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Presenters name

Presenters title

dd Month yyyy

FINANCIAL ANALYSIS TOOLS:

DESCRIPTION

Graphics

Regression

Common-Size Analysis

Financial Ratio Analysis

GRAPHICS: EXAMPLE

22% 21%

19%

38%

Europe/South Pacific Greater Asia/Africa

GRAPHICS: EXAMPLE

2010

2009

Europe/South Pacific 2008

2007

Latin America

North America

$ millions

GRAPHICS: EXAMPLE

30.0%

25.0%

20.0%

15.0%

10.0%

5.0%

0.0%

REGRESSION: EXAMPLE

14.0

12.0

10.0

8.0

R = 0.27

6.0

GDP Change

4.0

2.0

0.0

-40.0 -30.0 -20.0 -10.0 0.0 10.0 20.0 30.0 40.0

-2.0

-4.0

Sales Growth

COMMON-SIZE ANALYSIS

statements, in relation to a single financial statement item or base.

Vertical common-size

- Balance sheet: Each item as a percent of total assets.

- Income statement: Each item as a percent of total net revenues.

- Cash flow: Each line as a percent of sales, assets, or total in and out.

- Highlights composition and identifies whats important.

Horizontal common-size

- Percentage increase or decrease of each item from the prior year or

showing each year relative to a base year.

- Highlights items that have changed unexpectedly or have

unexpectedly remained unchanged.

COMMON-SIZE BALANCE SHEET EXAMPLE:

SINGLE COMPANY, TWO PERIODS

Partial common-size balance sheet

COMMON-SIZE BALANCE SHEET EXAMPLE:

CROSS-SECTIONAL, TWO COMPANIES, SAME TIME

% of Total % of Total

Assets Assets

Cash 38 12

Receivables 33 55

Inventory 27 24

Fixed assets net of depreciation 1 2

Investments 1 7

Total Assets 100 100

USE OF COMPARATIVE GROWTH

INFORMATION: EXAMPLE

Revenue +19%

Receivables +38%

Inventory +58%

Why is inventory growing so much faster than revenue?

FINANCIAL RATIOS

Ratios

- Express one number in relation to another.

- Standardize financial data in terms of mathematical

relationships expressed as percentages, times, or days.

- Facilitate comparisonstrends and across companies.

RATIO ANALYSIS

15.26%

A ratio is NOT the answer (except sometimes on

an exam).

A ratio is an indicatorfor example, an indicator

of relative activity, profitability, liquidity, solvency.

RATIO ANALYSIS

How profitable was company X?

COMPANY XS PROFITABILITY

HAS IMPROVED. ITS NET

PROFIT MARGIN WAS 15.3%,

UP FROM 14.9% LAST YEAR.

A ratio is NOT the answer (except sometimes on an exam).

A ratio is an indicatorfor example, an indicator of relative

activity, profitability, liquidity, solvency.

Interpretation generally involves comparison. Furthermore,

analysis will address the question of why.

RATIO ANALYSIS

How profitable was Company X?

COMPANY Y AS EVIDENCED BY ITS NET

PROFIT MARGIN. COMPANY XS MARGIN OF

15.3% WAS HIGHER THAN COMPANY YS

MARGIN OF 12.0%.

A ratio is an indicatorfor example, an indicator of relative

activity, profitability, liquidity, solvency.

Interpretation generally involves comparison. Furthermore,

analysis will address the question of why.

USING FINANCIAL ANALYSIS TOOLS

Computation Analysis

Analysis goes beyond collecting data and computing numbers.

Analysis encompasses computations and interpretations.

Where practical, directly experience the companys business.

Analysis of past performance:

What aspects of performance are critical to successfully competing

in the industry?

How well did the company perform (relative to own history and

relative to competitors)?

Why? What caused the performance?

Does the performance reflect the companys strategy?

USING FINANCIAL ANALYSIS TOOLS

Not every ratio is relevant in every situation.

- Some ratios are irrelevant for certain companies.

- Some ratios are redundant.

- Industry-specific ratios can be as important as general

financial ratios.

- Different users and questions (e.g., creditors, investors)

focus on different ratios.

include different ratios.

CATEGORIES OF FINANCIAL RATIOS

Category Description

Activity Activity ratios. How efficient are the firms operations

and the firms management of assets?

meet short-term obligations?

Solvency Solvency ratios. How well is the firm positioned to

meet long-term obligations?

achieving returns on its investments?

Valuation Valuation ratios. How does the firms performance or

financial position relate to its market value?

PROFITABILITY AND OVERVIEW

Category Description

Activity Activity ratios. How efficient are the firms operations

and the firms management of assets?

meet short-term obligations?

Solvency Solvency ratios. How well is the firm positioned to

meet long-term obligations?

achieving returns on its investments?

financial position relate to its market value?

MEASURE OF PROFITABILITY:

RETURN ON EQUITY (ROE)

equity it had available during the year?

Amount of return

Rate of return =

Amount invested

Net income

ROE =

Average equity

DECOMPOSE ROE

Net income

ROE =

Average equity

=

Average assets Average equity

= ROA Leverage

DECOMPOSE ROE

and/or

as long as returns on the incremental investment exceed

the cost of borrowing.

RETURN ON ASSETS

What rate of return has the firm earned on the assets it had available to

use during the year?

Amount of return

Rate of Return =

Amount invested

Net income

(1) ROA =

Average assets

(2) ROA =

Average assets

=

Average assets

PROFITABILITY, COMPETITION,

AND BUSINESS STRATEGY

Net income

ROA =

Average assets

ROA =

Revenue Average assets

In other words,

ROA can

be thought

of as:

DECOMPOSING

RETURN ON EQUITY

ROE =

Revenue Average assets Average equity

Du Pont Analysis

DECOMPOSING

RETURN ON EQUITY

What was the source of the firms return on equity?

To what extent

. . . was it derived from selling a high margin product or keeping

expenses lowderiving more profits from each $1 of sales? (return

on sales, net profit margin)

. . . was it derived from generating higher sales from a lower

investment in assets? (efficient use of assets, also known as

turnover or efficiency)

. . . was it derived from investing a lower amount of equityby

using more debt in its capital structure? (financial leverage)

DECOMPOSING RETURN ON EQUITY:

STYLIZED COMPARATIVE ANALYSIS MINI-CASE

Averag

Co. A Co. B Co. C e

Sales ($) 2,000 4,000 6,675 4,225

Net income (NI) ($) 200 200 200 200

Average assets ($) 1,000 2,000 1,500 1,500

Average equity ($) 1,000 1,000 1,000 1,000

Average liabilities ($) 0 1,000 500 500

ROE (NI/Equity)

Net profit margin

(NI/Sales)

Turnover

(Sales/Assets)

Leverage

(Assets/Equity)

Copyright 2013 CFA Institute 26

DECOMPOSING RETURN ON EQUITY:

STYLIZED COMPARATIVE ANALYSIS MINI-CASE

Co. A Co. B Co. C Average

Sales ($) 2,000 4,000 6,675 4,225

NI ($) 200 200 200 200

Average assets ($) 1,000 2,000 1,500 1,500

Average equity ($) 1,000 1,000 1,000 1,000

Average liabilities ($) 0 1,000 500 500

ROE (NI/Equity) 20.0% 20.0% 20.0% 20.0%

Net profit margin

(NI/Sales) 10.0% 5.0% 3.0% 4.7%

Copyright 2013 CFA Institute 27

DECOMPOSING RETURN ON EQUITY:

COMPARATIVE

ROE 27.19% 21.50% 61.19%

Net profit

Net income/Sales margin 14.88% 7.04% 4.06%

Asset

Sales/Average assets turnover 1.00 1.17 2.26

Average assets/ Financial

Average equity leverage 1.83 2.61 6.67

DUPONT ANALYSIS :

FURTHER DECOMPOSITION

Decompose ROE into five factors

ROE =

EBT EBIT Revenue

Average assets Average equity

PROFITABILITY: RETURN ON SALES

(FROM THE COMMON-SIZE INCOME STATEMENT)

Measures the ability to translate sales into profit after consideration of

cost of products sold.

Measures the ability to translate sales into profit after consideration of

operating expenses.

Measures the ability to translate sales into profit after consideration of all

expenses and revenues, including interest, taxes, and nonoperating

items.

DISCUSSION BY CATEGORY

Category Description

Activity Activity ratios. How efficient are the firms operations

and the firms management of assets?

short-term obligations?

Solvency Solvency ratios. How well is the firm positioned to meet

long-term obligations?

achieving returns on its investments?

Valuation Valuation ratios. How does the firms performance or

financial position relate to its market value?

ACTIVITY RATIOS

How efficiently is the firm using its assets? How many dollars of

sales was the firm able to generate from each dollar of assets?

Broadly

Asset turnover = Revenue/Average total assets

Low or declining ratios could mean

- Sales are sluggish,

- A heavy investment in assets (inefficient? plant modernization to

help in future? strategy shift?), and/or

- Asset mix changed.

Specifically, for fixed assets:

Fixed asset turnover = Revenue/Average net fixed assets

Can compute for any category of assets.

ACTIVITY RATIOS

Numerator Denominator

Working capital turnover Revenue Average working capital

Fixed asset turnover Revenue Average net fixed assets

Total asset turnover Revenue Average total assets

OTHER COMMON ACTIVITY RATIOS

Numerator Denominator

Number of days in

Days of inventory on hand (DOH) Inventory turnover

period

Days of sales outstanding (DSO)

period turnover

Average trade

Payables turnover Purchases

payables

Number of days in

Number of days of payables Payables turnover

period

ACTIVITY RATIOS AND THE CASH CYCLE

(CASH CONVERSION CYCLE, A LIQUIDITY RATIO)

Cash cycle: How long does it take for the firm to go from cash to cash?

- Service company: sell service receive cash.

- Merchandising company: buy inventory sell inventory receive

cash and pay for inventory.

- Manufacturing company: buy raw materials make product sell

product receive cash and pay for materials and labor.

+ Days inventory held Number of days of payables

investment required to support this cycle.

LIQUIDITY

obligations?

Account receivables)/Current liabilities

Current liabilities

DISCUSSION BY CATEGORY

Activity Activity ratios. How efficient are the firms operations

and the firms management of assets?

short-term obligations?

Solvency Solvency ratios. How well is the firm positioned to meet

long-term obligations?

achieving returns on its investments?

Valuation Valuation ratios. How does the firms performance or

financial position relate to its market value?

SOLVENCY: HOW WELL POSITIONED IS THE

FIRM TO MEET ITS LONGER-TERM LIABILITIES?

Debt ratios: How has the company financed itself?

Debt to total assets

}

Lower ratio > safer.

Debt to equity

Higher cushion against

Debt to total capital

potential creditor losses

decline without affecting firms ability to pay interest.

EBIT interest coverage = (EBT + Interest payments)/Interest

payments

Fixed charge coverage = (EBIT + Lease payments)/(Interest

payments + Lease payments)

COMMON SOLVENCY RATIOS

Debt ratios

Debt-to-assets ratio Total debt Total assets

Debt-to-capital ratio Total debt Total debt + Total

shareholders equity

Debt-to-equity ratio Total debt Total shareholders equity

Financial leverage Average total assets Average total equity

ratio

Coverage ratios

Interest coverage EBIT Interest payments

Fixed charge EBIT + Lease Interest payments + Lease

coverage payments payments

DISCUSSION BY CATEGORY

Category Description

Activity Activity ratios. How efficient are the firms operations

and the firms management of assets?

short-term obligations?

Solvency Solvency ratios. How well is the firm positioned to meet

long-term obligations?

achieving returns on its investments?

Valuation Valuation ratios. How does the firms performance or

financial position relate to its market value?

VALUATION RATIOS:

PRICE-TO-EARNINGS RATIO

P/E relates earnings per common share to the market price at

which the stock trades, expressing the multiple that the stock

market places on a firms earnings.

Price

P/E =

Earnings per share

- Firm is valued highly by market, possibly because of growth

expectations, or

- That a firm may have very low earnings per share.

VALUATION RATIOS

Numerator Denominator

Valuation ratios

P/E Price per share Earnings per share

P/CF Price per share Cash flow per share

P/S Price per share Sales per share

P/BV Price per share Book value per share

DIVIDEND-RELATED QUANTITIES

Dividend payout ratio =

Earnings per share

Dividend yield =

Price

SELECTED CREDIT RATIOS USED BY

STANDARD & POORS AS PART OF CREDIT ANALYSIS

Ratio Numerator Denominator

Gross interest (prior to

EBIT and EBITDA

EBIT or EBITDA deductions for capitalized

interest coverage

interest or interest income)

FFO plus interest Gross interest (prior to

FFO interest coverage paid minus operating deductions for capitalized

lease adjustments interest or interest income)

FFO to debt FFO Total debt

CFO (adjusted)

Free operating cash

minus capital Total debt

flow to debt

expenditures

CFO minus capital

Discretionary cash flow

expenditures minus Total debt

to debt

dividends paid

SELECTED CREDIT RATIOS USED BY

STANDARD & POORS AS PART OF CREDIT ANALYSIS

Average capital, where capital is

Return on capital EBIT equity plus noncurrent deferred

taxes plus debt

Net cash flow to capital

FFO minus dividends Capital expenditures

expenditures

Debt to EBITDA

Total debt to total debt Total debt Total debt plus equity

plus equity

SEGMENT ANALYSIS EXAMPLE:

LORAL

MODEL BUILDING:

EXAMPLES OF POSSIBLE USES OF RATIOS

income statement)

Gross profit (gross profit margin)

Operating profit (operating profit margin)

Liabilities (leverage ratios)

Cash flow

RATIOS IN MODEL BUILDING

Sales forecast

Forecast

Debt

Expenses

Gross Profit

Operating Profit

Forecast

Forecast

Interest

Cash Flow

Expense Assets

Liabilities

Forecast

Income and Cash Flow

Taxes

SUMMARY: FINANCIAL ANALYSIS TOOLS

relationships.

Common-size analysis expresses financial data, including entire

financial statements, in relation to a single financial statement item or

base.

Ratios, which express one number in relation to another, facilitate

comparisonstrends and cross-sectional.

A ratio is an indicator of

- Activity

- Profitability

- Liquidity

- Solvency

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