Financial Analysis Techniques: Presenter's Name Presenter's Title DD Month Yyyy

CHAPTER 7
FINANCIAL ANALYSIS TECHNIQUES
Presenters name
Presenters title
dd Month yyyy
FINANCIAL ANALYSIS TOOLS:
DESCRIPTION
Graphics
Regression
Common-Size Analysis
Financial Ratio Analysis
Copyright 2013 CFA Institute 2

GRAPHICS: EXAMPLE
Operating Profit by Geographic Segment
22% 21%
19%
38%
North America Latin America

Europe/South Pacific Greater Asia/Africa

GRAPHICS: EXAMPLE
Greater Asia/Africa 2011

2010
2009
Europe/South Pacific 2008
2007
Latin America
North America
0 200 400 600 800 1000 1200 1400 1600

$ millions

GRAPHICS: EXAMPLE
Operating profit margin

30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%

REGRESSION: EXAMPLE
14.0
12.0
10.0
f(x) = 0.12x + 5.82

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
Common-size analysis: Express financial data, including entire financial

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
Partial common-size balance sheet
Assets Company 1 Company 2

% 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
Sunbeam, Inc. 1997 vs.1996
Revenue +19%
Receivables +38%
Inventory +58%
Why are receivables growing so much faster than revenue?

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.
Ratios are interrelated

RATIO ANALYSIS
How profitable was Company X?
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 X WAS MORE PROFITABLE THAN

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 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.

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.
Different sources categorize some ratios differently and

include different ratios.
Differences in accounting standards can limit comparability.

CATEGORIES OF FINANCIAL RATIOS
Category Description
Activity Activity ratios. How efficient are the firms operations
and the firms management of assets?
Liquidity Liquidity ratios. How well is the firm positioned to

meet short-term obligations?
Solvency Solvency ratios. How well is the firm positioned to
meet long-term obligations?
Profitability Profitability ratios. How and how much is the firm

achieving returns on its investments?
Valuation Valuation ratios. How does the firms performance or
financial position relate to its market value?

PROFITABILITY AND OVERVIEW
Liquidity Liquidity ratios. How well is the firm positioned to

meet short-term obligations?
Solvency Solvency ratios. How well is the firm positioned to
meet long-term obligations?
Profitability Profitability ratios. How much and how is the firm



MEASURE OF PROFITABILITY:
RETURN ON EQUITY (ROE)
What rate of return has the firm earned on the shareholders

equity it had available during the year?
The general form of the rate of return computation:
Amount of return
Rate of return =
Amount invested
Applied to shareholders equity:
Net income
ROE =
Average equity

DECOMPOSE ROE
Net income
ROE =
Average equity
Net income Average assets

=
Average assets Average equity
= ROA Leverage

DECOMPOSE ROE
ROE = ROA Leverage
A company can increase its ROE
1. With a business strategy, by increasing its ROA
and/or
2. With a financial strategy, by increasing its use of leverage

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?
The general form of this computation is the same:

Amount of return
Rate of Return =
Amount invested
Two variants of ROA computation:

Net income
(1) ROA =
Average assets
Net income adjusted for interest

(2) ROA =
Average assets
Net income + [Interest expense (1 Tax rate)]

=
Average assets

PROFITABILITY, COMPETITION,
AND BUSINESS STRATEGY
Net income
ROA =
Average assets
Net income Revenue

ROA =
Revenue Average assets
In other words,
ROA can
be thought
of as:
Profit margin Turnover (efficiency)

DECOMPOSING
RETURN ON EQUITY
ROE = Profit margin Turnover Leverage
Net income Revenue Average assets

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 ($) 0 1,000 500 500
ROE (NI/Equity)
Net profit margin
(NI/Sales)
Turnover
(Sales/Assets)
Leverage
(Assets/Equity)
STYLIZED COMPARATIVE ANALYSIS MINI-CASE
Co. A Co. B Co. C Average
Sales ($) 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%
Turnover (Sales/Assets) 2 2 4.45 2.82
Leverage (Assets/Equity) 1 2 1.5 1.50

COMPARATIVE
AAPL HPQ DELL

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
ROE = Net income/Average equity

Decompose ROE into five factors
Net income EBT EBIT

ROE =
EBT EBIT Revenue
Revenue Average assets

Average assets Average equity

PROFITABILITY: RETURN ON SALES
(FROM THE COMMON-SIZE INCOME STATEMENT)
Gross profit margin = Gross profit/Revenue

Measures the ability to translate sales into profit after consideration of
cost of products sold.
Operating profit margin = Operating profit/Revenue

Measures the ability to translate sales into profit after consideration of
operating expenses.
Net profit margin = Net profit/Revenue

Measures the ability to translate sales into profit after consideration of all
expenses and revenues, including interest, taxes, and nonoperating
items.

DISCUSSION BY CATEGORY
Liquidity Liquidity ratios. How well is the firm positioned to meet

short-term obligations?
Solvency Solvency ratios. How well is the firm positioned to meet
long-term obligations?


ACTIVITY RATIOS
Also known as asset utilization or operating efficiency 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
Also known as asset utilization or operating efficiency 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
Inventory turnover Cost of sales Average inventory
Number of days in
Days of inventory on hand (DOH) Inventory turnover
period
Receivables turnover Revenue Average receivables
Number of days in Receivables

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.
Cash conversion cycle (net operating cycle) = Days sales outstanding

+ Days inventory held Number of days of payables
Close link to liquidity
Working capital (current assets minus current liabilities) reflects the

investment required to support this cycle.

LIQUIDITY
How well positioned is the firm to meet its near-term

obligations?
Current ratio = Current assets/Current liabilities
Quick ratio = (Cash + Short-term marketable investments +

Account receivables)/Current liabilities
Cash ratio = (Cash + Short-term marketable investments)/

Current liabilities




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
Coverage ratios: Degree to which earnings or cash flow can

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
Solvency ratios Numerator Denominator

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




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
High P/E indicates

- Firm is valued highly by market, possibly because of growth
expectations, or
- That a firm may have very low earnings per share.

VALUATION RATIOS
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
Dividends per share

Dividend payout ratio =
Earnings per share
Dividends 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
Credit Ratio Numerator Denominator

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
Total debt EBITDA

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
Sales forecast (percent change from horizontal common-size

income statement)
Expenses (from common-size income statement)

Gross profit (gross profit margin)
Operating profit (operating profit margin)
Assets (days receivable, days payable, PP&E turnover)

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
Graphics facilitate comparisons, and regressions quantify statistical

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

Financial Analysis Techniques: Presenter's Name Presenter's Title DD Month Yyyy

Transféré par

Informations du document

Titre original

Copyright

Formats disponibles

Partager ce document

Partager ou intégrer le document

Options de partage

Avez-vous trouvé ce document utile ?

Ce contenu est-il inapproprié ?

Droits d'auteur :

Formats disponibles

Financial Analysis Techniques: Presenter's Name Presenter's Title DD Month Yyyy

Transféré par

Droits d'auteur :

Formats disponibles

CHAPTER 7

FINANCIAL ANALYSIS TECHNIQUES

Copyright 2013 CFA Institute 2

Operating Profit by Geographic Segment

North America Latin America

Copyright 2013 CFA Institute 3

Greater Asia/Africa 2011

0 200 400 600 800 1000 1200 1400 1600

Copyright 2013 CFA Institute 4

Operating profit margin

Copyright 2013 CFA Institute 5

f(x) = 0.12x + 5.82

Copyright 2013 CFA Institute 6

Common-size analysis: Express financial data, including entire financial

Copyright 2013 CFA Institute 7

Copyright 2013 CFA Institute 8

Partial common-size balance sheet

Assets Company 1 Company 2

Copyright 2013 CFA Institute 9

Sunbeam, Inc. 1997 vs.1996

Why are receivables growing so much faster than revenue?

Copyright 2013 CFA Institute 10

Ratios are interrelated

Copyright 2013 CFA Institute 11

How profitable was Company X?

Copyright 2013 CFA Institute 12

Copyright 2013 CFA Institute 13

COMPANY X WAS MORE PROFITABLE THAN

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

Copyright 2013 CFA Institute 14

Copyright 2013 CFA Institute 15

Different sources categorize some ratios differently and

Differences in accounting standards can limit comparability.

Copyright 2013 CFA Institute 16

Liquidity Liquidity ratios. How well is the firm positioned to

Profitability Profitability ratios. How and how much is the firm

Copyright 2013 CFA Institute 17

Liquidity Liquidity ratios. How well is the firm positioned to

Profitability Profitability ratios. How much and how is the firm

Valuation Valuation ratios. How does the firms performance or

Copyright 2013 CFA Institute 18

What rate of return has the firm earned on the shareholders

The general form of the rate of return computation:

Applied to shareholders equity:

Copyright 2013 CFA Institute 19

Net income Average assets

Copyright 2013 CFA Institute 20

ROE = ROA Leverage

A company can increase its ROE

1. With a business strategy, by increasing its ROA

2. With a financial strategy, by increasing its use of leverage

Copyright 2013 CFA Institute 21

The general form of this computation is the same:

Two variants of ROA computation:

Net income adjusted for interest

Net income + [Interest expense (1 Tax rate)]

Copyright 2013 CFA Institute 22

Net income Revenue

Profit margin Turnover (efficiency)

Copyright 2013 CFA Institute 23

ROE = Profit margin Turnover Leverage

Net income Revenue Average assets

Copyright 2013 CFA Institute 24