Professional Documents
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Basics of Analysis
Basics of Analysis
Ratio Analysis
Liquidity
Measures a firms ability to meet its current obligations
Profitability
Measures the earning ability of a firm
Ratio Analysis
Interpreted in comparison with
Prior ratios Competitor ratios Industry ratios Predetermined standards
Common-Size Analysis
The use of percentages is usually preferable to the use of absolute amounts Vertical analysis
All amounts of a year expressed as a percentage of a base amount (e.g., net sales revenue, total assets)
Horizontal analysis
Amounts for comparative years are expressed as a percentage of the base year amount
Vertical Analysis
Melcher Company Income Statement For the Years Ended December 31 2005 2004 Sales revenue Cost of goods sold Gross profit Operating expenses: Selling expense General expense Total operating expense Operating Income before taxes Taxes related to operations Net Income $ $ 100,000 65,000 35,000 14,000 16,000 30,000 5,000 1,500 3,500 100.0% 65.0% 35.0% 14.0% 16.0% 30.0% 5.0% 1.5% 3.5% $ 95,000 60,800 34,200 11,400 15,200 26,600 7,600 2,280 $ 5,320 100.0% 64.0% 36.0% 12.0% 16.0% 28.0% 8.0% 2.4% 5.6% 2003 $91,000 56,420 34,580 10,000 13,650 23,650 10,930 3,279 $ 7,651 100.0% 62.0% 38.0% 11.0% 15.0% 26.0% 12.0% 3.6% 8.4%
Horizontal Analysis
Melcher Company Income Statement For the Years Ended December 31 2005 2004 2003 Sales revenue Cost of goods sold Gross profit Operating expenses: Selling expense General expense Total operating expense Operating Income before taxes Taxes related to operations Net Income $ $ 100,000 65,000 35,000 14,000 16,000 30,000 5,000 1,500 3,500 $ 95,000 60,800 34,200 11,400 15,200 26,600 7,600 2,280 $ 5,320 $ 91,000 56,420 34,580 10,000 13,650 23,650 10,930 3,279 $ 7,651 2005 109.9% 115.2% 101.2% 140.0% 117.2% 126.8% 45.7% 45.7% 45.7% 2004 104.4% 107.8% 98.9% 114.0% 111.4% 112.5% 69.5% 69.5% 69.5% 2003 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Each financial statement element is presented as a percentage of a base amount from a selected year.
Industry Variations
Financial components vary by type of industry Merchandising
Inventory is a principal asset Sales may be primarily for cash or on credit
Service
Inventory is low or nonexistent
Manufacturing
Large inventory holdings Substantial investment in plant assets
Descriptive Information
Narrative data
Annual report Trade periodicals Industry reviews
Comparisons
Provides context for analysis of ratios and financial data Common types
Trend analysis SIC: Standard Industrial Classification NAICS: North American Industry Classification System Industry averages; competitor comparisons
Highlight
Effective management Evidence of problems
Comparisons: SIC
Classifies business by industry
Defines industries in accordance with the composition and structure of the economy
Coding structure
Division
Major group Industry group
Industry
Comparisons: NAICS
Joint creation of NAFTA partners: Canada, U.S., and Mexico Industry is defined by similar production processes Coding structure
Sector Sub-sector Industry group NAICS industry National industry
Comparisons: Industry
Industry comparison complicated by highly diversified companies Financial services
Base their analysis on industry placement Provide composite industry data
Service
Economic Surveys Division, Bureau of the Census
Risk Management Association
Coverage
Manufacturing, mining, and trade corporations
Data
Income statement and balance sheet data and ratios
Common-size financial statements and ratios
Classification
NAICS
NAICS
NAICS
Data
Condensed financial statements; ratios Longitudinal financial information
Classification
SIC
Industry Norms Dun & Bradstreet and Key Business Ratios [various] Value Line Investment Service
98 industries
Comparisons: Caution
Ratios are subject to variance from: Differing data Inconsistent formula construction Optional (elective) accounting treatment Different fiscal year-ends Varying financial policies Inconsistent basis (before or after tax)
Information
Absolute: amplifies comparison difficulty Common-size: eliminates some of the difficulty
Other Resources: Standard & Poors Register Of Corporations, Directors, And Executives
3-volumes
V1 V21 V22 Alphabetical by firm name Alphabetical listing of key individuals Industries in 7 subsections
Indexes
Alphabetical Geographical SIC
Investors
Analysis of past and present information to project the future prospects of the entity
Creditors
Short-term: focus is on current resources Long-term: consider the future prospects of the firm