Working with financial statements final1
- 1. Basic Concepts in Financial AnalysisDavid Stevens, CPA, MBA1
- 2. Working with Financial StatementsAdapted fromEssentials of Corporate Finance, 7th Edition, McGraw-Hill Companies, Inc., Copyright © 2011 2
- 3. ObjectiveProvide Tools to Assess the Global Financial Health of a CompanyPart 1:Common Size and Comparative Financial StatementsPart 2: Financial Statement Ratio Analysis3
- 4. Part ICommon Size and Comparative Financial Statements4
- 5. Income StatementIncome Statement forThe Prufrock Corporation(in millions)5
- 6. Common Size Income StatementIn a Common Size Income Statement, each item is listed as a percentage of sales. The Prufrock Corporation6
- 7. ExampleIncome StatementTotal Sales$2,311$1,344Cost of Goods SoldCommon Size Income Statement58%$1,344=58%$2,3117
- 8. Income Statements Used in BusinessSee Comparative Income Statements.xls8
- 9. Part IIFinancial Statement Ratio Analysis9
- 10. What is the Current Ratio?An organization’s current ratio consists of the relationship between its current assets and liabilities.Current AssetsCurrent LiabilitiesCurrent Ratio =10
- 11. Calculating the Current RatioFirst, calculate your assets and liabilities. 11
- 12. Calculating the Current RatioThe current ratio is the ratio between Current Assetsand Liabilities708540Current RatioCurrent Assets7081.31===Current Liabilities54012
- 13. Current Ratio Why Is It Important?Current AssetsCurrent LiabilitiesCurrent Ratio=Current Ratio = 1.00What does this tell me?3-13
- 14. Current Ratio Current AssetsCurrent LiabilitiesCurrent Ratio=Which company is in the best and worst financial shape?14
- 15. Inventory Turnover andDays’ Sales in Inventory 3-15COGS$1,344Inventory$422InventoryTurnoverCOGS$1,344===3.2$422Inventory
- 16. Inventory Turnover andDays’ Sales in Inventory InventoryTurnover=3.2365365Days’ Sales in Inventory===114 daysInventoryTurnover3.2365365* Inventory==114 daysInventory * COGSCOGS3-16
- 17. Days’ Sales in InventoryWhyis this Important? Why Calculate it?365365Days’ Salesof Inventory==InventoryTurnover=114 days3.2Indicates how much inventory is on hand.
- 18. In the previous example, 114 days. If the company does not add to inventory, it will run out of inventory to sell after 114 days.17
- 19. Inventory TurnoverWhyis this Important? Why Calculate it?InventoryTurnoverCOGS$1,344===3.2$422InventoryInventory Turnoverindicateshow fast the company sells its inventory during the year.
- 20. The higher the number the better.For example, Prufrock sells bicycles.
- 21. Every time the inventory is low, they order $100,000 of bicycles from their manufacturer.
- 22. Then Prufrock will buy and sell their $100,000 blocks of inventory 3.2 times during the year.18
- 23. Days’ Sales in Inventory (Inventory on Hand)What is this Ratio Important? Why Calculate it?1. Would a Sales Manager want a low or high Days Sales in Inventory Ratio? 2. Would a Chief Financial Officer want a low or high Days’ Sales in Inventory ratio? 19
- 24. Receivables Turnover and Days’ Sales in Receivables$2,311Sales$188Accounts ReceivableSalesReceivablesTurnover2,311===12.3AccountsReceivable18820
- 25. Receivables Turnover and Days’ Sales in ReceivablesSales2,311ReceivablesTurnover===AccountsReceivable12.3188365Day’s Sale in Receivables365===30 daysReceivablesTurnover12.321
- 26. Receivables TurnoverWhyis this Important? Why Calculate it?Sales2,311ReceivablesTurnover===AccountsReceivable12.3188Indicates amount of sales which are made by cash versus credit.
- 27. The HIGHER the number, the better.Why? Higher ratio more sales are made by cash. It is better to have cash from a sale, than a receivable which will may or may not be collected.What if the ratio = 1? Sales = Accounts Receivable22
- 28. Days’ Sales in ReceivablesWhyis this Important? Why Calculate it?365Day’s Sale in Receivables365===30 daysReceivablesTurnover12.3The LOWER the number, the better.Why? Higher ratio more sales are made by cash. It is better to have cash from a sale, than a receivable which will hopefully be collected.If 30 days, roughly 1 month of sales has not been collected.If 60 days, roughly 2 months of sales has not been collected.23
- 29. Profit Margin2,311Sales363Net IncomeProfitMarginNet Income363===15.7%Sales2,31124
- 30. Profitability MeasuresWhy are they Important? Why Calculate them?ProfitMargin363Net Income===15.7%Sales2,311Profit Margin of 15.7% For every $100 in Sales, the company keeps $15.70 after expenses.Profit Margin of 25% For every $100 in Sales, the company keeps $25.00 after expenses.Profit Margin of 50% For every $100 in Sales, the company keeps $50.00 after expenses.25
- 31. Why Analyze Financial Statements?Internal Uses Performance evaluationPlanning for the future – estimating future cash flows.Profit Margin of 15% vs. 50% makes could drastically change company’s plans.3. Compare with companies in same industry.What if Nike Profit Margin = 20% AND Rebook’s Profit Margin = 5%?26
- 32. Why Analyze Financial Statements?ExternalUsesCreditors – owed money by our company.2. Suppliers – owed money and rely on sales to our company.3. Customers – regularly buy our products.4. Stockholders – own company stock.27
- 33. Thank you for listening.28
Editor's Notes
- #2: Hello Everyone, David Stubing. I will introduce myself just briefly.I have spent a lot of my career in corporate accounting.I have been the senior finance officer of small to mid-size companies.I am also a licensed CPA.I am also a Director in a couple of professional associations.
- #3: This chapter is all about reviewing a company’s statements to ascertain its health.First we will look at Financial Statements.And then we will see what key financial ratios tell us about the company.
- #4: Part 1, Common Size and Comparative Financial Statements.What are they?
- #5: Here is your standard income statementIf have had an accounting class this should look familryIt starts with you Sales and subtracts costsShows the dollar amounts
- #6: Here is a common size income statementEach line item is listed as a % of SalesAs a former Controller and CFO, I find this one particularly useful.Why is this use do you ask?This tells me For every $100 of Merchandise I see, wepay $58.20 for goods to sellpay $6.10 for interest on loansget to keep 15.7% or $15.70
- #7: This is not in the book, but I am going to add it as additional material.I want show you some financial reports I find particulalry useful from working as a CFO for a number of small companies. 08 – 09 -10 When most Accounting textbooks show an Income statement, as we saw before, is often one column with one time period of results.But any organization is certainly not limited to that.Here is a simplified example of a Income Statement I like.It is a combination of a common size income statement and a comparative one.It has three year of data, so as the CFO, I can see a trend.I want you to look at the bottom.Questions for the class?What is the pattern of my Net Income over these three years?What is my pattern of sales?Why is that? The answerSo, if I am the CFO of this, it would behoove me to find out what this isMaybe our supplier has raised its prices.Maybe it is time to find a new supplier.Are the people buying our goods aware of what is going on and the cumulative effect of these price increases.Common Size and Comparative Income Statements can be very useful in analyzing what is happening in your company. Month by MonthHere is a real internal income statementI am a member of the Finance Committee of a nonprofit.What does this show us?Question for the class:Where does most of the organization’s revenue come from?It is on the far right column.What is the organization’s biggest expense?Overall, what is the organization’s financial health? Not good. Over these three months, the organization is spending more money than it has.Thankfully, this organization has large endowment. An endowment is basically a savings account from donations over the years.Most non-profits as well private universities have an endowment.
- #8: The next part is using financial statement ratios to analyze the company’s financial health.
- #11: A very common financial ratio is the Current RatioHow to calculate it, is to take the Current Assets, here, divided by the Current Liabilities, here.You divide one by the other, and here is our Current ratio.
- #12: Question for the class, if the Current Ratio = 1, what does this tell me about the company’s ability to pay its bills?Hint – Current Liabilities are unpaid bills.Hint - Current Assets are either cash, or something that can turned into cash fairly.For an ratio to be 1, it mean the numerator and the denominator are the same.In this case, it has as much current assets as it has current liabilities.The answer is this, if my current ratio is 1, then for every $1 of unpaid bills, I have $1 of cash or cash equivalents.Not bad.
- #13: Questions for the Class?I have 3 companies here.Which company is in the best and worst financial shape, in terms of paying its bills.Generally speaking the higher the ratio, the better.So, ABC is in the best shape. They have $1.50 for every $1 in unpaid bills.At the bottom, Stubing’s Bike Store is in trouble. We have 25 cents for every $1 in unpaid bills.
- #15: Questions for the Class?I have 3 companies here.Which company is in the best and worst financial shape, in terms of paying its bills.Generally speaking the higher the ratio, the better.So, ABC is in the best shape. They have $1.50 for every $1 in unpaid bills.At the bottom, Stubing’s Bike Store is in trouble. We have 25 cents for every $1 in unpaid bills.
- #22: Let’s talk about another useful set of ratios, ReceiveablesPOINTMechanically, Here are the formulas.For turnover, you divie your Sales of the Income Statement by Reciables on the Balance Sheet.For the Day’s Sales, you divide 365 by your turnover figure.Next, how do we use this?Why is this important?
- #23: Ratio = 1All Sales are made by credit not cash, and the business has to wait to get paid.You have to wait to get paidNot all customers will pay you.And you will have to hound some before they will pay up.
- #24: Why is Day’s Sales in Receibables important?
- #27: Internally, the main reason is to gauge how well are doing.Question for the class why would those outsideWhy would a someone outside of the company evaluate our financial statements. For example why would a creditor be interested in the companies financial statements?How are you doing compared to your competitors?If your Profit Margin is 5%, and industry average is 20%, then there is something wrong.