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(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
5-5-11
The Analysis of The Analysis of Financial StatementsFinancial StatementsRatios are tools and their value is limited when used alone. The more tools used, the better the analysis. For example, you can’t use the same golf club for every shot and expect to be a good golfer. The more you practice with each club, however, the better able you will be to gauge which club to use on one shot. So to, we need to be skilled with the financial tools we use. - Diane Morrison
- CEO, R.E.C. Inc.
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Objectives of AnalysisObjectives of Analysis
Remember--the identity of the user helps Remember--the identity of the user helps define what information is needed define what information is needed
Objectives will vary depending on the Objectives will vary depending on the perspective of theperspective of the financial statement userspecific questions that are addressed
by the analysis
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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CreditorsCreditors
A creditor is ultimately concerned A creditor is ultimately concerned with the ability of an existing or with the ability of an existing or prospective borrower to make prospective borrower to make interest and principal payments interest and principal payments on borrowed funds on borrowed funds
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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InvestorsInvestors
An investor attempts to arrive at an An investor attempts to arrive at an estimation of a company’s future estimation of a company’s future earnings stream in order to earnings stream in order to attach a value to the securities attach a value to the securities being considered for purchase or being considered for purchase or liquidation liquidation
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Tools and TechniquesTools and Techniques
Common-size financial statementsCommon-size financial statements
Financial ratiosFinancial ratios
Trend analysisTrend analysis
Industry comparisonsIndustry comparisons
These include:These include:
Most important:Most important:Common sense and judgment
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Common-Size Common-Size Financial StatementsFinancial Statements
Express each account on the Express each account on the balance sheetbalance sheet as a percentage as a percentage
of total assets of total assets income statementincome statement as a as a
percentage of net sales percentage of net sales
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Key Financial RatiosKey Financial Ratios
Standardize financial data in terms Standardize financial data in terms of mathematical relationships of mathematical relationships expressed in the form of expressed in the form of
PercentagesPercentages
TimesTimes
DaysDays
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Key Financial RatiosKey Financial Ratios (cont.)(cont.)
Liquidity (Short-term liquidity)Liquidity (Short-term liquidity) ActivityActivity Leverage (Long-term solvency) Leverage (Long-term solvency) ProfitabilityProfitability MarketMarket
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Liquidity Ratios: Liquidity Ratios: Short-Term SolvencyShort-Term Solvency
Measures ability to meet short-Measures ability to meet short-term cash needs term cash needs
Current RatioCurrent Ratio
Current assetsCurrent assets
Current liabilitiesCurrent liabilities
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
5-5-1010
Liquidity Ratios: Liquidity Ratios: Short-Term SolvencyShort-Term Solvency (cont.) (cont.)
Measures ability to meet short-term cash needs Measures ability to meet short-term cash needs
more rigorously by eliminating inventorymore rigorously by eliminating inventory
Quick or Acid-Test Ratio
Current assets - InventoryCurrent assets - Inventory
Current liabilitiesCurrent liabilities
(Cash+short-term investments + A/R)
current liabilities
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Liquidity Ratios: Liquidity Ratios: Short-Term SolvencyShort-Term Solvency (cont.) (cont.)
Focuses on ability of the firm to Focuses on ability of the firm to generate operating cash flows generate operating cash flows as a source of liquidityas a source of liquidity
Cash Flow Liquidity Ratio
*Cash flow from operating
activities
Cash + Marketable securities + Cash + Marketable securities + CFO *CFO *
Current liabilitiesCurrent liabilities
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Liquidity RatiosLiquidity Ratios
Short term liquidity 2007 2006 2005 2004 2003Current Ratio 1,13 1,18 1,43 2,04 1,65 Quick Ratio 0,48 0,52 0,68 0,86 0,40 Cash Flow Liquidity 0,76 0,57 1,21 1,61 0,92
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Activity Ratios: Asset Activity Ratios: Asset Liquidity, Asset Liquidity, Asset Management EfficiencyManagement Efficiency
Another measure of efficiency of firm’s Another measure of efficiency of firm’s collection and credit policiescollection and credit policies
Accounts Receivable TurnoverAccounts Receivable Turnover
net s,receivable tradeAverage
net sales,Credit
turnoverreceivable
365
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Activity Ratios: Asset Activity Ratios: Asset Liquidity, Asset Management Liquidity, Asset Management EfficiencyEfficiency (cont.)(cont.)
Another measure of firm’s efficiency Another measure of firm’s efficiency in managing its inventoryin managing its inventory
Inventory Turnover
sinventorie average
sold goods ofCost
turnoverinventory
365
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Activity Ratios: Asset Activity Ratios: Asset Liquidity, Asset Management Liquidity, Asset Management EfficiencyEfficiency (cont.) (cont.)
Another way to gain insight into a firm’s Another way to gain insight into a firm’s pattern of payment to supplierspattern of payment to suppliers
Payables Turnover
payables tradeAverage
sinventoriein COGS
turnoverpayable
365
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Cash Conversion Cycle or Cash Conversion Cycle or Net Trade CycleNet Trade Cycle
Buying or manufacturing Buying or manufacturing inventory, with some purchases inventory, with some purchases on crediton credit
Selling inventory, with some sales Selling inventory, with some sales on crediton credit
Collecting the cash Collecting the cash
The normal cycle of a firm that The normal cycle of a firm that consists of:consists of:
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Cash Conversion Cycle or Cash Conversion Cycle or Net Trade CycleNet Trade Cycle (cont.)(cont.)
Key balance sheet accounts that affect Key balance sheet accounts that affect cash flow from operating activitiescash flow from operating activities
Accounts ReceivableAccounts Receivable InventoryInventory Accounts PayableAccounts Payable
Helps the analyst understand why Helps the analyst understand why cash cash flow generation has flow generation has improved or improved or deteriorated by deteriorated by analyzing:analyzing:
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Cash Conversion Cycle or Cash Conversion Cycle or Net Trade CycleNet Trade Cycle (cont.)(cont.)
Average collection periodAverage collection periodPlusPlus
Days inventory heldDays inventory heldMinusMinus
Days payable outstandingDays payable outstandingEqualsEquals
Cash conversion or net trade cycleCash conversion or net trade cycle
Calculated as follows:Calculated as follows:
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Activity Ratios: Asset Activity Ratios: Asset Liquidity, Asset Management Liquidity, Asset Management EfficiencyEfficiency (cont.)(cont.)
Assesses effectiveness in generating Assesses effectiveness in generating sales from investments in fixed sales from investments in fixed assetsassets
Fixed Asset Turnover
Net salesNet sales
Net property, plant, equipmentNet property, plant, equipment(Average)(Average)
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Activity Ratios: Asset Activity Ratios: Asset Liquidity, Asset Management Liquidity, Asset Management EfficiencyEfficiency (cont.) (cont.)
Assesses effectiveness in generating sales Assesses effectiveness in generating sales from investments in all assetsfrom investments in all assets
Total Asset Turnover
Net salesNet sales
Total assetsTotal assets(Average)(Average)
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Activity RatiosActivity Ratios- - SummarySummaryReceivable Turnover Net Sales/Average Trade ReceivablesInventory Turnover COGS/Average InventoriesPayable Turnover Purchases/Average Trade PayablesFixed Asset Turnover Net Sales/Average PP&ETotal Asset Turnover Net Sales/Average Total Assets
Average collection period 365/receivable turnover Average days in inventory 365/inverntory turnoverAvergae payment period 365/payable turnover
Net Trade Period collection period + days in inventory -
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Activity RatiosActivity Ratios- - SummarySummary
Activity Ratios 2007 2006 2005 2004Receivable Turnover 10,62 10,67 11,40 15,55 Inventory Turnover 4,84 4,98 6,08 6,57 Payable Turnover 17,75 14,21 13,90 25,24 PPE Turnover 1,13 0,96 0,91 0,98 Asset Turnover 0,71 0,60 0,58 0,63
Collection Period 34,37 34,21 32,00 23,47 Days in inventory 75,48 73,33 59,99 55,52 Payment period 20,57 25,68 26,26 14,46
Cash cycle 89,29 81,86 65,74 64,54
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Leverage Ratios: Leverage Ratios: Debt Financing and Debt Financing and CoverageCoverage
Considers the proportion of all assets Considers the proportion of all assets that are financed with debtthat are financed with debt
Debt Ratio
Total liabilitiesTotal liabilities
Total assetsTotal assets
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Leverage Ratios: Leverage Ratios: Debt Financing and Coverage Debt Financing and Coverage (cont.) (cont.)
Reveals the extent to which long-Reveals the extent to which long-term debt is used for the firm’s term debt is used for the firm’s permanent financing (both permanent financing (both long-term debt and equity)long-term debt and equity)
Long-term Debt to Total Capitalization
Long–term debtLong–term debt
Long-term debt + Stockholders’ Long-term debt + Stockholders’ equityequity
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Leverage Ratios: Leverage Ratios: Debt Financing and CoverageDebt Financing and Coverage
(cont.)(cont.)
Measures the riskiness of the firm’s Measures the riskiness of the firm’s capital structure in terms of the capital structure in terms of the relationship between the funds relationship between the funds supplied by creditors (debt) and supplied by creditors (debt) and investors (equity)investors (equity)
Debt to Equity
Total liabilitiesTotal liabilities
Stockholders’ equityStockholders’ equity
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Leverage Ratios: Leverage Ratios: Debt Financing and CoverageDebt Financing and Coverage
(cont.)(cont.)
Indicates how well operating earnings Indicates how well operating earnings cover fixed interest expensescover fixed interest expenses
Times Interest Earned
Operating profitOperating profit
Interest expenseInterest expense
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Leverage Ratios: Leverage Ratios: Debt Financing and CoverageDebt Financing and Coverage
(cont.)(cont.)
Measures how many times interest Measures how many times interest payments can be covered by payments can be covered by cash flow from operations cash flow from operations before interest and taxesbefore interest and taxes
Cash Interest Coverage
CFO + interest paid + taxes paidCFO + interest paid + taxes paid
Interest paidInterest paid
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Leverage Ratios: Leverage Ratios: Debt Financing and CoverageDebt Financing and Coverage
(cont.)(cont.)
Broader measure of how well operating Broader measure of how well operating earnings cover fixed chargesearnings cover fixed charges
Fixed Charge Coverage
*Rent expense = operating lease payments
Operating profit + Rent expenseOperating profit + Rent expense
Interest expense + Rent expenseInterest expense + Rent expense
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Leverage Ratios: Leverage Ratios: Debt Financing and CoverageDebt Financing and Coverage (cont.)(cont.)
Measures firm’s ability to cover capital Measures firm’s ability to cover capital expenditures, long-term debt expenditures, long-term debt payments and dividends each yearpayments and dividends each year
Cash Flow Adequacy
Cash flow from operating activitiesCash flow from operating activities
Capital expenditures + debt Capital expenditures + debt repayments + dividends paidrepayments + dividends paid
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
5-5-3030
Leverage Ratios: Debt Financing Leverage Ratios: Debt Financing and Coverage Summaryand Coverage Summary
Solvency RatiosDebt Ratio Total liabilities/Total assets LT Debt to CapitalDebt to equity Total liabilities/Total equity Times interest earned Oper. Income/Interest expense Cash interest coverage CFO + interest paid + tax paid)/Interest paid
Long-term Liquidity 2007 2006 2005 2004Debt ratio 0,43 0,43 0,38 0,29 L/T Debt to Capitalization 0,28 0,29 0,26 0,19 debt to equity 0,86 0,83 0,67 0,43 Times interest earned 4,79 3,84 11,57 8,63
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Profitability Ratios: Profitability Ratios: Overall Efficiency and Overall Efficiency and PerformancePerformance
Measures ability to translate sales Measures ability to translate sales into profit after consideration of into profit after consideration of cost of products soldcost of products sold
Gross Profit Margin
Gross profitGross profit
Net salesNet sales
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Profitability Ratios: Profitability Ratios: Overall Efficiency and PerformanceOverall Efficiency and Performance (cont.)(cont.)
Measures ability to translate sales Measures ability to translate sales into profit after consideration of into profit after consideration of operating expensesoperating expenses
Operating Profit Margin
Operating profitOperating profit
Net salesNet sales
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Profitability Ratios: Profitability Ratios: Overall Efficiency and PerformanceOverall Efficiency and Performance (cont.)(cont.)
Measures ability to translate sales Measures ability to translate sales into profit after consideration into profit after consideration of all expenses and revenues, of all expenses and revenues, including interest, taxes and including interest, taxes and nonoperating itemsnonoperating items
Net Profit Margin
Net earningsNet earnings
Net salesNet sales
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Profitability Ratios: Profitability Ratios: Overall Efficiency and PerformanceOverall Efficiency and Performance (cont.)(cont.)
Measures ability to translate sales into Measures ability to translate sales into cash (with which to pay bills!)cash (with which to pay bills!)
Cash Flow Margin
Cash flow from operating Cash flow from operating activitiesactivities
Net salesNet sales
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Profitability Ratios: Profitability Ratios: Overall Efficiency and PerformanceOverall Efficiency and Performance (cont.)(cont.)
Measures rate of return on Measures rate of return on stockholders’ investmentstockholders’ investment
Return on Equity (ROE)
Net earningsNet earnings
Stockholders’ equityStockholders’ equity(Average)
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Profitability Ratios: Profitability Ratios: Overall Efficiency and PerformanceOverall Efficiency and Performance (cont.)(cont.)
Measures overall efficiency of firm Measures overall efficiency of firm in managing investment in in managing investment in assets and generating profitsassets and generating profits
Return on Total Assets (ROA) or Return on Investment (ROI)
Net earningsNet earnings
Total assetsTotal assets(Average)
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Relating the RatiosRelating the Ratios—The Du Pont System—The Du Pont System
Is helpful to complete the evaluation of Is helpful to complete the evaluation of a firm by considering the a firm by considering the interrelationship among the individual interrelationship among the individual ratios ratios The Du Pont System helps the analyst The Du Pont System helps the analyst see how the firm’s decisions and see how the firm’s decisions and activities over the course of an activities over the course of an accounting period interact to produce accounting period interact to produce an overall return to the firm’s an overall return to the firm’s
shareholders, the return on equityshareholders, the return on equity
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Relating the RatiosRelating the Ratios—The Du Pont System—The Du Pont System
(cont.)(cont.)The summary ratios used are the following:
(1)Net profit margin
(2)Total asset turnover
(3)Return on investment
(3)Return on investment
(4)Financial leverage
(5)Return on equity
Net income Net sales Net incomeNet income Net sales Net income
Net sales X Total assets = Total assetsNet sales X Total assets = Total assets
Net income Total assets Net Net income Total assets Net incomeincome
Total assets X Stockholder equity = Stockholder Total assets X Stockholder equity = Stockholder equityequity
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Profitability Ratios: Profitability Ratios: Overall Efficiency and PerformanceOverall Efficiency and Performance (cont.)(cont.)
Measures firm’s ability to generate Measures firm’s ability to generate cash from the utilization of its cash from the utilization of its assetsassets
Useful comparison to ROAUseful comparison to ROA
Cash Return on Assets
Cash flow from operating Cash flow from operating activitiesactivities
Total assetsTotal assets(Average)
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Profitability Ratios-SummaryProfitability Ratios-Summary
Profitability RatiosGross Margin Gross profit/Sales revenue Operating Margin Operating Income/Sales revenueNet Profit Margin Net Income/Sales RevenueReturn on Assets Net income/Average total assets Return on Equity Net income/Average total equity Cash Return on Assets CFO/Average total assets
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Profitability Ratios-SummaryProfitability Ratios-Summary
Profitability 2007 2006 2005 2004Gross margin % 27,36% 27,14% 27,80% 30,83%Operating Margin 15,18% 10,99% 15,78% 18,61%Net Profit Margin 7,91% 5,45% 9,98% 12,61%ROA = 5,60% 3,25% 5,76% 7,94%ROE = 10,99% 5,99% 9,37% 11,96%Cash Return on Assets 14,15% 7,63% 16,58%
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Market RatiosMarket Ratios
1.1. Earnings per common shareEarnings per common share2.2. Price-to-earningsPrice-to-earnings3.3. Dividend payoutDividend payout4.4. Dividend yieldDividend yield
Four market ratios of particular interest to the investor are
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Market RatiosMarket Ratios (cont.) (cont.)
Provides the investor with a Provides the investor with a common denominator to common denominator to gauge investment returnsgauge investment returns
Earnings per Common Share
Net earningsNet earnings
Average shares outstandingAverage shares outstanding
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Market RatiosMarket Ratios (cont.) (cont.)
Relates earnings per common share to the Relates earnings per common share to the market price at which the stock trades, market price at which the stock trades, expressing the “multiple” that the stock expressing the “multiple” that the stock market places on a firm’s earningsmarket places on a firm’s earnings
Price-to-Earnings
Market price of common stockMarket price of common stock
Earnings per shareEarnings per share
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Market RatiosMarket Ratios (cont.) (cont.)
Determined by the formula cash Determined by the formula cash dividends per share divided by dividends per share divided by earnings per shareearnings per share
Dividend Payout
Dividends per shareDividends per share
Earnings per shareEarnings per share
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Market RatiosMarket Ratios (cont.) (cont.)
Shows the relationship between cash Shows the relationship between cash dividends and market pricedividends and market price
Dividend Yield
Dividends per shareDividends per share
Market price of common stockMarket price of common stock
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Market RatiosMarket Ratios
Market Ratios 2007 2006 2005 2004Price earnings ratio 12,73 46,67 16,93 11,16price to book value 1,35 1,34 1,49 1,28
Financial AnalysisFinancial Analysis
Credit AnalysisCredit Analysis Equity AnalysisEquity Analysis
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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CreditorsCreditors
What is the borrowing cause?What is the borrowing cause? What is the firm’s capital What is the firm’s capital
structure?structure? What will be the source of debt What will be the source of debt
repayment?repayment?
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Credit RatingCredit Rating Business RiskBusiness Risk
Industry characteristicsIndustry characteristics Company positionCompany position ManagementManagement
Financial RiskFinancial Risk Financial characteristicsFinancial characteristics Financial PolicyFinancial Policy ProfitabilityProfitability Capital StructureCapital Structure Cash Flow ProtectionCash Flow Protection Financial flexibilityFinancial flexibility
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Standard & Poor’s rating Standard & Poor’s rating methodmethod
1.1. EBIT interest coverageEBIT interest coverage
2.2. EBITDA interest coverageEBITDA interest coverage
3.3. Funds from operations/Total debt %Funds from operations/Total debt %
4.4. Free operating cash flow/Total debt %Free operating cash flow/Total debt %
5.5. Return on capital %Return on capital %
6.6. Operating income/SalesOperating income/Sales
7.7. Long-term debt/CapitalLong-term debt/Capital
8.8. Total debt/CapitalTotal debt/Capital
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Standard and Poors Standard and Poors Corporate RatingsCorporate Ratings
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Financial distressFinancial distress
The deterioration in a The deterioration in a company’s financial condition company’s financial condition such that its ability to repay such that its ability to repay debt is impaireddebt is impaired
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Prediction of financial Prediction of financial distressdistressUnivariate modelsUnivariate models
Beaver (1966) relied onBeaver (1966) relied on Cash flow to total debtCash flow to total debt Net income to total assetsNet income to total assets Total debt to total assetsTotal debt to total assets Working capital to total assetsWorking capital to total assets Current ratioCurrent ratio No-credit (defensive) intervalNo-credit (defensive) interval
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Prediction of financial Prediction of financial distressdistressMultivariate modelsMultivariate models
Altman Z-scoreAltman Z-score (Current assets – current liabilities)/total (Current assets – current liabilities)/total
assets (weightassets (weight-1,2-1,2)) Retained earnings/Total assets (weightRetained earnings/Total assets (weight--
1,1,4)4) EBIT/Total assets (weightEBIT/Total assets (weight--33,,3)3) Preferred and common stock market Preferred and common stock market
value/Book value of liabilities (weightvalue/Book value of liabilities (weight--00,,6)6) Sales/Total assets (weightSales/Total assets (weight-1,-1,0)0)
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Altman Z-scoreAltman Z-score
Z> 2,99 Z> 2,99 Not in financial Not in financial distressdistress
Z< 1,81 Z< 1,81 In financial stressIn financial stress 2,99>Z>1,81 2,99>Z>1,81 UncertainUncertain
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Altman Z score Altman Z score Anadolu Anadolu CamCam
Altman Z-score 2006 2005 2004Ratio 1 0,04 0,08 0,14 Ratio 2 0,11 0,12 0,10 Ratio 3 0,04 0,07 0,12 Ratio 4 1,60 2,27 2,97 Ratio 5 0,55 0,51 0,61 Altman Z-score 1,85 2,36 3,08
A. Cam
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Additional considerationsAdditional considerations
Mezzanine itemsMezzanine items Could be debt or equityCould be debt or equity
Off-balance-sheet liabilitiesOff-balance-sheet liabilities Operating leasesOperating leases Contingent liabilitiesContingent liabilities Environmental liabilitiesEnvironmental liabilities
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Equity AnalysisEquity Analysis
Buy-sideBuy-side Work for an institutional investors (mutual Work for an institutional investors (mutual
fund)fund) Make internal recommendations regarding Make internal recommendations regarding
the purchase of equity securitiesthe purchase of equity securities Might review reports of sell-side analystsMight review reports of sell-side analysts
Sell-sideSell-side Work for brokerage firmsWork for brokerage firms Issue reports for retail and institutional Issue reports for retail and institutional
customerscustomers
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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ValuationValuation
Current value Current value VV00 is a function ofis a function of Present value of next year’s cash Present value of next year’s cash
flow, flow, CFCF11
Required rate of return, Required rate of return, rr Expected constant growth rate, Expected constant growth rate, gg
10
CFV
r g
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Equity AnalysisEquity Analysis
Provides information regardingProvides information regarding1.1. The future cash flow generating The future cash flow generating
ability of the firmability of the firm2.2. The growth (or lack thereof) of The growth (or lack thereof) of
those cash flowsthose cash flows3.3. The risk of those cash flows, andThe risk of those cash flows, and4.4. The risk-free rate commanded The risk-free rate commanded
by the marketby the market
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Top-Down AnalysisTop-Down Analysis
Begin at highest (economy) Begin at highest (economy) levellevel
Allocation between domestic and Allocation between domestic and international equitiesinternational equities
Market sectorsMarket sectors Industries (within a sector)Industries (within a sector) End with evaluation of specific End with evaluation of specific
companiescompanies
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Bottom-Up AnalysisBottom-Up Analysis
Begin with individual Begin with individual companiescompanies
Look for key strengthsLook for key strengths
Screen large data bases for Screen large data bases for attractive characteristicsattractive characteristics
Compustat, Bloomberg, BaselineCompustat, Bloomberg, Baseline
Search for a combination of Search for a combination of characteristicscharacteristics
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Five Steps of a Financial Five Steps of a Financial Statement AnalysisStatement Analysis
Who are you and why are you Who are you and why are you interested in this company?interested in this company?
What questions would you like to What questions would you like to have answered?have answered?
What info is vital to the decision at What info is vital to the decision at hand? hand?
Establish objectives of the analysis
Step 1
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Five Steps of a Financial Five Steps of a Financial Statement AnalysisStatement Analysis (cont.)(cont.)
Study the industry in which the firm Study the industry in which the firm operates and relate industry operates and relate industry climate to current and projected climate to current and projected economic developments economic developments
Step 2Step 2
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Five Steps of a Financial Five Steps of a Financial Statement AnalysisStatement Analysis (cont.)(cont.)
How well does this firm appear to be run?How well does this firm appear to be run? Are they taking advantage of Are they taking advantage of
opportunities?opportunities? Are they innovative, forward-looking, etc?Are they innovative, forward-looking, etc?
Step 3
Develop knowledge of the firm and the quality of management
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Five Steps of a Financial Five Steps of a Financial Statement AnalysisStatement Analysis (cont.)(cont.)
Common-size financial statementsCommon-size financial statements Key financial ratiosKey financial ratios Trend analysisTrend analysis Comparison with industry competitorsComparison with industry competitors
Step 4
Evaluate financial statements–tools include:
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Five Steps of a Financial Five Steps of a Financial Statement AnalysisStatement Analysis (cont.)(cont.)
Short-term liquidityShort-term liquidity Operating efficiencyOperating efficiency Capital structure and long-term Capital structure and long-term
solvencysolvency ProfitabilityProfitability Market ratiosMarket ratios Segmental analysis (when relevant)Segmental analysis (when relevant)
Step 4 Evaluate financial statements–areas include:
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Five Steps of a Financial Five Steps of a Financial Statement AnalysisStatement Analysis (cont.)(cont.)
Reach conclusions about the Reach conclusions about the firm relevant to your firm relevant to your established objectives established objectives
Step 5
Summarize findings based on analysis
(C) 2007 Prentice Hall, Inc.(C) 2007 Prentice Hall, Inc.
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Financial StatementsFinancial StatementsAn OverviewAn OverviewMap