Corporate Finance
FINA 4332
Lecture 2
Financial Statement Analysis
Ronald F. Singer
Financial Statements
Most Corporations Prepare three basic financial
statements:
Income Statement
Balance sheet
Cash Flow Statements
Income Statement
A Listing of Revenue, Expenses, and Profits over a
period of time
Balance Sheet
A listing of Assets, Liabilities, and Net Worth at a
single point in time
Cash Flow Statement
The Flow of Cash over a period of time
Coca Cola
Balance Sheet
Total Assets = Total Liabilities + Equity
Or
Equity = Total Assets - Total Liabilities
Assets:
Current Assets
Cash
Marketable Securities
Account Receivable
Inventory
Other Current Assets (Prepaid Expenses)
Fixed Assets
Property, plant, and equipment
Less Accumulated Depreciation
Net Fixed Assets
Other Assets (Net Intangible Assets)
Goodwill
Patents
_______
Liabilities and Equity
Current Liabilities
Debt due within one year
Accounts payable
Other current liabilities
Long Term Debt
Other long-term liabilities ________
Total Liabilities
Shareholders’ Equity
Common stock and other paid in capital
Retained earnings
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
Income Statement
Revenues - Costs and Expenses = Profit
Income Statement
Net Sales
Less: Cost of Goods Sold
_________
(Gross Profit)
Less: Selling, general, and administrative
Expenses (GS&A)
Less: Other Expenses
Less: Depreciation
__________
Earnings Before Interest and Taxes (EBIT)
EBIT
Less: Net interest expense
Taxable Income
Less: Taxes
Net Income {What is available to Stockholders}
Dividends
Addition to retained earnings
Note: Net Income/(Number of shares) = EPS
EBIT
Plus
Depreciation
Minus
Taxes
Equals Cash Flow from Operations
Minus Net Investment {Capital Expenditures}
Free Cash Flow
Plus Change in Liabilities and Stockholder Equity
(Balance Sheet Adjustments)
Financial Ratios
•
•
•
•
•
Leverage Ratios
Liquidity Ratios
Efficiency Ratios
Profitability Ratios
Market-value Ratios
Leverage Ratios: Measures the degree to which
the firm has relied on fixed cost financing
Financial Leverage: The use of fixed cost
financing (debt and preferred stock)
What it does: Magnifies the return (and losses)
associated with changes in operating income
Balance Sheet Based
•
Long-term debt Ratio =
Long-term debt/(long-term debt plus equity)
•
Debt-Equity Ratio = long term debt/equity
•
Total Debt Ratio =
Total liabilities/Total assets
Income Statement Based (coverage ratios)
•
Times interest earned = EBIT/interest
•
Cash coverage ratio =
(EBIT + depreciation)/interest
Liquidity Ratios
Liquidity: The ability to convert an asset to
cash quickly at low cost.
Net Working Capital (NWC) Current assets
less current liabilities.
NWC/Total Assets Ratio
Current ratio =
Current assets/Current liabilities
Quick (acid-test) Ratio =
Cash +Marketable Securities +Accounts receivable
Current liabilities
Or
(NWC – inventory)/Current liabilities
Cash ratio =
(Cash + Marketable securities)/Current
assets
or
(NWC- inventory – accounts receivable)
Current assets
Efficiency ratios: How effective is the company in
using its assets.
Liquidity
Profitability
Performance
Asset Turnover Ratio = Sales/Average Total Assets
Revenue generated per dollar assets
Inventory Turnover =
Cost of Goods Sold/Ave. Inventory
Average Collection Period =
Ave. Receivables/Ave Daily Sales
Profitability Ratios
We usually want operating Income:
Operating Income = Net Income + Interest
Net Profit Margin = Operating Income/Sales
Return on Assets
Operating Income/Ave. Total Assets
Return on Equity
(Net Income – Preferred Div)/Ave. Equity
Payout Ratio = Dividends/Net Income
Plowback ratio = (1-payout ratio)/Net Income
= Change in retained earnings/Net Income
The Dupont System
A process of analyzing component Ratios
(Decomposition) of the ROA and ROE to explain the
cause of changes.
ROA = Net Operating Income
Total Assets
Sales times
Assets
Net Operating Income
Sales
Profit Margin times Asset turnover
So let’s suppose ROA declines from 25 % to 15%.
You want to know what is causing that: Look at
component sources of the change
Initial
Current
Profit Margin
50%
30%
Asset Turnover
50%
50%
Return on Equity (ROE)
Recall:
ROE = (Net Income less preferred Div)
Average Equity
=
Assets/Equity
{Leverage Ratio}
Times
Sales/Assets
{Asset Turnover}
Times
Operating Income/Sales
{Profit Margin}
Times
Net Income/(Net Operating Income) {Debt Burden}