December 1, 2015

1. December 1, 2015 Financial Statement Analysis

2. Financial Statement Analysis Horizontal Analysis (or Trend Analysis) Dollar and Percentage Changes Vertical Analysis Common Sized Statements Ratio Analysis Today’s Agenda

3. Be sure to recognize differences in accounting methods before coming to conclusions; ie, compare “like to like” Are costs skewed towards COGS? Inventory valuation Depreciation policy This information will be seen in the Notes to FS Need to look beyond the numbers Economic conditions Industry trends, consumer tastes Technical changes, changes within the company Cautions

4. Statements in Comparative and Common-Size Form • Dollar and percentage • changes on statements An item on a financial statement has little meaning by itself. The meaning of the numbers can be enhanced by drawing comparisons. • Common-size • statements • Ratios

5. Dollar and Percentage Changes on Statements Horizontal analysis (or trend analysis) shows the changes between years in the financial data in both dollar and percentage form.

6. Horizontal Analysis – Balance Sheet

7. Horizontal Analysis Calculating Change in Dollar Amounts Dollar Change Current Year Figure Base Year Figure = – The dollar amounts for last year become the “base” year figures.

8. Horizontal Analysis Calculating Change as a Percentage Percentage Change Dollar Change Base Year Figure × 100% =

9. Horizontal Analysis – Conclusions & Recommendations? • What happened to the company’s cash? • Prepaid expenses up 150%? Are you concerned?

10. Horizontal Analysis – Income Statement

11. Conclusions & Recommendations? • Comment on performance on Quon Corp. • What’s happens to gross margins? (Vertical Analysis)

12. Trend Percentage Current Year Amount Base Year Amount × 100% = Trend Analysis

13. Trend Percentages Use trend percentages to construct a graph so we can see the trend over time.

14. Trend Percentages and CAGR • Trend Percentages • Current year as a percentage of a base year • Is not comparable over different time periods • Y6 / Y1 *100 =(200/100 – 1) *100 = 100% • Cumulative Annual Growth Rated (CAGR) • Annualizes trends • (((Y6 /Y1) ^1/Years) -1) *100 = • = (((200/100)^1/5)-1) *100 = 14.9% • What was the CAGR on your case study company?

15. Common Sized Statements help analyze individual components within a statement On the Balance Sheet Express as % of assets On the Income Statement Express as a % of Sales Common-Size Statements (Vertical Analysis)

16. Common-Size Statements • Common Size Statements can be especially useful in comparing different companies

17. Common-Size Statements – Income Statement

18. Common-Size Statements What conclusions can we draw? • Impact on value of the Quon Corp? • Who’s compensation should be impacted?

19. Ratios are prepared for different audiences Shareholders Creditors Short term Long term Management Ratio Analysis

20. For Shareholders Earnings Per Share Price to Earnings Ratio Dividend Payout Ratio Dividend Yield Ratio Return on Assets Return on Equity Financial Leverage Net Book Value Per Share Ratio Analysis

21. Net Income – Preferred Dividends Average Number of Common Shares Outstanding Earnings per Share = Earnings Per Share Whenever a ratio divides an income statement balance by a balance sheet balance, the average for the year is used in the denominator. • EPS represents the owner of a single share’s portion of the company’s earnings

22. Price-Earnings Ratio Market Price Per Share Earnings Per Share = Price-Earnings Ratio • The higher the PE ratio is, the more the market is willing to pay for a share • This means the market believes the company will grew at a faster rate than a company with a lower PE ratio • Usually Tech companies have higher PEs than Utilities • PE ratios of your Case Study companies?

23. Dividend Payout Ratio Dividends Per Share Earnings Per Share = Dividend Payout Ratio This ratio gauges the portion of current earnings being paid out in dividends. Investors seeking current income would like this ratio to be large.

24. Dividend Yield Ratio Dividends per Share Market Price per Share = Dividend Yield Ratio This ratio identifies the return, in terms of cash dividends, on the current market price of the stock. • A focus of “Yield” investors • Typically more conservative • Seeking stable income • Would also invest in Fixed Income (bonds) and Prefs

25. Return on Total Assets Net Income + [Interest Expense × (1 – Tax Rate)] Average Total Assets = Return on Total Assets This ratio measures how well assets have been employed. • Return on Assets is adjusted for interest as it is a measure of return for ALL stakeholders, including debt holders. • It allows for comparison to companies with differing leverage profiles (proportion of debt to equity).

26. Return on Common Stockholders’ Equity Net Income – Preferred Dividends AverageStockholders’ Equity = Return on Common Stockholders’ Equity This measure indicates how well the company employed the owners’ investments to earn income.

27. Financial leverageinvolves acquiring assets with funds at a fixed rate of interest. Fixed rate of return on borrowed funds Return on investment in assets Positive financial leverage > = Fixed rate of return on borrowed funds Return on investment in assets Negative financial leverage < = Financial Leverage

28. Book Value per Share Common Stockholders’ Equity Number of Common Shares Outstanding = Book Value Per Share This ratio measures the amount that would be distributed to holders of each share of common stock if all assets were sold at their balance sheet carrying amounts and if all creditors were paid off. • Note: Net Book Value will almost always differ from Fair Market Value • Lower of cost or market principle helps here; conservative • Case Study examples?

29. For Management Working Capital Current Ratio Quick Ratio (Acid Test) AR Turnover AR Collection Period (Days Receivable) Inventory Turnover Days Inventory Days Payable Ratio Analysis

30. The current ratio measures a company’s short-term debt paying ability. Current Ratio Current Assets Current Liabilities = Current Ratio

31. Acid-Test Ratio Quick Assets Current Liabilities = Acid-Test (Quick) Ratio Quick assets include Cash, Marketable Securities, Accounts Receivable and current Notes Receivable. The quick ratio measures a company’s ability to meet obligations without having to liquidate inventory.

32. Accounts Receivable Turnover Sales on Account AverageAccounts Receivable = Accounts Receivable Turnover This ratio measures how many times a company converts its receivables into cash each year.

33. Average Collection Period 365 Days Accounts Receivable Turnover = Average Collection Period (Days AR) This ratio measures, on average, how many days it takes to collect an account receivable.

34. Inventory Turnover Cost of Goods Sold Average Inventory = Inventory Turnover This ratio measures how many times a company’s inventory has been sold and replaced during the year.

35. Average Sale Period 365 Days Inventory Turnover = Average Sale Period (Days Inventory) This ratio measures how many days, on average, it takes to sell the inventory.

36. For Creditors Times Interest Debt to Equity Ratio Ratio Analysis

37. Times Interest Earned = EBIT Interest Expense Times Interest Earned Ratio (Interest Coverage) The times interest earned ratio is the most common measure of a company’s ability to protect its long-term creditors.

38. This ratio indicates the relative proportions of debt to equity on a company’s balance sheet. Debt to– Equity Ratio Total Liabilities Stockholders’ Equity = Debt-to-Equity Ratio

39. Published Sources That Provide Comparative Ratio Data

40. Financial Statement Analysis Horizontal Analysis (or Trend Analysis) Dollar and Percentage Changes Vertical Analysis Common Sized Statements Ratio Analysis Today’s Agenda

41. Tutorial • CASE STUDIES DUE DURING TUTORIAL • Q & A re Case Study presentations