FS ANALYSIS

• Financial Statements


  Historical documents that summarize what has happened during a particular period
• Users of Financial Statements

  • Stockholders / Shareholders (concerned with future earnings and dividends)
  • Creditors (short-term and long-term, concerned with the company's future ability to repay its debts)
• Financial Statement Analysis


  • Examining trends in key financial data
  • Comparing financial data across companies
  • Analyzing financial ratios to assess the financial health and future prospects of a company
• Users of Financial Statement Analysis

  • External users (to estimate its potential for earnings growth, stock price appreciation, making dividend payments, and paying principal and interest on loans)
  • Internal users (to provide valuable feedback regarding their company's performance)
• Limitations of Financial Statement Analysis


  • Differences in accounting methods between companies sometimes makes it difficult to compare their financial data
  • Ratios should not be viewed as an end but rather as a starting point, managers should also look into other internal factors and external factors
• Analytical Techniques in Financial Statement Analysis


  • Horizontal Analysis (Peso and percentage changes on statements)
  • Vertical Analysis (Common-size statements)
  • Financial Ratios
• Horizontal Analysis


  Analyzing financial data over time, computing year-to-year peso and percentage changes within a set of financial statements
• Vertical Analysis


  Focuses on the relations among financial statement accounts at a given point in time, a common-size financial statement is a vertical analysis in which each account is expressed as a percentage
• Financial Ratios


  • Liquidity
  • Asset Management
  • Debt Management
  • Profitability
  • Market Performance
• Liquidity

  How quickly an asset can be converted to cash
• Current Ratio


  A measure of short-term debt paying ability, a declining current ratio might be a sign of a deteriorating financial condition or it might be the result of eliminating obsolete inventories or other stagnant current assets, an improving current ratio might be the result of stockpiling inventories or it might indicate an improving financial situation
• Acid Test (Quick) Ratio


  A more rigorous test of a company's ability to meet its short-term debts than the current ratio, inventories and prepaid expenses are excluded (not considered as "quick" assets), measures how well a company can meet its obligations without having to liquidate or depend too heavily on its inventory
• Asset Management

  • Creditors and stockholders fund a company's assets; they expect those assets to be deployed/utilized efficiently and effectively
• Accounts Receivable Turnover


  Measures how many times a company's accounts receivable have been turned into cash during the year
• Average Collection Period


  Measures the number of days taken to collect an accounts receivable
• Inventory Turnover


  Measures how many times a company's inventory has been sold and replaced during the year
• Average Sale Period


  The number of days needed on average to sell the entire inventory
• Operating Cycle


  Measures the elapsed time from when an inventory is received from suppliers to when cash is received from customers, if operating cycle < average payment period the company is receiving cash from customers before it has to pay suppliers for inventory purchases, if operating cycle > average payment period it creates the need to borrow money to fund its inventory and accounts receivable
• Total Asset Turnover


  Measures how efficiently a company's total assets are being used to generate sales, to increase total asset turnover, the company must either increase sales or reduce its investment in assets
• Debt Management


  • Long-term creditors are concerned with a company's ability to repay its loans over the long-run, often seek protection by requiring that borrowers agree to restrictive covenants or rules, stockholders look at debt from a financial leverage perspective
• Financial Leverage


  Borrowing money to acquire assets in an effort to increase sales and profits, if a company's ROA > after-tax cost of debt, financial leverage is positive and having debt can substantially benefit common stockholders, if a company's ROA < after-tax cost of debt, financial leverage is negative and common stockholders suffer
• Debt Management Ratios

  • Times Interest Earned Ratio
  • Debt-to-Equity Ratio
  • Equity Multiplier
• Times Interest Earned Ratio (TIER)


  The most common measure of a company's ability to provide protection to its long-term creditors, based on EBIT (Earnings Before Interest Expense and Income Tax) or NOI (Net Operating Income), a TIER of less than 1.0 is inadequate (interest expense > earnings available for paying that interest), a TIER of 2.0 or more is sufficient to protect long-term creditors
• Debt-to-Equity Ratio


  Indicates the relative proportion of debt and equity at one point in time on a company's Statement of Financial Position, as the ratio increases a company is increasing its financial leverage and relying on a greater proportion of debt rather than equity to fund its assets
• Equity Multiplier


  Indicates the portion of the company's assets funded by equity, as the ratio increases a company is increasing its financial leverage and relying on a greater proportion of debt rather than equity to fund its assets
• Creditors and equity holders have different views about the optimal debt-to-equity ratio, creditors would like to see less debt and more equity, equity holders would like a lot of debt to take advantage of positive financial leverage
• Profitability Ratios

  • Gross Margin Percentage
  • Net Profit Margin Percentage
  • Return on Total Assets
  • Return on Equity
• Gross Margin Percentage


  Focuses on only cost of goods sold and its impact on performance
• Net Profit Margin Percentage


  Looks at how cost of goods sold, selling and administrative expense, interest expense, and income tax expense have influenced performance
• Return on Total Assets


  Looks at profits relative to total assets, interest is added back to net income to show what earnings would have been if the company had no debt
• Return on Equity


  Looks at profits relative to the book value of the common stockholders' equity
• DuPont Formula

  • ROE is influenced by three elements - operating efficiency (measured by net profit margin percentage), asset usage efficiency (measured by total asset turnover), and financial leverage (measured by equity multiplier)
• If Return on Total Assets > After-tax cost of debt, financial leverage is positive and the company is employing financial leverage to the advantage of the common stockholders, this explains why Return on Equity > Return on Total Assets
• Market Performance Ratios

  • Earnings per Share
  • Price-Earnings Ratio
  • Dividend Payout Ratio
  • Dividend Yield Ratio
  • Book Value per Share
• Earnings per Share


  Earnings form the basis for dividend payments and future increases in the value of shares
• Price-Earnings Ratio


  Expresses the relationship between a stock's market price per share and its earnings per share, a high P-E ratio indicates investors are willing to pay a premium for the company's stock as they expect higher than average future earnings growth, a low P-E ratio indicates investors believe a company's future earnings growth prospects are limited
• Dividend Payout Ratio


  Quantifies the percentage of current earnings being paid out in dividends, companies with ample growth opportunities at high rates of return tend to have low payout ratios, companies with limited investment opportunities but with steady dependable earnings tend to have high payout ratios
• Dividend Yield Ratio


  Measures the rate of return (in the form of cash dividends only) that would be earned by an investor who buys common stock at the current market price
• Book Value per Share


  Measures the amount that would be distributed to holders of each share of common stock if all assets are sold at their balance sheet carrying amounts (book values), and if all creditors were paid off, ordinarily, the market price of a stock exceeds its book value as the market price reflects expectations about future earnings and dividends while book value reflects the results of events that have occurred in the past