1 / 54

Financial Statement Analysis / Entrepreneurial Finance

Financial Statement Analysis / Entrepreneurial Finance. Financial Analysis Overview. An assessment of a company’s past, present and future financial condition Purpose is to diagnose company’s financial strengths and weaknesses Primary tools Financial Statements Ratios. Financial Statements.

nelly
Download Presentation

Financial Statement Analysis / Entrepreneurial Finance

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Financial Statement Analysis / Entrepreneurial Finance

  2. Financial Analysis Overview • An assessment of a company’s past, present and future financial condition • Purpose is to diagnose company’s financial strengths and weaknesses • Primary tools • Financial Statements • Ratios

  3. Financial Statements

  4. Main Financial Statements • Balance Sheet • Income Statement • Statement of Cash Flows

  5. The Balance Sheet • The balance sheet shows a firm’s assets (what it owns) and liabilities (what it owes) • The difference between a firm’s assets and liabilities is the firm’s net worth • A snapshot in time

  6. Balance Sheet Items Assets • Current assets: • Cash & securities • Accounts Receivable • Inventories • Fixed assets: • Tangible assets like PPE • Intangible assets Liabilities and Equity • Current liabilities: • Accounts payable • Short-term debt • Long-term liabilities • Shareholders' equity

  7. Anheuser-Busch Example

  8. Income Statement • The income statement summarizes revenues and expenses for the business • Covers an interval of time (monthly, quarterly, annually) • Major components: • Revenues • Expenses • Taxes • Extraordinary Items

  9. Income Statement Format Sales revenue - Cost of goods sold = Gross profit margin - Operating expenses = EBITDA - Depreciation & Amortization = EBIT (Operating income) - Interest payments = Taxable income - Taxes = Net Income

  10. Anheuser-Busch Example

  11. Accounting vs. Economic Earnings • Accounting definition of earnings ignores unrealized changes in market value of assets and liabilities • Accounting profit does not recognize cost of equity capital • Accounting profit may not contain all relevant costs • e.g., opportunity cost of entrepreneur’s time

  12. Cash Flow Statement • Summarizes the levels of cash being generated or consumed by the business • Covers an interval of time (monthly, quarterly, annually)

  13. Cash Flow Statement Format Cash flow from operations Net income + Depreciation - Increase in accounts receivable - Increase in inventories + Increase in accounts payable Total cash flow from operations Cash flow from investing activities - Investment in plant and equipment Cash flow from financing activities - Dividends paid + Increase in short-term debt = Change in cash

  14. Anheuser-Busch Example

  15. Statement Connections • Excel example

  16. Ratio Analysis

  17. Why do ratio analysis? • A means of evaluating and diagnosing performance • Ratios standardize numbers and facilitate comparisons • Comparing performance to competitors or industry standards (horizontal comparison) • Comparing performance to prior history (vertical comparison) • Examine a variety of areas • Liquidity • Solvency • Efficiency • Profitability • Remember that ratios are meaningless unless you have something to compare

  18. Major Ratio Categories • Liquidity • ability to cover short-term obligations • Solvency • ability to cover long-term obligations; examines mix of debt and equity • Efficiency • amount of activity generated by resources deployed • Profitability • amount of profit generated by resources deployed • Market value (if applicable) • some of these ratios (e.g. price-earnings ratio, market-to-book ratio) are useful in valuation analysis, such as valuing private firms

  19. Liquidity Ratios • Current Ratio • The ratio between all current assets and all current liabilities. • Formula: •    Current Assets Current Liabilities • Quick Ratio • The ratio between all assets quickly convertible into cash (this excludes inventory) and all current liabilities. • Formula: • Cash + Accounts Receivable + Short-Term Investments       Current Liabilities

  20. Anheuser-Busch Example Current Ratio: 1829.5 / 2246.1 = 0.81 Quick Ratio: (219.2 + 720.1 + 195.2) / 2246.1 = 0.51

  21. Solvency Ratios • Debt to Equity • Shows the ratio between capital invested by the owners and the funds provided by lenders. • Formula: • Total Liabilities  Total Equity • Interest coverage ratio • A measurement of the number of times a company could make its interest payments with its earnings before interest and taxes; the lower the ratio, the higher the company’s debt burden. • Formula: • Pretax Operating Income + Interest Expense Interest Expense

  22. Anheuser-Busch Example Debt to Equity: (2246.1 + 1191.5 + 7653.5 + 1194.5 + 152.9) / 3938.7 = 3.16

  23. Anheuser-Busch Example Interest Coverage Ratio: (2719.6) / 451.3 = 6.03

  24. Profitability • Gross Profit Margin • Indicator of how much profit is earned on products without consideration of selling and administration costs. • Formula: • Sales - COGS Sales • Net Profit Margin / Return on Sales (ROS) • Shows how much profit comes from every dollar of sales. • Formula: • Net Income  Sales

  25. Anheuser-Busch Example Gross Profit Margin: 5552.1 / 15717.1 = 35.3% Net Profit Margin: 1965.2 / 15717.1 = 12.5%

  26. Profitability • Return on Equity (ROE) • Determines the rate of return on the investment in the business. • Formula: • Net Income Equity • Return on Assets (ROA) • Considered a measure of how effectively assets are used to generate a return. • Formula: •   Net Income     Total Assets • Return on Invested Capital (ROIC) • Formula: •    Net Income      Total Liabilities + Stockholder’s Equity – Current Liabilities

  27. Anheuser-Busch Example Return on Equity: 1965.2 / 3938.7 = 49.9% Info from income statement and balance sheet Return on Assets: 1965.2 / 16377.2 = 12.0% Info from income statement and balance sheet Return on Invested Capital: 1965.2 / (12438.5 + 3938.7 – 2246.1) = 13.9% Info from income statement and balance sheet

  28. Efficiency • Days in Receivables • This calculation shows the average number of days it takes to collect accounts receivable (number of days of sales in receivables). • Formula: • Accounts Receivable      Sales  /  365 days • Compare to industry standards. • Accounts Receivable Turnover • Number of times that trade receivables turnover during the year. • Formula: •   Net Sales           Accounts Receivable

  29. Efficiency • Days in Inventory • This calculation shows the average number of days it will take to sell inventory • Formula: • Average Inventory Cost of Goods Sold / 365 days • Inventory Turnover • Number of times that inventory is turned over (sold) during the year. • Formula: • Cost of Goods SoldAverage Inventory

  30. Efficiency • Asset Turnover • Indicates how efficiently business generates sales on each dollar of assets. • Formula: •      Sales        Total Assets • Days in Accounts Payable • This calculation shows the average length of time trade payables are outstanding before they are paid. • Formula: • Accounts Payable    COGS     /   365 days • Accounts Payable Turnover • The number of times trade payables turnover during the year. • Formula: •        COGS             Accounts Payable

  31. Anheuser-Busch Example Assigned Efficiency Ratios Some Additional Efficiency Ratios Days in Receivables: 720.20 / (15,717.1/365) = 16.73 AR Turnover: 15,717.1 / 720.20 = 21.8 Days in Inventory: (694.9 + 654.5)/2 / (10,165.0/365) = 24.23 Days in Accounts Payable: 1,426.3 / (10165.0/365) = 51.21 Accounts Payable Turnover: 10165.0 / 1,426.3 = 7.13 Inventory Turnover: 10,165.0 / (694.9 + 654.5)/2 = 15.07 Asset Turnover: 15,717.1 / 16377.2 = 0.96

  32. The DuPont Equation • ROE = (Net Income/Sales) x (Sales/Total Assets) x (Total Assets/Equity = profit margin x asset turnover x leverage multiplier • DuPont equation shows how three different areas combine to determine ROE • expense management (measured by the profit margin) • asset management (measured by asset turnover) • debt management (represented by the debt ratio or leverage multiplier)

  33. Using Ratio Analysis to Better Understand Profitability

  34. Seemingly Similar Companies Brinker International, Inc. NYSE: EAT Darden Restaurants, Inc. NYSE: DRI Outback Steakhouses, Inc. NASDAQ: OSI

  35. Seemingly Similar Performance Profitability Performance (Most Recent Year) • Net Margin • 4.63% • 5.04% • 6.50% • Return on Equity • 15.40% • 16.70% • 17.40% Source: Hoover’s Online

  36. Potential Paths to Performance • High Margins • High Efficiency • High Leverage

  37. Beginning the Investigation • Use company’s financial statements • Income Statement and Balance Sheet • Examine and compare common ratios • Across time • Across companies • Use three year period (2000 – 2002)

  38. Margin Performance

  39. Cost Efficiency Higher = better Lower = better

  40. Leverage Higher = more levered Lower = more levered

  41. Summary • Company A • High margins • Less efficient • Low leverage • Company B • Moderate margins • Moderate efficiency • High leverage • Company C • Low margins • High efficiency • Moderate leverage They run very similar businesses and deliver similar results, but the paths are very different.

  42. Questions to Consider • Company A • What value does it deliver to justify its higher margins? Are the margins sustainable? • Company B • Is a middle of the road strategy with higher leverage a good one? • Company C • What is the source of its operating efficiencies? Are the efficiencies sustainable?

  43. Who is Who? • A few additional clues • 2002 sales ($millions) • A: 2,362 • B: 4,369 • C: 2,887 • Sales growth (2002 – 2003) • A: 14.4% • B: 6.4% • C: 13.5%

  44. Using Financial in New Ventures

  45. How to use financial ratios in new ventures? • Remember, financial statements are pro-forma (expectations about what financial position will be) • Could use average industry ratios as a starting point for generating pro-forma statements • Pro-forma statements should reflect the underlying strategy of the firm

  46. Adjusting ratios according to your strategy

  47. Limitations of Ratios • They are outcome measures; if you have a problem with a ratio, you still have to figure out what’s causing the problem • Choosing the right comparison data is sometimes difficult • What’s the right industry? • Published industry averages are just rough guidelines • Who are the competitors? • Accounting practices can differ across firms • Seasonality may affect ratios • We have only discussed ratios generated from financial statements • These are based on historical data; we would like something that helps predict future performance • Operational / marketing measures may be more critical • Recall the Balanced Scorecard

  48. Other Values to Consider • SG&A to Sales • Is company controlling overhead expenses? • Direct labor utilization • Often critical in professional services companies • Customer acquisition cost • Compare to lifetime value of a customer • Others (company-specific) • Create a Balanced Scorecard

  49. The Balanced Scorecard Kaplan and Norton (1992)

  50. What is it? • A set of measures that gives top management a “fast but comprehensive view of the business” • Brings together, in one management report, disparate elements of company’s competitive agenda (customer measures, internal measures, financial measures, etc.) • Authors use analogy of dials and instruments in an airplane cockpit

More Related