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ACCY 291 Financial Statement Analysis Steps in Financial Analysis Steps in comprehensive financial analysis 1. BUSINESS STRATEGY Analysis 2. ACCOUNTING Analysis 3. FINANCIAL Analysis 4. PROSPECTIVE Analysis Business Strategy Industry analysis and Competitive strategy analysis

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slide1

ACCY 291

Financial Statement Analysis

Steps in Financial Analysis

steps in comprehensive financial analysis
Steps in comprehensive financial analysis

1. BUSINESS STRATEGY Analysis

2. ACCOUNTING Analysis

3. FINANCIAL Analysis

4. PROSPECTIVE Analysis

slide3

Business Strategy

Industry analysis and

Competitive strategy analysis

Understand the business and the firm.

Accounting

Evaluate

accounting &

financial reporting quality.

Financial

Evaluate

past performance.

Prospective

Make forecasts and

Value business.

slide4
BUSINESS STRATEGY Analysis

An effort to learn about the company’s product, strategy, and operating environment.

    • A qualitative analysis of profit drivers, profit potentials, and the associated risk.
    • SWOT analysis can be useful
  • Know the Industry
  • Know the key players (leaders, followers, newcomers)
  • What is the source of competitive advantage/weakness?
  • What are Goals, Strategies, and Implementation history?
    • Where does the firm want to go?
    • Is the goal achievable?
    • Does the firm have a good track record?
slide5
FINANCIAL Analysis

Quantitative evaluation of past performance,

Assessment of the status quo that is informative of the future.

PROSPECTIVE Analysis

Forecast of future financial statements.

Equity valuation.

What is involved is an empirical analysiswhere, we

  • Make informed guesses based on past data.
  • Simplify complex numbers into simpler key parameters.
slide6
ACCOUNTING Analysis

Background

  • We use “Accrual Accounting” vs. ______ accounting.
    • What is an “accrual”?
    • Key features?
    • Outcome?

Accrual accounting system leads to…

  • Manager’s accounting and financial reporting discretion.
  • Manager’s financial reporting strategy.
    • Release of voluntary information
    • Timing of the release of information
slide7

ACCY 291

Financial Statement Analysis

Financial Analysis

Preliminaries

overview of a firm from financial analysis standpoint
Overview of a Firmfrom Financial Analysis standpoint

i-freedebt

i-bearing debt

Assets

OE

Financing

Investment

Payoffs to the “capital providers”

(Measure of “Profit” for the “enterprise”)

Managers’ task?

Investment

Operating

Financing

Accounting

payoffs to the capital providers
Payoffs to the capital providers

i-free debt

i-bearing debt

Assets

OE

Payoffs to the “capital providers”

Measured in accounting numbers is typically called

____________________

Measured in cash is typically called

____________________

nopat and free cash flow
NOPAT and Free Cash Flow
  • NOPAT (Net Operating Profit After Tax)

= Accounting profits for both debtholders and shareholders

= All sales, minus expenses payable to all parties except debtholders and shareholders.

Since debtholders and shareholders are combined into one class, this measure cannot be influenced by capital structure.

  • Free Cash Flow (FCF)

= Cash flows for both debtholders and shareholders

= All cash inflows, minus cash outflows to all parties except debtholders and shareholders.

day to day performance goals
Day-to-Day Performance Goals

i-free debt

  • Managers’ objective (in finance theory)?

Maximize ________________The market value of the enterprise is considered to be ____________________.

  • Practical period-by-period Performance Goals(Typically relevant in conventional Ratio analysis)Maximize _____________While Minimizing____________ “Other things equal”
  • Together, they implyMaximizing___________

i-bearing debt

Assets

OE

a thought
A Thought

If the firm’s value is present value of future free cash flows, then why do we bother with NOPAT in measuring the firm’s performance in any period?

properties of nopat net operating profit after tax
Properties of NOPAT(Net Operating Profit After Tax)

What is NOPAT?

How different from net income?

nopat
NOPAT
  • is after tax income that would have been obtained regardless of its capital structure
  • Revenue 1000
  • CGS (500)
  • other S&A expense (150)
  • depreciation (50)
  • Interest expense (100)
  • Pretax income 200
  • tax expense (40%) (80)
  • Net income 120
  • NOPAT can be computed either as
  • EBIT(1- )
  • net income + interest expense (1- )
  • NOPAT
  • if interest expense is 200, not 100?
  • NOPAT
  • if interest expense is 0, not 100?
properties of nopat
Properties of NOPAT
  • Combined income payable to both the debt holders and the shareholders (the two are often called “capital providers”)
  • Cannot be affected by the amount of borrowing or borrowing rate.
  • Further caveats:
    • Definition of NOPAT can be different for different people.
    • NOPAT cannot be pulled out from income statement. It needs to be computed.
    • NI= (EBIT- Interest expense)*(1-t)
    • EBIT *(1- t) = Net Income + Interest expense*(1- t)
ebit and nopat definition for our discussions
EBIT and NOPATDefinition for our discussions

Financial

assets

______ Income

i-free debt

?_____

i-bearing debt

Operating

assets

OE

______ Income

Assets

Some authors define NOPAT as one excluding interest income.

income statements of cvs walgreens
Income statements of CVS & Walgreens

NOPAT? ______________ using reported tax rate

NOPAT? ______________ using “normal” tax rate