Analysis of financial statements
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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

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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

  • Income statement

  • Statement of cash flows


Example of Balance Sheets: Assets

2011

Cash9,000

Short-term inv.48,600

Acct Receivable351,200

Inventories715,200

Total Current Asset1,124,000

Gross Fixed Asset491,000

Less: Depreciation146,200

Net Fixed Asset344,800

Total assets1,468,800


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


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

  • 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

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


2011 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:

Investment in fixed assets($ 36,000)

Increase in notes payable$ 25,000

Increase in L-T debt101,180

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

  • Daily Revenue Report

  • Daily Payroll Cost Report

  • Rooms Revenue Forecast

  • Food and Beverage Menu Abstract

  • Accounts Receivable Aging Schedule


Daily Revenue Report


Daily Payroll Cost Report


Rooms Revenue Forecast


Food and Beverage Menu Abstract


Accounts Receivable Aging Schedule

Aging Schedule for Hanover Country Club


Ratio Analysis Categories

  • Liquidity

  • Asset management

  • Debt management

  • Profitability

  • Market value


  • Liquidity = the ability of a firm to meet its short-term obligations as they come due.

  • Liquidity analysis requires use of a forecasted cash budget but ratio analysis provides some quick measures of liquidity.


Measures of Liquidity

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.

CL

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

Quick ratio = .


CA

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

  • Inventory turnover ratio

  • Days sales outstanding (accounts receivable)

  • Fixed assets turnover

  • Total assets turnover


Sales

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

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 (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

2011 DSO =

$3,850,000/360

= 37.59 days.


2010

2011

Industry

DSO

36.8

37.6

32.0

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


Sales

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.]


2010

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

  • Debt ratio (balance sheet)

  • Debt/equity ratio (balance sheet)

  • Times interest earned (income statement)

  • Fixed charge coverage (income statement)


Debt Management Ratios

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

= 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.]


2010

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

  • Profit margin (PM)

  • Basic earning power (BEP)

  • Return on assets (ROA)

  • Return on equity (ROE)

  • Return on investors capital (ROC)


NI

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

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

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

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

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.]


2011

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

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

  • 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 = 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?

  • 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 cont.


Types of Analysis

  • 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

  • Employee Scheduling

    • Based on:

      • Accurate revenue forecasts

      • Productivity goals

      • Customer service goals


Management Decision Making

  • 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 Making

  • 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 Making

  • Revenue Management

    • Strategies

      • Close lower levels of pricing during high demand

      • Open all pricing levels during times of low demand


Management Decision Making

  • Profit Flexing

    • Utilized when revenues fall behind budget

    • Adjust pricing and reduce expenses

      • Without impacting customer service

    • Maximize remaining revenue opportunities


Management Decision Making

  • 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


Breakeven Volume Example

  • Sale price = $250 a night

  • Fixed costs = $40,000 per month

  • Variable cost = $35 per room


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