Financial-Accounting-An-Integrated-Approach-6th--chapter-15-ppt(ppt文档).ppt

Chapter 15Financial statement analysisLearning objectivesDescribe the objectives of financial statement analysis.Identify the limitations of financial statement analysis.Prepare common size statements.Calculate commonly used ratios to analyse a firms profitability,activity,liquidity and financial structure.Use ratios to analyse and evaluate a firms financial performance and financial position.Explain and use the Du Pont system of integrative ratio analysis.Who uses financial statement analysis?Managers,for strategic and operational decision making.Investors and financial analysts,to evaluate management performance and to make investment decisions.Creditors,to make lending decisions.Auditors,to assess the reasonableness of financial statement values.Suppliers,to assess opportunities and ability to repay.What to do before you start analysingLearn about the companyConsider the decision to be made(e.g.invest,lend,etc.)Calculate relevant ratiosObtain comparative data(e.g.previous period,competitors,industry)Sources of information about a companyFinancial statements are only one source of information about a company.Other sources of information include:financial newspaperspress releasesinterneteconomy-wide factorsinformation about other companies.What are we trying to achieve?Each user of financial statements will have different requirements:Some might be interested in profitability,others may be more interested in the companys ability to pay its short-term debts.Other financial statement users might be interested in the companys ability to repay its long-term borrowings.All of these are related.For example,a companys ability to pay long-term debts will be related to whether it will be able to pay short-term debts and generate sufficient profit.Common size financial statementsThe preparation of common size financial statements involves the presentation of all balance sheet items as a percentage of total assets and profit and loss items as a percentage of total sales.Common size financial statements attempt to factor out the size of the company.This assists in comparing companies and analysing trends for a single company.Common size financial statementsIllustration2016$2015Company ASales600 000500 000Cost of goods sold457 200384 000Company BSales400 000300 000Cost of goods sold319 200217 800Common size financial statements20162015$%$%Company ASales600 000100.0500 000100.0Cost of goods sold457 20076.2384 00076.8Gross margin142 80023.8116 00023.2Company BSales400 000100.0300 000100.0Cost of goods sold319 20079.8217 80072.6Gross margin80 80020.282 20027.4Common size financial statementsRatio analysisThe calculation of a ratio simply involves dividing the dollar amount of one item with the dollar amount of another.Only some relationships will,however,be meaningful.Careful thought must be applied to determining which ratios will be useful to the specific analysis.Ratio analysisKey attributes analysed using ratio analysis include:profitability:involves the companys effectiveness in earning profits and providing a return on shareholders investmentsactivity turnover ratio:involves the efficiency with which the company utilises its resources to generate revenues and profitsRatio analysisliquidity:involves the companys ability to meet its financial obligations on a timely basisfinancial structure:involves the relative balance of debt and owners equity as sources of the companys financing.Profitability ratiosProfitability ratios aim to give the financial statement user some indication of the companys record of generating profits and its potential for generating profits in the future.Profitability ratios:return on equity return on assets profit margin gross margin earnings per share cash flow to total assets price/earnings ratio dividend payout ratioProfitability ratios(examples)Return on Operating profit after tax assets Total assets Alternative:Return on Earnings before interest and tax assets Total assetsReturn on Operating profit after tax equity Shareholders equityBy comparing these two ratios,it is possible to obtain some indication of the entitys use of leverage(or borrowings).If return on equity is greater than return on assets,the company is using leverage to the benefit of shareholders.Profitability ratiosThese ratios should exceed 0,representing a positive return.You would prefer their values to be as high as possible.Values of these ratios generally range between 5%and 20%.ROE will generally exceed ROA in proportion to the amount of leverage.Trend analysisThoughts on trend analysis and cross-company comparisons with ROE and ROA:Ideally,the trend of a companys ROE and ROA will be stable or increasing.If ROE or ROA are negative,or have declined materially relative to prior years or are lower than their direct competitors,then you should read the narrative portions of the annual report and other sources to determine how management are responding to this problem.Trend analysisROE and ROA will naturally tend to be lower in highly competitive industries,and higher in industries where competition is less intense.Cross-company comparisons of ROE and ROA are most meaningful when the companies are direct competitors offering similar products.Some variations in calculating ratiosIn ratios where a P&L statement value is divided by a balance sheet value(e.g.ROA,ROE,turnover ratios),the balance sheet value employed might be either the(1)beginning,(2)ending,or(3)average value for the year.In ratios that use a measure of profit,the measure used might be(1)operating profit after tax,(2)operating profit before tax,or(3)operating profit before tax and interest(EBIT).Profitability ratios(examples)The return on assets may be further analysed by examining the profit margin and asset turnover using the Dupont relationship.Operating profitOperating profitSales revenue Total assets Sales revenue Total assets Profit margin Asset turnoverThe relationship highlights that the return on total assets may be affected by changes in profit margin and/or changes in asset turnover.Other profitability ratiosProfit margin=Operating profit after tax Sales revenueGross margin=(Sales revenue Cost of goods sold)Sales revenueCash flow to total assets=Cash provided by operations Total assetsEarnings per share=(Operating profit after tax Dividends on preference shares)Weighted average number of ordinary shares outstandingOther profitability ratiosPrice/earnings ratio=Market price per ordinary share Earnings per shareDividend payout ratio=Dividends declared per share Earnings per shareActivity(turnover)ratiosActivity(turnover)ratios aim to give the financial statement user some indication of the companys operations in certain areas.Activity ratios:total asset turnover inventory turnover debtors turnoverActivity(turnover)ratiosTotal asset turnover=Sales revenue Total assetsInventory turnover=Cost of goods sold InventoryDays inventory on hand=365 Inventory turnoverDebtors turnover=Credit sales revenue Trade debtorsDays sales in debtors=365 Debtors turnoverActivity(turnover)ratios(examples)Debtors Credit sales turnover The debtors turnover can be divided into 365 days in order to calculate the average number of days to collect accounts receivable.Days sales in debtors=365 debtors turnoverToo high a figure may indicate a problem with the granting of credit and/or collection policies.Too low a figure may indicate that the credit granting and/or collection policies are too strict(by,for example,industry standards)and sales are being lost.Trade debtorsActivity(turnover)ratios(examples)Inventory COGS turnover InventoryThe inventory turnover can be divided into 365 days in order to calculate days in inventory(i.e.time from purchasing inventory to selling it).Days inventory on hand=365 inventory turnoverToo high a figure means additional costs of holding inventory it may indicate obsolete inventory.Compare performanceCompanyDays in inventoryDays in debtorsDays in accounts payableA403030B506030C3130Liquidity ratiosLiquidity ratios are aimed at giving the financial statement user some indication of the companys ability to pay its short-term debts as they fall due.Remember,a company may be forced into liquidation if it cant pay its short-term debts(even though it might be profitable in the long term).Liquidity ratios(examples)CurrentCurrent assets ratio A low ratio may indicate a problem in paying short-term debts.A high ratio may indicate an excessive investment in non-productive current assets.Current liabilitiesOther liquidity ratiosQuick ratio=(Cash+Accounts receivable+Short term investments)Current liabilitiesInterest coverage ratio=(Earnings before interest and taxes)Net interest expenseFinancial structure ratiosFinancing ratios aim to provide an indication of the companys ability to continue operations in the long term.Financing ratios:debt/equity ratiodebt/assets ratioleverage ratioDebt/equity Total liabilities ratio Debt/assets Total liabilities ratio Leverage Total assets ratio Do we need to calculate all three ratios?Total assetsFinancing ratios(examples)Total shareholders equity Total shareholders equityCash flow ratiosCash flow ratios are closely related to liquidity.That is,whether the company can generate sufficient cash to meet its requirements.Cash flow ratios also look at how well the company generates cash.Cash flow ratiosCash sufficiency ratios:Cash efficiency ratios:cash flow adequacy cash flow to sales long-term debt payment operations index dividend payout cash flow return on assets reinvestment debt coverageSee Exhibit 15.2 for definitionsThe Du Pont systemThe Du Pont system of ratio analysis identifies the following links:This linkage is useful in evaluating a companys strategy regarding financial risk.This linkage is useful in evaluating a companys pricing and marketing strategy.Ratio analysisIllustrationRequired1.Comment on the companys profitability,asset management,liquidity and financial structure.2.Why could ROE and ROA move in different directions?3.What caused the fall in ROA?4.What caused the fall in asset turnover?5.What caused the increase in the current ratio?Relationship between ratiosMany ratios are related,and any analysis will benefit from an understanding of these relationships.ExamplesActivity(turnover)ratios are related to liquidity ratios.Profitability ratios are related to financing ratios.Profitability ratios are related to activity(turnover)ratios.Financial statement ratiosRatios summarise large amounts of financial statement information.Ratio analysis adds meaning to the information in financial statements.Ratios are scaled measures,so that values of the same ratio can be usefully compared over time or across companies.Ratios are useful in making various kinds of decisions.Limitations of financial statement ratiosThe quality of ratios is sensitive to any lack of consistency in the accounting methods used by a company over time.Ratio comparisons across companies can be misleading if the companies use different accounting methods.Ratio comparisons across companies can be misleading if the companies operate in different industries or are substantially different in other ways.Limitations of financial statement ratiosThe usefulness of ratios is based upon the belief that past relationships are useful in forecasting future performance.Failure to adjust for inflation or market values results in current dollar amounts often being compared to past dollar amounts.Limitations of financial statement ratiosYear end data may not be reflective of the typical situation of the company.Furthermore,management may attempt to improve certain ratios by,for example,using cash to pay off short term borrowings(improves the current ratio).Ratios tell only part of the story.To understand the full story requires a deeper understanding of a company and its industry.Revision questionROA=10%Current ratio=2:1What is the effect of each of the following transactions on the above ratios?1.Borrowed$200 000 from the bank,repayable in two years2.Issued shares for$300 0003.Purchased equipment for cash,$50 0004.Credit sales of$80 000(COGS$60 000)5.Paid$10 000 to accounts payable6.Received$20 000 from accounts receivable7.Received an electricity bill for$5 000 for electricity used in this periodAnswer1Decrease ROA Increase current ratio2Decrease ROA Increase current ratio3No effect ROA Decrease current ratio4Increase ROA Increase current ratio5Increase ROA Increase current ratio6No effect ROA No rffect current ratio7Decrease ROA Decrease current ratio