Business Analysis and Valuation

Business Analysis and Valuation
Financial
Statement
Analysis
Prof. Arturo Capasso

capassoa@luiss.it
Agenda
• Financial analysis: aims and tools
• Review of Financial Statements
• Financial Analysis: Case
• Conclusive remarks
2
Aims
• Assess the firm’s financial performances: …past,
present and future;
• Evaluate earnings in terms of: size, persistence,
quality and growth;
• Estimate firm’s solvency;
• Identify firm’s financial strengths and
weaknesses (potential risks)
3
Tools
The commonly used tools for financial
statement analysis are:
• Comparative financial statements analysis:
– Horizontal analysis/Trend analysis
– Vertical analysis/Common size analysis/
Component Percentages
• Financial Ratio Analysis
4
Sources of Data
• Insider (definitely the most reliable!)
• Annual reports
– Via company websites, SEC, Public exchange sites,
or Published collections of data: Dun and
Bradstreet , Robert Morris, BVDEP ….
• Google Finance, Yahoo Finance or other
investment sites:
• http://moneycentral.msn.com/investor
• http://www.marketguide.com
• http://www.damodaranonline.com
Essential financial structure
A D
E
A=D+E
One of the few certainties in the unpredictable business world!
The accounting perspective
(historical values)
Investments
(Expense list)
A=D+E
The economic perspective
(market value)
Contractually
defined cash-flows
Enterprise
Value
Residual cash-flows
A=D+E
The corporate governance
perspective
No control
rights
Investment &
Strategy
Decisions
Control rights
A=D+E
Value creation
Debt
Debt
Enterprise market Enterprise book
(market) value book value value
value
Equity Equity
market book
value value
Accounting vs Market
Value creation and value destruction
Value destruction
Value creation
Bankruptcy
Some consideration on real data
Data in USD billions – 2013
Cash &
Asset Debt Equity Mkt Cap EV Eq.
EXXON 347,0 173,0 174,0 439,0 612,0 5,0
142,4 63,5 78,9 289,4 352,9 83,7
18,0 2,5 15,5 139,0 141,5 11,5
207,0 83,5 123,5 504,5 588,0 40,5
110,9 23,6 87,3 377,3 400,9 58,7

Business Essentials
There are two key factors for business survival:
• Profitability
• Solvency
A D Solvency
E Profitability
13
Business Essentials
• Profitability is important because it measures
the capacity of the business to generate
revenue (income) in excess of the expenses
incurred in operating that business.
• The solvency of a business is important
because it looks at the ability of the business
in meeting its financial obligations.
14
Business Essentials
• Profitability is important because it measures
the capacity of the business to generate
revenue (income) in excess of the expenses
incurred in operating that business.
• The solvency of a business is important
because it looks at the ability of the business
in meeting its financial obligations.
15
Financial statements
• Balance Sheet
• Income Statement
• Cash-flow Statement
• Statement of Retained Earnings
16
Review: Major Balance Sheet Items
Assets Liabilities and Equity

• Current assets: • Current liabilities:
– Cash & securities – Payables
– Receivables – Short-term debt
– Inventories • Long-term liabilities
• Fixed assets: • Shareholders' equity
– Tangible assets
– Intangible assets
17
Review: Major Income Statement Items
• Sales - Costs of Goods = Gross Profit

• Gross Profit - Cash Operating Expenses = EBITDA
• EBITDA - Depreciation – Amortization = EBIT
• EBIT - Interest = EBT
• EBT- Taxes = Net Income (NI) or Earnings After Taxes (EAT)
Net Income is a primary determinant of the firm’s cash-flows

and, thus, the value of the firm’s shares
18
From Net Income to FCFF
• Free cash flow to the firm is:
FCFF = Net income available to common shareholders

Plus: Net Non-Cash Charges
Plus: Interest Expense times (1 – Tax rate)
Less: Investment in Fixed Capital
Less: Investment in Working Capital

From FCFF to FCFE
FCFE = Free cash flow to the firm

Less: Interest Expense * (1 – tax rate)
Plus: Net Borrowing
Or
FCFE = FCFF – Int * (1 – Tax rate) + Net borrowing

Financial Statement Information
Used extensively by internal users
– Management at various levels

Performance evaluation
Competitive analysis
Investment decisions
Valuation of targets
– Current and future employees
Is this firm going to meet its payroll and will
the stock options be worth anything?
21
Financial Statement Information
Used primarily by external users
– Financial intermediaries (analysts)

Stock recommendations
– Lenders
Loan decisions
Monitoring
– Investment bankers
Valuation for M&A and IPO
Top management performance evaluation
22
Financial Statement Analysis
come up with solutions/recommendations
Financial statement analysis and business

analysis applications
• Focus is more than a mechanical analysis of
financial statements.
• Draw heavily on your understanding of finance,
economics, marketing, and strategy.
• Combine that understanding with financial
statement information to diagnose problems and
point out solutions
23
Financial statement analysis
Financial Statement Analysis helps business
shareholders and stakeholders to analyse the
data in financial statements, in order to provide
them with better information about such key
factors for decision making and ultimate
business survival.
24
Methods of
• Horizontal (Trend) Analysis
• Vertical Analysis
• Ratio Analysis
Horizontal/Trend Analysis
Using comparative financial

statements to calculate dollar
or percentage changes in a
financial statement item from
one period to the others
Horizontal/Trend Analysis
Show changes over time in
given financial statement items
(can help evaluate financial
information of several years)
Vertical Analysis
For a single financial
statement, each item
is expressed as a
percentage of a
significant total,
e.g., all income
statement items are
expressed as a
percentage of sales
Vertical analysis is the tecnique used to display
the data in the excercise «Ratios tell a story»
Ratio Analysis
Expression of logical relationships
between items in a financial
statement of a single period
(e.g., percentage relationship
between revenue and net income)
Horizontal analysis/Trend analysis
• Trend percentage
• Line-by-line item analysis
• Items are expressed as a percentage of a base
year
• This is a time series analysis
• For example, a line item could look at
increase in sales turnover over a period of 5
years to identify what the growth in sales is
over this period.
30
Horizontal Analysis Example
MEF CORPORATION
Comparative Income Statements
For the Years Ended December 31, 2013 and 2012
Increase (Decrease)
2013 2012 Amount %
Net sales $ 520.000 $ 480.000 $ 40.000 8,3
Cost of goods sold 360.000 315.000 45.000 14,3
Gross margin 160.000 165.000 (5.000) (3,0)
Operating expenses 128.600 126.000 2.600 2,1
Net operating income 31.400 39.000 (7.600) (19,5)
Interest expense 6.400 7.000 (600) (8,6)
Net income before taxes 25.000 32.000 (7.000) (21,9)
Less income taxes (30%) 7.500 9.600 (2.100) (21,9)
Net income $ 17.500 $ 22.400 $ (4.900) (21,9)
Horizontal Analysis Example
MEF CORPORATION
Comparative Income Statements
For the Years Ended December 31, 2013 and 2012
Increase (Decrease)
2013 2012 Amount %
Net sales $ 520.000 $ 480.000 $ 40.000 8,3
Gross margin 160.000 165.000 (5.000) (3,0)
Sales increased by6.400
Interest expense 8.3% while net
7.000 (600) (8,6)
income decreased
Less income taxes (30%)
by
7.500
21.9%.9.600 (2.100) (21,9)
Net income $ 17.500 $ 22.400 $ (4.900) (21,9)
There were increases in both cost of goods
sold (14.3%) and operating expenses (2.1%).
These increased costs more than offset the
MEF
increase in sales, yielding an
Comparative overall
Income Statements
decreaseFor
in the
netYears
income.
Ended December 31, 2013 and 2012
Increase (Decrease)
2013 2012 Amount %
Net sales $ 520.000 $ 480.000 $ 40.000 8,3
Gross margin 160.000 165.000 (5.000) (3,0)
Interest expense 6.400 7.000 (600) (8,6)
Less income taxes (30%) 7.500 9.600 (2.100) (21,9)
Net income $ 17.500 $ 22.400 $ (4.900) (21,9)
Trend Percentages Example
Hohestaufen Inc. provides you with the following operating data
Hohestaufen Inc.
Operating Data
2013 2012 2011 2010 2009
Revenues $ 2.405 $ 2.244 $ 2.112 $ 1.991 $ 1.820
Expenses 2.033 1.966 1.870 1.803 1.701
Net income $ 372 $ 278 $ 242 $ 188 $ 119
Hohestaufen Inc. provides you with the following operating data
Hohestaufen Inc.
Operating Data
2013 2012 2011 2010 2009
Revenues $ 2.405 $ 2.244 $ 2.112 $ 1.991 $ 1.820
Expenses 2.033 1.966 1.870 1.803 1.701
Net income $ 372 $ 278 $ 242 $ 188 $ 119
$1,991 - $1,820 = $171

$171 ÷ $1,820 = 9% rounded
Using 2009 as the base year, we develop the
following percentage relationships.
Hohestaufen Inc.
Operating Data
2013 2012 2011 2010 2009
Revenues 132% 123% 116% 109% 100%
Expenses 120% 116% 110% 106% 100%
Net income 313% 234% 203% 158% 100%
Vertical analysis/Common size analysis/
Component Percentages
• All items are expressed as a percentage of a
common base item within a financial
statement
– e.g. Financial Performance – sales is the base
– e.g. Financial Position – total assets is the base
• Important analysis for comparative purposes
– Over time and
– For different sized enterprises
37
Vertical Analysis Example
Sample Company
Balance Sheet (Assets)
At December 31, 2013 and 2012
% of Total Assets
2013 2012 2013 2012
Cash $ 82.000 $ 30.000 17% 8%
Accts. Rec. 120.000 100.000 25% 26%
Inventory 87.000 82.000 18% 21%
Land 101.000 90.000 21% 23%
Equipment 110.000 100.000 23% 26%
Accum. Depr. (17.000) (15.000) -4% -4%
Total $ 483.000 $ 387.000 100% 100%
Sample Company
% of Total Assets
2013 2012 2013 2012
Cash $ 82.000 $ 30.000 17% 8%
Accts. Rec. 120.000 100.000 25% 26%
Inventory 87.000 = 17%
$82,000 ÷ $483,000 82.000
rounded18% 21%
Land 101.000 90.000
$30,000 ÷ $387,000 = 8% rounded 21% 23%
Equipment 110.000 100.000 23% 26%
Accum. Depr. (17.000) (15.000) -4% -4%
Total $ 483.000 $ 387.000 100% 100%
Sample Company
% of Total Assets
2013 2012 2013 2012
Acts. Payable $ 76.000 $ 60.000 16% 16%
Wages Payable 33.000 17.000 7% 4%
$76,000
Notes Payable÷ $483,000 = 16% 50.000
50.000 rounded 10% 13%
Common Stock
$60,000 ÷ $387,000 rounded 35%
= 16%160.000
170.000 41%
Retained Earnings 154.000 100.000 32% 26%
Total $ 483.000 $ 387.000 100% 100%
Financial ratio analysis
• Financial ratio analysis involves calculating and
analysing ratios that use data from one, two or
more reports.
• Ratio analysis also expresses relationships
between different financial statements in terms
of:
• Intra-company basis (within the company itself)
• Intercompany basis (between companies)
• Industry Averages (against that particular
industry’s averages)
41
Financial ratio analysis
Financial Ratios can be classified into five
main categories:
• Liquidity or Short-Term Solvency ratios
• Financial Structure or Capitalisation Ratios
• Asset Management or Activity Ratios
• Profitability Ratios
• Valuation Ratios
42
Liquidity ratios
Short-term funds management
• Working capital management is important as it signals
the firm’s ability to meet short term debt obligations.
For example: Current ratio

• The ideal benchmark for the current ratio is 2:1 where
there are two euro of current assets (CA) to cover 1
euro of current liabilities (CL). The acceptable
benchmark is 1:1 but a ratio below 1CA:1CL represents
liquidity riskiness as there is insufficient current assets
to cover 1 of current liabilities.
43
Liquidity ratios
• Working Capital = Current assets – Current Liabilities
• Current Ratio = Current Assets

Current Liabilities
• Quick Ratio = Current Assets – Inventory
Current Liabilities
• Cash Ratio = Cash & Equivalents
Current Liabilities
44
Financial leverage ratios
Long term funds management
• Measures the riskiness of business in terms of
leverage.
For example: Debt/Equity

• This ratio measures the relationship between debt and
equity. A ratio of 1 indicates that debt and equity
funding are equal (i.e. there is €1 of debt to €1 of
equity) whereas a ratio of 1.5 indicates that there is
higher debt gearing in the business (i.e. there is €1.5
of debt to €1 of equity). This higher debt gearing is
usually interpreted as bringing in more financial risk
for the business particularly if the business has
profitability or cash flow problems. 45
Financial leverarge ratios
• Debt/Equity ratio = Debt / Equity
• Debt/Total Assets ratio = Debt *100

Total Assets
• Equity ratio = Equity *100

Total Assets
• Times Interest Earned = Earnings before Interest and Tax

Interest
46
Activity ratios
• Efficiency of asset usage
– How well assets are used to generate revenues
(income) will impact on the overall profitability of
the business.
For example: Asset Turnover
• This ratio represents the efficiency of asset

usage to generate sales revenue
47
Activity Ratios
• Asset Turnover = Net Sales
Average Total Assets
• Debtors turnover = Net Credit Sales
Average Account Receivables
• Inventory Turnover = Cost of Goods Sold
Average Ending Inventory
Average Collection Period = Average acc. receivable
Avg daily net credit sales*
* Average daily net credit sales = net credit sales / 365 48

Profitability ratios
Key elements of the profitability analysis:
• Analysing on sales and trading margin
– focus on gross profit
• Analysing on the control of expenses
– focus on net profit
• Assessing the return on assets and return on
equity
– focus on profitability
49
Profitability Ratios
Margins
• Gross Profit % = EBIT______* 100

Net Sales
• Net Profit % = Net Profit after tax * 100
Net Sales
Or in some cases, firms use the net profit before tax
figure because they do not have over tax expense the
same control they have over other expenses.
Net Profit % = Net Profit before tax *100
Net Sales
50
Returns
• Return on Equity = Net Profit *100

Average Total Equity
• Return on Assets = Net Profit * 100

Average Total Assets
• RONA = Net Profit * 100
Avg Total Net Assets
51
Returns
• ROCE = Net Profit * 100
Avg Capital Employed
• ROCE (AT)= NOPAT *100

Average Total Equity
52
Profitability ratio
N
L L L
F
T D T D T
P
A A A
- - -
WCA WCL WCA WCA E
E
E L
53
Balance sheet restatement
Long term Financial Debt

assets
Working capital
liabilities
Working capital
assets
Equity
Cash & equivalents

Long term Net

assets financial
position
NWC
Equity
LTA FD
60
50
WCL
WCA 40
100 Equity
60
C&E10
TOTAL ASSETS = 160

LTA NFP
50
50
NWC
60 Equity
60
CAPITAL EMPLOYED = 110

Balance sheet / P&L restatement
LTA E E E
B
FD T
WCA I
T F
C&E WCL
Balance sheet / P&L restatement
LTA E E E
B
T
NWC NFP I
T F
Long Term Assets 46,7

Cash and equivalents 83,7
Other Current Assets 23,2
Total Assets 153,5
Current Liabilities 33,7

Long term debt 34,7
Equity 85,1
Total Liabilities 153,5

Cash and equivalents 83,7
Other Current Assets 23,2
Total Assets 153,5
Operating Income 26,5
CurrentROA = 26,5/153,5 = 17,3%
Liabilities 33,7
Long term debt 34,7
Equity 85,1

NWC -10,6
Capital Employed 36,1
NFP -49,0
Equity 85,1
Operating Income 26,5
ROCE = 26,5/36,5 = 72,6%
Market Efficiency and the Role of
Implications of stock market efficiency:
• Many profit-maximizing, actively competing traders
• Information almost freely available to all participants
• Competition means that the full effects of new
information
• Stock prices rapidly adjust to new information such
that the new price promises only a normal rate of
return to an investor
• If markets are efficient, then what’s the use of
“Fundamental Analysis” and Valuation?
63
Market Efficiency and the Role of
Conflicting evidence on market efficiency
– Markets are Efficient:
Market’s reaction to news events is instantaneous.
Mutual funds have on average been unable to outperform
broad indexes; in fact, generally under-performed.
Why publish “secrets” instead of making money yourself?.
– Markets are Inefficient:
Growing evidence of “easy ways” to beat market.
Greater acceptance of “Behavioral Explanations” for stock
market fluctuations.
64
Market Efficiency: Considerations
• Do not be dogmatic about efficiency.
– Let the evidence accumulate and speak for itself.
– Then you can decide.
• On the other hand, financial (stock) markets are very
competitive.
– It is not easy to make money above the expected rate for
return for a given level of (beta) risk.
– Trading strategies are not free of risk (Long Term Capital).
Regardless of your trustworthiness, knowing

state-of-the-art techniques will certainly help
get you a great job! 65
An example
• Walker Ltd, New Zealand, is a diversified company

with its main interests in the manufacturing and
retailing of plastic products.
• The financial statements of Walker Ltd need to be
analysed.
• An investor is considering purchasing shares in the
company.
• Relevant ratios need to be selected and calculated and
a report needs to be written for the investor. The
report should evaluate the company’s performance
and position
66
2005 2006 Horizontal
Analysis
$000 $000 $000 $000
Current Assets
Bank 33.5 41.0
Accounts receivable 240.8 210.2
Inventory 300.0 370.8
574.3 622.0 108
Non-current assets
Fixtures & fittings (net) 64.6 63.2
Land & buildings (net) 381.2 376.2
445.8 439.4 99
Total assets 1,020.1 1,061.4 104
Current Liabilities
Accounts payable 261.6 288.8
Income tax 60.2 76.0
321.8 364.8 113
Non-current liabilities
Loan 200.0 60.0 30
Shareholders Funds
Paid-up ordinary capital 300.0 334.1
Retained profit 198.3 302.5
498.3 636.6 128
Total liabilities & equity 1,020.1 1,061.4 104 67
2005 2006 Horizontal
Analysis
$000 $000 $000 $000
Sales 2,240.8 2,681.2 120
Less Cost of goods sold 1,745.4 2,072.0 119
Gross profit 495.4 609.2 123
Wages & salaries 185.8 275.6
Rates 12.2 12.4
Heat & light 8.4 13.6
Insurance 4.6 7.0
Interest expense 24.0 6.2
Postage & telephone 9.0 16.4
Depreciation -
Buildings 5.0 5.0
Fixtures & fittings 27.0 276.0 32.8 369.0 134
Net profit before tax 219.4 240.2 109

Less Income tax 60.2 76.0 126
Net profit after tax 159.2 164.2 103
68
2005 2006
$000 $000 $000 $000
Cash flow from operations
Receipts from customers 2,281 2,711.8
Payments to suppliers & employees (2,050) (2,460.4)
Interest paid (24) (6.2)
Tax paid (46.4) (60.2)
Net cash flow from operating activities 160.6 185
Investing activities
Purchase of non-current assets (121.2) (31.4)
Net cash used in investing activities (121.2) (31.4)
Financing activities
Dividends paid (32.0) (40.2)
Issue of ordinary shares 20.0 34.1
Repayment of loan capital -__ (140.0)
Net cash outflow from financing activities (12) (146.1)
Increase in cash & cash equivalents 27.4 7.5
69
Additional information
• Credit purchases for the year 2006 were €2,142,800.
• General prospects for the major industries in which Walker is
involved look good with a forecast glut of oil set to reduce the
cost of production and world demand for plastic remaining
strong.
Benchmarks:
• There are no exact benchmarks for Walker Ltd because it is a
diversified company. The following are average indicators that
relate to the plastic retailing and manufacturing industries for
the year 2006.
– Gross profit margin 25%
– Net profit margin 7%
– Inventory turnover 6 times
– Debt/equity ratio 0.6 : 1
– Return on Assets 12%
– Return on Equity 20%
70
Relevant ratios: profitability
Important note: The calculations of the ratios in this illustration did not use “averages” for total assets, equity and
inventory. The 2005 and 2006 year end figures were used and this is a slight variation to the formulas provided.
Profitability Benchmarks 2005 2006

ratios:
Gross Profit Industry 22% 22.7%

Margin 25%
Net Profit Industry 7.1% 6.1%

Margin 7%
Return on 12% 15.6% 15.5%

Assets
Return on Industry 32% 26%

Equity 20%
71
Additional information
Asset Benchmarks 2005 2006

Management
ratios:
Inventory Industry 5.8 times 5.58 times
Turnover 6%
Asset Turnover Not given 2.2 2.53
72
Relevant ratios: solvency
Liquidity Benchmarks 2005 2006
ratios:
Current Ratio Ideal standard 1.78:1 1.70:1
2:1
Acceptable
standard
1:1
Quick Ratio Ideal standard 0.85:1 0.69:1
2:1
Acceptable
standard
1:1
Days Payable Standard Credit 49.19 days
30 days purchases not
available
73
Relevant ratios: solvency
Financial Benchmarks 2005 2006
Structure
ratios:
Debt/Equity Industry 1.05: 1 0.67:1
0.6:1
Standard
benchmark
1:1
TIE Standard 10.14 times 39.74 times
benchmark:
Between 3 and 5.
Below 3 risky.
Above 5 very
favourable
74
The DuPont System
2005 2006
SALES 2.240,80 2.681,20
EBIT 243,40 246,40
NET INC. 159,20 164,20
TOT. ASSETS 1.020,10 1.061,40
ROA 0,16 0,15
ROA * 0,24 0,23
ROS 0,11 0,09
AT 2,20 2,53
ROS * AT 0,24 0,23
75
Report
• For the investor considering the purchase of shares in the
company, the return they will earn is the key financial factor
but an overall evaluation of the company’s performance and
position is also important to get a better picture of how well
the company is actually doing.
• ROE in 2006 is 26%. Whether or not this is attractive depends
on the perceived riskiness of this investment and other
alternatives available but this return is certainly more
attractive than current bank interest rates.
• ROE has decreased by 4% but the company’s ROE at 26% is
still better than the industry average of 20%
• Riskiness of business is being reduced by the significant
repayment of loan in 2006.
76
• Profitability
– The NP% and ROA ratios show a small downward trend in
% over the 2 year period. ROE% ratio show a more
significant decrease but is still better than the industry
average.
– Gross Profit Margin is slightly unfavourable at about 2.3%
below the industry benchmark of 25%.
– The horizontal analysis information show that Sales have
increased by 20%. However operating costs have increased
by 34%.
• Asset Management
– IT has gone down slightly from 5.8 to 5.58 times.
– IT is still close to the industry benchmark of 6 times.
– AT has increased showing more sales being generated from
asset usage
77
• Liquidity
– Current ratios of 1.78:1 (2005) and 1.70: 1 are at above
acceptable levels but below ideal level.
– Quick ratios appear more of a concern being below
acceptable levels in both years and even more so in 2006
(0.69:1).
– Raises some concerns over the liquidity of the business
and inventory management (although IT ratio only shows a
slight decline in 2006).
– Days Payable is a concern as there may be poor debt
payment management.
78
• Financial Structure
– Although slightly higher than D/E industry benchmark
(0.67:1), business has become less risky due to the
significant repayment of loan in 2006.
– TIE is extremely good for the business at 39.74 times (well
above 5 the standard benchmark).
• Cash flow situation

– Strong cash flow from operating activities (increased from
160,600 to 185,000).
– Spending under investing activities suggest more growth.
– Repayment of debt under financing activities imply
restructuring of business to have more equity funding
rather than debt funding.
79
Recommendation
Given:
1) the strong forecast for the industry (ie general
prospects looking good and world demand for
plastic products remaining strong),
2) the sales growth in this business,
3) acceptable ratios as they are quite close to the
industry averages,
4) good cash flows from operating activities and
5) favorable ROE, although it has decreased, it is still
better than the industry average ROE.
=> it is recommended that the investor purchase

shares in the Walker Ltd company.
80
Limitations of financial statement analysis
Believe it or not…
accounting data
are all but Gospel!
But in many
cases they’re the
best starting point
we have….
We must be careful with financial statement analysis.
Strong financial statement analysis does not necessarily

mean that the organisation has a strong financial future.
Financial statement analysis might look good but there

may be other factors that can cause an organisation to
collapse.
82
• 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/Cyclicality affects ratios
83
Ratios and Forecasting
• Common stock valuation based on
– Expected cashflows to stockholders
– ROE and r 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
84
Assignment: Analyst Reports
Student teams (up to 4 students) will be

responsible for creating and presenting a
financial statement analysis on a company of
their choice.
Due date: tbd

85
Prep for next classes
1) Prepare “Ratios tell a story”

2) Make sure to download material from the website
3) Collect handouts
4) Form teams for the analyst project (max 6 people)
5) Submit the names of your team members to me by
email
86

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Prof. Arturo Capasso

EXXON 347,0 173,0 174,0 439,0 612,0 5,0

142,4 63,5 78,9 289,4 352,9 83,7

18,0 2,5 15,5 139,0 141,5 11,5

207,0 83,5 123,5 504,5 588,0 40,5

110,9 23,6 87,3 377,3 400,9 58,7

Assets Liabilities and Equity

• Sales - Costs of Goods = Gross Profit

Net Income is a primary determinant of the firm’s cash-flows

FCFF = Net income available to common shareholders

Plus: Interest Expense times (1 – Tax rate)

Less: Investment in Fixed Capital

Less: Investment in Working Capital

FCFE = Free cash flow to the firm

FCFE = FCFF – Int * (1 – Tax rate) + Net borrowing

– Management at various levels

– Financial intermediaries (analysts)

Financial statement analysis and business

Using comparative financial

$1,991 - $1,820 = $171

For example: Current ratio

• Current Ratio = Current Assets

For example: Debt/Equity

• Debt/Total Assets ratio = Debt *100

• Equity ratio = Equity *100

• Times Interest Earned = Earnings before Interest and Tax

For example: Asset Turnover

• This ratio represents the efficiency of asset

* Average daily net credit sales = net credit sales / 365 48

• Gross Profit % = EBIT______* 100

• Return on Equity = Net Profit *100

• Return on Assets = Net Profit * 100

• ROCE (AT)= NOPAT *100

Long term Financial Debt

Cash & equivalents

Long term Net

TOTAL ASSETS = 160

CAPITAL EMPLOYED = 110

Long Term Assets 46,7

Current Liabilities 33,7

Long Term Assets 46,7

Long Term Assets 46,7

Regardless of your trustworthiness, knowing

• Walker Ltd, New Zealand, is a diversified company

Net profit before tax 219.4 240.2 109

Profitability Benchmarks 2005 2006

Gross Profit Industry 22% 22.7%

Net Profit Industry 7.1% 6.1%

Return on 12% 15.6% 15.5%

Return on Industry 32% 26%

Asset Benchmarks 2005 2006

Asset Turnover Not given 2.2 2.53

• Cash flow situation

=> it is recommended that the investor purchase

We must be careful with financial statement analysis.

Strong financial statement analysis does not necessarily

Financial statement analysis might look good but there

• 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