1_Lecture002.pdf
- 1. CHAPTER 3 Financial Statements Analysis and Financial Model 1
- 2. Financial Statements Analysis Standardized statements Standardized statements make it easier to compare financial statements, particularly as the company grows. ➢ Common-Size Balance Sheets – Compute all accounts as a percent of total assets ➢ Common-Size Income Statements – Compute all line items as a percent of sales ◼ They are also useful for comparing companies of different sizes, particularly within the same industry. 2
- 4. Ratio Analysis ◼ Ratios also allow for better comparison through time or between companies. ◼ As we look at each ratio, ask yourself: ➢ How is the ratio computed?（如何计算？） ➢ What is the ratio trying to measure and why?（用来度量什么？在什么 情况下需要用到？） ➢ What is the unit of measurement?（度量的单位是什么？） ➢ What does the value indicate?（值比较高或者比较低可能说明什么？） ➢ How can we improve the company’s ratio?（这个度量可以做怎样的改 进？） 4
- 5. Ratio Analysis ◼ Financial ratios allow for better comparison through time or between companies. ◼ Categories of Financial Ratios ➢ Short-term solvency or liquidity ratios ➢ Long-term solvency or financial leverage ratios ➢ Asset management or turnover ratios ➢ Profitability ratios ➢ Market value ratios 5
- 6. Liquidity Ratios ◼Do we have enough liquid assets to meet approaching obligations? 6
- 7. Liquidity Ratios ◼ Current Ratio = Current Assets / Current Liabilities ➢ 708 / 540 = 1.31 times ◼ Quick Ratio = (Current Assets – Inventory) / Current Liabilities ➢ (708 - 422) / 540 = .53 times ◼ Cash Ratio = Cash / Current Liabilities ➢ 98 / 540 = .18 times 7
- 8. Liquidity analysis：China Mobile(0941.HK） Financial ratios should be compared with peers or industry average. AT&T. China Unicom ？ Year 2009 2010 2011 Current ratio 1.37 1.26 1.40 Quick Ratio 1.35 1.24 1.37 8
- 9. Current Ratio Year 2009 2010 2011 China Mobile 1.37 1.26 1.40 AT&T 0.68 0.60 0.75 Verizon 0.75 0.73 1.01 China Unicom 0.1820 0.2143 0.1539 9
- 10. Leverage Ratios ◼Measure the impact of using debt capital to finance assets. ◼Firms use debt to lever (increase) returns on common equity. 10
- 11. Leverage Ratios ◼ Total Debt Ratio = (Total Assets – Total Equity) / Total Assets ➢ (3588 - 2591) / 3588 = 28% ◼ Debt-Equity Ratio = Total Debt / Total Equity ➢ (3588 – 2591) / 2591 = 38.5% ◼ Equity Multiplier = Total Assets / Total Equity = 1 + Debt / Equity ➢ 1 + .385 = 1.385 11
- 12. Debt ratio Year 2009 2010 2011 China Mobile 32.44% 33.01% 31.72% AT&T 62.15% 58.56% 60.96% China Unicom 50.18% 53.03% 54.50% 12
- 13. Coverage Ratios ◼ Times Interest Earned = EBIT / Interest ➢ 691 / 141 = 4.9 times ◼ Cash Coverage = (EBIT + Depreciation + Amortization) / Interest ➢ (691 + 276) / 141 = 6.9 times 13
- 14. Inventory Ratios ◼ Inventory Turnover = Cost of Goods Sold / Inventory ➢ 1344 / 422 = 3.2 times ◼ Days’ Sales in Inventory = 365 / Inventory Turnover ➢ 365 / 3.2 = 114 days 14
- 15. Low inventory turnover ◼The firm may have too much inventory, which is expensive because: ➢ Inventory takes up costly warehouse space. ➢ Some items may become spoiled or obsolete. 15
- 16. Receivables Ratios ◼ Receivables Turnover = Sales / Accounts Receivable ➢ 2311 / 188 = 12.3 times ◼ Days’ Sales in Receivables = 365 / Receivables Turnover ➢ 365 / 12.3 = 30 days 16
- 17. Computing Total Asset Turnover ◼ Total Asset Turnover = Sales / Total Assets ➢ 2311 / 3588 = .64 times ➢ It is not unusual for TAT < 1, especially if a firm has a large amount of fixed assets. 17
- 18. Why asset turnover rate is important? ◼ Return on Assets (ROA) ＝ Profit Margin × Total Asset Turnover Rate ◼ Wal-Mart： ➢ Profit Margin＝3.51% ➢ Total Asset Turnover rate =2.52 times ➢ ROA=8.87% 18
- 19. Computing Profitability Measures ◼ Profit Margin = Net Income / Sales ➢ 363 / 2311 = 15.7% ◼ Return on Assets (ROA) = Net Income / Total Assets ➢ 363 / 3588 = 10.1% ◼ Return on Equity (ROE) = Net Income / Total Equity ➢ 363 / 2591 = 14.0% ◼ EBITDA Margin = EBITDA / Sales ➢ 967 / 2311 = 41.8% ◼ EPS = Net Income / numbers of shares outstanding 19
- 20. ROE&EPS Year (ROE) 2009 2010 2011 China Mobile 22.76% 20.78% 19.28% AT&T 11.95% 17.73% 3.73% China Unicom 4.42% 1.74% 1.99% Year (EPS) 2009 2010 2011 China Mobile 5.74 5.96 6.27 AT&T 2.05 3.35 0.66 China Unicom 0.067 0.0158 0.0545 20
- 21. Computing Market Value Measures ◼ Market Capitalization = Price per share Numbers of shares outstanding ➢ $88 per share 33 million shares = 2904 million ◼ PE Ratio = Price per share / Earnings per share ➢ 88 / 11 = 8 times ◼ Market-to-book ratio = market value per share / book value per share ➢ 88 / (2591 / 33) = 1.12 times ◼ Enterprise Value (EV) = Market capitalization + Market value of interest bearing debt – cash ➢ 2904 + (196 + 457) – 98 = 3465 ◼ EV Multiple = EV / EBITDA ➢ 3465 / 967 = 3.6 times 21
- 22. P/E ratio ◼Indicates the amount investors are willing to pay for each $1 of a firm’s earnings. ◼Indicates the growth prospects of the firm. ◼However, an extremely high (low) P/E indicates the possible overvaluation (undervaluation) of the firm. 22
- 23. Name of Corporate Code Price Market Capitalization(in 100 million dollars) EPS P/E Exxon Mobil Corp. XOM 83.34 4105.4 7.02 11.87 British Petroleum BP 44.98 1410.6 -0.87 N/A Pepsi-Co PEP 70.03 1106.9 3.74 18.73 Goldman Sachs Group Inc. GS 150.4 822.8 13.18 11.41 Morgan Stanley MS 25.46 385.0 2.63 9.68 Google Inc. GOOG 542.66 1744.8 27.29 19.88 Apple APPL 349.45 3231.60 20.99 16.65 Microsoft Corporation MSFT 25.67 2164.70 2.52 10.20 Oracle Corp. ORCL 35.62 1802.60 1.51 20.59 23
- 24. Using Financial Statements ◼ Ratios are not very helpful by themselves: they need to be compared to something ◼ Time-Trend Analysis ➢ Used to see how the firm’s performance is changing through time ◼ Peer Group Analysis ➢ Compare to similar companies or within industries ➢ SIC and NAICS codes 24
- 25. How can we explain the changes in ROE? ROE Profit margin Total assets turnover rate Equity multiplier 1989 12.1% 3.4% 0.71 4.95 1993 44.1% 1.8% 0.73 33.62 25
- 26. The Du Pont Identity arg Net Income Total Assets ROE Total Assets Equity ROA Equity Multiplier Net Income Sales Total Assets Total Assets Sales Equity Net Income Sales Total Assets Sales Total Assets Equity Profit M in Asset Turnov = = = = = er Equity Multiplier 26
- 27. Using the Du Pont Identity ◼ ROE = Profit Margin (PM) Total Asset Turnover (TAT) Equity Multiplier (EM) ➢ Profit margin is a measure of the firm’s operating efficiency – how well it controls costs. ➢ Total asset turnover is a measure of the firm’s asset use efficiency – how well it manages its assets. ➢ Equity multiplier is a measure of the firm’s financial leverage. 27
- 28. Du Pont Identity ROE Profit margin Total assets turnover rate Equity multiplier 1989 12.1% 3.4% 0.71 4.95 1993 44.1% 1.8% 0.73 33.62 28
- 29. Aeropostale Extended DuPont Chart ROE = 29.49% ROA = 16.66% PM = 6.97% NI = 83.96 Total Costs = - 1,120.39 COGS = - 841.87 SG&A = - 227.04 Interest = - (3.67) Taxes = - 55.15 Sales = 1,204.35 Sales = 1,204.35 TAT = 2.39 Sales = 1,204.35 TA = 503.96 Fixed Assets = 164.62 Current Assets = 339.34 Cash = 225.27 Inventory = 91.91 Other CA = 22.16 EM = 1.77 + + 29
- 30. Potential Problems When Using Financial Ratios ◼ There is no underlying theory, so there is no way to know which ratios are most relevant. ◼ Benchmarking is difficult for diversified firms. ◼ Globalization and international competition makes comparison more difficult because of differences in accounting regulations. ◼ Firms use varying accounting procedures. ◼ Firms have different fiscal years. ◼ Extraordinary, or one-time, events 30
- 31. Long-Term Financial Planning ◼ Investment in new assets – determined by capital budgeting decisions ◼ Degree of financial leverage – determined by capital structure decisions ◼ Cash paid to shareholders – determined by dividend policy decisions ◼ Liquidity requirements – determined by net working capital decisions 31
- 32. Financial Planning Ingredients ◼ Sales Forecast – many cash flows depend directly on the level of sales (often estimate sales growth rate) ◼ Pro Forma Statements – setting up the plan as projected (pro forma) financial statements allows for consistency and ease of interpretation ◼ Asset Requirements – the additional assets that will be required to meet sales projections ◼ Financial Requirements – the amount of financing needed to pay for the required assets ◼ Plug Variable – determined by management decisions about what type of financing will be used (makes the balance sheet balance) ◼ Economic Assumptions – explicit assumptions about the coming economic environment 32
- 33. Example: Historical Financial Statements Gourmet Coffee Inc. Balance Sheet December 31, 2021 Assets 1000 Debt 400 Equity 600 Total 1000 Total 1000 Gourmet Coffee Inc. Income Statement For Year Ended December 31, 2021 Revenues 2000 Less: costs (1600) Net Income 400 33
- 34. Example: Pro Forma Income Statement ◼ Initial Assumptions ➢ Revenues will grow at 15% (2,000 1.15) ➢ All items are tied directly to sales and the current relationships are optimal ➢ Consequently, all other items will also grow at 15% Gourmet Coffee Inc. Pro Forma Income Statement For Year Ended 2022 Revenues 2,300 Less: costs (1,840) Net Income 460 34
- 35. Example: Pro Forma Balance Sheet ◼ Case I ➢ Dividends are the plug variable, so equity increases at 15% ➢ Dividends = 460 NI – 90 increase in equity = 370 ◼ Case II ➢ Debt is the plug variable and no dividends are paid ➢ Debt = 1,150 – (600+460) = 90 ➢ Repay 400 – 90 = 310 in debt Gourmet Coffee Inc. Pro Forma Balance Sheet Case I Assets 1,150 Debt 460 Equity 690 Total 1,150 Total 1,150 Gourmet Coffee Inc. Pro Forma Balance Sheet Case II Assets 1,150 Debt 90 Equity 1,060 Total 1,150 Total 1,150 35
- 36. Percent of Sales Approach ◼ Some items vary directly with sales, others do not. ◼ Income Statement ➢ Costs may vary directly with sales - if this is the case, then the profit margin is constant ➢ Depreciation and interest expense may not vary directly with sales – if this is the case, then the profit margin is not constant ➢ Dividends are a management decision and generally do not vary directly with sales – this affects additions to retained earnings 36
- 37. Percent of Sales Approach ◼ Balance Sheet ➢ Initially assume all assets, including fixed, vary directly with sales. ➢ Accounts payable also normally vary directly with sales. ➢ Notes payable, long-term debt, and equity generally do not vary with sales because they depend on management decisions about capital structure. ➢ The change in the retained earnings portion of equity will come from the dividend decision. ◼ External Financing Needed (EFN) ➢ The difference between the forecasted increase in assets and the forecasted increase in liabilities and equity. 37
- 38. Example: Income Statement Tasha’s Toy Emporium Income Statement, 2021 % of Sales Sales 5,000 Less: costs (3,000) 60% EBT 2,000 40% Less: taxes (40% of EBT) (800) 16% Net Income 1,200 24% Dividends 600 Add. To RE 600 Tasha’s Toy Emporium Pro Forma Income Statement, 2022 Sales 5,500 Less: costs (3,300) EBT 2,200 Less: taxes (880) Net Income 1,320 Dividends 660 Add. To RE 660 Assume Sales grow at 10% Dividend Payout Ratio= 50% 38 Retention Ratio=1-dividend payout ratio=50%
- 39. Example: Balance Sheet Tasha’s Toy Emporium – Balance Sheet Current % of Sales Pro Forma Current % of Sales Pro Forma ASSETS Liabilities & Owners’ Equity Current Assets Current Liabilities Cash $500 10% $550 A/P $900 10% $990 A/R 2,000 40 2,200 N/P 2,500 n/a 2,500 Inventory 3,000 60 3,300 Total 3,400 n/a 3,490 Total 5,500 110 6,050 LT Debt 2,000 n/a 2,000 Fixed Assets Owners’ Equity Net PP&E 4,000 80 4,400 CS & APIC 2,000 n/a 2,000 Total Assets 9,500 190 10,450 RE 2,100 n/a 2,760 Total 4,100 n/a 4,760 Total L & OE 9,500 10,250 39
- 40. External Financing Needed ◼External Financing Needed (EFN): ➢ The difference between the forecasted increase in assets and the forecasted increase in liabilities and equity. 40
- 41. External Financing Needed ◼ External Financing Needed (EFN) can also be calculated as: ) 1 ( Sales) Projected ( ΔSales Sales Liab Spon Sales Sales Assets d PM − − − Asset requirements Spontaneous increase of debts Increase of retained earnings d: dividend payout ratio b=1-d: retention ratio, plowback ratio 41
- 42. Example: External Financing Needed ◼ The firm needs to come up with an additional $200 in debt or equity to make the balance sheet balance ➢ TA – TL&OE = 10,450 – 10,250 = 200 ◼ Choose plug variable ($200 external financing) ➢ Borrow more short-term (Notes Payable) ➢ Borrow more long-term (Long-term Debt) ➢ Sell more common stock (Common Stock) ➢ Decrease dividend payout, which increases the Additions To Retained Earnings 42
- 43. Growth？ Growth Est MSFT Industry Sector S&P 500 Current Quarter 10.3% 10.4% 68.8% 41.1% Next Quarter 22.2% 14.9% 51.8% 22.3% This Year 18.2% 10.2% 28.9% 29.0% Next Year 10.0% 14.3% 15.1% 20.7% Past 5 Years (per annum) 10.879% N/A N/A N/A Next 5 Years (per annum) 11.4% 12.75% 12.54% N/A Price/Earnings (avg. for comparison categories) 14.56 15.54 15.35 14.41 43
- 44. Growth？ Growth Est GOOG Industry Sector S&P 500 Current Quarter 26.7% 10.4% 68.8% 41.1% Next Quarter 20.3% 14.9% 51.8% 22.3% This Year 18.1% 10.2% 28.9% 29.0% Next Year 14.8% 14.3% 15.1% 20.7% Past 5 Years (per annum) 43.321% N/A N/A N/A Next 5 Years (per annum) 22.06% 12.75% 12.54% N/A Price/Earnings (avg. for comparison categories) 21.15 15.54 15.35 14.41 PEG Ratio (avg. for comparison categories) 0.96 1.22 1.22 N/A 44
- 45. Growth and External Financing ◼ At low growth levels, internal financing (retained earnings) may exceed the required investment in assets ◼ As the growth rate increases, the internal financing will not be enough and the firm will have to go to the capital markets for money ◼ Examining the relationship between growth and external financing required is a useful tool in long-range planning 45
- 46. The Internal Growth Rate ◼ The internal growth rate tells us how much the firm can grow assets using retained earnings as the only source of financing. ◼ Using the information from the Hoffman Co. ➢ ROA = 66 / 500 = .132 ➢ b = 44/ 66 = .667 % 65 . 9 0965 . 667 . 132 . 1 667 . 132 . b ROA - 1 b ROA Rate Growth Internal = = − = = 46
- 47. The Sustainable Growth Rate ◼ The sustainable growth rate tells us how much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt ratio. ◼ Using the Hoffman Co. ➢ ROE = 66 / 250 = .264 ➢ b = .667 % 4 . 21 214 . 667 . 264 . 1 667 . 264 . b ROE - 1 b ROE Rate Growth e Sustainabl = = − = = 47
- 48. Determinants of Growth ◼ Profit margin – operating efficiency ◼ Total asset turnover – asset use efficiency ◼ Financial leverage – choice of optimal debt ratio ◼ Dividend policy – choice of how much to pay to shareholders versus reinvesting in the firm 48
- 49. Sustainable growth rate ◼ Microsoft: ➢ ROE=43.96%， ➢ Dividend payout ratio=23.00% ➢ Sustainable growth rate=51.17% ➢ Actual sales growth rate=11.70% ➢ If actual growth rate < sustainable growth rate, the company has no needs for external financing and has surplus in cash. ➢ Actually, Microsoft has a cash account of $6.08 billion in 2009 and a cash account of $5.05 billion in 2010. ➢ Microsoft paid a cash dividends of $4.57 billion and repurchased stock of $8.96 billion. 49
- 50. Some Caveats ◼ Financial planning models do not indicate which financial polices are the best. ◼ Models are simplifications of reality, and the world can change in unexpected ways. ◼ Without some sort of plan, the firm may find itself adrift in a sea of change without a rudder for guidance. 50
- 51. Quick Review ◼ How do you standardize balance sheets and income statements? ◼ Why is standardization useful? ◼ What are the major categories of financial ratios? ◼ How do you compute the ratios within each category? ◼ What are some of the problems associated with financial statement analysis? 51
- 52. Quick Review ◼ What is the purpose of financial planning? ◼ What are the major decision areas involved in developing a plan? ◼ What is the percentage of sales approach? ◼ What is the internal growth rate? ◼ What is the sustainable growth rate? ◼ What are the major determinants of growth? 52