvency. Investors Profitability Dividends Stock price appreciation. FINANCIAL STATEMENT ANALYSIS Objectives. Prediction of future returns Assessment of risks associated with those returns. HORIZONTAL ANALYSIS.

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FINANCIAL STATEMENT ANALYSIS

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  1. FINANCIAL STATEMENT ANALYSIS

  2. Creditors Short term liquidity Long-term solvency Investors Profitability Dividends Stock price appreciation FINANCIAL STATEMENT ANALYSISObjectives Prediction of future returns Assessment of risks associated with those returns

  3. HORIZONTAL ANALYSIS • Percentage changes in comparative statements • (Year to Year comparisons) • Establishment of “Base Period” • Trend percentages • Form of horizontal analysis • Series of years • Current year data / Base year data

  4. VERTICAL ANALYSIS • Relationship of statement items to a specified “Base Item” • Income statement = Net sales • Balance sheet = Total assets

  5. COMMON-SIZE STATEMENTS • Reports only percentages for statement items • “Base Items” normally same as vertical analysis • Allows comparison of firms of different size %

  6. BENCHMARKING • Comparison of a company to standards found in the environment • Against Industry Average • Against a Major Competitor • Against yourself (over time)

  7. FINANCIAL STATEMENT RATIOSObjectives • Ability to pay current liabilities (Liquidity) • Ability to sell inventory and collect receivables (Liquidity / Turnover) • Ability to pay long-term debt (Solvency) • Profitability of the company • Analysis of company’s stock as an investment

  8. FINANCIAL STATEMENT ANALYSISLimitations • Statements are largely historical and involve many estimates • Comparability between firms may be difficult • Financial ratios are only indicators • Specific reasons for problems must still be identified • External factors will often impact the financial results of a company • Users must look at the entire picture when using financial statement analysis

  9. Return on Sales (ROS) Net Income Sales Revenue $39,700 $305,000 = 13.0% ROS = = • Cup-A-Jo expects to generate 13 cents of bottom line profit for every dollar of sales revenue. A profitability measure Also known as profit margin ratio Considers relative firm size @Cambridge Business Publishers, 2009

  10. Return on Assets (ROA) [Net income + Interest expense × (1 – Tax rate)] Total assets ROA = $39,700 + [$6,300 × (62.3%)] $472,450 = = 9.2% *Effective Tax rate = $24,000/$63,700 = 37.7% • Cup-A-Jo has earnings of 9.2% available for its business capital providers. A profitability measure Considers relative firm size @Cambridge Business Publishers, 2009

  11. Return on Equity (ROE) Net income Shareholders’ equity $39,700 $371,700 ROE = = = 10.7% • Cup-A-Jo is expected to generate about 10.7 cents of profit for every dollar of shareholders’ investment in the company. A profitability measure Also known as return on shareholders’ equity Considers relative firm size @Cambridge Business Publishers, 2009

  12. Return on Equity Paradigm Reveals four ways to improve ROE Improve return on sales Improve asset turnover Improve use of financial leverage Some combination of 1, 2, and 3 @Cambridge Business Publishers, 2009

  13. Asset Turnover Sales revenue Total assets $305,000 $472,450 Asset Turnover = = = 0.646 • For every dollar invested in the company’s assets. Cup-A-Jo generated 64.6 cents of sales. How effective a business’s assets are being used by management to generate sales revenue Key performance indictor @Cambridge Business Publishers, 2009

  14. Financial Leverage Total assets Shareholders’ equity $472,450 $371,700 Financial Leverage = = = 1.27 • Cup-A-Jo’s assets are about 1.27 times the amount of shareholders’ equity invested Relative mix of debt versus equity financing used by a business @Cambridge Business Publishers, 2009

  15. Return on Equity for Cup-A-Jo ROE = Return on Sales × Assets Turnover × Financial Leverage Net income Sales revenue Sales revenue Total assets Total assets Shareholders’ equity = × × $39,700 $305,000 $305,000 $472,450 $472,450 $371,700 = × × × = 13.0% 0.646 × 1.27 = 10.7% @Cambridge Business Publishers, 2009

  16. Long-term Debt-to-Equity Debt-to-Equity Long-term debt Shareholders’ equity $67,500 $371,700 = = = 0.182 Cup-A-Jo’s long-term debt is about 18% of the amount of shareholders’ equity. Reveals the relative investment of long-term lenders versus that of shareholders Indicates whether the financing strategy of the company is heavier on debt or equity @Cambridge Business Publishers, 2009

  17. Times-Interest-Earned Ratio Interest Coverage Operating income Interest expense $70,000 $6,300 = = = 11.1 Cup-A-Jo’s operating income is able to cover interest about 11 times per year. Reveals the extent to which operating earnings is able to ‘cover’ current debt service charges (interest) @Cambridge Business Publishers, 2009

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