FINANCIAL STATEMENT ANALYSIS

Statement Analysis - 2FINANCIAL STATEMENT

ANALYSISObjectives

Creditors

Short term liquidity

Long-term solvency

Investors

Profitability

Dividends

Stock price appreciation

Prediction of future returns Assessment of risks associated with those returns

Statement Analysis - 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

Statement Analysis - 4

VERTICAL ANALYSIS

Relationship of statement items to a specified “Base Item”

– Income statement = Net sales

– Balance sheet = Total assets

Statement Analysis - 5

COMMON-SIZE STATEMENTS

Reports only percentages for statement items

“Base Items” normally same as vertical analysis

Allows comparison of firms of different size

%

Statement Analysis - 6

BENCHMARKING

Comparison of a company to standards found in the environment

Against Industry Average

Against a Major Competitor

Against yourself (over time)

Statement Analysis - 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

Statement Analysis - 8FINANCIAL 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

Statement Analysis - 9

Return on Sales (ROS)

A profitability measure Also known as profit margin ratio Considers relative firm size

@Cambridge Business Publishers, 2009

Net IncomeSales RevenueROS = = $39,700

$305,000= 13.0%

Cup-A-Jo expects to generate 13 cents of bottom line profit for every dollar of sales revenue.

Statement Analysis - 10

Return on Assets (ROA)

A profitability measure Considers relative firm size

@Cambridge Business Publishers, 2009

[Net income + Interest expense × (1 – Tax rate)] Total assetsROA =

= $39,700 + [$6,300 × (62.3%)] $472,450 = 9.2%

Cup-A-Jo has earnings of 9.2% available for its business capital providers.

*Effective Tax rate = $24,000/$63,700 = 37.7%

Statement Analysis - 11

Return on Equity (ROE)

A profitability measure Also known as return on shareholders’ equity Considers relative firm size

@Cambridge Business Publishers, 2009

Net incomeShareholders’ equity

ROE = = $39,700$371,700

= 10.7%

Cup-A-Jo is expected to generate about 10.7 cents of profit for every dollar of shareholders’ investment in the company.

Statement Analysis - 12

Return on Equity Paradigm

Reveals four ways to improve ROE1.Improve return on sales2.Improve asset turnover3.Improve use of financial leverage4.Some combination of 1, 2, and 3

@Cambridge Business Publishers, 2009

Statement Analysis - 13

Asset Turnover

How effective a business’s assets are being used by management to generate sales revenue

Key performance indictor

@Cambridge Business Publishers, 2009

Sales revenueTotal assets

Asset Turnover

= $305,000$472,450 = 0.646

For every dollar invested in the company’s assets. Cup-A-Jo generated 64.6 cents of sales.

=

Statement Analysis - 14

Financial Leverage

Relative mix of debt versus equity financing used by a business

@Cambridge Business Publishers, 2009

Total assetsShareholders’

equity

FinancialLeverage

= $472,450$371,700 = 1.27

Cup-A-Jo’s assets are about 1.27 times the amount of shareholders’ equity invested

=

Statement Analysis - 15

Return on Equity for Cup-A-Jo

@Cambridge Business Publishers, 2009

Total assetsShareholders’

equity

×

$472,450$371,700

1.27

=

ROE = Return on Sales × Assets Turnover × Financial Leverage

Sales revenueTotal assets

$305,000$472,450

0.646

Net incomeSales revenue

= $39,700$305,000

= 13.0%

× ×

×

× ×

= 10.7%

Statement Analysis - 16

Long-term Debt-to-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

Debt-to-Equity

Long-term debtShareholders’

equity

$67,500$371,700

= 0.182= =

Cup-A-Jo’s long-term debt is about 18% of the amount of shareholders’ equity.

Statement Analysis - 17

Times-Interest-Earned Ratio

Reveals the extent to which operating earnings is able to ‘cover’ current debt service charges (interest)

@Cambridge Business Publishers, 2009

Interest Coverage

Operating incomeInterest expense

$70,000$6,300 = 11.1= =

Cup-A-Jo’s operating income is able to cover interest about 11 times per year.