Financial Statement Analysis

Mujtaba Khalid

Learning Objectives
Perform a horizontal analysis of comparative financial statements Perform a vertical analysis of financial statements

Compute the standard financial ratios

Use ratios in decision making

Types of Analyses
Horizontal Analysis
Study of percentage changes in comparative financial statements Considers changes over time.

Compute the dollar amount of the change from the base period to the later period
Divide the dollar amount of the change by the base period amount

Horizontal Analysis
Revenue 2012 $8,380 2011 $7,757 Increase (Decrease) Amount Percentage $623 8.0%

Compute the dollar amount of change from 2002 to 2003 $8,380 - $7,757 = $623 Divide the dollar amount of the change by the base period amount to get the percentage change. $623 / $7,757 = 8.0%

Horizontal Analysis
XYZ Inc. Statements of Income (Adapted) Years Ended December 31, 2012 and 2011 Increase (Decrease) Amount Percentage $623 8.0% 191 149 207 32 1 15 28 (6) $ 34 9.1 7.9 11.5 3.5 0.6 62.5 3.3 (2.2) 5.8

Dollars in millions Revenues Expenses: Food and paper (cost of goods sold) Payroll and employee benefits Occupancy and other operating expenses General and administrative expenses Interest expense Other expense, net Income before income taxes Income tax expense Net income

2012 $8,380 2,300 2,024 2,013 945 173 39 886 269 $ 617

2011 $7,757 2,109 1,875 1,806 913 172 24 858 275 $ 583

Horizontal Analysis
XYZ Inc. Statements of Income (Adapted) Years Ended December 31, 2012 and 2011 Increase (Decrease) Amount Percentage $623 8.0% 191 149 207 32 1 15 28 (6) $ 34 9.1 7.9 11.5 3.5 0.6 62.5 3.3 (2.2) 5.8

Dollars in millions Revenues Expenses: Food and paper (cost of goods sold) Payroll and employee benefits Occupancy and other operating expenses General and administrative expenses Interest expense Other expense, net Income before income taxes Income tax expense Net income

2012 $8,380 2,300 2,024 2,013 945 173 39 886 269 $ 617

2011 $7,757 2,109 1,875 1,806 913 172 24 858 275 $ 583

Trend Percentages
Horizontal analysis over a period of several years. Indicates the direction a business is taking.
(In millions) Net Income 2012 $617 2011 $583 2010 $492 2009 $413 2008 $627 Base 2007 $445

2012 Net Income 39%

2011 31%

2010 11%

2009 -0.07%

2008 41%

Base 2007 0%

Vertical Analysis
Shows the relationship of a financial statement item to its base. Income Statement base is usually Total Revenue Balance Sheet base is usually Total Assets

Each income statement item Vertical analysis % Total revenue

Vertical Analysis
Dollars in millions Revenues Expenses: Food and paper (cost of goods sold) Payroll and employee benefits Occupancy and other operating expenses General and administrative expenses Interest expense Other expense, net Income before income taxes Income tax expense Net income YUM Brands, Inc. Statements of Income (Adapted) Years Ended December 31, 2012 and 2011 2012 2011 Percentage Percentage Amount of Total Amount of Total $8,380 100.0% $7,757 100.0% 2,300 2,024 2,013 945 173 39 886 269 $ 617 27.4 2,109 24.2 1,875 24.0 1,806 11.3 913 2.1 172 0.4 24 10.6 858 3.2 275 7.4% $ 583 27.2 24.2 23.3 11.8 2.2 0.3 11.0 3.5 7.5%

Vertical Analysis
Dollars in millions Revenues Expenses: Food and paper (cost of goods sold) Payroll and employee benefits Occupancy and other operating expenses General and administrative expenses Interest expense Other expense, net Income before income taxes Income tax expense Net income YUM Brands, Inc. Statements of Income (Adapted) Years Ended December 31, 2012 and 2011 2012 2011 Percentage Percentage Amount of Total Amount of Total $8,380 100.0% $7,757 100.0% 2,300 2,024 2,013 945 173 39 886 269 $ 617 27.4 2,109 24.2 1,875 24.0 1,806 11.3 913 2.1 172 0.4 24 10.6 858 3.2 275 7.4% $ 583 27.2 24.2 23.3 11.8 2.2 0.3 11.0 3.5 7.5%

Other Financial Analysis Tools

Common-size statements
Similar to vertical analysis except no dollar amounts are shown Allows one to compare companies of different sizes

Benchmarking
Comparison of a company to a standard set by others

Ratio Analysis
Ratios are used to highlight weaknesses and strengths. Ratios dont mean anything by themselves They must be compared over time and with similar companies
Examples:

Liquidity: Can we make required payments?

Asset Management: right amount of assets vs. sales? Debt Management: Right mix of debt and equity? Profitability: Do sales prices exceed unit costs?

Liquidity Ratios
Current Ratio Total Current Assets Total Current Liabilities

Interpretation

Relatively high ratio values mean that the business is liquid, but cash is not working
If the current ratio is greater than 1.0, the business is liquid If the current ratio is less than 1.0, the business is illiquid

Liquidity Ratios
Acid Test Ratio Total Current Assets - Inventory Total Current Liabilitie s

Interpretation

Relatively high ratio values mean that the business is liquid, but cash is not working
If the acid test ratio is greater than 1.0, the business is liquid If the acid test ratio is less than 1.0, the business is illiquid

Solvency Ratios
Total Assets Net Capital Ratio Total Liabilitie s
Interpretation The higher the value, the more solvent the business If greater than 1.0, the business is solvent

If less than 1.0, the business is insolvent

Profitability Ratios
Measure the return earned by a company during a year Profitability Ratios express various sub-totals on the income statement (Gross Profit, Operating Profit, Net Profit) as a percentage of revenue Measure the ability of a firm to generate profit on capital invested

Profitability Ratios
Gross Profit Gross Profit Margin Revenue
Interpretation

Indicates the percentage of revenue available to cover operating and other expenses

Net Profit Net Profit Margin Revenue

Reflects the effects on profitability of non-operating expenses

Profitability Ratios
Net Profit Return on Assets Average Total Assets
Measures the return earned by a company on its assets. The higher the ratio, the more income is generated by a given level of assets

Net Profit - Preferred Dividends Return on Common Equity Average Common Equity
Measures the return earned by a company on its common equity. The higher the ratio, the more income is generated on equity