Anda di halaman 1dari 7

Analysis of Financial Statements (MBA) Instructor: Prof.

Asif Bashir
Project Instructions Project writing is not a difficult task at all. However, it is an art by which the writer represents his point of view in a way that it looks professional, clear and comprehensive, and finally leaves a long lasting impression on the reader.

Ethics of project writings: Project writing has some ethics which must have to be followed by the writer in order to make a professional project. Emphasis on these ethics will make you learn how to write a project in a professional manner. Ethics of project writing include making a main page, writing a preface, giving an acknowledgement, making a table of contents, putting executive summary, giving an introduction to the project, mentioning the contents of the project, concluding it, including all the tables and annexure, and finally writing a bibliography.

What this project involves: The idea is to concentrate on doing a full analysis of one firm. Since I suspect that you may have other courses or jobs, what is required here is somewhat less than a full analytical workup. You will be applying some of the financial principles we have discussed in class. A comprehensive outline is given below to make the project. 1. Select a company of your choice as a first step and apply principles that are mentioned below. (I understand that some data will not be available for the firms.

However, you have to assume missing figures based on your understanding and our class discussions.)

FIRM COMPARABILITY: Data on a firm all by itself is not very revealing the data needs to be related to other firms. But the other firms must be similar to the subject firm. The good news is that here we are not making any comparisons; rather we are going to focus on one firm. The following items should be checked to evaluate the firm as initial homework: 1. Industry: a. SEC Code, principle line of business b. Diversification does the firm have multiple lines of business? c. Competitors who are the firms competitors Size of the firm: Capitalization: How much capital the firm has engaged for its business. Sales: What is the trend in sales of the firm? How stable you think sales are? Ownership: a. Is the firm independent or it is a subsidiary? b. Does any other firm have significant interest in your firm? International: a. How much of sales is outside Pakistan? b. How much of assets are outside Pakistan? c. What is the business situation in the major non-Pakistani customers/suppliers?

2. 3. 4. 5.

CREDIT ANALYSIS: The idea here is to consider whether you would extend shortterm trade credit to the firm. If it seems like a lot of work, well, it is. However as this analysis will be shared by different sections, your workload will be adjusted somehow. 1. Footnotes accounting comparability (indicate the required adjustments if any) a. LIFO/FIFO/Other inventory accounting b. Revenue recognition c. Factoring/Sales of receivables/discounting

2. 3.

4.

5.

6.

7.

d. Lines of credit, Loan commitments, ratings (Bonds, preferred) e. Restriction on sales of assets f. Business Cycle Analysis of current assets and liabilities composition: a. Current assets composition b. Current liability composition Working Capital and related ratios a. Working capital b. Current Ratio c. Net Trade Cycle d. Cash Ratio e. Cash to current liabilities Operating measures, Accounts Receivables a. Accounts receivable turnover b. Collection Period c. Days Sales in receivables d. Aging Operating measures, inventory a. Inventory turnover ratio b. Days to sell inventory c. Days sales in inventory d. Conversion Period e. Days purchases in accounts payable Additional measures: a. Liquidity index b. Acid Test c. Cash Flow ratio Financial flexibility, alternatives a. Lines of credit, loan commitments b. Debt ratings i. Planned issues ii. Maturing issues c. Stock Ratings i. Planned issues ii. Options/warrants/convertibles d. Availability of assets for liquidation i. Short Term assets ii. Long Term assets e. Contingencies

At this point you should have a list of ratios that will be used for credit analysis and it should end up with a definite conclusion as to whether or not you would be willing to extend short term credit to the firm.

FORECASTED / PRO FORMA STATEMENTS: Just accepting the firms forecast, if any, is not sufficient here. You should be able to look at the trend and extrapolate it. 1. 2. 3. 4. Income Statement Statement of Cash Flows Balance Sheet Longer term cash flow forecasting. a. Specifications for assumptions b. Cash flows from operating, investing and financing activities 5. Special Ratios. a. Cash Flow adequacy b. Cash reinvestment ratio 6. Reliability/reality of Pro Forma statements a. Comparison to historical ratios b. Comparisons to firm projections 7. Sensitivity analysis of Pro Forma Statements a. Individual Variables b. Decision Tree/probability distribution For Restricted purposes of this course, the decision tree analysis would be restricted I would suggest a two-stage tree for three level of occurrence. At this point, you should have Pro Forma Income statement, Balance Sheet and Cash Flow Statement. I would keep them relatively simple in form.

LONG TERM SOLVENCY ANALYSIS: The emphasis of the examination of statements now shifts to long term. 1. Accounting Adjustments/Uncertainties a. Deferred tax assets/liabilities b. Pensions c. Unconsolidated subsidiaries (Guaranteed/senior earnings, revaluation of assets). d. Contingent liabilities e. Minority interests f. Convertible Debt (Debt or Equity) g. Preferred Stock (Debt or Equity) h. Market Value of assets i. Inventories (FIFO/LIFO/Other) j. Intangible assets (Value/Remove)

debt,

undistributed

2. Miscellaneous items: a. Sinking funds b. Putables c. Pledged assets/guarantees d. Compensating balances e. Covenants/restrictions 3. Solvency Ratios Analysis of asset Distribution and capital structure/leverage a. Total Debt to total Capital b. Total Debt to Equity Capital 4. Solvency Ratios Asset Coverage a. Fixed assets to common equity b. Net tangible assets to long term debt c. Total liabilities to net tangible assets 5. Solvency Ratios Earnings Coverage: a. Earnings available for fixed charges to Fixed charges i. Earnings Extraordinary, preferred dividends, minority earnings, taxes, averaged/smoothed. ii. Fixed charges amortization of discounts/premiums, capitalized interest, implied lease interest, pre-tax preferred dividends, scheduled principal payments, payments under guarantees b. Times interest Earned 6. Cash flow to fixed charges 7. Earnings coverage to preferred dividends At this point, you should have a comparison of ratios and of qualitative aspects over years for the firm. This comparison should end up with a definite conclusion as to whether or not you would be willing to extend long term credit to the firm

PROFITABILITY ANALYSIS: This section might indicate a modification of the results of the previous section, which primarily emphasized safety and recoverability in bankruptcy. 1. Return on invested capital: a. Invested capital b. Income 2. Return on equity a. Corrections to equity 3. Return on total assets 4. Return on Long term capitalization

5. Disaggregation: a. Break down developed in class b. Historical breakdown/trends c. Estimation of the sustainable growth rate i. Analysis of earnings retention trend 6. Miscellaneous: this is where you look for anything not covered above. You should definitely look for acquisitions and whether they were treated using purchase or pooling. You should also consider whether there is any use of options as executive compensation, and whether there is any effect from pensions and/or post-retirement benefit accounting. The analysis of these items will usually be qualitative in nature, and in this analysis would be caught in the uncertainty of the forecasts.

VALUATION: Valuation is a vast topic. It is the basis of the stock selection, of course, but is also basic to mergers and acquisitions and actually underlies almost any area of Finance. There are several professional designations available in this area, and there are consulting firms that specialize in this area, providing assistance in buyouts and expert witness testimony. The analysis is based, of course, on your restated statements. 1. Required rate of return: a. DDM: K=(D1/P) + g i. Estimated dividend ii. Estimated sustainable growth iii. Observed price b. CAPM i. Risk Free rate is 30-day T-bill rate ii. Expected market risk premium is set to be at 8% iii. Beta from commercial sources or calculated 2. Risk Return comparative framework: a. Draw a security market line i. Risk Free rate is 30-day T-bill rate ii. Expected market risk premium is set to be at 8% b. Plot returns at the appropriate beta c. Comments on price vs value 3. Price comparison: a. Using beta and CAPM, find Expected rate of Return b. Using estimated dividend, sustainable growth rate and the CAPM Expected rate of return, estimate DDM price

c. Comment on price vs value

CONCLUSION: Last but not the least, making a suggestion or conclusion, about the firm, the quality of earnings and the value of the firm. Dont forget to attach financial statements for the respective years, in order to support your analyses.

Thats it! Obviously, we could go on at some length, and the analysis would cover several firms or an entire industry. But we have time constraints, and what is above will point you in the right direction. Some extensions are clear, some are simply more of what is here, and some will come out of the blue. You will need to keep up with the fertile imaginations of statement preparers as they devise even more devious versions of CRAP.

Best of luck with this small project and rest of the course work!

Anda mungkin juga menyukai