Fin MGT Lesson 02 Financial Statements and Analysis ECA Handouts

MANAGERIAL FINANCE
MANAGERIAL
FINANCE
Lesson 02
Financial Statements
MANAGERIAL FINANCE
and Analysis
Prof. Erich C. Acabado, CPA, REB
Prof. Erich C. Acabado, CPA, REB
Prof. Erich C. Acabado, CPA, REB Prof. Erich C. Acabado, CPA, REB
1 2
Learning Goals Learning Goals
1. Review the contents of the stockholders’ report 5. Use ratios to analyze a firm’s profitability
and the procedures for consolidating
international financial statements.
and market value.
2. Understand who uses financial ratios, 6. Use a summary of financial ratios and
and how. the DuPont system of analysis to
3. Use ratios to analyze a firm’s liquidity perform a complete ratio analysis.
and activity.
4. Discuss the relationship between debt and
financial leverage and the ratios used to
analyze a firm’s debt.
Prof. Erich C. Acabado, CPA, REB 2-3 Prof. Erich C. Acabado, CPA, REB 2-4
3 4
Prof. Erich C. Acabado CPA, REB Lesson 2 - 1

MANAGERIAL FINANCE
The Stockholders’ Report The Stockholders’ Report
• The guidelines used to prepare and maintain financial • The PCAOB is charged with protecting the
records and reports are known as generally accepted interests of investors and furthering the public
accounting principles (GAAP).
interest in the preparation of informative, fair,
• GAAP is authorized by the Financial Accounting and independent audit reports.
Standards Board (FASB).
• Public corporations with more than
• The Sarbanes-Oxley Act of 2002, passed to eliminate
the many disclosure and conflict of interest problems of
$5 million in assets and more than 500
corporations, established the Public Company stockholders are required by the SEC to
Accounting Oversight Board (PCAOB), which is a not- provide their stockholders with an annual
for-profit corporation that overseas auditors. stockholder's report.
5 6
The Four Key Financial Statements:

The Income Statement The Four Key
Financial
• The income statement provides a financial Statements
summary of a company’s operating results
during a specified period.
• Although they are prepared annually for
reporting purposes, they are generally
computed monthly by management and
quarterly for tax purposes.
7 8

MANAGERIAL FINANCE

The Four Key Financial Statements
The Balance Sheet
• The balance sheet presents a summary of
a firm’s financial position at a given point
in time.
• Assets indicate what the firm owns,
equity represents the owners’ investment,
and liabilities indicate what the firm
has borrowed.
9 10
The Four Key The Four Key Financial Statements:

Financial Statements Statement of Retained Earnings
• The statement of retained earnings
reconciles the net income earned and
dividends paid during the year, with the
change in retained earnings.
11 12

MANAGERIAL FINANCE

Statement of Cash Flows
• The statement of cash flows provides a
summary of the cash flows over the period
of concern, typically the year just ended.
• This statement not only provides insight
into a company’s investment, financing
and operating activities, but also ties
together the income statement and
previous and current balance sheets.
13 14
Consolidating International
Financial Statements
• FASB 52 mandated that U.S. based companies
translate their foreign-currency denominated assets
and liabilities into dollars using the current rate
(translation) method.
• Under the translation method, companies translate all
foreign-currency-denominated assets and liabilities into
dollars at the exchange rate prevailing at the fiscal year
ending date (the current rate).
• Income statement items are usually treated similarly.
15 16

MANAGERIAL FINANCE
Consolidating International Using Financial Ratios:

Financial Statements Interested Parties
• Equity accounts, on the other hand, are • Ratio analysis involves methods of
translated into dollars by using the calculating and interpreting financial ratios
exchange rate that prevailed when the to assess a firm’s financial condition
parent’s equity investment was made (the and performance.
historical rate).
• It is of interest to shareholders, creditors,
• Retained earnings are adjusted to reflect and the firm’s own management.
each year’s operating profits (or losses).
17 18
Using Financial Ratios: Using Financial Ratios:

Types of Ratio Comparisons Types of Ratio Comparisons
• Trend or time-series analysis • Trend or time-series analysis
– Used to evaluate a firm’s performance • Cross-sectional analysis
over time
– Used to compare different firms at the same
point in time
19 20

MANAGERIAL FINANCE

• Trend or time-series analysis • Trend or time-series analysis
• Cross-sectional analysis • Cross-sectional analysis

– Industry comparative analysis – Benchmarking
• One specific type of cross-sectional analysis. • A type of cross-sectional analysis in which the
Used to compare one firm’s financial performance firm’s ratio values are compared to those of a key
to the industry’s average performance competitor or group of competitors that it wishes
to emulate
21 22

• Trend or time-series analysis
• Cross-sectional analysis
• Combined Analysis
– Combined analysis simply uses a
combination of both time series analysis and
cross-sectional analysis
23 24

MANAGERIAL FINANCE

Types of Ratio Comparisons Cautions for Doing Ratio Analysis
• Ratios must be considered together; a single
ratio by itself means relatively little.
• Financial statements that are being compared
should be dated at the same point in time.
• Use audited financial statements when possible.
• The financial data being compared should have
been developed in the same way.
• Be wary of inflation distortions.
25 26
Ratio Analysis Example Ratio Analysis
• We will illustrate the use of financial ratios • Liquidity Ratios

for analyzing financial statements using
– Current Ratio
the Bartlett Company Income Statements
and Balance Sheets presented earlier in Current ratio = total current assets
Tables 2.1 and 2.2. total current liabilities
Current ratio = ₱1,233,000 = 1.97

₱620,000
27 28

MANAGERIAL FINANCE
Ratio Analysis Ratio Analysis
• Liquidity Ratios • Liquidity Ratios

– Current Ratio • Activity Ratios
– Quick Ratio – Inventory Turnover
Quick ratio = Total Current Assets - Inventory Inventory Turnover = Cost of Goods Sold
total current liabilities Inventory
Quick ratio = ₱1,233,000 - ₱289,000 = 1.51 Inventory Turnover = ₱2,088,000 = 7.2

₱620,000 ₱289,000
29 30

• Activity Ratios • Activity Ratios
– Average Age of Inventory – Average Collection Period
Average Age of Inventory = 365 ACP = Accounts Receivable
Inventory Turnover Net Sales/365
Inventory Turnover = 365 = 50.7 days ACP = ₱503,000 = 59.7 days

7.2 ₱3,074,000/365
31 32

MANAGERIAL FINANCE

– Average Payment Period – Total Asset Turnover
APP = Accounts Payable Total Asset Turnover = Net Sales

Annual Purchases/365 Total Assets
APP = ₱382,000 = 95.4 days Total Asset Turnover = ₱3,074,000 = .85

(.70 x ₱2,088,000)/365 ₱3,597,000
33 34

• Liquidity Ratios
• Activity Ratios
• Financial Leverage Ratios
– Debt Ratio
Insert Table 2.6 here
Debt Ratio = Total Liabilities/Total Assets
Debt Ratio = ₱1,643,000/₱3,597,000 = 45.7%
35 36

MANAGERIAL FINANCE

• Activity Ratios
• Activity Ratios
• Leverage Ratios
• Leverage Ratios
– Times Interest Earned Ratio
– Fixed-Payment coverage Ratio (FPCR)
FPCR = EBIT + Lease Payments
Times Interest Earned = EBIT/Interest Interest + Lease Pymts + {(Princ Pymts + PSD) x [1/(1-t)]}
Times Interest Earned = ₱418,000/₱93,000 = 4.5 FPCR = ₱418,000 + ₱35,000 = 1.9

₱93,000 + P35,000 + {(₱71,000 + ₱10,000) x [1/(1-.29)]}
37 38
• Activity Ratios
• Leverage Ratios
• Profitability Ratios
– Common-Size Income Statements
39 40

MANAGERIAL FINANCE

• Leverage Ratios • Leverage Ratios
• Profitability Ratios • Profitability Ratios
– Gross Profit Margin – Operating Profit Margin (OPM)
GPM = Gross Profit/Net Sales OPM = EBIT/Net Sales

GPM = ₱986,000/₱3,074,000 = 32.1% OPM = ₱418,000/₱3,074,000 = 13.6%
41 42

• Activity Ratios
• Activity Ratios
• Leverage Ratios
• Leverage Ratios
– Net Profit Margin (NPM)
– Earnings Per Share (EPS)
NPM = Earnings Available to Common Stockholders EPS = Earnings Available to Common Stockholders
Sales Number of Shares Outstanding
NPM = ₱221,000/₱3,074,000 = 7.2%
EPS = ₱221,000/76,262 = ₱2.90
43 44

MANAGERIAL FINANCE

– Return on Total Assets (ROA) – Return on Equity (ROE)
ROA = Earnings Available to Common Stockholders ROE = Earnings Available to Common Stockholders
Total Assets Total Equity
ROA = ₱221,000/₱3,597,000 = 6.1% ROE = ₱221,000/₱1,754,000 = 12.6%
45 46

• Market Ratios • Market Ratios
– Price Earnings (P/E) Ratio – Market/Book (M/B) Ratio
P/E = Market Price Per Share of Common Stock BV/Share = Common Stock Equity
Earnings Per Share Number of Shares of Common Stock
P/E = ₱32.25/ ₱2.90 = 11.1 BV/Share = ₱1,754,000/72,262 = ₱23.00
47 48

MANAGERIAL FINANCE
Ratio Analysis Summarizing All Ratios

• Activity Ratios
• Leverage Ratios
• Market Ratios
– Market/Book (M/B) Ratio
M/B Ratio = Market Price/Share of Common Stock

Book Value/Share of Common Stock
M/B Ratio = ₱32.25/₱23.00 = 1.40
49 50
Summarizing All Ratios Summarizing All Ratios
51 52

MANAGERIAL FINANCE
Summarizing All Ratios DuPont System of Analysis
• The DuPont system of analysis is used to dissect

the firm’s financial statements and to assess its
financial condition.
• It merges the income statement and balance sheet into
two summary measures of profitability: ROA and ROE
as shown in the equation below and in Figure 2.2 on the
following slide.
53 54
DuPont System Modified DuPont Formula

of Analysis
• The Modified DuPont Formula relates the firm’s
ROA to its ROE using the financial leverage
multiplier (FLM), which is the ratio of total assets
to common stock equity:
55 56

MANAGERIAL FINANCE
Modified DuPont Formula
• Use of the FLM to convert ROA into ROE

reflects the impact of financial leverage on the
owner’s return.
• Substituting the values for Bartlett Company’s End
ROA of 6.1 percent calculated earlier, and Thank you
Bartlett’s FLM of 2.06 (₱3,597,000 total assets ÷
₱1,754,000 common stock equity) into the
Modified DuPont formula yields:
ROE = 6.1% X 2.06 = 12.6%
Prof. Erich C. Acabado, CPA, REB 2-57 Prof. Erich C. Acabado, CPA, REB
57 58
Prof. Erich C. Acabado, CPA, REB 2-59
59

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MANAGERIAL FINANCE

Prof. Erich C. Acabado, CPA, REB

Learning Goals Learning Goals

Prof. Erich C. Acabado CPA, REB Lesson 2 - 1

The Stockholders’ Report The Stockholders’ Report

The Four Key Financial Statements:

Prof. Erich C. Acabado CPA, REB Lesson 2 - 2

The Four Key Financial Statements:

The Four Key The Four Key Financial Statements:

Prof. Erich C. Acabado CPA, REB Lesson 2 - 3

The Four Key Financial Statements:

Prof. Erich C. Acabado CPA, REB Lesson 2 - 4

Consolidating International Using Financial Ratios:

Using Financial Ratios: Using Financial Ratios:

Prof. Erich C. Acabado CPA, REB Lesson 2 - 5

Using Financial Ratios: Using Financial Ratios:

• Cross-sectional analysis • Cross-sectional analysis

Using Financial Ratios: Using Financial Ratios:

Prof. Erich C. Acabado CPA, REB Lesson 2 - 6

Using Financial Ratios: Using Financial Ratios:

Ratio Analysis Example Ratio Analysis

• We will illustrate the use of financial ratios • Liquidity Ratios

Current ratio = ₱1,233,000 = 1.97

Prof. Erich C. Acabado CPA, REB Lesson 2 - 7

Ratio Analysis Ratio Analysis

• Liquidity Ratios • Liquidity Ratios

Quick ratio = ₱1,233,000 - ₱289,000 = 1.51 Inventory Turnover = ₱2,088,000 = 7.2

Ratio Analysis Ratio Analysis

• Liquidity Ratios • Liquidity Ratios

Inventory Turnover = 365 = 50.7 days ACP = ₱503,000 = 59.7 days

Prof. Erich C. Acabado CPA, REB Lesson 2 - 8

Ratio Analysis Ratio Analysis

• Liquidity Ratios • Liquidity Ratios

APP = Accounts Payable Total Asset Turnover = Net Sales

APP = ₱382,000 = 95.4 days Total Asset Turnover = ₱3,074,000 = .85

Ratio Analysis Ratio Analysis

Debt Ratio = Total Liabilities/Total Assets

Debt Ratio = ₱1,643,000/₱3,597,000 = 45.7%

Prof. Erich C. Acabado CPA, REB Lesson 2 - 9

Ratio Analysis Ratio Analysis

Times Interest Earned = ₱418,000/₱93,000 = 4.5 FPCR = ₱418,000 + ₱35,000 = 1.9

Ratio Analysis Ratio Analysis

Prof. Erich C. Acabado CPA, REB Lesson 2 - 10

Ratio Analysis Ratio Analysis

GPM = Gross Profit/Net Sales OPM = EBIT/Net Sales

Ratio Analysis Ratio Analysis

Prof. Erich C. Acabado CPA, REB Lesson 2 - 11

Ratio Analysis Ratio Analysis

• Liquidity Ratios • Liquidity Ratios

ROA = ₱221,000/₱3,597,000 = 6.1% ROE = ₱221,000/₱1,754,000 = 12.6%

Ratio Analysis Ratio Analysis

• Liquidity Ratios • Liquidity Ratios

P/E = ₱32.25/ ₱2.90 = 11.1 BV/Share = ₱1,754,000/72,262 = ₱23.00

Prof. Erich C. Acabado CPA, REB Lesson 2 - 12

Ratio Analysis Summarizing All Ratios

M/B Ratio = Market Price/Share of Common Stock

M/B Ratio = ₱32.25/₱23.00 = 1.40

Summarizing All Ratios Summarizing All Ratios

Prof. Erich C. Acabado CPA, REB Lesson 2 - 13

Summarizing All Ratios DuPont System of Analysis

• The DuPont system of analysis is used to dissect

DuPont System Modified DuPont Formula