Financial Statements & Analysis

Financial Statements and Analysis
Understanding Financial Statements
Dr Mazila Md Yusuf
Financial Statements & Analysis
The Annual Report

Income statement (Profit and Loss Account)
A statement that summarizes a firms revenues, expenses , and profit or loss over a given period of time.
Balance sheet
A statement that provides a snapshot of a firms financial position at one point in time, detailing the firms assets, liabilities, and owners equity.
Statement of cash flows

A statement that provides a summary of the cash flows of a firm over a given period of time.
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Income Statement SALES

- EXPENSES
= PROFIT
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- EXPENSES
Revenue
= PROFIT
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- EXPENSES
Cost of Goods Sold Operating Expenses
(marketing, administrative)
= PROFIT
Financing Costs Taxes
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SALES
- Cost of Goods Sold

GROSS PROFIT - Operating Expenses
Income Statement
OPERATING PROFIT (EBIT) - Interest Expense EARNINGS BEFORE TAXES (EBT) - Income Taxes EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends

- NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
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SALES
- Cost of Goods Sold

GROSS PROFIT - Operating Expenses
Income Statement
OPERATING INCOME (EBIT) - Interest Expense EARNINGS BEFORE TAXES (EBT) - Income Taxes EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends

- NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
Dr Mazila Md Yusuf
Income - Cost of Goods Sold GROSS PROFIT - Operating Expenses OPERATING INCOME (EBIT) - Interest Expense EARNINGS BEFORE TAXES (EBT) - Income Taxes EARNINGS AFTER TAXES (EAT) - Preferred Stock Dividends - NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
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SALES
Statement
Balance Sheet
Consists of: 1. Assets 2. Financing: Liabilities (Debt) Equity
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Assets
Current Assets: assets that are relatively liquid,
and are expected to be converted to cash within a year.

Cash, marketable securities, accounts receivable, inventories, prepaid expenses.
Fixed Assets: asset with long-term use or value

- machinery and equipment, buildings, and land.
Other Assets: any asset that is not a current asset
or fixed asset.
Intangible assets, such as patents and copyrights.
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Financing
Debt Capital: financing provided by a creditor. Short-term debt: borrowed money that must be repaid within the next 12 months.
Accounts payable, other payables such as interest or taxes payable, accrued expenses, short-term notes.
Long-term debt: loans from banks or other sources that lend money for longer than 12 months.
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Financing
Equity Capital: shareholders investment in the firm. Preferred Stock: holders receive fixed dividends, have higher priority than common stockholders in event of liquidation of the firm. Common Stock: holders are residual owners of the firm. They receive whatever is left after creditors and preferred stockholders are paid.
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Common or Owners Equity Capital

Refers to equity excluding preferred stock Owners equity components are: 1. Common stock 2. Paid-in capital additional money paid directly to a firm by its owner 3. Share premium difference between market price and par value when new stock are issued 4. Retained earnings net profits that are retained by a firm for its use rather than paid as dividends
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Balance Sheet
Assets
Current Assets Cash Marketable Securities Accounts Receivable Inventories Prepaid Expenses Fixed Assets Machinery & Equipment Buildings and Land Other Assets Investments & patents
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Liabilities (Debt) & Equity

Current Liabilities Accounts Payable Accrued Expenses Short-term notes Long-Term Liabilities Long-term notes Mortgages Equity Preferred Stock Common Stock Paid in Capital Retained Earnings
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Cash Flow Statement

Shows how funds are generated and used during a certain period. (Refer to Figure 3.1 on page 109) Provides answers to questions such as: - Why was money borrowed during the period? - Why did firm issue additional shares? - What was done to firm's net profits? - How did firm retire long-term debt? - How did firm finance additional plants & equipments? Provides insight into companys investment, financing & operating activities and reconciles them with changes in its cash and marketable securities during the period.
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Cash Flow Statement
Cash flows from Operations
Net cash flows from operations after taxes and interest expenses
Cash Flows from Investing
Includes acquisition of real assets (capital expenditures) and disposal and purchase of financial assets.
Net cash flow from the issue and repurchase of equity, from the issue & repayment of debt and after dividend payments
Cash flows from Financing = Net Change in Cash Balance
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Cash Flow Statement

Total Operating CF + Total Investment CF + Total Financing CF = Net change in Cash & MS*
*Note: Net increase (decrease) in cash + MS should be equal to difference between cash & MS on the balance sheet at the beginning and end of year.
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Cash Flow Statement

Basic Inflows (Sources) and Outflows (Uses) of cash
Inflows (Sources) Decrease in any asset Increase in any liability Net profits after taxes Depreciation & noncash charges Sale of stock Outflows (Uses) Increase in any asset Decrease in any liability Net loss Dividends paid Repurchase or retirement of stock
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Financial Analysis
Process of analyzing financial statements to enable managers to evaluate performance & whether objectives are being met or not. Enables weaknesses & strengths to be identified. Indicates how a firm has performed & likely to perform in the future Tool for analysis - financial ratios
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Financial ratios
Ratios- an attempt to standardize financial information to facilitate meaningful comparisons
ratios answer questions concerning well-being of a firm:

has the firm been able to meet its debt obligations? is management making enough profits from firms assets? how does management finance its investment? are owners getting enough returns on their investment? ratios are of interest to shareholders, creditors and firms own management
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Types of comparison
Cross-sectional analysis
comparing ratios of a single firm in
a single year against the

benchmark (industry average) for the same year. comparing ratios of a single firm over a period of time, usually 5
Trend or Time-Series analysis
years
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Cautions when doing ratio analysis

ratios must be considered together, a single ratio by itself means relatively little. financial statements being compared should be dated at the same point in time.
use audited financial statements when possible

financial data being compared should have been developed in the same way.
be wary of inflation especially when comparing old firms and new firms.
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Limitations of Ratio Analysis

Ratios are not useful for analyzing operations of a company involved in various industrial sectors Seasonal factors may distort ratios and thus fail to provide a true picture of firms condition Different operating policies and accounting practices can distort comparison between companies Ratio analysis has to be comprehensive (not just a single ratio) in order to reflect true performance of a company
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Categories of Financial Ratios

1. 2. 3. 4. 5. Liquidity Ratios Efficiency/Activity Ratios Leverage/Debt Ratios Profitability Ratios Market Ratios
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1. Liquidity Ratios
Measure solvency of firms overall financial position Measure ability to meet short-term obligations on time Higher liquidity ratios are better for they indicate that firm has a margin of safety after fulfilling its short-term obligations
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1. Liquidity Ratios
Current ratio = Current assets
Current liabilities
Quick or Acid-test ratio =
Current assets - Inventories

Current liabilities
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2. Efficiency/Activity ratios
Measure the speed with which specific current accounts are converted into sales or cash (inflows and outflows) Due to liquidity ratios are inadequate to assess the activity of specific current accounts due to different composition of the accounts Also important to look beyond liquidity of assets to assess their activity
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Inventory turnover
Cost of Goods Sold Inventory * Measures activity or liquidity of firms inventory
Ave. Collection Period =
Acc. Receivables x 365 Annual Credit Sales * Measures amount of time needed to collect accounts receivable
Ave. Payment Period
Accounts Payable x 365 Annual Credit Purchases * Measures amount of time needed to pay accounts payable
Total Assets Turnover
Sales Total Assets * Measures firms efficiency of using its assets to generate sales
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3. Leverage Ratios
Measure amount of debt a firm uses to generate profits Higher debt means higher financial leverage and thus greater potential risk and return to the firm Also measure ability to service debts (payment of the fixed charges)
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Debt ratio
Total Liabilities Total Assets Measures proportion of total assets financed by creditors Debt-Equity ratio Long-term debt Owners equity * Indicates relationship between funds provided by longterm creditors versus those provided by owners =
Times Interest Earned = EBIT / Interest expense Measures ability to meet contractual interest payments
Fixed Payment Coverage Ratio (FPCR) FPCR EBIT + Lease pmts
Int. + Lease pmts + {(Pcipal pmts + PS div.) x [1/(1-T)]}
* Measures ability to meet all fixed payment obligations

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4. Profitability Ratios
Measure ability to generate profits with respect to sales, assets or owners funds
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Gross profit margin
Gross profits Sales * profits after payment of raw material costs Operating profit margin Operating Profits Sales * profits after all operating costs and expenses are deducted Net profit margin Net profits Sales * profits after deducting all operating costs, expenses, interest and taxes
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Return on Total Assets (ROA) = Net profits Total assets * Measures managements effectiveness in generating profits with available assets
Return on Common Equity (ROE) = Net profits Common equity * Measures return earned on owners investment
Earnings per Share (EPS) EPS = Earnings Available to Common Holders Unit of common shares outstanding * Amount of profits earned for every unit of shares of common stock outstanding and not amount of profits actually obtained or distributed to stockholders
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5. Market Ratios
Relate a firms market value to certain accounting values Measure how well investors in the marketplace feel the firm is doing in terms of risk and return
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Price/Earnings (P/E) Ratio =
Market price per share EPS
* Amount investors are willing to pay for every dollar of companys earnings * Used to assess investors confidence in a company Can be used as basis for share valuation; higher ratio greater confidence on the firm
Market/Book (M/B) Ratio
= Market price per share Book value per share
* Provides an assessment of how investors view the firms performance * It relates the market value of firms shares to their book value Enable comparison made with other firms.
Market/Book (M/B) Ratio
= Market price per share Book value per share

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Dr Mazila Md Yusuf

Financial Statements & Analysis

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Financial Statements and Analysis

Understanding Financial Statements