METHODS OF FINANCIAL ANALYSIS

Horizontal analysis: Percentage change over time in financial statem

Vertical analysis: Common size statements over time

Financial statement line items as a percent of sales
Balance sheet line items as a percent of total assets

Vertical analysis: Ratios over time

Liquidity ratios: ability to pay off short term obligations
Current Ratio = Current assets / current liabilities
Quick Ratio = (Current assets - inventory) / current l

Solvency ratios: too much debt endangers the organization

Long term debt to equity
Liabilities to assets

Efficiency ratios: how well assets are being used

Days receivables outstanding = Accts Receivable / (S
Days inventory outstanding = Inventory / (COGS or C
Days payables outstanding = Accounts Payable / (CO
Net days financing required:
Days inventory outstanding - Days payables

Profitability ratios: financial performance

Return on assets = Net income / total assets
Return on equity = Net income / owners equity
Common size statements and ratios in comparison to the industry

Cash flow statements

Projections of financial statements

 r time in financial statements

over time
percent of sales
nt of total assets

hort term obligations

ets / current liabilities
ts - inventory) / current liabilities

dangers the organization

re being used
ng = Accts Receivable / (Sales/365)
= Inventory / (COGS or COS/365)
= Accounts Payable / (COGS or COS/365)

standing - Days payables outstanding + Days Receivables outstanding

me / total assets
me / owners equity
parison to the industry
ILLUSTRATION OF VERTICAL AND HORIZONTAL FINANCIAL ANALYSIS

Financial Statements for XYX Corporation Vertical Analysi

Actual Actual Actual Actual
Year 2010 2011 2012 2010
Sales $1,000 $1,200 $1,440 100%
COGS 500 600 710 50.0%
Gross Profit 500 600 730 50.0%
Expenses 300 400 500 30.0%
Profit before Taxes 200 200 230 20.0%
Taxes 80 80 92 8.0%
Net Income 120 120 138 12.0%

Cash 20 30 40 2.0%
A/R 100 110 130 10.0%
Inventory 100 120 130 10.0%
Current Assets 220 260 300 22.0%
Net Plant & Equipment 800 900 1018 80.0%
Total Assets 1020 1160 1318 102.0%

Accounts Payable 40 50 60 4.0%

Accrued Expenses 10 20 30 1.0%
Current Liabilities 50 70 90 5.0%
Equity 970 1090 1228 97.0%
Total Liabilities & Assets 1020 1160 1318 102.0%

Vertical Analysis with Assets

 Actual
2010
Cash $20 $30 $40 2.0%
A/R 100 110 130 9.8%
Inventory 100 120 130 9.8%
Current Assets 220 260 300 21.6%
Net Plant & Equipment 800 900 1018 78.4%
Total Assets 1020 1160 1318 100.0%

Accounts Payable 40 50 60 3.9%

Accrued Expenses 10 20 30 1.0%
Current Liabilities 50 70 90 4.9%
Equity 970 1090 1228 95.1%
Total Liabilities & Assets 1020 1160 1318 100.0%
NALYSIS

Vertical Analysis with Sales Horizontal Analysis

Actual Actual Actual Actual
2011 2012 2011 2012
100% 100% 20.0% 20.0%
50.0% 49.3% 20.0% 18.3%
50.0% 50.7% 20.0% 21.7%
33.3% 34.7% 33.3% 25.0%
16.7% 16.0% 0.0% 15.0%
6.7% 6.4% 0.0% 15.0%
10.0% 9.6% 0.0% 15.0%

2.5% 2.8% 50.0% 33.3%

9.2% 9.0% 10.0% 18.2%
10.0% 9.0% 20.0% 8.3%
21.7% 20.8% 18.2% 15.4%
75.0% 70.7% 12.5% 13.1%
96.7% 91.5% 13.7% 13.6%

4.2% 4.2% 25.0% 20.0%

1.7% 2.1% 100.0% 50.0%
5.8% 6.3% 40.0% 28.6%
90.8% 85.3% 12.4% 12.7%
96.7% 91.5% 13.7% 13.6%

with Assets
Actual Actual
2011 2012
2.6% 3.0%
9.5% 9.9%
10.3% 9.9%
22.4% 22.8%
77.6% 77.2%
100.0% 100.0%

4.3% 4.6%
1.7% 2.3%
6.0% 6.8%
94.0% 93.2%
100.0% 100.0%
WHAT DO YOU MEAN BY…?
Be careful! Definitions vary.

I. Current Ratio
A. Current Assets divided by Current Liabilities
B. Current Operating Assets divided by Current Operatin

II. Working Capital

A. Current Assets
B. Current Assets minus Current Liabilities: aka Net Wo
C. Current Operating Assets minus Current Operating Li

III. Return on Investment (ROI)

A. Return on Assets (ROA)
B. Return on Equity (ROE)
C. Return on Equity plus Interest Bearing Debt (Capitali

IV. Return on Anything (i.e., Define Return)

A. Profit After Taxes or Net Income (PAT) or PAT + After
B. Earnings Before Interest and Taxes (EBIT)
C. Earnings Before Interest After Taxes (EBIAT)
1. After Actual Taxes
2. After Operating Costs (Assume No Debt, No I
D. Net Operating Profit After Taxes (NOPAT): See above
E. Earnings Before Interest, Taxes, Depreciation, and Am
V. Debt to Equity or Debt to Total Assets
A. Debt
1. Total Liabilities
2. Interest Bearing Debt
B. Equity (With or Without Preferred Stock and Options
1. Book Value of Assets minus Total Liabilities
2. Market Value of Assets
3. Liquidation Value of Assets
4. Market Value of Equity (Shares Outstanding X

VI. Comparable Ratios

A. Average of the industry? Percentiles?
B. What is the industry?
C. Balance Sheet: Beginning, Middle, End of the year?
 nt Liabilities
d by Current Operating Liabilities

iabilities: aka Net Working Capital

Current Operating Liabilities

Bearing Debt (Capitalization)

e (PAT) or PAT + After Tax Interest

xes (EBIT)
axes (EBIAT)

Assume No Debt, No Interest)

s (NOPAT): See above C2.
Depreciation, and Amortization (EBITDA)
red Stock and Options)
inus Total Liabilities

(Shares Outstanding X Price Per Share)

dle, End of the year?

GRADUATED CORPORATE INCOME TAX

Taxable Income ($)

0 to 50,000
50,000 to 75,000
75,000 to 100,000
100,000 to 335,000
335,000 to 10,000,000
10,000,000 to 15,000,000
15,000,000 to 18,333,333
18,333,333 and up
NCOME TAX

Tax Rate
15% or $7,500 (at income of $50,000)
$7,500 + 25% Of the amount over $50,000
$13,750 + 34% Of the amount over $75,000
$22,250 + 39% Of the amount over $100,000
$113,900 + 34% Of the amount over $335,000
$3,400,000 + 35% Of the amount over $10,000,000
$5,150,000 + 38% Of the amount over $15,000,000
35%
METHODS OF FORECASTING

I. INTUITIVE (SUBJECTIVE)
A. Senior Manager (CEO, Division Manager, Department Manager
B. Jury of Senior Executive Opinion
C. Sales Force Composite
D. Delphi Technique (Opinions of Experts)
E. Scenario Analysis (usually with Sensitivity Analysis)

II. CAPACITY FORECAST

A. Sales growth limited by bottlenecks other than demand
1. Management capacity
2. Plant capacity
3. Shortages of labor, materials, other.
4. Technology limitations
B. Forecast based upon overcoming the limits

III. SURVEY METHODS

A. Census ("bottom up" forecast)
B. Sample

IV. HISTORICAL
A. Historical Analogy
B. Leading or Coincident Indicators
1. Percent to Indicator - Ratio Analysis (% or % change)
2. Activity Based Costing
C. Regression and Correlation Analysis
D. Econometric Model
E. Extrapolation (Trend Analysis)
1. No change
2. Constant change
3. Average change
4. Time series extrapolation
Department Manager)

Analysis)

r than demand

is (% or % change)
ITERATON, INC. ($000)

You can solve for the size of the bank note by iteration:
2012 2013 2013
Actual Iteration 1 Iteration 2
Sales 1000.0 1400.0 1400.0
Operating Costs 850.0 1190.0 1190.0
Interest 80.0 80.0 112.0
Profit Before Taxes 70.0 130.0 98.0
Taxes @ 40% 28.0 52.0 39.2
Net Income 42.0 78.0 58.8

Total Assets 1500.0 2100.0 2100.0

Operating Liabilities 100.0 140.0 140.0

Bank Note @ 10% 800.0 800.0 1120.0
Current Liabilities 900.0 940.0 1260.0
Equity 600.0 678.0 658.8
Total Lia. & Equity 1500.0 1618.0 1918.8

Or you can do it the easy way:

2012 2013
Actual Iteration 1
Sales 1000.0 1400.0
Operating Costs 850.0 1190.0
Interest 80.0 131.3
Profit Before Taxes 70.0 78.7
Taxes @ 40% 28.0 31.5
Net Income 42.0 47.2

Total Assets 1500.0 2100.0

Operating Liabilities 100.0 140.0

Bank Note @ 10% 800.0 1312.8
Current Liabilities 900.0 1452.8
Equity 600.0 647.2
Total Lia. & Equity 1500.0 2100.0
 2013 2013 2013
Iteration 3 Iteration 4 Iteration 5
1400.0 1400.0 1400.0
1190.0 1190.0 1190.0
144.0 128.0 131.3
66.0 82.0 78.7
26.4 32.8 31.5
39.6 49.2 47.2

2100.0 2100.0 2100.0

140.0 140.0 140.0

1440.0 1280.0 1312.8
1580.0 1420.0 1452.8
639.6 649.2 647.2
2219.6 2069.2 2100.0

Use Tools - Goal Seek or Solver

Set cell C36 equal to
2100 by changing C33.
Be sure to create a
formula for interest in
the income statement
before using these programs.

Goal Seek works only with

relatively simple problems.
EXAMPLE
Certain assumptions for 2013 are already provided in the 2013 proformas. A
to finance yourself for 2013. The long term debt interest is 8%. Short term d
at the beginning of 2013 so that the stated interest will continue throughout

Please fill in the blanks in the 2013 financials.

Actual Forecast
2012 2013
Sales 8,000 9,600
Interest (145)
Depreciation (250) (400)
All other costs (variable) (7,400)
Profit before taxes 205
Taxes @ 40% (82)
Profit after taxes 123

Current Operating Assets 2,500 3,000

Gross Fixed Assets 4,500 5,500
Accumulated Depreciation (2,500)
Net Fixed Assets 2,000
Total Assets 4,500

Current operating liabilities 800 960

Bank note 500
Current portion long term debt 100 120
Long term debt 1,100 1,320
Net Worth (Equity) 2,000
Total Liabilities and Equity 4,500
 the 2013 proformas. Assume you can borrow enough from your bank short term
est is 8%. Short term debt interest is 6%. Assume the debt is increased
ll continue throughout the year from the beginning of 2013 to the end of 2013.
our bank short term
increased
the end of 2013.
EXAMPLE
Certain assumptions for 2013 are already provided in the 2013 proformas. A
to finance yourself for 2013. The long term debt interest is 8%. Short term d
at the beginning of 2013 so that the stated interest will continue throughout

Please fill in the blanks in the 2013 financials.

2012 2013
Sales 8,000 9,600
Interest (145) (182)
Depreciation (250) (400)
All other costs (variable) (7,400) (8,880)
Profit before taxes 205 138
Taxes @ 40% (82) (55)
Profit after taxes 123 83

Current Operating Assets 2,500 3,000

Gross Fixed Assets 4,500 5,500
Accumulated Depreciation (2,500) (2,900)
Net Fixed Assets 2,000 2,600
Total Assets 4,500 5,600

Current operating liabilities 800 960

Bank note 500 1,117
Current portion long term debt 100 120
Long term debt 1,100 1,320
Net Worth (Equity) 2,000 2,083
Total Liabilities and Equity 4,500 5,600
he 2013 proformas. Assume you can borrow enough from your bank short term
st is 8%. Short term debt interest is 6%. Assume the debt is increased
continue throughout the year from the beginning of 2013 to the end of 2013.
ur bank short term
ncreased
he end of 2013.
COMPOUNDING AND COMPOUND INTEREST

Save $100 at 10% from time period 0 to…

End of 1 Year 110.00 110.00

End of 2 Years 121.00 121.00
End of 3 Years 133.10 133.10
End of 4 Years 146.41 146.41
End of 5 Years 161.05 161.05

Save $100 per year at 10% from time

period 0 to…

End of 1 Year 110.00 110.00

End of 2 Years 231.00 231.00
End of 3 Years 364.10 364.10
End of 4 Years 510.51 510.51
End of 5 Years 671.56 671.56
THE POWER OF COMPOUNDING
Return on 18.62% Every Two Weeks
From a payday loan web site on 8/21/2010

Beginning
Amount Interest Compound
Week Owed Rate Interest
0 $100.00 18.62% 18.62%
2 $118.62 18.62% 40.71%
4 $140.71 18.62% 66.91%
6 $166.91 18.62% 97.98%
8 $197.98 18.62% 134.85%
10 $234.85 18.62% 178.58%
12 $278.58 18.62% 230.45%
14 $330.45 18.62% 291.98%
16 $391.98 18.62% 364.97%
18 $464.97 18.62% 451.54%
20 $551.54 18.62% 554.24%
22 $654.24 18.62% 676.06%
24 $776.06 18.62% 820.56%
26 $920.56 18.62% 991.97%
28 $1,091.97 18.62% 1195.30%
30 $1,295.30 18.62% 1436.48%
32 $1,536.48 18.62% 1722.57%
34 $1,822.57 18.62% 2061.93%
36 $2,161.93 18.62% 2464.49%
38 $2,564.49 18.62% 2941.99%
40 $3,041.99 18.62% 3508.41%
 42 $3,608.41 18.62% 4180.30%
44 $4,280.30 18.62% 4977.29%
46 $5,077.29 18.62% 5922.68%
48 $6,022.68 18.62% 7044.11%
50+ $7,144.11 20.08% 8478.34%
26.07143

Quoted Annual Percentage Rate (APR) =

Number of payments: 365 days / 14 days =
Calculated as: (365 days / 14 days) X 18.62 =

Effective Interest Rate

(1+r )m-1 r = APR
m = Number of payments

Alternative Formula:
1+(r / m)m-1
Ending
Amount
Owed
$118.62
$140.71
$166.91
$197.98
$234.85
$278.58
$330.45
$391.98
$464.97
$551.54
$654.24
$776.06
$920.56
$1,091.97
$1,295.30
$1,536.48
$1,822.57
$2,161.93
$2,564.49
$3,041.99
$3,608.41 14.0384615
$4,280.30
$5,077.29 1.00341209
$6,022.68
$7,144.11
$8,578.34
($100.00) Principal
$8,478.34 Interest

485.45%
26.0714286
485.45%

8478.34%

8478.34%
HOW TO CALCULATE THE RETURN ON INVESTMENT BY TAKIN

The old way, which you still sometimes see for simplicity:
The percent discount offered divided by (1 - discount percent), w
(or sometimes 360) divided by the regular payment date minus
Example: 1/10, net 40. Payment in 10 days reduces the cost on
[0.01/(1.00-.01)] X [365/(40-10)]
12.29%

The current way takes into account reinvestment of the savings each period,
Note: when multiplying percentages, you have to add 1 to each of the percen
Otherwise, you reduce the product rather than increasing it. Then, subtract

30-Day Invoice in Payment Annual

Periods Dollars Discount Due Percentage
12.1666667 $100 $1.00 $99.00 13.01%

END OF PERIOD
Cumulative
Compound Buyer's
Period Interest Reward
1 1.01% $1.01 In this transaction, the seller gets to us
 2 2.03% $2.03 The cost to the seller is $1.00/$99.00 o
3 3.06% $3.06 would have to pay $100.00. But the se
4 4.10% $4.10
5 5.15% $5.15
6 6.22% $6.22 From the buyer's standpoint: If the bu
7 7.29% $7.29 over 30 days, the buyer would have $1
8 8.37% $8.37 If the buyer reinvested at a rate of 1.01
9 9.47% $9.47 would have $101.0101 X 1.010101, or
10 10.57% $10.57 Then, at the end of 90 days (3 periods)
11 11.69% $11.69 and so on. If this went on for a year, 1
12.167 13.01% $13.01 the buyer would have $113.01 at the e

SHOULD THE BUYER TAKE THE DISCOU

The buyer compares the annual effecti
capital for the firm and selects the bes

The formula:
{[1+(1/99)]365/30 - 1.0} =
((1+(1/99))^(365/30)-1)
13.01%

Question: Suppose a supplier gave you terms of 3/

would you take the deal?
37.39% VS. 10.00%
STMENT BY TAKING THE DISCOUNT

1 - discount percent), with that quantity multiplied by 365

payment date minus the discount payment date.
ys reduces the cost on the invoice by 1%.

e savings each period, a geometric progression.

to each of the percentages before multiplying.
ng it. Then, subtract 1 to get the percentage.

n, the seller gets to use the buyer's $99.00 for 30 days (40-10).
eller is $1.00/$99.00 or 1.0101%. Otherwise, the buyer
y $100.00. But the seller (the supplier) wants the cash now.

standpoint: If the buyer could invest $100.00 at 1.0101%

buyer would have $101.01 at the end of that time.
ested at a rate of 1.0101% per 30-day period, that person
.0101 X 1.010101, or $102.03 at the end of 60 days.
of 90 days (3 periods) $102.03 X 1.0101 = $103.06,
went on for a year, 12.167 periods at 30 days per period,
have $113.01 at the end.

YER TAKE THE DISCOUNT?

ares the annual effective percentage rate (13.01%) with the cost of
m and selects the best deal.

+(1/99)]365/30 - 1.0} = 0.1301

(1/99))^(365/30)-1)

r gave you terms of 3/10, net 45. If you could get money at 10%
he deal?
10.00%
WHAT IS THE DIFFERENCE BETWEEN 2/10, NET 40 AND 2/10, NET 30
$100

2/10, net 40 2/10, net 30

Seller's offfer of 2% for every 30 days: Seller's offer of 2% for ever
Cumulative
Compound Buyer's
Periods Interest Reward Periods
1 2.04% $2.04 1
2 4.12% $4.12 2
3 6.25% $6.25 3
4 8.42% $8.42 4
5 10.63% $10.63 5
6 12.89% $12.89 6
7 15.19% $15.19 7
8 17.54% $17.54 8
9 19.94% $19.94 9
10 22.39% $22.39 10
11 24.89% $24.89 11
12.1667 27.86% $27.86 12
13
14
15
16
17
18.25
The formula: The formula:
{[1+(2/98)]365/30 - 1.0} = 0.2787 {(1+(2/98)}^365/20 - 1.0} =
27.86% 44.59%
AND 2/10, NET 30

10, net 30
ller's offer of 2% for every 20 days:
Cumulative
Compound Buyer's
Interest Reward
2.04% $2.04
4.12% $4.12
6.25% $6.25
8.42% $8.42
10.63% $10.63
12.89% $12.89
15.19% $15.19
17.54% $17.54
19.94% $19.94
22.39% $22.39
24.89% $24.89
27.43% $27.43
30.04% $30.04
32.69% $32.69
35.40% $35.40
38.16% $38.16
40.98% $40.98
44.59% $44.59
he formula:
1+(2/98)}^365/20 - 1.0} = .4459
THE FIVE C's OF CREDIT

Character

Capacity (Cash Flow)

Collateral

Covenants

Conditions (Economic conditions)

BREAKEVEN ANALYSIS

OR: AT WHAT POINT DO YOU BEGIN MAKING AN ACCOUNTING PRO

YOU MAKE A PROFIT WHEN YOUR SALES ARE ENOUGH TO COVER FI

VARIABLE COSTS

SO:
1. Fixed Costs / [1 - (Variable Costs / Sales)]
OR
2. Fixed Costs / [1 - (Variable Costs per Unit / Unit Price

EXAMPLE: Sales = $2,000.00

Units Sold 50
Price Per Unit $40.00
Fixed Costs = $1,000.00
Variable Costs = $400.00
Variable Cost Per Unit $8.00

Method 1: $1,250.00
Method 2: $1,250.00

Question: Your sales are $10 million. Half of that represents variab
fixed costs at $3.5 million.
What is your breakeven point in millions?
$7.00
CCOUNTING PROFIT?

GH TO COVER FIXED AND

Unit / Unit Price)]

presents variable costs with