Financial Statement Analysis-

1
Session XII

• Financial Statement Analysis-
• Introduction

2
The 3 Ps

• Preparation
• Processing
• Presentation

3
Reasons for Analysis

• Investment decisions
• Credit decisions
• Performance
• Valuation (investment)
• Legal liability amount (credit perf.)
• Going concern decisions (credit perf.)
• Unreasonable returns (performance)

4
Traditional FSA Methods

• Index analysis
• Trend analysis
• Percentage analysis
• Comparative analysis
• Horizontal analysis
• Vertical analysis
• Use of critical ratios

5
Typical Ratio Classifications

• Liquidity and solvency ratios
• Efficiency or performance ratios
• Profitability ratios
• Coverage or leverage ratios
• Key Financial Statement Ratio handout

6
FSA Cautions

• General
• Numerator and denominator content
• Comparative issues
• Timeliness
• GAAP alternatives
• Management aggressiveness/pro-forma stmts.
• Just win, baby attitude
• Size
• Geographic span of operations

7
Other F/S Considerations

• Quality of Earnings/Transparency
• Measurement Bias
• Management Bias

8
Quality of Earnings Issues

• Non-recurring itemssustainability
• Essentially we are trying to determine if what is
  reported is going to recur in the future.

9
Sustainability Issues

• Discontinued operations
• Extraordinary gains and losses
• Changes in accounting principles
• Impairment of long-lived assets
• Restructuring charges
• Changes in estimates
• Peripheral gains and losses

10
Sources of Information

• Annual Report
• Form 10-K
• Form 10-Q
• Form 8-K
• Prospectus
• Form 20-F (foreign entity 10-K)
• SECs EDGAR service

11
Iqbals International FSA Rationale

• High foreign returns (I)
• Risk diversification (I)
• Competitive positioning (I)
• Currency appreciation (C I)
• Ownership opportunity (I)
• Competitive analysis (I P)
• Foreign operating decisions (C, I P)

12
Unique International Problems

• Reliability of data
• Adequacy of disclosure
• Timeliness of information
• Language and terminology
• Foreign currency issues
• Financial statement format and focus

13
Unique Intl. FSA Content

• Discussion of accounting frameworks
• Discussion of business customs
• Impact of tax laws
• Use local currency

14
Typical Approach

• Industry and company analysis
• Review of auditors report, management letter and
  MDA
• Review of each financial statement together with
  the footnotes
• Structured quantitative analysis
• Assessment of position today and in the future

15
Profitability Analysis

• Rate of Return on Assets--ROA
• Measures success in using assets to generate
  earnings (excluding financing)
• Disaggregated ROA
• ROA Profit Margin X Asset Turnover
• Line by line P L Analysis
• A/R, Inventory F/A turnover

16
ROA Summary

• Level 1 ROA as a whole
• Level 2 Disaggregate ROA
• Level 3a Margin analysis in detail
• Level 3b Disaggregate turnover
• Level 4 ROA, margin turnover by geographic
  segment

17
Disaggregated ROCE

• ROCE ROA X CEL X CSL
• Common Earnings Leverage op. Income available
  to common s/h
• Cap. Structure Leverage multiplier effect of
  other capital sources

18
ROCE--Return on Common Shareholders Equity

• Return after interest and senior security
  considerations
• ROA and ROCE
• ROCE gt ROA when ROA exceeds the cost of creditor
  and pref. Shareholder capital

19
Risk Analysis

• Types of risk
• International
• Domestic
• Industry
• Firm-specific
• Financial
• Solvency
• Liquidity

20
L/T Financial Risk

• L/T Debt Ratio
• Debt/Equity Ratio
• Cash Sufficiency Ratio
• (CFO I T)
• (PPE D I T Div)

21
S/T Financial Risk

• Current ratio
• Quick ratio
• Working Capital Activity ratios
• A/R turnoverDSO
• Inventory turnoverDays in inventory
• A/P turnoverDIP
• Cash Conversion Cycle
• DSO DII - DIP.should be negative