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Overview of Financial Statement Analysis

Business Analysis
Evaluate Prospects Evaluate Risks

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CHAPTER
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Business Decision Makers


Equity investors Creditors Managers Merger and Acquisition Analysts External Auditors Directors Regulators Employees & Unions Lawyers

Information Sources for Business Analysis


Quantitative
Financial Statements Industry Statistics Economic Indicators Regulatory filings Trade reports Management Discussion & Analysis Chairperson s Letter Vision/Mission Statement Financial Press Press Releases Web sites

Credit Analysis Management & Control

Equity Analysis

Qualitative

Labor Negotiations Types of Business Analysis

Regulation

Director Oversight

Financial Management

External Auditing Mergers, Acquisitions & Divestitures

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Credit Analysis Management & Control

Equity Analysis

Credit Analysis
Creditors Trade Creditors Non-trade Creditors
Provide major financing Most long-term Usually explicit interest Bear risk of default

Labor Negotiations Types of Business Analysis

Regulation

Director Oversight

Financial Management

External Auditing Mergers, Acquisitions & Divestitures

Provide goods or services Most short-term Usually implicit interest Bear risk of default

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Credit Analysis
Credit worthiness: Ability to honor credit obligations (downside risk)

Credit Analysis
Debt Characteristics
Seniority - order claims are paid Collateral - asset earmarked for claims Covenants - constraints on debtholders to protect creditors Other provisions - sinking fund requirements, etc.

Liquidity Ability to meet shortterm obligations Focus: Current Financial conditions Current cash flows Liquidity of assets
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Solvency Ability to meet longterm obligations Focus: Long-term financial conditions Long-term cash flows Extended profitability
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Credit Analysis Management & Control

Equity Analysis

Equity Analysis

Labor Negotiations Types of Business Analysis

Regulation

Director Oversight

Passive Investing Aim: Diversification based on risk propensity & investment horizon Example: Indexing

Financial Management

External Auditing Mergers, Acquisitions & Divestitures

Active Investing Aim: Beat the market -earn above normal stock returns Examples: Technical analysis & Fundamental analysis

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Intrinsic Value
(or Fundamental Value)

Credit Analysis Management & Control

Equity Analysis

Value of Company (or stock) without reference to market value (or stock price) Intrinsic value > Market value Intrinsic value < Market value Intrinsic value = Market value Buy Sell Hold Strategy

Labor Negotiations Types of Business Analysis

Regulation

Director Oversight

Financial Management

External Auditing Mergers, Acquisitions & Divestitures

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Components of Business Analysis

Business Environment & Strategy Analysis

Accounting Analysis
Process to evaluate and adjust financial statements to better reflect economic reality
Comparability problems across firms and across time

Industry Analysis

Strategy Analysis

Financial Analysis

Manager estimation error Distortion problems Prospective Analysis Earnings management Distortion of business

Accounting Analysis

Analysis of Sources Risk &Uses of Profitability Funds Analysis Analysis

Accounting Risk

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Cost of Capital Estimate

Intrinsic Value

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Financial Analysis
Process to evaluate financial position and performance using financial statements

Prospective Analysis
Process to forecast future payoffs
Business Environment & Strategy Analysis Accounting Analysis Financial Analysis

Profitability analysis Evaluate return on investments Risk analysis Evaluate riskiness & creditworthiness Sources and uses Evaluate source & of funds analysis deployment of funds
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Common tools

Ratio analysis

Cash flow analysis

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Intrinsic Value

Business Activities
Competition Market demands Planning Activities: Goals & Objectives Pricing

Business Activities
Financing activities Owner (equity)

Tactics

Nonowner (liabilities)

Distribution

Promotion Projections

Financing

Managerial performance

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Opportunities

Obstacles

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Business Activities
Investing activities Buying resources Selling resources

Business Activities
Planning Activities

Investing Activities

Financial Activities

Investing

Financing
Operating Activities
Revenues and expenses from providing goods and services

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Investing = Financing

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Financial Statements Reflect Business Activities Planning Investing


Current:
l
l l l

Kodak
Dec 31, 1998 (In millions, except per share data)

Financing
Current:
l
l l l

Operating
l
l l l l l

Cash Accounts Receivable Inventories Marketable Securities Land, Buildings, & Equipment Patents Investments

Noncurrent:
l

Sales Cost of Goods Sold Selling Expense Administrative Expense Interest Expense Income Tax Expense

Notes Payable Accounts Payable Salaries Payable Income Tax Payable

Noncurrent:
l
l

l l

Net Income Income statement

Bonds Payable Common Stock Retained Earnings

Liabilities & Equity Balance Sheet Statement of Shareholders Equity

Assets Current Assets Cash and cash equivalents Marketable securities Receivables Inventories Deferred income tax charges Other Total current assets Properties Land, buildings and equipment at cost Less: Accumulated depreciation Net properties Other Assets Goodwill (net of accumulated amortization of $534) Long-term receivables and other non-current assets Deferred income tax charges Total Assets

Liabilities and Shareholders Equity $ 457 43 2,527 1,424 855 293 5,599 13,482 7,568 5,914 Current Liabilities Payables Short-term borrowings Taxes - income and other Dividends payable Deferred income tax credits Total current liabilities Other Liabilities Long-term borrowings Post-employment liabilities Other long-term liabilities Deferred income tax credits Total liabilities Shareholders' Equity Common stock, par value $2.50 per share, 950,000,000 shares authorized; issued 391,292,760 shares Additional paid in capital Retained earnings Accumulated other comprehensive loss Treasury stock, as cost, 68,494,402 shares Total shareholders' equity Total liabilities and equity $ 3,906 1,518 593 142 19 6,178 504 2,962 1,032 69 10,745

1,232 1,705 283 $ 14,733

Assets Balance Sheet


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Cash Flow Statement of Cash Flows

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978 902 6,163 (111) 7,932 3,944 3,988 $ 14,733

Income Statement
Kodak
For Year Ended Dec. 31, 1998 (In millions, except per share data)

Statement of Shareholders Equity Kodak


For year ended Dec. 31, 1998 Accumulated Additional Other Pail In Retained Comprehensive Treasury Capital Earnings Income (Loss) Stock 914 5,343 (202) (3,872) 1,390 Common Stock 978 -

Sales Cost of goods sold Gross profit Selling, general and administrative expenses Research and development costs Purchased research and development Restructuring costs and asset impairments EARNINGS FROM OPERATIONS Interest expense Other income (charges) Earnings before income taxes Provision for income taxes Earnings from continuing operations Gain on sale of discontinued operations NET EARNINGS 1-23

$13,406 7,293 6,113 3,303 880 42 1,888 110 328 2,106 716 1,390 $ 1,390

(In millions, except number of shares)

Shareholders Equity Dec 31, 1997 Net earnings Other comprehensive income (loss): Unrealized holding gains arising during period ($122 million pre-tax) Reclassification adjustment for gains included in net earnings ($66 million pre-tax) Currency translation adjustment Minimum pension liability adjustment ($7 million pre-tax) Other comprehensive income Comprehensive income Cash dividends declared Treasury stock repurchased (3,541,295 shares) Treasury stock issued under employee plans (3,272,713 shares) Tax reductions - employee plans Shareholders Equity Dec 31, 1998

Total 3,161 1,390

$978

(58) 46 $902

(570) $6,163

91 ($111)

(258) 186 ($3,944)

80 (44) 59 (4) 91 1,481 (570) (258) 128 46 $3,988

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Statement of Cash Flows


Kodak
For year Ended Dec. 31, 1998 (In millions)
Cash flows from operating activities: Earnings from continuing operations Adjustments to reconcile to net cash provided by operating activities: Depreciation and amortization Purchased research and development Provisions (benefit) for deferred income taxes (Gain) loss on sale/retirement of assets (Increase) decrease in receivables (Increase) decrease in inventories (Decrease) increase in liabilities excluding borrowings Other items, net Total adjustments Net cash provided by operating activities Cash flow from Investing activities: Additions to properties Proceeds from sale of assets Cash flows related to sales of businesses Acquisitions, net of cash acquired Marketable securities - sales Marketable securities - purchases Net cash used in investing activities Cash flows from financing activities: Net increase (decrease) in borrowings with original maturities of 90 days or less Proceeds from other borrowings Repayment of other borrowings Dividends to shareholders Exercise of employee stock options Stock repurchase programs Net cash provided by (used in) financing activities Effect of exchange rate changes on cash 1-25 (decrease) increase in cash and cash equivalents Net $ 1,390 853 42 202 (166) (1) (43) (516) (278) 93 1,483 (1,108) 297 (59) (949) 162 (182) (1,839) 894 1,133 (1,251) (569) 128 (258) 77 8 (271)

Financial Statement Links - Kodak


Balance Sheet Dec. 31, 1997
Assets Cash Non-Cash Assets Total Assets Liabilities & Equity Total liabilities Equity: Share Capital Retained Earnings Treasury Stock Total equity Liabilities & Equity (Period of time) $ 728 12,417 $13,145

Statement of Cash Flows for Year Ended Dec. 31, 1998 Operating Cash flows $ 1,483 Investing Cash flows (1,839) Financing Cash flows 77 Exchange rate changes on cash 8 Net Change in Cash $ (271) Cash Balance, Dec. 31, 1997 728 Cash Balance, Dec. 31, 1998 $ 457 Income Statement for Year Ended Dec. 31, 1998 Sales $13,406 Expenses 12,016 Net Earnings $ 1,390 Other Comprehensive Income 91 Comprehensive Income $ 1,481 Statement of Shareholders Equity for Year Ended Dec. 31, 1998 Share Capital, Dec. 31, 1997 Adjustments/Stock Issue Share Capital, Dec. 31, 1998 Retained Earnings, Dec. 31, 1997 Add: Comprehensive Income Less: Dividends Retained Earnings, Dec. 31, 1998 Treasury Stock, Dec. 31, 1997 Treasury Stock Issued Treasury Stock Repurchased Treasury Stock, Dec. 31, 1998 $ 1,892 (12) $ 1,880 $ 5,141 1,481 (570) $ 6,052 $ 3,872 186 (258) $ 3,944 Balance Sheet Dec. 31, 1998 Assets Cash Non-Cash Assets Total Assets Liabilities & Equity Total liabilities Equity: Share Capital Retained Earnings Treasury Stock Total equity Liabilities & Equity

$ 457 14,276 $14,733

$ 9,984

$10,745

1,892 5,141 (3,872) $ 3,161 $13,145

1,880 6,052 (3,944) $ 3,988 $14,733

(Period of time)

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(Period of time)

Additional Information
(Beyond Financial Statements)

Analysis Preview
Yr1 Yr2 Yr3

Management Discussion & Analysis (MD&A) Management Report Auditor Report Notes to Financial Statements Supplementary Information (10-K, 10-Q, 8-K, 20-F) Proxy Statement Social Responsibility Report

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 Analysis
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Analysis Preview
Year-to-Year Analysis
Kodak's Comparative Income Statements
Change Change (in mil.) % (7.8)% $ 13,406 $14,538 ($ 1,132) 7,293 7,976 (683) (8.5) $ 6,113 $ 6,562 ($ 449) (6.8) 1998 1997 3,303 922 $ 1,888 110 328 $ 2,106 716 $ 1,390 3,912 1,230 1,290 $ 130 98 21 $ 53 48 $ 5 (609) (308) (1,290) $ 1,758 12 307 $ 2,053 668 $ 1,385 (15.6) (25.0) (100) 1,352 (12.2) 1,461 3,873 1,391 27,700

Analysis Preview Index-Number Trend Analysis


Kodak's Index - Number Trend Series (base year 1994)
1998 99 94 144 249 98 99 1997 107 118 10 1 88 79 1996 117 115 141 182 96 118 1995 110 106 148 224 97 127 1994 100 100 100 100 100 100

Sales Cost of goods sold Gross profit Operating Expenses: Selling, general and admin. Research and development Restructuring costs Earnings from operations Interest Expense Other income (charges) Earnings before income taxes Provision for income taxes Net earnings

Sales Total operating expenses Earnings from operations Net earnings Total assets Shareholders' equity
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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
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Analysis Preview Common-Size Analysis


Kodak's Common-Size Income Statements 1998
Sales Cost of goods sold Gross profit Selling, general and administrative expenses Research and development costs Restructuring Costs Earnings from operations Interest expense Other income Earnings before income taxes Provision for income taxes Net 1-32 earnings 100.0% 54.4 45.6% 24.6 6.9 0 14.1% 0.8 2.4 15.7% 5.3 10.4%

1997
100.0% 54.9 45.1% 26.9 8.5 8.9 0.9% 0.7 0.1 0.3% 0.3 0.0%

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
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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)
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Analysis in an Efficient Market Three assumed forms of market efficiency


Weak Form - prices reflect information in past prices Semi-strong Form - prices reflect all public information Strong Form - prices reflect all public and private information
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Analysis in an Efficient Market

Market Efficiency
assumes competent and informed analysis distinguish aggregate from individual behavior reflects information (both reliable and unreliable) cross-country differences in rewards to analysis

Financial statement analysis relevant to more than just market analysis, e.g.,

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credit and lending auditing valuation of nonpublicly traded firms mergers and acquisitions etc...

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