Financial Ratio Analysis for Company Performance Evaluation, Slides of Finance

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FIN 254

Chapter 3

Financial Statement & Ratio

Analysis

Overview

1. Why Do We Analyze Financial Statements
2. Common Size Statements – Standardizing Financial Information
3. Using Financial Ratios
4. Selecting a Performance Benchmark
5. The Limitations of Ratio Analysis 2

Why Analyze Financial Statements?

 An internal financial analysis might be done:  To evaluate the performance of employees and determine their pay raises and bonuses.  To compare the financial performance of the firm’s different divisions.  To prepare financial projections, such as those associated with the launch of a new product.  To evaluate the firm’s financial performance in light of its competitors and determine how the firm might improve its operations.  A variety of firms and individuals that have an economic interest might also undertake an external financial analysis:  Banks and other lenders deciding whether to loan money to the firm.  Suppliers who are considering whether to grant credit to the firm.  Credit-rating agencies trying to determine the firm’s creditworthiness.  Professional analysts who work for investment companies considering investing in the firm or advising others about investing.  Individual investors deciding whether to invest in the firm. 4

The Annual Report

 A report issued annually by a corporation to its stockholders.  It contains basic financial statements as well as management’s analysis of the firm’s past operations and future prospects.

Balance Sheet

Balance Sheet

Balance Sheet  Debt or Liabilities: ◦ Long-term debt – Interest bearing. E.g.: bonds, loans ◦ Current debt – Non-interest bearing. E.g.: payables, accruals  Preferred Stock - Part of equity that is a hybrid of debt and common stock  Common Stock – Portions of ownership of a company  In the event of bankruptcy priority of payback are as follows: debt- preferred stocks-common stocks  Paid in Capital  Retained Earnings

Income Statement

Income at different stages  Depreciation : The charge to reflect the cost of assets used up in the production process. Depreciation is not a cash outflow.  Amortization : A noncash charge similar to depreciation except that it is used to write off the costs of intangible assets.  Since these are non-cash so Earnings Before Interest Tax Depreciation and Amortization (EBITDA) is also an important indicator of firm performance

Market Value VS Book Value  Book Values are the values of assets calculated using methods of GAAP and put in the balance sheet.  Market Values are the current price of an asset in the market if it were to put up for sale.

Statement of Cash flows

Statement of Cash Flows

 Operating Activities : Deals with items that occur as part of normal ongoing operation.  Investing Activities : Activities involving long-term assets.  Financing Activities : Activities involving long-term debt or equity financing.

Common Size Statements

 A common size financial statement is a standardized

version of a financial statement in which all entries are

presented in percentages.

 A common size financial statement helps to compare entries

in a firm’s financial statements, even if the firms are not of

equal size.

 How to prepare a common size financial statement?

 For a common size income statement, divide each entry in the income statement by the company’s sales.  For a common size balance sheet, divide each entry in the balance sheet by the firm’s total assets. 20