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transcript
Chapter 14
Financial Performance Measurement
Skyline College
Lecture Notes
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Financial Performance Measurement
Shows important relationships in the financial statements and relates them to important financial objectives; also called financial statement analysis
Internal External
Top managers
Mid-level managers
Employees who own stock in the company
Creditors
Investors
Customers who have agreements with the company
Users of Financial Information
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Management: Financial Objectives and Related Performance Objectives
Able to increase stockholders’ wealthMarket strength
Generate sufficient cash through operating, investing, and financing activities
Cash flow adequacy
Able to survive for many yearsLong-term solvency
Earn a satisfactory net incomeProfitability
Able to pay bills when due and meet unexpected needs for cash
Liquidity
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External Users
Use financial performance measurement to:
Judge past and present position
Assess future earnings potential and risk
Assess future debt paying ability
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Assessment of Risk
• Well-established, stable company
Can predict future profitability with higher level of confidence
Lower risk
• Newly established, small company
Difficult to predict future profitability
Higher risk
Investors demand higher expected returns for high risk investments
Creditors demand higher interest rates from high risk companies
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Standards of Comparison
When analyzing financial statements, decision makers often use these three common methods to determine whether the results are favorable or unfavorable:
Rule-of-thumb measures There is no proof that apply to all companies Must be used with caution
Past performance Provides a basis for judging whether the measure or ratio chnging It may also be helpful in showing possible future trends Past
performance may not be a useful indicator of adequacy for the future
Industry norms or averages
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Industry Norms
Limitations: Companies in the same
industry may not be strictly comparable
Diversified companies are difficult to compare
Use of different accounting procedures often makes companies difficult to compare
Shows how a company compares with other companies in the same industry
Wal-Mart Target
Return on assets
7.8% 6.1%
Profit margin
3.1% 3.4%
Return on equity
19.3% 18.5%
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Sources of Financial Information
Reports published by the corporation
Annual report, interim financial statements
Reports filed with the SEC
Form 10-K (annual); Form 10-Q (quarterly)
Business periodicals and credit and investment advisory services
The Wall Street Journal, Forbes, Barron’s
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Executive Compensation
A public corporation’s board must establish a compensation committee to determine how the company’s top executives will be compensated and report the details of compensation to the SEC.
Components of compensation:Annual base salaryIncentive bonusesStock option awards
Starbuck’s CEO received a base salary of $1,190,000, an incentive bonus of an
equal amount, and a stock option award of 550,000 shares of common stock.
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Discussion: Ethics on the Job
Explain the following statement: As long as chief financial officers and other corporate managers' salaries, bonuses, or promotions are linked to earnings, the temptation to manage earnings will remain a problem.
A manager whose bonus or salary is tied to corporate performance stands to benefit personally if he or she boosts earnings, even if artificially so. This places an ethical dilemma before the officers of a corporation.
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Horizontal Analysis
AmountYear Base
Change ofAmount 100 Change Percentage
Computes changes from the previous year to the current year in both dollar amounts and percentages
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Starbucks’ Horizontal Analysis
(Dollar amounts in thousands) 2004 2003 Amount Percentage
Net revenues 5,294,247$ 4,075,522$ 1,218,725$ 29.9Cost of sales, including occupancy costs 2,198,654 1,685,928 512,726 30.4Gross margin 3,095,593$ 2,389,594$ 705,999$ 29.5Operating expenses: Store operating expenses 1,790,168$ 1,379,574$ 410,594$ 29.8 Other operating expenses 171,648 141,346 30,302 21.4 Deprec. and amortization expenses 280,024 237,807 42,217 17.8 General and adminstrative expenses 304,293 244,550 59,743 24.4 Total operating expenses 2,546,133$ 2,003,277$ 542,856$ 27.1Operating income 549,460$ 386,317$ 163,143$ 42.2Other income, net 74,797 50,018 24,779 49.5Income before income taxes 624,257$ 436,335$ 187,922$ 43.1Provision for income taxes 232,482 167,989 64,493 38.4Net income 391,775$ 268,346$ 123,429$ 46.0
Increase (Decrease)
Starbucks CorporationConsolidated Income Statements
For the Years Ended October 3, 2004, and September 28, 2003
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Trend Analysis
Calculation of percentage changes for several successive years
2004 2003 2002 2001 2000
Dollar values(In thousands)Net revenues $5,294,247 $4,075,522 $3,288,908 $2,648,980 $2,177,614Operating income 549,460 386,317 282,893 252,479 191,952
Trend analysis(In percentages)Net revenues 243.1 187.2 151.0 121.6 100.0Operating income 286.2 201.3 147.4 131.5 100.0
Starbucks CorporationNet Revenues and Operating Income
Trend Analysis
AmountYear Base
AmountYear Index 100 Index Uses an index
number
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Vertical Analysis
Shows how the different components of a financial statement relate to a total figure on the statement
On the balance sheet, set total assets or total liabilities and stockholders’ equity to 100%.
On the income statement, set net sales to 100%.
The resulting statement, expressed entirely in percentages, is called a common-size statement.
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Starbucks Common-Size Income Statement
2004* 2003*
Net revenues 100.0 % 100.0 %Cost of sales, including occupancy costs 41.5 41.4Gross margin 58.5 % 58.6 %Operating expenses: Store operating expenses 33.8 % 33.9 % Other operating expenses 3.2 3.5 Depreciation and amortization expenses 5.3 5.8 General and administrative expenses 5.7 6.0 Total operating expenses 48.1 % 49.2 %Operating income 10.4 % 9.5 %Other income, net 1.4 1.2Income before income taxes 11.8 % 10.7 %Provision for income taxes 4.4 4.1Net income 7.4 % 6.6 %
*Percentages don't always add up due to rounding.
Starbucks CorporationCommon-Size Income Statements
For the Years Ended October 3, 2004, and September 28, 2003All other figures are expressed in relation to net
revenues
Cost of sales including
occupancy costs is 41.5% of net
revenues; Depreciation and amortization is
5.3% of net sales
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Ratio Analysis
Identifies meaningful relationships between the components of the financial statements
Ratios may be expressed in several ways:
Net income is 1/10 of sales
Net income is 10 percent of sales
The ratio of net income to sales is 10 to 1 (10:1)
Sales are 10 times net income
For every dollar of sales, the company has an average net income of 10 cents
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Evaluating Liquidity
Selected liquidity ratios for Starbucks:2003
Current Assets $1,368,485Current Liabilities $782,980
Current Ratio
2004
1.5 times= = 1.7 times=
2003Net Sales $5,294,247
Average A/R ($140,226 + $114,448) ÷ 2Receivable Turnover
2004
38.4 times= = 41.6 times=
2003Cost of Goods Sold $2,198,654Average Inventory ($422,663 + $342,944) ÷ 2
Inventory Turnover
2004
5.6 times= = 5.7 times=
Starbuck’s management of receivables and inventory improved from 2003 to 2004.
The company has sufficient current assets to cover current liabilities.
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Evaluating Profitability
2003Net Income $391,775Net Sales $5,294,247
Profit Margin
2004
6.6%= = 7.4%=
Selected profitability ratios for Starbucks:
2003Net Income $391,775
Average Stockholders' Equity $2,284,591Return on Equity
2004
14.1%= = 17.1%=
Starbucks is doing a better job of managing its costs per dollar of sales in 2004.
Both return on assets and return on equity improved from 2003 to 2004.
2003Net Income $391,775
Average Total Assets $3,028,957Return on Assets
2004
10.9%= = 12.9%=
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Evaluating Long-Term Solvency
Solvency ratio for Starbucks:2003
Total Liabilities $841,413Stockholders' Equity $2,486,755
Debt-to-Equity Ratio
2004
0.3 times= = 0.3 times=
Long-term solvency means that a company is expected to survive for many years.
Increasing amounts of debt may mean that it is becoming too heavily leveraged and can result in bankruptcy
This ratio shows the amount of Starbucks’ assets provided by creditors in relation to the amount provided by stockholders. The ratio is stable from 2003 to 2004 – a positive indicator.
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Evaluating Cash Flow Adequacy
2003Net Cash Flows from Operating Activities $793,848
Net Income $391,775Cash Flow
2004
2.1 times= = 2.0 times=
2003Net Cash Flows from Operating Activities $793,848
Net Sales $5,294,247Cash Flows
to Sales
2004
13.9%= = 15.0%=
Selected cash flow adequacy ratios for Starbucks:
The cash flow yield decreased, revealing that net income increased faster than net cash flows provided by operating activities.
The cash-generating ability of sales increased from 2003 to 2004.
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Evaluating Market Strength
Market price indicates how investors view the potential risk and return of owning the stock.
Ratios that combine market price with earnings or dividends help measure investors’ confidence in a company.
Starbucks' 2003Market Price per Share $45.23
Earnings per Share $0.99Price/Earnings
Ratio
2004
39.7 times= = 45.7 times=