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Analysis of Financial Statements. Financial statements and reports Ratio analysis. The Annual Report Provides. A verbal description of the firms operating results during the past year Discussion of new developments Financial statements. Key Financial Statements. Balance sheet

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Analysis of financial statements
Analysis of Financial Statements

  • Financial statements and reports

  • Ratio analysis


The Annual Report Provides

  • A verbal description of the firms operating results during the past year

  • Discussion of new developments

  • Financial statements


Key financial statements
Key Financial Statements

  • Balance sheet

  • Income statement

  • Statement of cash flows


Example of balance sheets assets
Example of Balance Sheets: Assets

2011

Cash 9,000

Short-term inv. 48,600

Acct Receivable 351,200

Inventories 715,200

Total Current Asset 1,124,000

Gross Fixed Asset 491,000

Less: Depreciation146,200

Net Fixed Asset 344,800

Total assets 1,468,800


Example of Balance Sheets: Liabilities and Equity

2011

Accts payable

145,600

Notes payable

200,000

Accruals

136,000

Total Current Liability

481,600

Long-term debt

323,432

Common stock

460,000

Retained earnings

203,768

Total equity

663,768

Total liability and equity

1,468,800


Example of Income Statement

2011

Sales

3,432,000

COGS

2,864,000

Other expenses

340,000

Deprecication

18,900

3,222,900

Tot. operating. costs

EBIT

209,100

Interest expenses

62,500

EBT

146,600

Taxes (30%)

43,980

102,620

Net income


Ebitda earnings before interest taxes depreciation and amortization

Good to Know!!

EBITDA (Earnings before interest, taxes, depreciation and amortization

To measure cash earnings without accrual accounting, cancelling tax jurisdiction effects, and cancelling the effects of different capital structures.


Statement of cash flows
Statement of Cash Flows

  • The Statement of Cash Flows reports:

    • Operating activities

    • Investing activities

    • Financing activities


To determine whether a change in a balance sheet account by using these rules
To determine whether a change in a balance sheet account by using these rules

Uses of Cash

Decrease in a liabilities or equity account

- Paying off a loan or buying back stock uses cash

Increase in an asset account

- Buying fixed assets or buying more

inventory uses cash.

Sources of Cash

Increase in a liabilities or equity account

- Borrowing funds or selling stock provides the firm with cash

Decrease in an asset account

- Selling inventory or collecting receivables

provides cash


20 using these rules11 Statement of Cash Flows

Cash flow from operating activities:

Net income $ 44,220

Additions (sources of cash):

Depreciation 20,000

Incr. in accruals 4,000

Incr. in accounts payable 29,600

Subtractions (uses of cash):

Incr. in receivables (50,800)

Incr. in inventories ( 120,800)

NCF from operations ($ 73,780)


Cash flow from investing activities: using these rules

Investment in fixed assets ($ 36,000)

Increase in notes payable $ 25,000

Increase in L-T debt 101,180

Common dividends ( 22,000)

NCF from financing $104,180

Net increase (decr.) in cash ($ 5,600)

Cash at beginning of year 57,600

Cash at end of year $ 52,000

Cash flow from financing activities:


Management reports
Management Reports using these rules

  • Daily Revenue Report

  • Daily Payroll Cost Report

  • Rooms Revenue Forecast

  • Food and Beverage Menu Abstract

  • Accounts Receivable Aging Schedule


Daily revenue report
Daily Revenue Report using these rules


Daily payroll cost report
Daily Payroll Cost Report using these rules


Rooms revenue forecast
Rooms Revenue Forecast using these rules



Accounts receivable aging schedule
Accounts Receivable Aging Schedule using these rules

Aging Schedule for Hanover Country Club


Ratio Analysis Categories using these rules

  • Liquidity

  • Asset management

  • Debt management

  • Profitability

  • Market value



Measures of Liquidity obligations as they come due.

CA

CL

Current ratio = .

To indicate the extent to which the claims of S-T creditors are covered by assets that will soon be converted to cash


CA - Inv. obligations as they come due.

CL

To measure how quick the firm can pay off S-T debt without liquidating inventories

Quick ratio = .


CA obligations as they come due.

CL

Current ratio = .

CA - Inv.

CL

Quick ratio = .

2010

2011

Industry

Current

Quick

2.3x

0.8x

2.4x

0.8x

2.7x

1.0x

A little weaker than average.


Asset Management Ratios obligations as they come due.

  • Inventory turnover ratio

  • Days sales outstanding (accounts receivable)

  • Fixed assets turnover

  • Total assets turnover


Sales obligations as they come due.

Inventory

Inventory turnover = .

(To indicate whether a firm carries too many inventories and whether it manages inventories effectively.)

2010

4.8x

2011

4.6x

Industry

7.0x

Low inventory turnover--excess

inventory for current level of sales.


Problems with Inventory Turnover obligations as they come due.

Measurement

  • Sales prices include markups but inventories carried at cost.

  • Sales occur throughout the year, but inventory is at a particular point in time.

  • Differences in accounting methods may make comparisons difficult (e.g. LIFO vs. FIFO).


Days Sales Outstanding obligations as they come due.(DSO) is the average number of days the firm must wait after making a sale before it receives cash.

Receivables

.

DSO =

Sales/day


$402,000 obligations as they come due.

2011 DSO =

$3,850,000/360

= 37.59 days.


20 obligations as they come due.10

2011

Industry

DSO

36.8

37.6

32.0

High DSO--firm is collecting too slowly or has overly liberal credit terms.


Sales obligations as they come due.

Fixed assets turnover = .

Fixed assets

[ To show how effective the firms utilizes its fixed assets to generate sales.]

Sales

Total assets turnover = .

TA

[To indicate the extent to which a firm uses its total resources to generate sales.]


20 obligations as they come due.10

2011

Industry

FATO

TATO

10.0

2.3

10.7

2.3

10.7

2.6

Fixed assets turnover OK, but total

assets turnover is low--indicates

problem with current assets (inventory and receivables).


Debt Management Ratios obligations as they come due.

  • Debt ratio (balance sheet)

  • Debt/equity ratio (balance sheet)

  • Times interest earned (income statement)

  • Fixed charge coverage (income statement)


Debt Management Ratios obligations as they come due.

D

D

Debt ratio = = .

A

D + E

[It measures the proportion of a firm’s total assets that is financed with creditors’ funds.]

D

Debt/equity = .

E

[It is similar to debt ratio and relates the amount of a firm’s debt financing to the amount of equity financing.]


and Equity multiplier = A/E obligations as they come due.

= 1/(1 - D/A).

Times interest earned (TIE)

EBIT

Interest

charges

= .

[It tells the extent to which the firm’s current earnings are able to meet current interest payments.]


20 obligations as they come due.10

Industry

2011

DR

TIE

54.8%

3.3

58.4%

2.0

50.0%

2.5

Debt ratio high, TIE low and falling.

Debt is risky; would have high kd.


Profitability ratios
Profitability Ratios obligations as they come due.

  • Profit margin (PM)

  • Basic earning power (BEP)

  • Return on assets (ROA)

  • Return on equity (ROE)

  • Return on investors capital (ROC)


NI obligations as they come due.

PM = .

Sales

[ It gives the profit per dollar of sales.]

2011

1.1%

2010

2.6%

Industry

3.5%

Indicates: Sales prices are low and/or

costs are high.


EBIT obligations as they come due.

BEP = .

TA

[It shows the raw earning power of the firm’s assets, before influence of taxes and leverage. ]

2010

14.2%

2011

9.1%

Industry

19.1%

Indicates: Firm is doing a poor job of

generating earnings from its assets.


NI obligations as they come due.

NI

ROA = .

ROE = .

Common

equity

TA

[It measures a firm’s net income in relation to the total asset investment.]

[It measures the rate of return that the firm earns on stockholders’ equity.]


Profitability Ratios Summary obligations as they come due.

2011

2010

Industry

ROA

ROE

6.0%

13.3%

2.7%

6.4%

9.1%

18.2%

All profitability measures are low and falling.

High inventory, A/R levels lead to low profits.


Market Value Ratios obligations as they come due.

Price/Share

P/E = .

Earnings/Share

[The price the market places on $1 of a firm’s earnings.]

Common equity

Book value/Share = .

# Shares

Price/Share

Market/Book = .

Book value/Share

[The higher the rate of return a firm is earning on its common equity relative to the return required by investors (the cost of common equity), the higher will be the M/B.]


20 obligations as they come due.11

Industry

2010

P/E

M/B

9.7%

1.3

13.6%

0.9

14.2%

1.4

P/E ratios can rise if a decline in EPS is not expected to be permanent.

M/B ratio is low. “Normalized” P/E probably low too.


NI obligations as they come due.

E

NI

S

S

TA

TA

E

= x x .

Use the Du Pont Equation to get an overview of the firm’s financial position

Profit

margin

Total asset

turnover

Equity

multiplier

ROE = x x


Du Pont Equation Provides an Overview obligations as they come due.

  • Profitability measured by ROE

  • Expense control measured by PM

  • Asset utilization measured by TATO

  • Financial leverage measured by EM (debt utilization)

  • The interaction between the determinants of ROE


ROE obligations as they come due. = PM x TATO x EM

13.30% 2.60 2.3 2.2

6.40% 1.15 2.3 2.4

18.20% 3.50 2.6 2.0

2010

2011

IND.


What is common size analysis? obligations as they come due.

  • Converting income statement and balance sheet values into % to facilitate comparison between firms of different sizes and firms over time.

    • Income statement: Divide by sales.

    • Balance sheet: Divide by total assets.

  • Used to supplement ratio analysis.


Readers of financial analysis
Readers of Financial Analysis obligations as they come due.


Readers of financial analysis cont
Readers of Financial Analysis cont. obligations as they come due.


Types of analysis
Types of Analysis obligations as they come due.

  • Vertical Analysis

    • Used to analyze variable expenses

    • All accounts are sized using either:

      • Total revenue or

      • Departmental revenue

    • Variable expenses should increase or decrease with the level of sales


Management decision making
Management Decision Making obligations as they come due.

  • Employee Scheduling

    • Based on:

      • Accurate revenue forecasts

      • Productivity goals

      • Customer service goals


Management decision making1
Management Decision Making obligations as they come due.

  • Food and Beverage Pricing

    • Track sales of each menu item

    • Calculate each items gross profitability

    • Set menu prices

    • Remove unprofitable items from the menu


Management decision making2
Management Decision Making obligations as they come due.

  • Revenue Management

    • Goal is to maximize RevPAR

  • RevPar= Rooms Revenue/Rooms Available

    • Rooms revenue = the revenue generated by room sales

    • Rooms Available= the number of rooms available for sale in the time period


Management decision making3
Management Decision Making obligations as they come due.

  • Revenue Management

    • Strategies

      • Close lower levels of pricing during high demand

      • Open all pricing levels during times of low demand


Management decision making4
Management Decision Making obligations as they come due.

  • Profit Flexing

    • Utilized when revenues fall behind budget

    • Adjust pricing and reduce expenses

      • Without impacting customer service

    • Maximize remaining revenue opportunities


Management decision making5
Management Decision Making obligations as they come due.

  • Cost-volume-profit Modeling

    • Also known as Breakeven Analysis

    • Target the amount of revenue required to reach the owner’s goal


Cost volume profit equations
Cost-volume-profit Equations obligations as they come due.


Breakeven volume example
Breakeven Volume Example obligations as they come due.

  • Sale price = $250 a night

  • Fixed costs = $40,000 per month

  • Variable cost = $35 per room


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