Financial

Statement
Analysis

K R Subramanyam
John J Wild

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 6-2

Overview of Financial
Statement Analysis

1
CHAPTER
 6-3

Information Sources for Analysis

 6-4

Business Activities

Operating
OperatingActivities
Activities
Revenues
Revenuesand
andexpenses
expensesfrom
fromproviding
providing
goods
goodsand
andservices
services
 6-5

Financial Statements Reflect Business Activities

 6-6

Major aspects of financial statement analysis

1. Profitability analysis
2. Credit analysis
3. Cash flow analysis
Basic analysis

4. Market measures
5. Financial distress and bankruptcy
analysis

Special analysis topics

6. Financial forecast
7. Equity valuation

Prospective analysis
 6-7

Analysis Process
 6-8

Comparative analysis
8

• Why we need to compare?

• What we need to compare?
– Period-to-period
– Firm-to-firm
– Division-to-division
• Difference types:
– In dollars: ∆A = A1 – A0
– In percentages:

A1
x 100 (%)
A0
 6-9

Horizontal analysis

To compare a company’s financial position

and performance between periods.

Time
 6-10

Trend analysis

Trend
Trend analysis
analysis isis used
used for
for comparison
comparison of of the
the same
same
item
item over
over aa significantly
significantly long
long period
period to
to detect
detect
general
general pattern
pattern of
of aa relationship
relationship between
between associated
associated
factors
factors and
and project
project the
the future
future direction
direction ofof this
this
pattern.
pattern.
10
 6-11

Trend analysis

11
 6-12

Vertical analysis

Technique for identifying relationship between

items in the same financial statement by
expressing all amounts as the percentage of
the total amount taken as 100 (a common-size
financial statement).
 6-13

Common-size graph
13

Other
Othergains
gains
Income
Incometax
tax 0.2%
2007
2007
0.2%
Revenues 1.4%
Revenues1.4% 100.0%
100.0%
Interest
Interest Net
NetIncome
Cost
Cost
expense
ofofgoods
goods sold
sold 69.2
Income
69.2
expense 3.6%
3.6%
Selling
Selling and administrative
1.20% and administrative
1.20% 24.7
24.7
Net
Netinterest
interest 1.2
1.2
Income
SellingIncome
&
taxes
taxes 1.4
1.4 Costs
Costsofof
Selling & revenue
Other
Othergains
administrative
administrative gains 0.2 revenue
0.2
69.0%
expenses 69.0%
Net
expenses
Net earnings
earnings 3.6
3.6
24.6%
24.6%
Net
Netincome
income per
pershare
share
 6-14

Common-size Balance sheets

Sears Wal-Mart J.C. Penney

% % %
Account payables 8,021 20.7% 13,319 29.3% 4,271 18.2%
Short-term loans 7,769 20.1% 1,141 2.5% 1,866 7.9%
Total short-term liabilities 15,790 40.8% 14,460 31.9% 6,137 26.1%
Long-term debts 13,071 33.8% 9,674 21.3% 6,986 29.7%
Other long-term liabilities 3,977 10.3% 2,747 6.1% 3,013 12.8%
Total long-term liabilities 17,048 44.1% 12,421 27.4% 9,999 42.6%
Total liabilities 32,838 84.9% 26,881 59.2% 16,136 68.7%
0.0% 0.0% 0.0%
Common stocks 3,921 10.1% 809 1.8% 3,292 14.0%
Retained earnings 4,158 10.7% 18,167 40.0% 4,114 17.5%
Treasury stocks (2,217) -5.7% (473) -1.0% (49) -0.2%
Total equity 5,862 15.1% 18,503 40.8% 7,357 31.3%
Total liabilitites & equity 38,700 100.0% 45,384 100.0% 23,493 100.0%
 6-15

Common-size balance sheets

Sears Wal-Mart J.C. Penney

% % %
Cash 358 0.9% 1,447 3.2% 287 1.2%
Receivables 20,178 52.1% 976 2.2% 4,892 20.8%
Inventories 5,044 13.0% 16,497 36.3% 6,162 26.2%
Other current assets 5,102 13.2% 432 1.0% 143 0.6%
Total current assets 30,682 79.3% 19,352 42.6% 11,484 48.9%
0.0% 0.0% 0.0%
PP&E 6,414 16.6% 23,606 52.0% 5,329 22.7%
Investments 0 0.0% 0 0.0% 1,774 7.6%
Goodwill 0 0.0% 0 0.0% 3,500 14.9%
Other long-term assets 1,604 4.1% 2,426 5.3% 1,406 6.0%
Total long-term assets 8,018 20.7% 26,032 57.4% 12,009 51.1%
Total assets 38,700 100.0% 45,384 100.0% 23,493 100.0%
 6-16

In mil. US$ 2000 2001 2002 2003 2004 … 2010 2011 2012

Account
17.301 28.155 30.759 1.956 1.239   689 695 635
receivables
Inventories 5.618 4.912. 5.115 5.335 5.549   8.951 8.407 7.558

Total assets 36.889 44.317 50.409 27.723 22.474   24.360 21.381 19.340
 6-17

Vinaconex
Common-size Income statement
For the year ended Dec. 31, 2009
2009 2008
VND mil. % VND mil. %
1 Net sales 3,849,352 100.0% 2,848,155 100.0%
2 Cost of goods sold 3,574,803 92.9% 2,767,680 97.2%
3 Gross profit 274,549 7.1% 80,475 2.8%
4 Finance revenue 802,940 20.9% 199,225 7.0%
5 Finance expenses 581,012 15.1% 112,749 4.0%
Interest expense 356,843 9.3% 34,061 1.2%
6 Selling expenses 2,770 0.1% 54,100 1.9%
7 Administrative expenses 331,893 8.6% 226,096 7.9%
8 Operating profit 161,814 4.2% (113,245) -4.0%
9 Other gains 968,632 25.2% 423,067 14.9%
10 Other losses 574,717 14.9% 3,705 0.1%
11 Net other gains (losses) 393,915 10.2% 419,362 14.7%
12 Profit before tax 555,729 14.4% 306,117 10.7%
13 Income tax expense 140,464 3.6% 925 0.0%
14 Profit after tax 415,265 10.8% 305,192 10.7%
 6-18

Ratio analysis
• To evaluate relationships among financial
statement items
• Four groups:
– Liquidity
– Solvency
– Efficiency
– Profitability
 6-19

Equity Valuation
Valuation - an important goal of many types
of business analysis

Purpose: Estimate intrinsic value of a

company (or stock)
Basis: Present value theory (time value of
money)
 6-20

Present value theory

P: Present value
1 Fn: Future value at period
P = Fn n
(1 + r)n A: Annual cash flows (from
period 1 to period n)
r: discounted rate

1 1
P=Ax x 1-
r (1 + r)n
 6-21

Equity valuation –
Residual Income Model
Investors should pay more than book value if actual income is
higher than expected and less than book value if actual income is
lower than expected.

Expected Income = Required rate of equity x Book value of equity

Residual Income = Actual Income – Expected Income

Fair value of Equity = Book value of Equity +

PV{Expected Residual Incomes}
 6-22

Equity valuation –
Residual Income Model

BV is the book value at the end of period t

tt

Rit+n
t+n
is the residual income in period t + n [defined as
net income, NI, minus a charge on beginning
book value, BV, or RItt = NItt - (k x BVt-1
t-1
)]
k is the cost of capital
E refers to an expectation
 6-23

Example

In VND mil. 2013 2014 2015 2016 2017 2018

Net income 609 628 639 702 773 773
Dividends 357 433 370 407 448 448
Beginning book value of 2917 3169 3364 3633 3928 4253
equity
Cost of equity 13%

23
 6-24

Example

2013 2014 2015 2016 2017 2018

1. Beginning book value of equity BVE

2. Required Income (rE= 13%)

3. Projected Income

4. Residual Income

5. Discounted factor (rE = 13%)

6. PV {RI2013→2018}

Fair value of equity VE = 24

 6-25

Equity valuation –
Dividend model

Vtt is the value of an equity security at time t

Dtt +n
+n
is the dividend in period t+n
k is the cost of capital
E refers to expected dividends
 6-26

Equity Valuation –
Free cash flow to equity model

FCFEt+n
t+n
is the free cash flow to equity in the period t + n
[often defined as cash flow from operations less capital
expenditures]
k is the cost of capital
E refers to an expectation