Analysis of Financial Statements
Chapter 2 Analysis of Financial Statements
Of the reports that corporations issue to its shareholders, the annual report is the most important, has two types of information, a director’s letter describing the results of the previous year and new developments that will affect future operations and two presents four basic financial statements, income statement, balance sheet, statement of retained earnings and cash flow statement, which provided an overview of accounting in relation to business operations and financial position (corporate finance) annexing key operating statistics of the last 5.
It is the document that presents the financial position of the company to a certain date
Cash versus other assets .- accounts receivable, inventories showing the company’s investment in raw materials, production processes and finished products for sale. Fixed assets are the amount paid by the plant and equipment. Cash and marketable securities
Liabilities versus equity of shareholders .- the taxes levied on the assets are of two types, a passive or money you owe the company and two property position of shareholders
The common equity shareholders and net equity equals assets less liabilities, less preferred equity.
Common stock versus preferred capital .- The CP represents a compromise between common equity and debt, their dividends are fixed and do not benefit when the shares rise in bankruptcy and is listed below debt but above common stock , companies rarely use it.
Analysis of the common equity account or net worth .- It is divided into three, social capital, capital exhibited and retained earnings, which are constructed cumulative over time, when the company saves instead of paying the full earnings as dividends. And the other two accounts are the issue of shares to obtain capital.
Accounting for inventories .- You can take as FIFO with higher values in the inventory of stock, but with a lower sales cost in the income statement or LIFO.
.- Depreciation methods using the straight-line method, which is faster with a lower charge and tax purposes.
Dimension of time .- The statement is a photograph that reports on the operations over a period of time. The balance sheet changes daily as the inventory increases or decreases, changes in fixed assets, bank loans, etc.
.- Retained Earnings Statement shows the earnings of the company were not paid as dividends, as appears to retained earnings annually and make up the history of the company, are the changes to equity, retained earnings to expand the business, not represent cash and are not available for the payment of dividends or otherwise.
Depreciation .- It is a position that does not represent a cash outflow, and therefore should be added to net income to obtain an estimate of cash flow from operations.
Countable income versus cash flow .- The actual net cash a company generates for a specific period as opposed to accounting net income. The value of a business is determined by cash flows generated, which are coming from cash sales less cash operating costs (including depreciation, labor and raw materials) less interest charges and fewer taxes. The present value of an action is based on the present value of expected cash flows in the future. The flows are related to the accounting profit
The companies have two separate bases of value related, existing assets (profits and cash flows) and growth opportunities, and administrators are equally concerned about the flow than the profits.
Cash flows are divided into two, operating cash flows and cash flows
Other cash flows .- It is those who come from the issuance of equity, loan or sale of fixed assets
Operating cash flows .- They are those arising from normal operations, the difference between sales revenues and cash expenses incurred including taxes differ from accounting profits for two reasons, one for taxes in the state reported Results may not be paid the same year, and two sales can be spending on credit and do not represent cash outflow.
Cash flow cycle .- In making sales reduce inventory, increase cash, if the selling price over the cost of the item, this requires changes to the outcome of results.
If the company is profitable, its sales revenues exceed its costs and cash inflows exceed cash disbursements. If it happens it will not be able to cover its obligations and its operations to fail. Thus the forecast of cash flows is important in financial management, thus they require analytical techniques to identify cash flow problems before it becomes a problem.
Cash flow statement .- presents the impact of operational activities, investment and financing of a company on cash flows over an accounting period. An important part in the annual report.
Profits and dividends .- Most reports a summary of earnings and dividends over time, dividends per share (DPS) are the basic cash flows of the company sent to shareholders, thereby affecting the stock price .
Earnings per share for any year may be higher than the earnings per share (EPS), but long-term dividends are paid from profits. Earnings per share are smaller than the earnings per share and are called because of dividend payments.
Financial Ratio Analysis
The financial statements report a company’s position in time, but its real value is that it can be used to predict future earnings and dividends, and as a starting point for planning operations.
The analysis of financial ratios (first step in a financial analysis) have been designed to show the relationships between financial statements.
Liquidity ratios .- A liquid asset is one that can be converted into cash at a fair market value. The liquidity ratios show the relationship between a firm’s cash and other assets with its liabilities.
.- Current ratio is calculated by dividing current assets between current liabilities and indicates the degree to which current liabilities are covered by assets is expected to become effective in the near future. It is the best indicator of the extent to which the rights of short-term creditors are covered by assets that are expected to become effective, as is the measure of short-term credit is used more often.
Current ratio = Current assets
Quick ratio (acid test) .- It is calculated by deducting inventories from current assets and dividing the remainder by current liabilities.
Quick ratio or acid = current assets less inventories
Current assets include cash, marketable securities, accounts receivable and inventories.
The liabilities consist of accounts payable, notes payable to the short-term debt maturities circulating long-term income taxes payable and other accrued expenses (wages).
When the financial ratios are far from the average of its industry will have to find the cause of movement.
Reasons for administration of the assets .- measure the effectiveness with which the company is managing its assets. It can identify if requested borrowing or capital from other sources to acquire assets, if they are too active, interest will be very high, and if it happens otherwise is lost productivity.
Inventory turnover .- It is the division of sales between inventories:
Inventory turnover ratio = sales
Notes that each inventory item is sold every x days inventory turnover.
We present two problems, one sales are stated at market value, if inventories are carried at cost, calculated reason exaggerates the real reason of rotation. It would therefore be more appropriate to use the cost of sales instead of sales in the numerator of the formula. And two, the sales occur in the course of the year, and the number of inventory referred to a specific point in time, so it is best to use an average measure of the inventory.
Days sales outstanding or average collection period .- Evaluate accounts receivable and is calculated by dividing the average daily sales from the accounts receivable. And to determine the number of days of sale are included in accounts receivable, which represent the average amount of time that a company expects to receive cash after the sale.
Days Sales Outstanding = Accounts receivable = accounts receivable
Sales Average annual sales per day / 360
.- Fixed asset turnover measures the effectiveness with which the firm uses its plant and equipment, is the ratio of sales to net fixed assets.
Turnover ratio of fixed assets = ventas_________
Net fixed assets
Total asset turnover measures the rotation .- all company assets and is calculated by dividing sales by total assets.
Ratio of total assets turnover = ventas______
Debt management ratio .- how use it in the company financing through debt or leverage involved, raise funds through debt, creditors provide the equity to see the margin of safety, if the company gets better return on investments funded in loans that the interest paid on them, just so there is leverage in the performance of the owners.
Reason for basic generation utilities .- It is equal to EBIT between total assets, resulting in the expected utility before interest and taxes.
Financial leverage increases expected rate of return for shareholders for two reasons, the interest is a deductible expense, the use of debt financing through reduces the amount of taxes and allows a greater amount of income in operation company is in the hands of shareholders. And two, if the rate of return expected on EBIT assets / Total assets exceeds the rate of interest on debt, then one firm can use debt to finance assets, to pay interest on debt and get rewards for shareholders . The debts are used to leverage up the rate of return on equity, although it involves more risk.
To examine the debts of a company in financial analysis, one will verify the reasons for the balance sheet to determine the extent to which we have used the borrowed funds to finance the assets and 2 review the reasons the income statement to determine the number of times fixed charges are covered by operating profits.
Debt Ratio of total debt to total assets .- measures the percentage of funds provided by creditors.
Debt Ratio = total debt
Total debt includes current liabilities and long-term debt, while lower the ratio the greater the cushion against the losses of the creditors on liquidation
Ratio of interest-earnings TIE .- Obtained by dividing earnings before interest and taxes EBIT between interest charges. Measures the extent to which operating income can fall before the company becomes unable to meet its annual interest costs.
Ratio of interest-earnings TIE = EBIT
Coverage ratio of fixed charges .- It is similar to the rotation of interest to utilities, but acknowledges that many companies active income and also must make payments to its sinking fund. The sinking fund payment to be divided by one minus the tax rate to determine the pre-tax income required to pay taxes and leftover funds to make payments to the sinking fund.
Fixed charges include interest, annual obligations of long-term leases and sinking fund payments.
Ratio fixed-charge coverage = EBIT + lease payments
+ Interest charges + lease payments to the sinking fund payments
(1 – tax rate)
.- Profitability ratios Profitability is the net result of several policies and decisions. Show the combined effects of liquidity, asset management and debt management on operating results.
Profit margin on sales .- It is calculated by dividing the net income from sales, shows the utility gained per dollar of sales. Indicates that sales are very low or that the costs are too high or both.
Profit margin on sales = Net income available to common shareholders
BEP basic utilities Generation .- Calculated by dividing earnings before interest and taxes EBIT between total assets. Displays the basic potential of generating profit before tax assets and leverage.
Basic Generation BEP = EBIT______Activos total earnings
Return on total assets ROA .-
Return on total assets ROA = net income available to common shareholders
Return on equity
Return on common equity ROE = net income available to common stockholders – Common Equity
Reasons for market value .- relates the price of the shares of the company with earnings and book value per share, provides an indication of what investors think of past performance and future plans.
Reasons price / earnings .- Show the number of investors who are willing to pay per dollar of reported earnings. Shows the level of risk and growth prospects
Reasons price / earnings per share = price
Earnings per share
Ratio of market value / book value .- It shows how investors see the company’s high rates of return on equity latos sold in multiples to their book value.
Book value per share common equity =
And dividing the market price per share of book value yields the market value ratio at book value (M / B)
Carrying market value = market price per share
Book value per share
Trend analysis .- It is the trend analysis of financial ratios over time. It is done through the charting of the reasons according to the years
Du Pont Chart .- It is designed to show the relationship between the return on investment, asset turnover, profit margin and leverage.
.- Du Pont equation is obtained by multiplying the profit margin by asset turnover total and gives us the rate of return on assets ROA
ROA = profit margin x total asset turnover
= Net income x Sales
total assets sales
ROA is net income available to common shareholders divided by total assets, where the rate of return on assets ROA, must be multiplied by a factor of equity ROE
ROE = ROA x equity multiplier
X = Net income Total assets
Common equity Total assets
Du Pont equation changed
ROE = Net Income x Sales x Total assets
selling common equity total assets
Uses and limitations of financial ratio analysis
The financial ratio analysis is used by three groups, administrators to analyze and monitor and improve business operations, credit analysts, to grant bank loans and bond analysts to investigate the ability to pay of the companies, and analysts values, actions to achieve the efficiency of enterprises. Provides information about business operations and financial condition.
Some limitations are that financial ratios are most useful for small businesses with few divisions, prefer to rely on industry leaders and be above average, it is difficult to compare between two different companies because of their inherent complexity, there are problems with inventory turnover by product type, used makeup to enhance business, the reasons are distorted by the variability of the information, financial ratios are not determinative to indicate good or bad judgments, organizations may have reasons to see good and some not, which does not mean they are doing things wrong.
Make use of financial ratios, requires an awareness of the settings and should be used wisely, as they can provide useful indications of the operations of the company.
Chapter 3 The financial environment, markets, institutions, interest rates and taxes
Financial managers must understand the environment and gift markets businesses operate and where capital is obtained, the securities are traded and where prices are fixed for the actions and institutions operating these markets.
Also require knowledge of how costs are determined and the main factors that determine the level of interest rates in the economy, tax levels and government regulations.
Business enterprises, individuals and government units often need to raise capital, either jointly with those who have excess funds which occurs in financial markets, we have different types of markets:
Markets fixed assets (tangible or real assets) .- are those used to transport products such as wheat, cars, real estate, computers, machinery. Financial asset markets dealing in shares, debentures, notes, mortgages and other rights over real assets.
Markets in the immediate term and future .- if an asset was purchased or sold for delivery immediately or at some future date.
Money markets .- In the circulating values representing sa debts owed less than a year.
Capital markets .- In circulating long-term debt and corporate actions.
Mortgage markets .- Manage loans on residential real estate, commercial and industrial land and agricultural in nature.
Credit markets for consumers .- include loans for the purchase of automobiles and appliances, as well as loans for education, vacations and the like.
World Markets national, regional and local .-
.- Primary markets where corporations get new capital through the issuance of common stock.
.- Those secondary market where existing securities in circulation and are traded among investors
It is essential that markets work efficiently, quickly and inexpensively, since a healthy economy depends on efficient transfer of funds from individuals and businesses that save and they need capital. Without this transfer of funds, the economy could not function.
The transfers occur in three ways:
Direct transfers of money and securities, occurs when a business sells its shares or bonds directly to savers without any intermediary.
Transfers through an investment banking house that operates as an intermediary and facilitates the issuance of securities.
Transfers through a financial intermediary like a bank or a mutual fund, which issues securities intermediary, the sale and purchase other securities. Create new financial products.
They are secondary markets in which securities are traded that are already in circulation that were issued earlier, here will be the stock prices of firms and seeks to maximize the value of the shares.
The stock market
There are two types of securities markets, organized exchanges and the market for sales on the counter. Stock exchanges are physical entities which are directed auction markets specific securities listed on the exchange. Facilitate communication between buyers and sellers.
The sales market on the counter is defined as the set of interconnected brokers and sellers electronically via telephones and computers, which is responsible for unregistered securities transactions on the exchange. There are few dealers, thousands of brokers who act as dealers and investors with the necessary equipment to operate.
The cost of money
The interest rate is the price paid by borrow debt capital, while stockholders’ equity, investors expect to receive dividends and capital gains.
There are four fundamental factors that affect the cost of money (or the supply of investment capital and its application): production opportunities, preferences for consumption, irrigation and inflation.
Time opportunities will depend mainly by the consumption of current consumption instead of saving with a view to future consumption, one example on this point would be: if the entire population was living at the subsistence level, time preferences for consumption Current necessarily be high, the aggregate savings will be low, the interest rate would be high and capital formation would be difficult.
The risk of direct concern to investors, the higher the perceived risk, the higher would be the required rate of return, is the probability that a loan is not repaid as pledged.
Credit to: Enrique Macías García