Working With Financial Statements - PowerPoint Presentation

1. Working With Financial Statements0

2. Know how to standardize financial statements for comparison purposesKnow how to compute and interpret important financial ratiosBe able to compute and interpret the DuPont IdentityUnderstand the problems and pitfalls in financial statement analysis1Key Concepts and Skills

3. Sample Income StatementRevenues5,000Cost of Goods Sold(2,006)Expenses(1,740)Depreciation(116)EBIT1,138Interest Expense(7)Taxable Income1,131Taxes(442)Net Income689EPS3.61Dividends per share1.082Numbers in millions, except EPS & DPS

4. Sample common size Income StatementRevenues5,000100%Cost of Goods Sold(2,006)(40.1)Expenses(1,740)(34.8)Depreciation(116)(2.3)EBIT1,13822.8Interest Expense(7)(0.1)Taxable Income1,13122.6Taxes(442)(8.8)Net Income68913.8EPS3.61Dividends per share1.083Numbers in millions, except EPS & DPS

5. Common-Size Balance SheetsCompute all accounts as a percent of total assetsCommon-Size Income StatementsCompute all line items as a percent of salesStandardized statements make it easier to compare financial information, particularly as the company growsThey are also useful for comparing companies of different sizes, particularly within the same industry4Standardized Financial Statements

6. Common base year Income Statement2005200620072008Revenues5000600065007000Cost of Goods2006223024002700EBIT1138130014001450Net Income68973075177052005200620072008Revenues100%120%130%140%Cost of Goods100%111%119%135%EBIT100%114%123%127%Net Income100%106%109%112%

7. Combined common size and base year Balance Sheet6

8. Ratios also allow for better comparison through time or between companiesAs we look at each ratio, ask yourself what the ratio is trying to measure and why that information is importantRatios are used both internally and externally7Ratio Analysis

9. Short-term solvency or liquidity ratiosLong-term solvency or financial leverage ratiosAsset management or turnover ratiosProfitability ratiosMarket value ratios8Categories of Financial Ratios

10. Sample Income StatementRevenues5,000Cost of Goods Sold(2,006)Expenses(1,740)Depreciation(116)EBIT1,138Interest Expense(7)Taxable Income1,131Taxes(442)Net Income689EPS3.61Dividends per share1.089Numbers in millions, except EPS & DPS

11. Sample Balance Sheet2007200620072006Cash69658A/P307303A/R956992N/P26119Inventory301361Other CL1,6621,353Other CA303264Total CL1,9951,775Total CA2,2561,675LT Debt8431,091Net FA3,1383,358C/S2,5562,167Total Assets5,3945,033Total Liab. & Equity5,3945,03310Numbers in millions

12. Current Ratio = CA / CL2,256 / 1,995 = 1.13 timesQuick Ratio = (CA – Inventory) / CL(2,256 – 301) / 1,995 = .98 timesCash Ratio = Cash / CL696 / 1,995 = .35 timesNWC to Total Assets = NWC / A(2,256 – 1,995) / 5,394 = .05Interval Measure = CA / average daily operating costs2,256 / ((2,006 + 1,740)/365) = 219.8 days11Liquidity Ratios for 2007

13. Total Debt Ratio = (A –E) / A(5,394 – 2,556) / 5,394 = 52.61%Debt/Equity = D / E(5,394 – 2,556) / 2,556 = 1.11 timesEquity Multiplier = A / E = 1 + D/E1 + 1.11 = 2.11Long-term debt ratio = LTD / (LTD + E)843 / (843 + 2,556) = 24.80%12Computing Long-term Solvency Ratios

14. Times Interest Earned = EBIT / Interest1,138 / 7 = 162.57 timesCash Coverage = (EBIT + Depreciation) / Interest(1,138 + 116) / 7 = 179.14 times13Computing Coverage Ratios

15. Inventory Turnover = Cost of Goods Sold / Inventory2,006 / 301 = 6.66 timesDays’ Sales in Inventory = 365 / Inventory Turnover365 / 6.66 = 55 days14Computing Inventory Ratios

16. Receivables Turnover = Sales / Accounts Receivable5,000 / 956 = 5.23 timesDays’ Sales in Receivables = 365 / Receivables Turnover365 / 5.23 = 70 days15Computing Receivables Ratios

17. Total Asset Turnover = Sales / Total Assets5,000 / 5,394 = .93It is not unusual for TAT < 1, especially if a firm has a large amount of fixed assetsNWC Turnover = Sales / NWC5,000 / (2,256 – 1,995) = 19.16 timesFixed Asset Turnover = Sales / NFA5,000 / 3,138 = 1.59 times16Computing Total Asset Turnover

18. Profit Margin = Net Income / Sales689 / 5,000 = 13.78%Return on Assets (ROA) = Net Income / Total Assets689 / 5,394 = 12.77%Return on Equity (ROE) = Net Income / Total Equity689 / 2,556 = 26.96%17Computing Profitability Measures

19. Market Price = $87.65 per shareShares outstanding = 190.9 millionPE Ratio = Price per share / Earnings per share87.65 / 3.61 = 24.28 timesMarket-to-book ratio = market value per share / book value per share87.65 / (2,556 / 190.9) = 6.55 times18Computing Market Value Measures

20. ROE = NI / EMultiply by 1 (A/A) and then rearrangeROE = (NI / E) (A / A)ROE = (NI / A) (A / E) = ROA * EMMultiply by 1 (Sales/Sales) again and then rearrangeROE = (NI / A) (A / E) (Sales / Sales)ROE = (NI / Sales) (Sales / A) (A / E)ROE = PM * TAT * EM19Deriving the DuPont Identity

21. ROE = PM * TAT * EMProfit margin is a measure of the firm’s operating efficiency – how well it controls costsTotal asset turnover is a measure of the firm’s asset use efficiency – how well does it manage its assetsEquity multiplier is a measure of the firm’s financial leverage20Using the DuPont Identity

22. Bal. Sheet (1/28/06) Data (millions, $U.S.)Cash = 225.27Inventory = 91.91Other CA = 22.16Fixed Assets = 164.62ComputationsTA = 503.96TAT = 2.39EM = 1.772006 Inc. Statement Data (millions, $U.S.)Sales = 1,204.35COGS = 841.87SG&A = 227.04Interest = (3.67)Taxes = 55.15ComputationsNI = 83.96PM = 6.97%ROA = 16.66%ROE = 29.49%21Expanded DuPont Analysis – Aeropostale Data

23. 22Aeropostale Extended DuPont Chartxx++

24. A firm has an equity multiplier of 1.90, an asset turnover of 1.2 and a profit margin of 8%. What is the firm’s ROA, and ROE.23Example : Du-Pont Identity

25. Liquidity ratiosCurrent ratio = 1.40x; Industry = 1.8xQuick ratio = .45x; Industry = .5xLong-term solvency ratioDebt/Equity ratio (Debt / Worth) = .54x; Industry = 2.2x.Coverage ratioTimes Interest Earned = 2282x; Industry = 3.2x24Real World Example – Home Depot

26. Asset management ratios:Inventory turnover = 4.9x; Industry = 3.5xReceivables turnover = 59.1x (6 days); Industry = 24.5x (15 days)Total asset turnover = 1.9x; Industry = 2.3xProfitability ratiosProfit margin before taxes = 10.6%; Industry = 2.7%ROA (profit before taxes / total assets) = 19.9%; Industry = 4.9%ROE = (profit before taxes / tangible net worth) = 34.6%; Industry = 23.7%25Real World Example – Home Depot

27. Internal usesExternal uses26Why Evaluate Financial Statements?

28. Ratios are not very helpful by themselves; they need to be compared to somethingTime-Trend AnalysisUsed to see how the firm’s performance is changing through timeInternal and external usesPeer Group AnalysisCompare to similar companies or within industriesSIC and NAICS codes27Benchmarking

29. There is no underlying theory, so there is no way to know which ratios are most relevantBenchmarking is difficult for diversified firmsGlobalization and international competition makes comparison more difficult because of differences in accounting regulationsVarying accounting procedures, i.e. FIFO vs. LIFODifferent fiscal yearsExtraordinary events28Potential Problems

30. 29The Story of EnronEnron - a natural gas, natural gas liquids, electricity, exploration and production, operator of power plants and natural gas pipelines.Enron stock price fell from $75 to nothing due to bankruptcy. One aspect of their collapse was the way they managed to keep debt off their balance sheet and hid commitments to honor the debt. Without full disclosure, no one knew the true situation.

31. 30Off balance sheet practice is more common than you thinkMake companies and managers look good because return on capital looks better.Investors and regulators do not freak out when debt balloons.Spreads confusionThese off balance sheet debt obligations are typically triggered (parent requited to pay debt) if stock falls bellow a certain level or its debt is downgraded. That is why the SEC is taking care of these issues.

32. How do you standardize balance sheets and income statements and why is standardization useful?What are the major categories of ratios and what are they good for?What are some of the problems associated with financial statement analysis?31Quick Quiz

33. XYZ Corporation has the following financial information for the previous year:Sales: $8M, PM = 8%, CA = $2M, FA = $6M, NWC = $1M, LTD = $3MCompute the ROE using the DuPont Analysis.32Comprehensive Problem

34. 33Working CapitalA Simple Cycle of Operations:CASHCASHRAW MATERIALS INVENTORYFINISHED GOODS INVENTORYRECEIVABLESRECEIVABLES

35. 34

36. Assume: AVG. Inventory – 352.5; AVG AR=285; AVG AP=235; COGS=480; Sales (all on credit) = 710 – calculate cash cycle:35Calculating the cash cycle