Analyzing Financial Statements

1
Chapter 14

• Analyzing Financial Statements
• 9/01/03

2
Understanding The Business
FINANCIAL STATEMENT USERS
EXTERNAL DECISION MAKERS
MANAGEMENT
3
Understanding The Business
THREE TYPES OF FINANCIAL STATEMENT INFORMATION
PastPerformance
PresentCondition
FuturePerformance
Income, sales volume, cash flows, return-
on-investments,EPS.
Assets, debt, inventory, various ratios.
Sales and earnings trends are good indicators of
future performance.
4
Understanding The Business
Return on an equitysecurity investment
5
Understanding The Business
Invest?
No
Yes
6
Understanding a Companys Strategy
7
Fundamental Strategies

• Product differentiation unique features,
  quality, I.e., Lexus
• Cost advantage lower costs, better efficiency,
  lower prices, I.e., Honda
• What is Home Depots Strategy?
• Are they successful with it?

8
Financial Statement Analysis

• Financial statement analysisis based on
  comparisons.

Examines a single company to identify trends
over time.
9
Financial Statement Analysis

• Financial statement analysisis based on
  comparisons.

Provides insightsconcerning acompanys
relativeperformance.
10
Ratio and Percentage Analyses

• Ratio analysis, or percentage analysis, is
  used to express the proportionate relationship
  between two different amounts.

11
Component Percentages

• Express each item on a particular statement as a
  percentage of a single base amount.

12
Component Percentages Example

• The comparative income statements of Home Depot
  2001 and 2000 appear on the next slide.
• Prepare component percentage income statements
  where net sales equal 100.

13
Component Percentages
14
Component Percentages
2001 Cost 2001 Sales
15
Component Percentages
16
(No Transcript)
17
Commonly Used Ratios

• The 2001 and 2000 balance sheets for Home Depot
  are presented next.
• We will be referring to these financial
  statements throughout the ratio analyses.

18
Comparative Statements
19
Comparative Statements
20
Tests of Profitability

• Profitability is a primary measure of the
  overall success of a company.
• Now, lets look at the profitability ratios for
  Home Depot for 2001.

21
Return on Equity
This measure indicates how much income was earned
for every dollar invested by the owners. Lowes
ratio 15.9 ROT 15
22
Return on Assets
Corporate tax rate is 34 percent.
This ratio is generally considered the best
overall measure of a companys profitability. Lowe
s ratio 9.1 ROT 10
23
Financial Leverage
5.4 18.9 13.5
Financial leverage is the advantage or
disadvantage that occurs as the result of earning
a return on equity that is different from the
return on assets. Lowes 6.8.
24
Earnings per Share (EPS)
Earnings per share is probably the single most
widely watched financial ratio.
25
Quality of Income
26
Quality of Income
A ratio higher than 1 indicates higher-quality
earnings. No significant non-cash earnings. Cash
from Current Assets/Liabilities balanced. ROT 1.0
27
Profit Margin
This ratio describes a companys ability to earn
income from sales. Lowes 4.3 ROT 10
28
Fixed Asset Turnover
This ratio measures a companys ability to
generate sales given an investment in fixed
assets. Lowes ratio 3.1 ROT 1.0
29
Total Asset Turnover Ratio

• Total Asset Net Sales Revenue
• Turnover Average Total Assets
• Home Depot 45,738
• (21,385 17,081) /
  2
• 2.38
• Lowes 1.86

30
Tests of Liquidity

• Tests of liquidity focus on the relationship
  between current assets and current liabilities.
• Now, lets look at the liquidity ratios for Home
  Depot for 2001.

31
Cash Ratio
This ratio measures theadequacy of available
cash. Lowes ratio 0.15
32
Current Ratio
This ratio measures the ability of the company to
pay current debts as they become due. ROT 2.0 to 1
33
Quick Ratio (Acid Test)(Excludes inventory
other curr. Assets)
This ratio is like the current ratio but measures
the companys immediate ability to pay debts.
34
Receivable Turnover(per year)
This ratio measures how quickly a company
collects its accounts receivable.
35
Average Age of Receivables(DSO)
This ratio measures the average number of days it
takes to collect receivables. ROT 45 to 60
days. Why is HD so low? Lots of Cash Sales.
36
Inventory Turnover
This ratio measures how quickly the company sells
its inventory. Lowes ratio 4.4 times ROT 4.0
times or better.
37
Average Days Supply in Inventory
This ratio measures the average number of days it
takes to sell the inventory. Lowes days 83.
38
Tests of Solvency and Equity Position

• Tests of solvency measure a companys ability
  to meet its obligations.
• Now, lets look at the solvency ratios for Home
  Depot for 2001.

39
Times Interest Earned
This ratio indicates a margin of protection for
creditors. ROT 7 times or better.
40
Cash Coverage
41
Cash Coverage
This ratio compares the cash generated with the
cash obligations of the period.
42
Debt/Equity Ratio
This ratio measures the amount of liabilities
that exists for each 1 invested by the owners.
Lowes ratio 0.52. ROT 1.00.
43
Total Debt Ratio

• Debt Ratio Total Debt
• Total Assets
• Home Depot 6,381 29.8
• 21,385
• ROT 50

44
Market Tests

• Market tests relate the current market price
  of a share of stock to an indicator of the return
  that might accrue to the investor.
• Now, lets look at the market tests forHome
  Depot for 2001.

45
Price/Earnings (P/E) Ratio
A recent price for Home Depotstock was 35 per
share.
This ratio measures the relationship between the
current market price of the stock and its
earnings per share. Lowes p/e ratio 14 ROT 20
46
Other Analytical Considerations

• In addition to financial ratios, special
  factors might affect company analysis
• Rapid growth.
• Uneconomical expansion.
• Subjective factors.

47
Interpreting Ratios

• Ratios may be interpreted by comparison with
  ratios of other companies or with industry
  average ratios.
• Ratios may vary because of thecompanys
  industry characteristics,nature of operations,
  size, andaccounting policies.

48
Efficient Markets

• A securities market in which prices fully
  reflect available information is called an
  efficient market.
• In an efficient market, a companys stock
  reacts quickly when new, relevant information is
  released about the company.

49
End of Chapter 14
Ratios
Ratios
Ratios
Ratios
Ratios