Financial Statement Analysis

Curriculum designed for use with the Iowa Electronic Markets
by

Cynthia J. Brown Marilyn M. Dutton Thomas A. Rietz
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Financial Statement Analysis: Lecture Outline

Review of Financial Statements Ratios
– Types of Ratios – Examples

  

The DuPont Method Ratios and Growth Summary
– Strengths – Weaknesses – Ratios and Forecasting

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Stock Price
Expected Cashflows NPV MVA EVA Market Conditions

Timing of Cashflows

Stock Price

Risk of Cashflows

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industry. sector and all firms 4 . present and future financial conditions Done to find firm’s financial strengths and weaknesses Primary Tools: – Financial Statements – Comparison of financial ratios to past.Financial Analysis    Assessment of the firm’s past.

Financial Statements Balance Sheet  Income Statement  Cashflow Statement  Statement of Retained Earnings  5 .

msn.Sources of Data  Annual reports – Via mail.marketguide.com/investor http://www. SEC or company websites  Published collections of data – e.com 6 .g.. Dun and Bradstreet or Robert Morris  Investment sites on the web – Examples   http://moneycentral.

Costt)x(1-t) + txDept —OR—  Revtx(1-t) .Dept)x(1-t) + Dept —OR—  (Revt .The Main Idea   Value for the firm comes from cashflows Cashflows can be calculated as:  (Revt .Costt .Costtx(1-t) + txDept 7 .

Review: Major Balance Sheet Items  Assets Current assets: – Cash & securities – Receivables – Inventories Liabilities and Equity  Current liabilities: – Payables – Short-term debt   Fixed assets: – Tangible assets – Intangible assets  Long-term liabilities Shareholders' equity 8 .

and Equity: 9 .471.An Example: Dell Abbreviated Balance Sheet  Assets: – Current Assets: – Non-Current Assets: – Total Assets: $7.00 $11.192.308.: Equity: Total Liab.00 $3.00 $5.471.790.681.00 $971.00 $11.00 $5.00  Liabilities: – – – – Current Liabilities: LT Debt & Other LT Liab.

Cash Operating Expenses EBIT = EBDIT .Taxes Net Income is a primary determinant of the firm’s cashflows and.Costs of Goods Sold EBITDA = Gross Profit . the value of the firm’s shares 10 .Amortization EBT = EBIT .Review: Major Income Statement Items       Gross Profit = Sales .Interest NI or EAT = EBT. thus.Depreciation .

00 -$0.00 -$2.00 $1.761.00 -$194.666.An Example: Dell Abbreviated Income Statement Sales Costs of Goods Sold Gross Profit Cash operating expense EBITDA Depreciation & Amortization Other Income (Net) EBIT Interest EBT Income Taxes Special Income/Charges Net Income (EAT) $25.613.00 -$156.00 2.00 11 .00 -$6.00 $2.451.265.00 -$785.374.00 $5.451.00 $2.00 -$19.891.

Objectives of Ratio Analysis       Standardize financial information for comparisons Evaluate current operations Compare performance with past performance Compare performance against other firms or industry standards Study the efficiency of operations Study the risk of operations 12 .

Rationale Behind Ratio Analysis   A firm has resources It converts resources into profits through – production of goods and services – sales of goods and services  Ratios – Measure relationships between resources and financial flows – Show ways in which firm’s situation deviates from     Its own past Other firms The industry All firms13 .

Types of Ratios  Financial Ratios: – Liquidity Ratios  Assess ability to cover current obligations Assess ability to cover long term debt obligations – Leverage Ratios   Operational Ratios: – Activity (Turnover) Ratios  Assess amount of activity relative to amount of resources used Assess profits relative to amount of resources used Assess market price relative to assets or earnings – Profitability Ratios   Valuation Ratios:  14 .

40 Current Liabilitie s $1.Liquidity Ratio Examples: Dell  Current Ratio: Current Ratio : Current As sets $7.00  Quick (Acid Test) Ratio: Current As sets .48 Current Liabilitie s $5.107.681.00  $391.000 Acid Test Ratio : 15 .192.00   1.Inventorie s $7.00   1.681.

90 Jan-99 1.80 Jan-98 1.08 1.5 0 Jan-96 Dell Industry 2.45 1.Ratio Comparison: Current Ratio 2.5 1 0.60 Jan-00 1.66 1.72 1.5 2 Current Ratio 1.80 Jan-97 1.48 16 .

00 17 .471.00 Debt Ratio :   53.Leverage Ratio Examples: Dell  Debt Ratio: Total Liabilitie s $6.163.73% Total Assets $11.

6 Debt Ratio 0.1 0 Jan-96 Dell Industry 54.70% 52.5 0.8 0.25% 62.00% Jan-98 69.4 0.70% 62.Ratio Comparison: Debt Ratio 0.38% Jan-99 66.2 0.3 0.7 0.73% 18 .96% Jan-00 53.07% 60.96% Jan-97 73.

308.00   14.00 19 .00  Return on Equity (ROE): ROE : Net Income $1.666.471.52% Total Assets $11.666.Profitability Ratio Examples: Dell  Return on Assets (ROA): ROA : Net Income $1.39% Total Common Equity $5.00   31.

00  Retention Ratio EPS .59% Sales $25.265.Div $0.66 20 .Profitability Ratio Examples: Dell  Net Profit Margin: EBIT $2.451.66  $0 Retention Ratio (  ) :   100% EPS $0.00 Net Profit Margin :   6.

60% Jan-98 73.90% 18.00% Jan-00 31.Ratio Comparison: ROE 80% 70% 60% 50% 40% 30% 20% 10% 0% ROE Jan-96 Dell Industry 28.01% 25.27% 30.13% 22.39% 21 .50% Jan-99 62.30% Jan-97 64.

Ratio Comparison: ROA 25% 20% ROA 15% 10% 5% 0% Jan-96 Dell Industry 12.23% 5.20% Jan-99 21.70% Jan-00 14.31% 10.12% 7.90% Jan-98 22.80% Jan-97 17.66% 6.52% 22 .

14% 3.79% Jan-99 8.85% Jan-00 6.59% 23 .66% 3.68% 4.Ratio Comparison: Profit Margin 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Profit Margin Jan-96 Dell Industry 5.74% Jan-98 7.40% Jan-97 6.00% 2.

00 Inventory Turnover :   64.265.20 Total Assets $11.Activity (Turnover) Ratio Examples: Dell  Total Asset Turnover Ratio: Total Asset Turnover : Sales $25.471.265.00 24 .00  Inventory Turnover Ratio: Sales $25.00   2.62 Inventory $391.

00 Jan-00 2.00 Jan-97 2.59 2.89 1.Ratio Comparison: Asset Turnover 350% 300% Asset Turnover 250% 200% 150% 100% 50% 0% Jan-96 Dell Industry 2.47 2.65 2.20 25 .30 Jan-98 2.90 Jan-99 2.

The DuPont System  Method to breakdown ROE into: – ROA and Equity Multiplier  ROA is further broken down as: – Profit Margin and Asset Turnover   Helps to identify sources of strength and weakness in current performance Helps to focus attention on value drivers 26 .

The DuPont System ROE ROA Profit Margin Equity Multiplier Total Asset Turnover 27 .

The DuPont System ROE ROA Profit Margin Equity Multiplier Total Asset Turnover ROE  ROA  Equity Multiplier Net Income Total Assets   Total Assets Common Equity 28 .

The DuPont System ROE ROA Profit Margin Equity Multiplier Total Asset Turnover ROA  Profit Margin  Total Asset Turnover Net Income Sales   Sales Total Assets 29 .

The DuPont System ROE ROA Profit Margin Equity Multiplier Total Asset Turnover ROE  Profit Margin  Total Asset Turnover  Equity Multiplier Net Income Sales Total Assets    Sales Total Assets Common Equity 30 .

39% 31 .666.The DuPont System: Dell ROE  Net Income Sales Total Assets   Sales Total Assets Common Equity  Profit Margin  Total Asset Turnover  Equity Multiplier  ROA  Equity Multiplier $1.1611  31.00 $11.00 ROE    $25.00  0.1611  0.308.471.00 $5.471.00 $25.265.2025  2.0659  2.265.1452  2.00 $11.

capital gains (g) and forward dividend yields (D1/P0): – r = g + D1/P0 = g + Do(1+g)/P0  Note: r & g must be quarterly if D is quarterly and annual if D is annual 32 .A Note on Sustainable Growth and Stock Returns  In the long run – Sustainable growth and long run capital gains (g) = ROE x   Recall the relationship between stock returns (r).

3139 + 0/P = 51.39% – r = 0.Example: Predicted Sustainable Growth for Dell  Based on the most recent numbers: – ROE = 31.3139 x 1 = 31.94% 33 .39%  Based on 5 year averages: – ROE = 51.94% &  = 100% – g = 0.94% – r = 0.5194 x 1 = 51.39% &  = 100% – g = 0.3139 + 0/P = 31.

Summary of Financial Ratios  Ratios help to: – Evaluate performance – Structure analysis – Show the connection between activities and performance  Benchmark with – Past for the company – Industry  Ratios adjust for size differences 34 .

Limitations of Ratio Analysis       A firm’s industry category is often difficult to identify Published industry averages are only guidelines Accounting practices differ across firms Sometimes difficult to interpret deviations in ratios Industry ratios may not be desirable targets Seasonality affects ratios 35 .

Ratios and Forecasting  Common stock valuation based on – Expected cashflows to stockholders – ROE and  are major determinants of cashflows to stockholders  Ratios influence expectations by: – Showing where firm is now – Providing context for current performance  Current information influences expectations by: – Showing developments that will alter future performance 36 .

this can help to: – Assess likely future performance – Predict future valuation and earnings growth – Predict returns 37 .How Might Ratios Help Me on the IEM?  Analysis of AAPL. and comparisons to the S&P500 companies can help to: – Assess the (absolute and relative) financial state of each company – Show each company’s strengths and weaknesses – Predict sustainable growth rate  Combined with current information. IBM and MSFT.