Financial
Statement
Analysis
K R Subramanyam
John J Wild
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Overview of Financial
Statement Analysis
1
CHAPTER
1-2
1-3
Business Analysis
Evaluate Prospects
Evaluate Risks
1-4
Information Sources for Business
Analysis
1-5
1-6
Credit Analysis
1-7
Credit Analysis
Credit worthiness: Ability to honor credit obligations
(downside risk)
Liquidity
Ability to meet shortterm obligations
Focus:
• Current cash flows
• Make up of current
assets and liabilities
• Liquidity of assets
Solvency
Ability to meet longterm obligations
Focus:
• Long-term profitability
• Capital structure
1-8
Equity Analysis
Assessment of downside risk and upside potential
Technical analysis /
Charting
• Patterns in price or
volume history of a
stock
• Predict future price
movements
Fundamental Analysis
Determine Intrinsic value
without reference to
price
• Analyze and interpret
key factors
– Economy
– Industry
– Company
1-9
1-10
Accounting Analysis
Process
Process to
to evaluate
evaluate and
and adjust
adjust financial
financial
statements
statements to
to better
better reflect
reflect economic
economic reality
reality
Accounting
Risk
1-11
Financial Analysis
Process
Process to
to evaluate
evaluate financial
financial position
position and
and
performance
performance using
using financial
financial statements
statements
Profitability analysis — Evaluate return
on investments
Risk analysis ——— Evaluate riskiness
& creditworthiness
Analysis of —
cash flows
Evaluate source &
deployment of funds
Common
Commontools
tools
Ratio
analysis
Cash
flow
analysis
1-12
Prospective Analysis
Process to forecast future payoffs
Business Environment
& Strategy Analysis
Accounting Analysis
Financial Analysis
Intrinsic Value
1-13
Dynamics of Business Activities
Business Activities
Time
1-14
Business Activities
1-15
Business Activities
Financing activities
• Owner (equity)
• Nonowner (liabilities)
Financing
1-16
Business Activities
Investing activities
• Buying resources
• Selling resources
Investing
Financing
Investing = Financing
1-17
Business Activities
Operating Activities
Revenues and expenses from providing
goods and services
1-18
Financial Statements Reflect Business Activities
1-19
Financial Statements
1-20
1-21
Balance Sheet
Total Investing = Total Financing
= Creditor Financing + Owner Financing
1-22
1-23
Income Statement
Revenues – Cost of goods sold = Gross Profit
Gross profit – Operating expenses = Operating Profit
Colgate’s Profitability
(in $billions)
$12.238 - $5.536 = $6.701 Gross Profit
$6.701 - $4.5411 = $2.160 Operating profit
1-24
1-25
Statement of Cash Flows
1-26
1-27
Additional Information
(Beyond Financial Statements)
1-28
Analysis Preview
Yr1
Yr2
Yr3
Comparative Analysis
Purpose: Evaluation of consecutive
financial statements
Output: Direction, speed, & extent of any
trend(s)
Types: •
Year-to-year Change
Analysis
•
Index-Number Trend
1-29
Analysis Preview
1-30
Analysis Preview
Common-Size Analysis
Purpose : • Evaluation of internal makeup
of financial statements
• Evaluation of financial statement
accounts across companies
Output:
Proportionate size of assets,
liabilities, equity, revenues, &
expenses
1-31
Analysis Preview
1-32
Analysis Preview
1-33
Analysis Preview
Ratio Analysis
Purpose :
Evaluate relation between two or more
economically important items (one
starting point for further analysis)
Output:
Mathematical expression of relation
between two or more items
Cautions: • Prior Accounting analysis is important
• Interpretation is key - long vs short
term & benchmarking
1-34
Analysis Preview
Valuation
Valuation - an important goal of many types
of business analysis
Purpose: Estimate intrinsic value of a
company (or stock)
Basis:
Present value theory (time value of
money)
1-35
Analysis Preview
Debt (Bond) Valuation
Bt is the value of the bond at time t
It +n is the interest payment in period t+n
F is the principal payment (usually the debt’s face value)
r is the investor’s required interest rate (yield to maturity)
1-36
Analysis Preview
Equity Valuation
Vt is the value of an equity security at time t
Dt +n is the dividend in period t+n
k is the cost of capital
E refers to expected dividends
1-37
Analysis Preview
Equity Valuation - Free Cash Flow to Equity
Model
FCFt+n is the free cash flow in the period t + n [often
defined as cash flow from operations less capital
expenditures]
k is the cost of capital
E refers to an expectation
1-38
Analysis Preview
Equity Valuation - Residual Income Model
BV is the book value at the end of period t
Rit+n is the residual income in period t + n [defined as
net income, NI, minus a charge on beginning
book value, BV, or RIt = NIt - (k x BVt-1)]
k is the cost of capital
E refers to an expectation
t
1-39
Analysis in an Efficient Market
Three assumed forms of market efficiency
Weak Form - prices reflect information in
past prices
Semi-strong - prices reflect all public
Form
information
Strong Form - prices reflect all public and
private information
1-40
Book Organization