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MPA702 Topic 10

Financial Analysis
(E-reading, CloudDeakin)

Objectives
Financial analysis: aim and sources of risk
Assessing performance and risk
Common-size financial statements
Financial ratio analysis

Analysis of financial statements

Internal influences
External influences
Sources of information
Limitations
Concluding remarks

Exercises
2

Financial analysis
Aim

To assess performance through analysis of


profitability, growth and risk management
Product market strategies:

Financial market strategies:

Operating decisions.
Investment decisions.

Financing decisions.
Dividend decisions.

Sources of risk ...


3

Financial analysis
Sources of risk

Business risk

Financial risk

Flows from nature of industry.


Affected by:

Flows from use of debt.


Affected by:

Technology
Competition
Regulation
Consumer taste

Interest rates
Type of funding

Assessing performance and risk


Common size financial statements - balance sheet: assets

Steam Ltd
Current assets

Power Ltd

Ind. Ave.

$000

$000

112 118

16.1

83 560

6.8

8.9

Accounts receivable

99 725

14.4

283 861

23.2

13.9

Inventories

12 251

1.8

57 367

4.7

2.1

Other current assets

3 604

0.5

27 477

2.2

10.3

Total current assets

227 698

32.8

452 265

36.9

35.2

67 759

9.8

327 406

26.8

18.9

395 056

57.0

369 732

30.2

42.2

2 682

0.4

75 072

6.1

3.7

465 497

67.2

772 210

63.1

64.8

693 195

100.0

1 224 475

100.0

100.0

Cash and liquid assets

Non-current assets
Investments
Land, buildings, plant & equipment
Intangible assets
Total non-current assets
Total assets
5

Common
Size
Balance
Sheet
(Assets)

Assessing performance and risk


Common size financial statements - balance sheet: liabilities & equity

Steam Ltd

Current liabilities

Ind.
Ave.

$000

76 855

11.1

234 247

19.1

7.3

Other current liabilities

123 332

17.8

78 093

6.4

19.6

Total current liabilities

200 187

28.9

312 340

25.5

26.9

Long term liabilities

171 055

24.7

573 918

46.9

32.2

Total liabilities

371 242

53.6

886 258

72.4

59.1

Shareholders equity

321 953

46.4

338 217

27.6

40.9

Total liabilities & equity

693 195

100.0

100.0

100.0

Accounts payable

$000

Power Ltd

1 224 475

Common
Size
Balance
Sheet
(Liabilities & Equity)

Assessing performance and risk


Common size financial statements - profit and loss

Steam Ltd

Power Ltd

Ind. Ave.

$000

$000

639 731

100.0

1 624 341

100.0

100.0

47 378

7.4

40 538

2.5

3.7

493 765

77.2

1 447 113

89.1

85.8

98 588

15.4

136 690

8.4

10.5

Interest expense

15 628

2.4

51 108

3.1

2.8

Tax

33 676

5.3

20 303

1.3

2.6

Net profit after tax

49 284

7.7

65 279

4.0

5.1

Dividends

16 826

2.6

24 822

1.5

2.0

Sales revenue
Depreciation
Other expenses (incl. COGS)
EBIT

Market data
Market price/share at 30/6/X1
No. of shares (million)

$9.40

$5.14

77.9

195.8

Common
Size
Profit
and
Loss

Assessing performance and risk


Financial ratio analysis

Profitability ratios
Measure ability to earn profits steadily over an extended period of time.

Investment ratios
Measure efficiency in management of assets.

Financing ratios
Measure liquidity and solvency in the light of dividend policy.

Market and per share ratios


Measures related to ordinary shares.
8

Assessing performance and risk


Financial ratio analysis - Profitability ratios: ROE

Return On Equity (ROE)


Indicates how much a company has earned on funds invested by
ordinary shareholders (i.e., excluding preference shareholders).
Numerator determined by profitability of sales.

Denominator

determined by financing structure (gearing).

ROE = NPAT and Preference Dividends / Ordinary Shareholders Equity

Assessing performance and risk


Financial ratio analysis - Profitability ratios: ROE - example

ROE = NPAT and Preference Dividends / Ordinary Shareholders Equity

Steam Ltd ROE = 49 284 / 321 953 = 15.3%


Power Ltd ROE = 65 279 / 338 217 = 19.3%

Notes:
Financing

with more debt reduces Ordinary Shareholders


Equity, thereby causing an increase in ROE. However, this
comes at greater financial risk.

It is common to use average shareholders equity.


10

Assessing performance and risk


Financial ratio analysis - Profitability ratios: ROA

Return On Assets (ROA)

Indicates how efficient a company has been in earning profits from its assets,
ignoring financing.

Measures profitability of total investment by shareholders and lenders; that is,


return on total funds employed.

ROA = EBIT / Total Assets

11

Assessing performance and risk


Financial ratio analysis - Profitability ratios: ROA - example

ROA = EBIT / Total Assets

Steam Ltd ROA = 98 588 / 693 195 = 14.2%

Power Ltd ROA = 136 690 / 1 224 475 = 11.2%

Notes:

Some analysts prefer NPAT instead of EBIT; however, EBIT


removes effect of interest and tax and focuses on profits from
operating decisions.

It is common to use average total assets.


12

Assessing performance and risk


Financial ratio analysis - Profitability ratios: ROA components

ROA components
Asset

Turnover: measures the ability of assets to generate sales.

Gross

Profit Margin: measures profitability of those sales.


ROA = Asset Turnover * Gross Profit Margin

Asset Turnover = Sales / Total Assets

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Gross Profit Margin = EBIT / Sales

Assessing performance and risk


Financial ratio analysis - Profitability ratios: Asset Turnover - example

Asset Turnover = Sales / Total Assets

Steam Ltd Asset Turnover = 639 731 / 693 195 = 0.92 times
Power Ltd Asset Turnover = 1 624 341 / 1 224 475 = 1.33 times

Notes:
Decisions to buy new equipment, build up inventory levels and
grant credit reduce Asset Turnover.
Decision to run 3 (instead of 1 or 2) shifts per day increases
Asset Turnover.
It is common to use average total assets.

14

Assessing performance and risk


Financial ratio analysis - Profitability ratios: Gross Profit Margin - example

Gross Profit Margin = EBIT / Sales

Steam Ltd Gross Profit Margin = 98 588 / 639 731 = 15.4%


Power Ltd Gross Profit Margin = 136 690 / 1 624 341 = 8.4%

Notes:

Primarily suits businesses that sell goods as opposed to


services.
Indicator of mark-up.
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Assessing performance and risk


Financial ratio analysis - Profitability ratios: Expense ratios

Expense ratios
Measure
Can

cost structure.

be based on either depreciation expense or interest expense.

Depreciation Expense = Depreciation / Sales

Interest Expense = Interest / Sales

16

Assessing performance and risk


Financial ratio analysis - Profitability ratios: Depreciation Expense - example

Depreciation Expense = Depreciation / Sales

Steam Ltd Depreciation Expense = 47 378 / 639 731 = 7.4%


Power Ltd Depreciation Expense = 40 538 / 1 624 341 = 2.5%

Notes:

Although a lower Depreciation Expense is desirable, the


company could be missing out on a tax shield.
Lower depreciation implies lower cash flow.

17

Assessing performance and risk


Financial ratio analysis - Profitability ratios: Interest Expense - example

Interest Expense = Interest / Sales

Steam Ltd Interest Expense = 15 628 / 639 731 = 2.4%


Power Ltd Interest Expense = 51 108 / 1 624 341 = 3.1%

Notes:

Although a lower Interest Expense is desirable, the company


could be missing out on a tax shield.

Determination of the optimal interest expense is dependent


on the companys capital structure policy.
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Assessing performance and risk


Financial ratio analysis - Investment ratios: Inventory management ratios
Inventory management ratios
Measure

efficiency in inventory control and level of investment in inventory.


Determined by nature of business: e.g., milk versus cars.
Affected by seasonal factors: e.g., Christmas.
There is a trade-off between high inventory levels and inventory carrying costs.
Build-up of inventory may be indicative of change in consumer taste.
Evaluated using either Inventory Turnover or Inventory Days Outstanding.

Inventory Turnover = COGS / Inventory


Inventory Days Outstanding = (Inventory * 365) / COGS
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Assessing performance and risk


Financial ratio analysis - Investment ratios: Inventory Turnover - example

Inventory Turnover = COGS / Inventory

Steam Ltd Inventory Turnover = 493 765 / 12 251 = 40.3 times


Power Ltd Inventory Turnover = 1 447 113 / 57 367 = 25.2 times

Notes:

Other Expenses used as a proxy for COGS, because


COGS is unavailable.
It is common to use average inventory.

20

Assessing performance and risk


Financial ratio analysis - Investment ratios: Inventory Days Outstanding - example

Inventory Days Outstanding = (Inventory * 365) / COGS

Steam Ltd Inventory Days Outstanding = (12 251 * 365) / 493 765 = 9 days
Power Ltd Inventory Days Outstanding = (57 367 * 365) / 1 447 113 = 14 days

Notes:

Other Expenses used as a proxy for COGS, because


COGS is unavailable.
It is common to use average inventory.

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Assessing performance and risk


Financial ratio analysis - Investment ratios: Receivables management ratios

Receivables management ratios


Reflect a companys credit policy particularly its effectiveness in collecting
money from customers.
Affected by economic conditions, industry as well as seasonal factors.
Companies may implement looser credit terms in order to gain market share.
Evaluated using either Receivables Turnover or Average Collection Period.

Receivables Turnover = Credit Sales / Receivables


Average Collection Period = (Receivables * 365) / Credit Sales
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Assessing performance and risk


Financial ratio analysis - Investment ratios: Receivables Turnover - example

Receivables Turnover = Credit Sales / Receivables

Steam Ltd Receivables Turnover = 639 731 / 99 725 = 6.4 times


Power Ltd Receivables Turnover = 1 624 341 / 283 861 = 5.7 times

Notes:
Calculation

assumes that all sales are credit sales.

It is common to use average receivables.

23

Assessing performance and risk


Financial ratio analysis - Investment ratios: Average Collection Period - example

Average Collection Period = (Receivables * 365) / Credit Sales

Steam Ltd Average Collection Period = (99 725 * 365) / 639 731 = 56 days
Power Ltd Average Collection Period = (283 861 * 365) / 1 624 341 = 63 days

Notes:
Calculation assumes that all sales are credit sales.
Results should be compared with credit terms: e.g, 30 days.
With the use of EFTPOS, the Average Collection Period for
many retailers in Australia is around 3 days.
It is common to use average receivables.

24

Assessing performance and risk


Financial ratio analysis - Investment ratios: Payables Days Outstanding

Payables Days Outstanding

Measures how long it takes a company to pay its creditors.

A rising ratio could be indicative of liquidity problems; however, it could also


imply that a company is trying to match its Average Collection Period.

Payables Days Outstanding = (Payables * 365) / Sales

25

Assessing performance and risk


Financial ratio analysis - Investment ratios: Payables Days Outstanding - example

Payables Days Outstanding = (Payables * 365) / Sales

?
?

Steam Ltd Payables Days Outstanding = (76 855 * 365) / 639 731 = 44 days
Power Ltd Payables Days Outstanding = (234 247 * 365) / 1 624 341 = 52 days

Notes:

Calculation uses sales as a proxy for purchases, because


the latter are seldom disclosed.

It is common to use average payables.

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Assessing performance and risk


Financial ratio analysis - Investment ratios: Cash Cycle

Cash Cycle
Measures how long it takes for inventories to be converted to cash.
As demand grows, inventories, receivables and payables grow. If not
carefully managed, liquidity problems may arise.

Cash Cycle = Operating Cycle - Payables Days Outstanding

Operating Cycle = Inventory Days Outstanding + Average Collection Period

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Assessing performance and risk


Financial ratio analysis - Investment ratios: Cash Cycle - example

Operating Cycle = Inventory Days Outstanding + Average Collection Period

Steam Ltd Operating Cycle = 9 + 56 = 65 days


Power Ltd Operating Cycle = 14 + 63 = 77 days
Cash Cycle = Operating Cycle - Payables Days Outstanding
Steam Ltd Cash Cycle = 65 - 44 = 21 days
X Power Ltd Cash Cycle = 77 - 52 = 25 days

Notes:
It

is possible to have a negative Cash Cycle.

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Assessing performance and risk


Financial ratio analysis - Financing ratios: general principles

Financing ratios: general principles


The higher the proportion of assets financed by equity, the lower financial
risk.
However, companies with low levels of debt may be missing out on tax
shields.
At the same time excessive debt is undesirable, particularly when cash flows
are unstable.
Moreover, companies with higher business risk should borrow less.
Furthermore, the nature of the industry affects how much a company can
borrow.
The nature of assets also plays an important role: tangible assets versus
intangible assets.
Financial managers should take all the above into consideration when
determining optimal capital structure (i.e., the level of debt in relation to
equity).

29

Assessing performance and risk


Financial ratio analysis - Financing ratios: Debt-to-Assets

Debt-to-Assets
Measures

proportion of assets financed by debt.

Debt-to-Assets = Liabilities / Assets

30

Assessing performance and risk


Financial ratio analysis - Financing ratios: Debt-to-Assets - example
Debt-to-Assets = Liabilities / Assets

Steam Ltd Debt-to-Assets = 371 242 / 693 195 = 53.6%


Power Ltd Debt-to-Assets = 886 258 / 1 224 475 = 72.4%

Notes:
A high Debt-to-Assets ratio is indicative of a high level of
financial risk.
It is common to use average liabilities and assets.

31

Assessing performance and risk


Financial ratio analysis - Financing ratios: Debt-to-Equity

Debt-to-Equity
Measures

proportion of debt financing relative to equity financing.

Debt-to-Equity = Liabilities / Ordinary Shareholders Equity

32

Assessing performance and risk


Financial ratio analysis - Financing ratios: Debt-to-Equity - example

Debt-to-Equity = Liabilities / Ordinary Shareholders Equity

Steam Ltd Debt-to-Equity = 371 242 / 321 953 = 115.3%


Power Ltd Debt-to-Equity = 886 258 / 338 217 = 262%

Notes:
A high Debt-to-Equity ratio is indicative of a high level of
financial risk.
It is common to use average liabilities and shareholders
equity.

33

Assessing performance and risk


Financial ratio analysis - Financing ratios: Times Interest Earned

Times Interest Earned


Measures

the number of times interest expense is covered by EBIT.

Times Interest Earned = EBIT / Interest

34

Assessing performance and risk


Financial ratio analysis - Financing ratios: Times Interest Earned - example

Times Interest Earned = EBIT / Interest

Steam Ltd Times Interest Earned = 98 588 / 15 628 = 6.3 times


Power Ltd Times Interest Earned = 136 690 / 51 108 = 2.7 times

Notes:
Companies with stable income can accommodate lower Times
Interest Earned ratios.
Banks like to see Times Interest Earned greater than 3 before
they lend to businesses.
Some analysts use cash flow from operations instead of EBIT.

35

Assessing performance and risk


Financial ratio analysis - Financing ratios: Current ratio

Current ratio
Measures the proportion of current assets to current liabilities.
Varies according to type of industry: e.g., manufacturers require higher
current ratio than service providers.
Affected by inventory valuation method.
Indicates safety margin for lenders of short-term funds.

Current ratio = Current Assets / Current Liabilities

36

Assessing performance and risk


Financial ratio analysis - Financing ratios: Current ratio - example

Current ratio = Current Assets / Current Liabilities

Steam Ltd Current ratio = 227 698 / 200 187 = 1.1 times
Power Ltd Current ratio = 452 265 / 312 340 = 1.4 times

Notes:
If the Current ratio is too high it may be indicative of inefficient
management of working capital.
A Current ratio less than 1 is undesirable.

37

Assessing performance and risk


Financial ratio analysis - Financing ratios: Quick ratio

Quick ratio
Measures

immediate ability of current assets to cover current liabilities.


Affected by inventory valuation method.
Affected by nature of inventory: whether liquid or not.
Indicates a more stringent safety margin for lenders of short-term funds.

Quick ratio = (Current Assets - Inventory) / (Current Liabilities - Bank Overdraft)

38

Assessing performance and risk


Financial ratio analysis - Financing ratios: Quick ratio - example

Quick ratio = (Current Assets - Inventory) / (Current Liabilities - Bank Overdraft)

Steam Ltd Quick ratio = (227 698 - 12 251) / (200 187 - 0) = 1.1 times
Power Ltd Quick ratio = (452 265 - 57 367) / (312 340 - 0) = 1.3 times

Notes:

Bank overdraft is excluded, because it is regarded as a more


permanent form of debt.

39

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: EPS

Earnings Per Share (EPS)


Measures

net profit attributable to a single ordinary share.


Forward-looking in terms of expected capacity of company to pay dividends.

EPS = (NPAT - Dividends paid to Preference Shareholders) / Number of Ordinary Shares

40

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: EPS - example

EPS = (NPAT - Dividends paid to Preference Shareholders) / Number of Ordinary Shares

Steam Ltd EPS = (49 284 - 0) / 77 900 = 63.3 cents

Power Ltd EPS = (65 279 - 0) / 195 800 = 33.3 cents

Notes:

Relates to number of shares issued rather than shareholders


equity.

41

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: Earnings Yield

Earnings Yield
Measures

return as a percentage of current market share price.

Earnings Yield = EPS / Market Price of a Single Ordinary Share

42

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: Earnings Yield - example

Earnings Yield = EPS / Market Price of a Single Ordinary Share

Steam Ltd Earnings Yield = 63.3 / 940 = 6.7%


Power Ltd Earnings Yield = 33.3 / 514 = 6.5%

Notes:

Numbers are from EPS calculations on slide 44

Although Earnings Yield for Steam Ltd. is indicated to be


superior, it is only marginally better than that of Power Ltd. For
all practical purposes, the difference is insignificant.
43

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: PE

Price Earnings (PE)


The inverse of Earnings Yield.
Indicates how many times currentearnings investors are willing to pay for a
share.
As such, PE is forward-looking in that it reflects investors perceptions of a
companys earnings potential.

PE = Market Price of a Single Ordinary Share / EPS

44

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: PE - example

PE = Market Price of a Single Ordinary Share / EPS

Steam Ltd PE = 940 / 63.3 = 14.9 times

Power Ltd PE = 514 / 33.3 = 15.4 times

Notes:

Numbers are from EPS calculations on slide 44.

For all practical purposes, the difference is insignificant.

A relatively high PE is indicative of expected growth in


earnings.
45

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: DPS

Dividends Per Share (DPS)


Measures

the dollar dividend income received from each ordinary share.

DPS = Dividends Paid to Ordinary Shareholders / Number of Ordinary Shares

46

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: DPS - example

DPS = Dividends Paid to Ordinary Shareholders / Number of Ordinary Shares

Steam Ltd DPS = 16 826 / 77 900 = 21.6 cents


Power Ltd DPS = 24 822 / 195 800 = 12.7 cents

Notes:

DPS is usually less than EPS, because companies normally


retain a portion of their profits.

47

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: Dividend Yield

Dividend Yield

Measures the percentage dividend income received from each ordinary


share, based on its current market price.

Dividend Yield = DPS / Market Price of a Single Ordinary Share

48

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: Dividend Yield - example
Dividend Yield = DPS / Market Price of a Single Ordinary Share

Steam Ltd Dividend Yield = 21.6 / 940 = 2.3%

Power Ltd Dividend Yield = 12.7 / 514 = 2.5%

Notes:

Numbers are from DPS calculations on slide 50.

For all practical purposes, the difference is insignificant.

Market price is affected by expectations about future earnings.


49

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: Dividend Payout

Dividend Payout
Measures

the percentage of profit paid out as dividends.

Dividend Payout = Amount of Dividends Paid / NPAT

50

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: Dividend Payout - example
Dividend Payout = Amount of Dividends Paid / NPAT

Steam Ltd Dividend Payout = 16 826 / 49 284 = 34%

Power Ltd Dividend Payout = 24 822 / 65 279 = 38%

Notes:

Dividend payout is indicative of a companys policy on what


percentage of profit is to be retained.

Companies usually follow a policy of a constant dividend


payout.
51

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: Dividend Coverage

Dividend Coverage

Measures how many times earnings (profit) cover dividends on a per-share


basis.

Dividend Coverage = EPS / DPS

52

Assessing performance and risk


Financial ratio analysis -

Market and per share ratios: Dividend Coverage - example

Dividend Coverage = EPS / DPS

Steam Ltd Dividend Coverage = 63.3 / 21.6 = 2.9 times


Power Ltd Dividend Coverage = 33.3 / 12.7 = 2.6 times

Notes:

Numbers are from EPS calculations on slide 44.

Numbers are from DPS calculations on slide 50.

53

Assessing performance and risk


Financial ratio analysis - Market and per share ratios: NAPS

Net Assets Per Share (NAPS)


Measures

asset backing by shareholders equity on a per-share basis.

NAPS = Ordinary Shareholders Equity / Number of Ordinary Shares

54

Assessing performance and risk


Financial ratio analysis -

Market and per share ratios: NAPS - example

NAPS = Ordinary Shareholders Equity / Number of Ordinary Shares

Steam Ltd NAPS = 321 953 / 77 900 = $4.13


Power Ltd NAPS = 338 217 / 195 800 = $1.73

Notes:
Calculation reflects the book value of assets, rather than their
market value.
A relatively high NAPS may be indicative of a potential
takeover.

55

Assessing performance and risk


Financial ratio analysis -

Summary of profitability ratios

Steam Ltd

Power Ltd

Industry

ROE

15.3%

19.3%

15.9%

ROA

14.2%

11.2%

12.1%

0.92 times

1.33 times

0.87 times

15.4%

8.4%

10.5%

Depreciation Expense

7.4%

2.5%

N.A.

Interest Expense

2.4%

3.1%

N.A.

Profitability ratios

Asset Turnover
Gross Profit Margin

56

Assessing performance and risk


Financial ratio analysis -

Summary of investment ratios

Steam Ltd

Power Ltd

Industry

40.3 times

25.2 times

78 times

9 days

14 days

5 days

6.4 times

5.7 times

8.1 times

Average Collection Period

56 days

63 days

44 days

Payables Days Outstanding

44 days

52 days

N.A.

Cash Cycle

21 days

25 days

N.A.

Investment ratios
Inventory Turnover
Inventory Days Outstanding
Receivables Turnover

57

Assessing performance and risk


Financial ratio analysis -

Summary of financing ratios

Steam Ltd

Power Ltd

Industry

Debt-to-Assets

53.6%

72.4%

59.1%

Debt-to-Equity

115.3%

262%

N.A.

Times Interest Earned

6.3 times

2.7 times

3.7 times

Current ratio

1.1 times

1.4 times

1.3 times

Quick ratio

1.1 times

1.3 times

1.2 times

Financing ratios

58

Assessing performance and risk


Financial ratio analysis -

Summary of market and per share ratios

Steam Ltd

Power Ltd

Industry

63.3 cents

33.3 cents

N.A.

6.7%

6.5%

N.A.

PE

14.9 times

15.4 times

N.A.

DPS

21.6 cents

12.7 cents

N.A.

Dividend Yield

2.3%

2.5%

N.A.

Dividend Payout

34%

38%

N.A.

2.9 times

2.6 times

N.A.

$4.13

$1.73

N.A.

Market and per share ratios


EPS
Earnings Yield

Dividend Coverage
NAPS

59

Analysis of financial statements


Internal influences

Developmental stage of company


New companies typically have poor liquidity, particularly when they operate in
growth industries.

Seasonal patterns
Inventories typically build up prior to seasonal demand: e.g., Christmas, Easter,
Summer, Winter, etc.

Nature of product
Some products typically have higher turnover than others: e.g., fast food
compared to hardware.

60

Analysis of financial statements


External influences

External influences include:


Competition.
Technological
Economic

61

change.

/ political factors.

Can be either local or global.

Analysis of financial statements


Sources of information

Annual reports are the primary source of information.


Other sources include:
Media

releases, particularly the financial press.

The Australian
Analyst

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Securities Exchange (ASX).

reports.

Analysis of financial statements


Limitations

Limitations of financial statement analysis include:

Variation in the classification of financial information: e.g., valuation of


inventory.

Non-disclosure of certain information: e.g., sales by division or by


product line.

Timing of the release of financial information: in some cases this can be


up to 15 months late.

63

Analysis of financial statements


Limitations - continued

Limitations - continued:

Lack of benchmarks: e.g., in some cases industry averages are


unavailable.

Overlooks narrative (non-numerical) information: e.g., comments made


in the Notes to the financial statements.

End-of-year numbers may represent extremes: sometimes it is better to


use averages.

64

Analysis of financial statements


Concluding remarks

Do

X Do not

Do consider numerous ratios.

Do not rely on only one or two ratios.

Do pay attention to implications and


limitations of ratios.

Do not merely focus on number


crunching.

Do consider ratios from various


categories.

Do not concentrate on ratios that


convey similar information.

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MPA702 in T1 2015

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