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Financial Reporting and Analysis PDF
Financial Reporting and Analysis PDF
Financial Reporting and Analysis PDF
Mark Hendricks
University of Chicago
September 2012
Outline
Financial Reporting
Financial Analysis
Financial statements
Balance equation
The first section of the balance sheet lists the assets of the firm.
I The short-term, or current assets are listed first.
12000
Billions $
10000
8000
6000
4000
2000 2002 2004 2006 2008 2010 2012
Source: FDIC (CB14)
Accounting rules
Mark-to model
Income statement
Earnings, (or net income,) are simply revenues minus costs. They
are an accounting measure of profits.
I Earnings would not be a good measure of economic profits
given that the financial statements are subject to accounting
rules.
Retained earnings
Operating Income
Interest income 603.3 74.4
Noninterest income 207.4 25.6
Service charges on deposit accounts 39.5 4.9
Other noninterest income 167.9 _____ 20.7 _____
Total operating income 810.7 100.0
Operating Expenses
Interest expenses 245.6 31.1
Noninterest expenses 367.9 46.6
Salaries and employee benefits 151.9 19.2
Premises and equipment 43.4 5.5
Other 172.6 21.9
Provisions for loan losses 175.9 22.3
Total operating expense 789.4 100.0
Net Operating Income 21.3
Gains (losses) on securities -15.3
Extraordinary items, net 5.3
Income taxes -6.2
Net Income 5.1
100
Billions $
50
−50
2000 2002 2004 2006 2008 2010 2012
Source: FDIC (CB04)
200
Billions $
150
100
50
0
2000 2002 2004 2006 2008 2010 2012
Source: FDIC (CB04)
Cash-flow statement
Aside from the three major financial statements, firms often attach
notes.
I These notes may often be skimmed or ignored, but at times
they reveal important clues.
I The notes for AIG explained that their CDS position was not
hedged.
Earnings management
Capital leases
Beyond earnings
The lesson is that earnings are not a sufficient statistic for the
financial health of a firm.
I World Com had suspicious levels of investment due to their
use of capital leases.
Disclosure requirements
Outline
Financial Reporting
Financial Analysis
Return on assets
15
10
ROE %
−5
−10
1985 1990 1995 2000 2005 2010 2015
Source: FRED (USROE)
Profit margin
earnings EBIT
net profit margin = , gross profit margin =
sales sales
Sales
Asset Turnover =
Assets
I Notice that assets reduce asset turnover and thus reduce ROA
and ROE.
ROA
A high profit margin and a high asset turnover is ideal, but can be
expected to attract considerable competition. Conversely, a low
profit margin combined with a low asset turn will attract only
bankruptcy lawyers. — Higgins (2009).
1
ROA %
0.5
−0.5
1985 1990 1995 2000 2005 2010 2015
Source: FRED (USROA)
Leverage
Liabilities
Debt-to-assets =
Assets
Liabilities
Debt-to-equity =
Equity
15
10
5
1940 1950 1960 1970 1980 1990 2000 2010
Source: FDIC (CB14)
There are many other ways to measure the extent to which a firm
is financing with debt.
I Measures based on income are often preferred, given that
bankruptcy is caused by defaulting on payments, not on the
share of equity versus debt.
Rollover risk
There are many other ways to measure the extent to which a firm
is financing with debt.
I Times burden covered is similar to times interest earned,
but takes account of principal repayment.
I This left them very little flexibility to deal with asset declines.
The capital requirements take two forms: the first is based on the
leverage ratio.
I A bank is well capitalized with a leverage ratio below 20.
I They say that this will cause investors to withdraw, which will
cause big problems in financial markets.
We have noted that the book value of firm equity may be much
different than its market value.
I The market-to-book ratio is the market value of equity
divided by the book value of equity.
I Recall that the ratio can be much different than one given
that book-values tend to be based on historical transactions
while market values look forward to future growth.
I Mutual funds are offered for both growth and value stocks
and have become very popular.
References