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Chapter 4

Using Financial Statements


for Investing and Credit
Decisions

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Financial Performance Decisions
Credit-granting decisions
Involve judgment about a firms ability to make
timely payments towards
Existing debt
Pending credit obligations
Investment decisions
Involve determining an appropriate intrinsic
value for a security based on a firms ability to
generate future payoffs that exceed the
resources used to generate those payoffs
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Trend Analysis on the Income Statement
Examining a firms financial statement to
observe any trends in account balances
Sometimes called longitudinal analysis or
ocular regression
Examine key performance indicators such as
Revenue
Income from operations
Net income
Watch for one time charges



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Avis Budget Groups Income Statement Trends
Trend Analysis
Operating revenues
and expenses
decreased
proportionately,
while one-time
charges decreased
significantly
causing a decrease
in net loss.
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Avis Budget Group, Inc. (in $millions) Year Ending Dec. 31
Consolidated Statements of Operations 2009 2008
Revenues
$5,131 $5,984
Expenses
Operating expenses
2,636 3,147
Depreciation and lease charges, net
1,521 1,785
Selling, general and administrative
551 655
Interest expense
447 450
Restructuring charges
20 28
Impairment
33 1,262
Total expenses
5,208 7,327
Loss before income taxes
(77) (1,343)
Benefit from income taxes
(30) (219)
Net income (loss)
$ (47) $ (1,124)
Trend Analysis on the Balance Sheet
Examine key performance indicators
Total assets
Property, plant, and equipment
Current portion of long-term debt
Long-term debt
Debt compared to equity
Capital intensive business
Requires a large investment in property, plant, and
equipment and/or intangible assets
Impaired assets are written down with a loss
reported on the income statement
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Avis Budget Groups Balance Sheet Trends
Trend Analysis
Though current
assets increased, a
large decrease in
plant assets
caused total assets
to decline. Both
current debt and
long-term debt
increased.
Shareholders
equity also
increased.
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Assets December 31
Current Assets 2009 2008
Cash And Cash Equivalents $ 482 $ 258
Net Receivables 290 360
Other Current Assets 958 455
Total Current Assets 1,730 1,073
Long Term Investments 398 650
Property Plant and Equipment 6,409 7,649
Intangible Assets 554 542
Other Assets 1,002 1,404
Total Assets $10,093 $11,318
Liabilities
Current Liabilities
Accounts Payable $ 1,272 $ 901
Short/Current Long Term Debt 12 10
Total Current Liabilities 1,284 911
Long Term Debt 2,833 2,671
Other Liabilities 5,754 7,643
Total Liabilities 9,871 11,225
Stockholders' Equity
Common Stock 9,099 9,198
Retained Earnings (2,691) (2,644)
Treasury Stock (6,149) (6,267)
Other Stockholders Equity (37) (194)
Total Stockholders Equity 222 93
Total liabilities & Stockholders' Equity $10,093 $11,318
(in $millions)
Trend Analysis on the Statement of Cash Flow
Key performance indicators
Primary source of cash for the period should
be from operating cash flow
Net increase in cash from all activities for
the period
Discretionary cash flow availability
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Avis Budget Groups Cash Flow Trends
Avis Budget Group, Inc. Year Ending Dec. 31
Consolidated Statements of Cash Flows 2009 2008
Cash Flows From Operating Activities
Net Income ($ 47) ($1,124)
Depreciation 1,487 1,727
Adjustments To Net Income (27) 1,021
Changes In Accounts Receivables 52 50
Changes In Liabilities (9) (33)
Changes In Other Operating Activities 35 63
Net Cash Flow from Operating Activities 1,491 1,704
Cash Flows From Investing Activities
Capital Expenditures (6,814) (8,691)
Other Cash flows from Investing Activities 6,980 6,595
Net Cash Flows From(for) Investing Activities 166 (2,096)
Cash Flows From Financing Activities
Sale/ Purchase of Stock - (33)
Net Borrowings (1,393) 558
Other Cash Flows from Financing Activities (72) (62)
Net Cash Flows from(for) Financing Activities (1,465) 463
Effect Of Exchange Rate Changes 32 (27)
Change In Cash and Cash Equivalents $ 224 $ 44
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(in $millions)
Although less than
prior year, the
company had a
positive cash flow
from operating
activities. Cash flow
from investing
activities increased
dramatically from
prior year. These
cash flows were
used to pay off debt
in the current year.
Common-Size Financial Statements
A widely used technique for analyzing financial
performance
Allows the financial statement user to readily
compare
Different size firms or
Performance of the same firm that changes size
over time
All income statement items are expressed as a
percentage of net revenues
All balance sheet items are expressed as a
percentage of total assets

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Revenue, Returns, and Discounts
Gross revenue
Sales Discounts
Sales Returns
= Net revenue



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Sales Discounts
Price reductions that are incentives for quick
payment
Sales returns
The value of goods allowed to be returned
by customers who are dissatisfied with a
product
Avis Budget Groups
Common-Size Income Statement
Avis Budget Group, Inc. Year Ending Dec. 31
Consolidated Statements of Operations 2009 2008
Revenues 100.0% 100.0%
Expenses:
Operating expenses 51.4% 52.6%
Depreciation and lease charges, net 29.7% 29.8%
Selling, general and administrative 10.7% 10.9%
Interest expense 8.7% 7.5%
Restructuring charges 0.4% 0.5%
Goodwill impairment 0.6% 21.1%
Total expenses 101.5% 122.4%
Loss before income taxes -1.5% -22.4%
Benefit from income taxes 0.6% 3.6%
Net income (loss) -0.9% -18.8%
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Selling, general
and
administrative
expense declined,
but the non-
recurring items
caused the most
impact on the
substantial
change in net loss
for the year.
Avis Budget Groups Common-Size Balance Sheet
Assets Year Ending Dec. 31
Current Assets 2009 2008
Cash And Cash Equivalents 4.8% 2.3%
Net Receivables 2.9% 3.2%
Other Current Assets 9.5% 4.0%
Total Current Assets 17.2% 9.5%
Long Term Investments 3.9% 5.7%
Property Plant and Equipment 63.5% 67.6%
Intangible Assets 5.5% 4.8%
Other Assets 9.9% 12.4%
Total Assets 100.0% 100.0%
Liabilities
Current Liabilities
Accounts Payable 12.6% 8.0%
Short/Current Long Term Debt 0.1% 0.1%
Total Current Liabilities 12.7% 8.1%
Long Term Debt 28.1% 23.6%
Other Liabilities 57.0% 67.5%
Total Liabilities 97.8% 99.2%
Stockholders' Equity
Common Stock 90.2% 81.3%
Retained Earnings -26.7% -23.4%
Treasury Stock -60.9% -55.4%
Other Stockholder Equity -0.4% -1.7%
Total Stockholder Equity 2.2% 0.8%
Total liabilities & Stockholders' Equity 100.0% 100.0%
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While cash and other
current assets
increased significantly,
PP&E and other non-
current assets
decreased.
Accounts payable and
debt increased while
other liabilities
increased. The equity
accounts increased as
a percentage of total
assets.
Key Financial Ratios
Ratios have no generally accepted definitions
Variations often based on personal preference
Key issue is to use consistent components
Enhance comparability
Global application of ratios
Executed exactly the same worldwide
Some ratios are not relevant in all countries
Such as countries without credit systems

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How Well is Google, Inc. Doing?
December 31 2012 2011
Assets
Current Assets
Cash and cash equivalents $14,778 $9,983
Short term investments 33,310 34,643
Net receivables 9,729 6,387
Inventory 505 35
Other current assets 2,132 1,710
Total Current Assets 60,454 52,758
Long term investments 1,469 790
Property, plant and equipment 11,854 9,603
Intangible assets 18,010 8,924
Other long term assets 2,011 499
Total Assets $93,798 $72,574
Liabilities
Current Liabilities
Accounts payable $ 10,893 $7,148
Current portion of long-term debt 2,549 1,218
Other current liabilities 895 547
Total Current Liabilities 14,337 8,913
Long-term debt 2,988 2,986
Other long-term liabilities 4,758 2,530
Total Liabilities 22,083 14,429
Stockholders' Equity
Common stock 23,373 20,540
Retained earnings 48,342 37,605
Total Stockholders' Equity 71,715 58,145
Total Liabilities & Stockholders'
Equity
$93,798 $72,574
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Years Ending December 31 2012 2011
Total Revenue $50.175 $37,905
Cost of Revenue 20,634 13,188
Gross Profit 29,541 24,717
Operating Expenses
Research Development 6,793 5,162
Selling General and Administrative 9,988 7,813
Total Operating Expenses 16,781 12,975
Income from Continuing Operations 12,760 11,742
Total Other Income /(Expense) 710 642
Earnings Before Interest and Taxes 13,470 12,384
Interest Expense 84 58
Income Before Tax 13,386 12,326
Income Tax Expense 2,598 2,589
Income from continuing operations 10,788 9,737
Discontinued operation (51)
Net Income $10,737 $9,737
Years Ending December 31 2012 2011
Operating Activities
Net Income $ 10,737 $ 9,737
Adjustments To Net Income 5,882 4,828
Net Cash Flow From Operating Activities 16,619 14,565
Investing Activities
Capital Expenditures (3,273) (3,438)
Investments 785 (13,703)
Other Cash flows from Investing Activities (10,568) (1,900)
Net Cash Flow From Investing Activities (13,056) (19,041)
Financing Activities
Net borrowings 1,328 726
Other Cash Flows from Financing Activities (99) 81
Net Cash Flow From Financing Activities 1,229 807
Effect of Exchange Rate Changes 3 22
Change In Cash and Cash Equivalents $ 4,795 $(3,647)
Using ratios to analyze
financial data is helpful.
All numbers in millions
Analyzing Profitability
Refers to how much income was generated by
a business
Particularly relative to the amount of total assets
invested
Key ratios
Return on shareholders equity (ROE)
Return on assets (ROA)
Return on sales (ROS)
Gross profit margin ratio
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Profitability Analysis
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Return on
Shareholders
Equity
Net Income Preferred Stock Dividends
Shareholders Equity
=
Indicates the rate of return generated by a business
for its common shareholders.
Google, Inc. 2012:
$9,737 $0
$58,145
= 16.7%
$10,737 $0
$71,715
= 15.0%
Google, Inc. 2011:
Google generated an decrease in its return on equity, an
unfavorable change.
Profitability Analysis
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Return on
Assets
Net Income + Interest Expense (1- Tax rate)
Total Assets
=
Indicates the rate of return generated on a
companys investment in assets from all sources.
Google, Inc. 2012:
$10,737 + $84(1 0.190*)
$93,798
= 11.5%
Google, Inc. 2011:
Google generated 11.5 cents of profit for every dollar
invested in assets in 2012, an unfavorable change from
2011.
*2012 tax rate = $2,598/$13,689= 19.0%
2011 tax rate = $2,589/$12,326 = 21.0%
$9,737 + $58(1 0.210*)
$72,574
= 13.5%
Profitability Analysis
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Return on
Sales
Net Income
Net Sales
=
Indicates the percentage of net income remaining
from a dollar of sales after subtracting all expenses.
Google, Inc. 2012:
$9,737
$37,905
= 25.7%
$10,737
$50,175
= 21.4%
Google, Inc. 2011:
Google generated 21.4 cents of profit per dollar of sales
in 2012 compared to 25.7 cents in 2011.
Profitability Analysis
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Gross Profit
Margin Ratio
Net Sales Cost of Goods Sold
Net Sales
=
Indicates the percentage of income generated from
sales after deducting the cost of goods sold.
Google, Inc. 2012:
$50,175 $20,634
$50,175
= 58.9%
Google, Inc. 2011:
Google generated 58.9 cents of gross profits from each
sales dollar in 2012 compared to 65.2 cents in 2011.
$37,905 $13,188
$37,908
= 65.2%
Analysis of Asset Management
Refers to how well management uses a
companys assets to generate profits
Common ratios used to calculate
Receivable turnover
Receivable collection period
Inventory turnover
Inventory-on-hand period
Asset turnover
Desired effects
Collect receivables as quickly as possible
Sell inventory as quickly as possible
Generate large amounts of sales using assets
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Asset Management
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Receivable
Turnover
Net Sales
Accounts Receivable
=
Indicates the number of sales/collection cycles
experienced by a firm.
Google, Inc. 2012:
$50,175
$9,729
= 5.16 times
Google, Inc. 2011:
Googles sales/collections cycles numbered 5.16 in 2012,
down from 5.94 times in 2011.
$37,905
$6,387
= 5.94 times
Asset Management
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Receivable
Collection
Period
365
Net Sales / Accounts Receivable
=
Indicates the number of days required, on average,
to collect an outstanding account receivable
Google, Inc. 2012:
365
$50,175 / $9,729
= 70.8 days
Google, Inc. 2011:
Google required 70.8 days on average to collect an
outstanding receivable in 2012, an unfavorable increase
from 61.5 days in 2011.
365
$37,905 / $6,387
= 61.5 days
Asset Management
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Inventory
Turnover
Cost of Goods Sold
Inventory
=
Indicates the number of production/sales cycles
experienced by a firm
Googles inventory turnover numbered 40.9 in 2012, down from 376.8
times in 2011. These numbers are not really relevant since Google
maintains so small a level of inventory.
Google, Inc. 2012:
20,634
$505
= 40.9 days
Google, Inc. 2011:
13,188
$35
= 376.8 days
Asset Management
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Inventory-on-
Hand Period
365
Cost of Goods Sold / Inventory
=
Indicates the number of days, on average, required
to sell the inventory currently on hand
Google required 8.9 days on average to sell its inventory in 2012, an
unfavorable increase from 1.0 days in 2011, however these numbers
are not really relevant since Google maintains so small a level of
inventory.
.
Google, Inc. 2012:
365
$20,634 / $505
= 8.9 days
Google, Inc. 2011:
365
$13,188 / $35
= 1.0 days
Asset Management
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Asset
Turnover
Net Sales
Total Assets
=
Amount of sales generated from each dollar invested
in assets.
Google, Inc. 2012:
$50,175
$93,798
= 0.54
Google, Inc. 2011:
Every dollar invested in Googles assets generated $0.54
of sales revenue during 2012, up from $0.52 in 2011.
$37,905
$72,574
= 0.52
Analysis of Liquidity
Refers to the amount of liquid resources
available to pay current obligations as they
come due
Common liquidity measures
Cash and marketable securities to total assets
Quick ratio
Current ratio
Accounts payable turnover
Days payable period
Goal is to maintain an adequate but not
excessive liquidity
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Liquidity
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Cash and Marketable
Securities to Total
Assets
Cash + Marketable Securities
Total Assets
=
Percentage of total assets held as highly liquid assets.
Google, Inc. 2012:
$14,778 + $33,310
$93,798
= 0.51
Google, Inc. 2011:
About half of Googles assets are highly liquid at the end
of 2012, down from 62% at the end of 2011.
$9,983 + $34,643
$72,574
= 0.62
Liquidity
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Quick Ratio
Cash + Marketable Securities
+ Accounts Receivable
Current Liabilities
=
Amount of liquid assets available to pay short-term
liabilities.
Google, Inc. 2012:
$14,778 + $33,310 + $9,729
$14,337
= 4.0
Google, Inc. 2011:
Googles liquid assets are 4.0 times as large its current
obligations at the end of 2012, down from 5.7 at the end of
2011, indicating lower, but still high liquidity.
$9,983 + $34,643 + $6,387
$8,913
= 5.7
Liquidity
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Current
Ratio
Current Assets
Current Liabilities
=
Amount of current assets available to service
current liabilities.
Google, Inc. 2012:
$60,454
$14,337
= 4.2
Google, Inc. 2011:
Googles current assets are 4.2 times as large as its
current obligations at the end of 2012, down from 5.9 at
the end of 2011, indicating lower, but still high liquidity.
$52,758
$8,913
= 5.9
Liquidity
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Accounts
Payable
Turnover
Cost of Goods Sold
Accounts Payable
=
Number of account payable cycles experienced by
a firm.
Google, Inc. 2012:
$20,634
$10,893
= 1.9 times
Google, Inc. 2011:
Googles experienced 1.9 payment cycles in 2012, a slight
increase from 1.8 during 2011.
$13,188
$7,148
= 1.8 times
Liquidity
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Days Payable
Period
365
Cost of Goods Sold Accounts Payable
=
Number of days, on average, required to pay an
outstanding account payable.
Google, Inc. 2012:
365
$20,634 $10,893
= 192.7 days
Google, Inc. 2011:
On average, it took Google 192.7 days to pay an
outstanding account payable during 2012, a little quicker
than the 197.8 days during 2011.
365
$13,188 $7,148
= 197.8 days
Credit Risk Analysis
What are creditors concerned about?
Downside risk
The risk of not getting paid interest and principal
Common measures
Long-term debt to total assets
Long-term debt to shareholders equity
Interest coverage ratio


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Solvency
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Long-term
Debt to Total
Assets Ratio
Long-term Debt +
Current Portion of Long-Term Debt
Total Assets
=
Percentage of total assets provided by creditors.
Google, Inc. 2012:
$2,988 + $2,549
$93,798
= 5.9%
Google, Inc. 2011:
Google financed 5.9% of its assets with debt as of the end
of 2012 up slightly from 5.8% at the end of 2011, but still a
very low debt financing amount.
$2,986 + $1,218
$72,574
= 5.8%
Solvency
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Long-term Debt
to Shareholders
Equity Ratio
Long-term Debt +
Current Portion of Long-Term Debt
Shareholders Equity
=
Relative investment of long-term creditors versus
shareholders in a business.
Google, Inc. 2012:
$2,988 + $2,549
$71,715
= 7.7%
Google, Inc. 2011:
Googles debt-to-equity ratio is 7.7% in 2012, up slightly
from 7.2% in 2011, but still very low.
$2,986 + $1,218
$58,145
= 7.2%
Solvency
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Interest
Coverage
Ratio
Net Income Before Taxes + Interest Expense
Interest Expense
=
Extent to which current operating income covers
current debt service charges.
Google had relatively no interest expense in 2012 or 2011, so
this ratio is not really relevant.
Google, Inc. 2012:
Google, Inc. 2011:
$13,386 + $84
$84
$12,326 + $58
$58
=
=
160.4
213.5
Off-Balance Sheet Liabilities
Liabilities not reported on the balance sheet
Such as operating leases
Exist due to certain complex accounting
standards
Can be found in notes to financial statements
Investors must exercise due diligence
i.e. read the entire set of financial statements
including notes

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Benchmarking
What is benchmarking?
Comparing with similar companies
Also known as cross-sectional analysis
Ratios of companies in the same industry are
compared
North American Industry Classification System
A system for classifying companies into common
industry groups
Makes it easy for companies to benchmark against
their competitors
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ROE Model Framework
Used to evaluate a firms overall enterprise
performance
Shows that a business can increase its overall
performance by increasing any of the following
ratios:


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Return on Equity
(ROE)
Return on
Sales (ROS)
Asset Turnover
(AT)
Financial
Leverage (LEV)
ROE Analysis of Google, Inc.
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The decrease in ROE was due to an decrease in ROS to
21.4% in 2012 down from 25.7% in 2011.
Google, Inc. 2012 2011
Total revenues $50,175 $37,905
Net income

10,737
9,737
Total assets 93,798 72,574
Shareholders' equity 71,715 58,145
ROE Analysis
ROE = Net income Shareholders' Equity 15.0%* 16.7%
ROS = Net income Revenues 21.4% 25.7%
AT = Revenues Total Assets 0.54 0.52
LEV = Total Assets Shareholders' Equity 1.31 1.25
* Difference due to rounding
Financial Statement Analysis Limitations
Measurement concerns
Market value can be subjective
Historical cost is reliable, but not current
Incomplete data
Some assets and liability values are omitted from
the balance sheet due to conservatism, such as
Trained workforces
Management talent
Internal processes
Brand recognition

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Thank you & Feel Free to
Call me anytime at:
607 759-0918
END OF CHAPTER 4