Financial Statements and Analysis

Prof. Junnell E. Guia

Key Concepts and Objectives

Objectives and Characteristics of Financial Reports Classified Balance Sheet Assets = Liabilities + Owner s Equity Financial Statement Analysis Financial Ratios Liquidity Measures Solvency Measures Profitability Measures Components of Annual Financial Report

Objectives of Financial Reporting

Primary Objective:
Provide information for decision making by users

Secondary Objectives:
Reflect Resources and Claims to Them Summarize Revenue Inflows and Expense Outflows Assess Cash Flows to/from Company

Qualitative Characteristics
(What Financial Statement information should be)

Understandable
To those willing to take the time to understand it

Relevant Has the capacity to

make a difference Represents what it purports to

Reliable

Qualitative Characteristics
(What Financial Statement information should be)

Comparable between companies

Why compare companies?

Consistent from one period to the next

Why should info be consistent over time?

Financial Statement and Analysis

It is defined as the process of identifying financial strengths and weaknesses of the firm. These are prepared to meet external reporting obligations and also for decision making purposes. They play a dominant role in setting the framework of managerial decisions. However, the information provided in the financial statements is of immense use in making decisions through analysis and interpretation of financial statements.

The Stockholder s Report

It summarizes and documents the firms financial activities during the past year. The guidelines used to prepare and maintain financial records and reports are known as Generally Accepted Accounting Principles (GAAP) These are accounting practices and procedures authorized by the accounting profession ruling body, Financial Accounting Standards Board (FASB). Securities and Exchange Commission (SEC) - is the federal regulatory body that governs the sale and listing of securities.

The Letter to Stockholders - is the primary communication from the management. - is the first element of the annual stockholders report.

The Four Key Financial Statements

Income Statement Balance Sheet

- provides a financial summary of the firm s operating results during a specified period.

- presents a summary statement of the firm s financial position at a given point in time.

Statement of Stockholders Equity

Statement Flows

of

Cash

- shows all equity account transactions that occurred during a given year.

- is a summary of the cash flows over the period concern.

Income Statement

- Most common income statements cover a 1-year period ending at a specified date, ordinarily December 31 of the calendar year.

Balance Sheet

- It balances the firm s assets (what it owns) against its financing, which can either be debt (what it owes) or equity (what was provided by owners). Current Assets and Liabilities - Short-Term and Long-Term - expected to be converted into cash (current assets) or paid (current liabilities) within a year or less. - expected to remain on the firm s book for more than a year. - assumed to have an infinite life

Assets are listed from the most liquid. Liabilities and equity are listed from short-term to long-term.

Balance Sheet
Assets Marketable Securities are very liquid short-term investments, such as Treasury Bills or Certificate of Time Deposit; are viewed as a form of cash (near cash). Accounts Receivable represent the total moneys owed by customers to the firm. Inventories include raw materials, work in process, and finished goods. Gross Fixed Assets is the original cost of all fixed (long-term assets). Net Fixed Assets represent the difference between gross fixed assets and accumulated depreciation. Liabilities and Stockholders Equity Accounts Payable are the total moneys owed by the firm to the suppliers. Accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced. Long-Term Debt represents debt for which payment is not due in the current year. Stocksholders Equity represents the owners claims on the firm. Preferred Stock Common Stock Paid-in Capital

Statement of Retained Earnings Statement of Stockholder s Equity

- It is an abbreviated form of the statement of stockholder s equity. - It shows all equity account transactions that occurred during a given year.

Statement of Cash Flows

It is a summary of the cash flows over the period of concern.

Financial Ratios
Types of Ratio Comparisons 1. Cross-Sectional Analysis involves the comparison of different firms financial ratios at the same point in time. 2. Time-Series Analysis evaluates performance over time. 2. Combined Analysis combines cross-sectional and time-series analysis. Categories of Financial Ratios 1. Liquidity Ratios 2. Activity Ratios 3. Debt Ratios 4. Profitability Ratios 5. Market Ratios

Liquidity Ratios
Current Ratios urrent Assets urrent Liabilities

Liquidity is the firm s ability to satisfy its short-term obligations.

Generally, the higher the current ratio, the more liquid the firm is considered to be. A current ratio of 2.0 is occasionally cited as acceptable, but a value s acceptable depends on the industry which the firm operates.

urrent Ratio

The current ratio for Barlett ompany in 2006 is

urrent Ratio

$ ,22 ,000 $ 620,000

.97

Liquidity Ratios
Quick Ratios Current Assets - Inventory Current Liabilities 6 is A quick ratio of 1. or greater is occasionally recommended, but as with current ratio, what value is acceptable depends largely on the industry. The quick ratio provides a better measure of overall liquidity only when a firm s inventory cannot be easily converted to cash. = 1.51

Quick Ratio =

The quick ratio for Barlett Company in 1, 3, 6 , 89,

Quick Ratio =

Activity Ratios
Inventory Turnover

Activity ratio measure the speed with which various accounts are converted into sales or cash inflows and outflows.

Inventory Turnover commonly measures the activity, or liquidity, of a firm s inventory. It is calculated as follows: Inventory Turnover Cost of Goods Sold Inventory The resulting turnover is meaningful only when compared with that of other firms in the same industry or to the firm s past inventory turnover.

Applying this relationship to Barlett Company in 2006 yields $ ,22 ,000 $ 620,000 7.2

Inventory Turnover

Activity Ratios
Average Collection Period Average Collection Period is the average amount of time needed to collect accounts receivables. Accounts Receivable Average Collection Period = Annual Sales / days Average Collection Period = = = . days . days to , / , 8,4

4,

days

On the average, it takes the firm collect an account receivables.

Activity Ratios
T e difficulty in Average Payment Period calculating t is ratio Average Payment Period is t e average of time needed stems from t e need to find annual purc ases, to pay accounts payables. a value not available in publis ed financial Accounts Payable Average Payment Period = Average Purc ases / days statements. Ordinarily, purc ases 8 , are estimated as a Average Payment Period = . X , 88, / days given percentage of cost of goods sold. 8 , = Assume t at Barlett , Company s purc ases = . days equaled % of its cost of goods sold..

Activity Ratios
Total Asset Turnover The Total Asset Turnover indicates the efficiency with which the firm uses its assets to generate sales. Total Asset Turnover = Sales Total Assets 3, 7 , 3, 7,

Total Asset Turnover = = .8

This means the Barlett Company s turns over its assets .8 times per year. Generally, the higher a firm s total asset turnover, the more efficiently its assets have been used.

Debt Ratios
Debt Ratio Debt Ratio measures the proportion of total assets financed by firm s creditors. The higher the ratio , the greater the amount of other people s money being used to generate profits. Debt Ratio= Total Liabilities Total ssets 1,6 3, 3, , or . %

Debt Ratio= = .

This value means that Barlett Company has financed close to half of its assets with debt.

Debt Ratios
Times Interest Earned Ratio It measures the firm s ability to make contractual interest payments. The higher its value, the better able the firm is to fulfill its interest obligations. Earnings Before Interest and Taxes Times Interest Earned Ratio = Interest Times Interest Earned Ratio = = .5 The times interest earned ratio for Barlett Company seems acceptable. A value of at least . and preferably close to 5. is often suggested. 18, ,

Debt Ratios
Fixed-Payment Coverage Ratio It measures the firm s ability to meet all fixed payment obligations such as loan interest and principal, lease payments, and preferred stock dividends. Earnings before Interest and Taxes + Lease Payments Fixed-Payment Coverage Ratio = Interest + Lease Payments + ((Principal Payments + Preferred Stock Dividends) (1/(1 T))) 18, + 35, + 35, + (( 71, + 1 , ) (1/(1 Fixed-Payment Coverage Ratio = 93, . 9))) = 1.9 where T is the corporate tax rate applicable to the firm s income. The term 1/(1 T) is included to adjust the after-tax principal and preferred stock dividend payments back to a before-tax equivalent that is consistent with the before-tax values of all other terms.

Profitability Ratios
Gross Profit Margin It measures the percentage of each sales dollar remaining after the firm has paid for its goods. The higher the gross profit margin, the better. Sales Cost of Goods Sold Gross Profit Margin = Sales 3, 7 , - , 88, Gross Profit Margin = 3, 7 , =3 . The higher the gross profit margin, the better.

Profitability Ratios
Net Profit M argin It measures the percentage of each sales dollar remaining after all cost and expenses, including taxes, interests, and preferred stock dividends, have been deducted. Earning Available for Common Stockholders Sales 1, 3, 7 , = 7. % The net profit margin is a commonly cited measure of the firm s success with respect to earning on sales. Good net profit margins differ considerably across industries.

Net Profit Margin = Net Profit Margin =

Profitability Ratios
Earnings Per Share The Earnings Per Share is generally of interest to present or prospective stockholders and management. Earnings Per Share = Earnings Per Share = = .9 Earnings Available for Common Stockholders mber of Shares of Common Stock tstanding 1, 76, 6

The fig re represents the dollar amo nt earned on behalf of each o tstanding share of common stock. It s distrib ted to shareholders as dividend per share.

Profitability Ratios
Return on Total Assets or Return on Investment It measures the overall effectiveness of management in generating profits with its available assets. The higher the firm s ROI, the better. Return on Total Assets = Return on Total Assets = = 6.1% This indicates that Barlett Company earned 6.1 cents on each dollar of asset investment. Earnings Available for Common Stockholders Total Assets 1, 3,597,

Profitability Ratios
Return on Common Equity (COE) It measures the return earned on the common stockholders investment in the firm. The higher the return, the better off are the owners. Earnings Available for Common Stockholders Return on Common Equity = Common Stock Equity Return on Common Equity = = 1 .6% Note: The value of common stock equity was found by subtracting the , of preferred stock equity from the total stockholders equity of 1,95 , . The 6 calculated ROE of 1 .6% indicates that during Barlett Company earned 1 .6 cents on each dollar of common stock equity. 1, 1,75 ,

Market Ratios
Price / Earnings Ratio It measures the amount that investors are willing to pay for each dollar of a firm s earnings. The higher the P/E Ratio, the greater the investor confidence. Price / Earnings Ratio = Price / Earnings Ratio = = 11.1

Market Ratios relate the firm s market value, as measured by its current share price, to certain accounting values. These ratios give insight into how well investors in the marketplace feel the firm is doing in terms of risk and return.

Market Price Per Share of Common Stocks Earnings Per Share 3 . 5 .9

This figure indicates that investors were paying 11.1 for each 1. of earnings. The P/E Ratio is most informative when applied in cross-sectional analysis using an industry average P/E Ratio of a benchmark firm.

Market Ratios
Market / Book Ratio It provides an assesment of how investors view the firm s performance. To calculate the firm s M/B Ratio, we first need to find out the Book Value Per Share of Common Stock: Common Stocks Equity Number of Shares of Common Stock Outstanding 1,75 , 76, 6 3.

Book Value Per Share of Common Stock =

Book Value Per Share of Common Stock = =

Market Ratios
Market / Book Ratio Market / Book Ratio = Market Price Per Share of Common Stock Book Value Per Share of Common Stock 3 . 5 3.

Market / Book Ratio = = 1.

The M/B Ratio means that investors are currently paying 1. for each 1. of book value of Barlett Company s stock.

Elements of an Annual Report

 Management's Discussion & Analysis  Summary of financial data  Letters to stockholders
 Financial statements  Footnotes to financial statements  Report of independent auditors

Thank you!