Overview of Financial Statement Analysis

Business Analysis
Evaluate Prospects Evaluate Risks

1
CHAPTER
1-2

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

1-3

1-4

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

1-5

1-6

constraints on debtholders to protect creditors Other provisions . Acquisitions & Divestitures Active Investing Aim: • Beat the market -earn above normal stock returns Examples: Technical analysis & Fundamental analysis 1-9 1-10 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. etc. Liquidity Ability to meet shortterm obligations Focus: • Current Financial conditions • Current cash flows • Liquidity of assets 1-7 Solvency Ability to meet longterm obligations Focus: • Long-term financial conditions • Long-term cash flows • Extended profitability 1-8 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.asset earmarked for claims Covenants .order claims are paid Collateral .sinking fund requirements.Credit Analysis Credit worthiness: Ability to honor credit obligations (downside risk) Credit Analysis Debt Characteristics Seniority . Acquisitions & Divestitures 1-11 1-12 .

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 1-13 Cost of Capital Estimate Intrinsic Value 1-14 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 1-15 Common tools Ratio analysis Cash flow analysis 1-16 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 1-17 Opportunities Obstacles 1-18 .

113 3. except per share data) Statement of Shareholders’ Equity Kodak For year ended Dec.760 shares Additional paid in capital Retained earnings Accumulated other comprehensive loss Treasury stock.988 $ 14. 68. 950.733 Income Statement Kodak For Year Ended Dec.906 1. 31.293 6.161 1.944 3.962 1.390 Common Stock 978 - Sales Cost of goods sold Gross profit Selling.106 716 1. 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. 1998 (In millions.568 5.494.292.50 per share. 1998 Total 3. & 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 l 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.527 1.163 91 ($111) (258) 186 ($3.295 shares) Treasury stock issued under employee plans (3.232 1.914 Current Liabilities Payables Short-term borrowings Taxes .481 (570) (258) 128 46 $3. issued 391.406 7. 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.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.541.872) 1.178 504 2. 31.000. except number of shares) Shareholders’ Equity Dec 31.032 69 10.482 7.390 $978 (58) 46 $902 (570) $6.705 283 $ 14. 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 (3.745 1.888 110 328 2.944) 80 (44) 59 (4) 91 1.303 880 42 1. Buildings. 1998 (In millions.402 shares Total shareholders' equity Total liabilities and equity $ 3.343 (202) (3.599 13.390 $ 1.163 (111) 7.733 Assets Balance Sheet 1-21 Cash Flow Statement of Cash Flows 1-22 978 902 6.272.932 3.713 shares) Tax reductions .employee plans Shareholders’ Equity Dec 31.518 593 142 19 6.000 shares authorized. par value $2.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 1-19 Investing = Financing 1-20 Financial Statements Reflect Business Activities Planning Investing Current: l l l l Kodak Dec 31.424 855 293 5. 1998 Accumulated Additional Other Pail In Retained Comprehensive Treasury Capital Earnings Income (Loss) Stock 914 5. except per share data) Financing Current: l l l l Operating l l l l l l Cash Accounts Receivable Inventories Marketable Securities Land.390 (In millions.988 1-24 . as cost.

0) (100) 1.461 3.303 922 $ 1. Dec. 31.352 (12. & extent of any trend(s) Types: • Year-to-year Change Analysis • Index-Number Trend Analysis 1-28 1-27 Analysis Preview Year-to-Year Analysis Kodak's Comparative Income Statements Change Change (in mil. 1998 Operating Cash flows $ 1.141 1.944) $ 3.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. Dec. Dec.106 716 $ 1.406 Expenses 12.976 (683) (8.745 1. 1997 Adjustments/Stock Issue Share Capital.052 (3. speed. 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.016 Net Earnings $ 1. 31.290) $ 1. 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. 31.251) (569) 128 (258) 77 8 (271) Financial Statement Links . 1997 Treasury Stock Issued Treasury Stock Repurchased Treasury Stock.8) 1998 1997 3.839) 894 1. Dec.483 Investing Cash flows (1.880 $ 5.230 1.892 (12) $ 1.161 $13.888 110 328 $ 2.988 $14.Kodak Balance Sheet Dec.133 (1. 8-K.390 853 42 202 (166) (1) (43) (516) (278) 93 1.145 Statement of Cash Flows for Year Ended Dec.872) $ 3.483 (1. 20-F) •Proxy Statement •Social Responsibility Report Comparative Analysis Purpose: Evaluation of consecutive financial statements Output: Direction. Dec.6) (25.417 $13.2) 1.276 $14.984 $10.700 Analysis Preview Index-Number Trend Analysis Kodak's Index . 31. 1998 Treasury Stock.481 Statement of Shareholders’ Equity for Year Ended Dec. 31. 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. 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 12.880 6.5) $ 6.113 $ 6.385 (15. 1998 Sales $13.390 3. 10-Q.053 668 $ 1. 31.141 (3. 1998 Share Capital.758 12 307 $ 2.052 $ 3.406 $14. 31. 31. 31. 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 1-30 1-29 . Dec.872 186 (258) $ 3.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.290 $ 130 98 21 $ 53 48 $ 5 (609) (308) (1. 1998 $ 1. Dec.839) Financing Cash flows 77 Exchange rate changes on cash 8 Net Change in Cash $ (271) Cash Balance. general and admin. 1998 $ 457 Income Statement for Year Ended Dec.944 Balance Sheet Dec.108) 297 (59) (949) 162 (182) (1.132) 7. 31.sales Marketable securities .562 ($ 449) (6.873 1. 1997 728 Cash Balance.892 5.390 Other Comprehensive Income 91 Comprehensive Income $ 1. Dec.538 ($ 1. 31.733 $ 9.733 (Period of time) 1-26 (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. 31.391 27. net of cash acquired Marketable securities .8)% $ 13.145 1.293 7. 1997 Add: Comprehensive Income Less: Dividends Retained Earnings. 31.) % (7. 1998 Retained Earnings.481 (570) $ 6.Statement of Cash Flows Kodak For year Ended Dec.912 1.

4 45.1% 0. equity.4 15.9 0.. liabilities.7% 5.4% 1997 100.3% 0.1 0.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.long vs short term & benchmarking 1-33 Analysis Preview Valuation Valuation . 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 100.7 0.3 10.g.8 2.prices reflect all public information Strong Form . .6 6.0% 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 -.5 8.9% 0. • • • • • 1-36 credit and lending auditing valuation of nonpublicly traded firms mergers and acquisitions etc...0% 54.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 in an Efficient Market Three assumed forms of market efficiency Weak Form .9 8.prices reflect all public and private information 1-35 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.prices reflect information in past prices Semi-strong Form .1% 26. & expenses 1-31 Analysis Preview Common-Size Analysis Kodak's Common-Size Income Statements 1998 Sales Cost of goods sold Gross profit Selling.6% 24. revenues.9 0 14.9 45. e.3 0.0% 54.

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