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K R Subramanyam John J Wild
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Overview of Financial Statement Analysis
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
Press Releases Qualitative Management discussion & Analysis Chairperson’s Letter
1-5 Credit Analysis Equity Analysis Management & Control Types of Business Analysis Labor Negotiations Regulation Director Oversight Financial Management External Auditing Mergers. Acquisitions & Divestitures .
1-6 Credit Analysis Trade Creditors Non-trade Creditors Provide major financing Provide goods or services Bear risk of default Bear risk of default Most shortterm Usually implicit interest Most longterm Usually explicit interest .
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 Component Processes of Business Analysis Business Environment & Strategy Analysis Industry Analysis Strategy Analysis Financial Analysis Analysis of cash flows Risk Profitability Analysis Analysis Accounting Analysis Prospective Analysis Cost of Capital Estimate Intrinsic Value .
1-10 Accounting Analysis Process to evaluate and adjust financial statements to better reflect economic reality Comparability problems — across firms and across time Manager estimation error Distortion problems Earnings management Accounting Standards Accounting Risk .
1-11 Financial Analysis Process to evaluate financial position and performance using financial statements Profitability analysis — Evaluate return on investments Risk analysis ——— Evaluate riskiness & creditworthiness Analysis of — cash flows Evaluate source & deployment of funds Common tools Cash flow analysis Ratio 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 Investing Financing Planning Time Beginning of period Operating Planning Investing Financing End of period .
1-14 Business Activities Competition Pricing Tactics Planning Activities: Goals & Objectives Market demands Distribution Promotion Projections Managerial performance Opportunities Obstacles .
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 Investing Activities Planning Activities Financial Activities Operating Activities Revenues and expenses from providing goods and services .
1-18 Financial Statements Reflect Business Activities Planning Investing Current: • • • • Financing Current: • • • • Operating Sales • Cost of Goods Sold • Selling Expense • Administrative Expense • Interest Expense • Income Tax Expense • Cash Accounts Receivable Inventories Marketable Securities Land. Buildings. & Equipment Patents Investments Notes Payable Accounts Payable Salaries Payable Income Tax Payable Bonds Payable Common Stock Retained Earnings Noncurrent: • Noncurrent: • • • • • Net Income Income statement Assets Liabilities & Equity Cash Flow Balance Sheet Balance Sheet Statement of Cash Flows Statement of Shareholders’ Equity .
1-19 Financial Statements Balance Sheet Income Statement Statement of Shareholders’ Equity Statement of Cash Flows .
410 .727 + $1.1-21 Balance Sheet Total Investing = Total Financing = Creditor Financing + Owner Financing Colgate Financing (in $billions) $9.138 = $7.
701 .701 Gross Profit $6.1-23 Income Statement Revenues – Cost of goods sold = Gross Profit Gross profit – Operating expenses = Operating Profit Colgate’s Profitability (in $billions) $12.160 Operating profit .$4.238 .$5.5411 = $2.536 = $6.
1-25 Statement of Cash Flows Net Cash Flows from Operating Activities Net Cash Flows from Investing Activities Net Cash Flows from Financing Activities .
1-27 Additional Information (Beyond Financial Statements) Management’s Discussion & Analysis (MD&A) Management Report Auditor Report Explanatory Notes to Financial Statements Supplementary Information Proxy Statement .
1-28 Analysis Preview Yr1 Yr2 Yr3 Comparative Analysis Purpose: Evaluation of consecutive financial statements Output: Direction. & extent of any trend(s) Types: Year-to-year Change Analysis Index-Number Trend Analysis . speed.
1-29 Analysis Preview .
revenues. liabilities. equity.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. & 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 .
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) .1-34 Analysis Preview Valuation Valuation .
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 .
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 .1-37 Analysis Preview Equity Valuation .
BV. minus a charge on beginning book value. NI.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.1-38 Analysis Preview Equity Valuation . or RIt = NIt .(k x BVt-1)] k is the cost of capital E refers to an expectation t .
prices reflect information in past prices Semi-strong .prices reflect all public Form information Strong Form .1-39 Analysis in an Efficient Market Three assumed forms of market efficiency Weak Form .prices reflect all public and private information .
1-40 Book Organization Financial Statement Analysis Part I Introduction and Overview Part II Accounting Analysis Chapter 3: Analyzing Financial Activities Chapter 4: Analyzing Investing Activities Chapter 5: Analyzing Investing Activities: Special topic Chapter 6: Analyzing Operating Activities Part III Financial Analysis Chapter 7: Cash Flow Analysis Chapter 8: Return on Invested Capital Chapter 9: Profitability Analysis Chapter 10: Prospective Analysis Chapter 11: Credit Analysis Chapter 12: Equity Analysis and Valuation Chapter 1: Overview of Financial Statement Analysis Chapter 2: Financial Reporting and Analysis .
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