Tài chính doanh nghiệp - Chapter 5: Essentials of financial statement analysis

Essentials of Financial Statement AnalysisRevsine/Collins/Johnson/Mittelstaedt/Soffer: Chapter 5Learning objectivesHow cause of change analysis and common-size and trend statements illuminate financial statement patterns and shed light on business activities. How competitive forces and business strategies affect firms’ financial statements.How return on assets (ROA) is used to evaluate profitability.How return on equity (ROCE) can be used to assess the effect of financial leverage on profitability. How short-term liquidity risk and long-term solvency risk are assessed.How to use the Statement of Cash Flows to assess credit and risk.How to interpret the results of an analysis of profitability and risk.How to prepare and analyze business segment disclosures.5-*Financial statement analysis:Tools and approachesTools:Approaches used with each tool:Time-series analysis: the same firm over time (e.g., Wal-Mart in 2012 and 2010)Common size statementsTrend statements2. Cross-sectional analysis: different firms at a single point in time (e.g., Wal-Mart and Target in 2012).Financial ratios(e.g., ROA and ROCE)3. Benchmark comparison: using industry norms or predetermined standards.5-*Evaluating accounting “quality”Analysts use financial statement information to “get behind the numbers”.However, financial statements do not always provide a complete and faithful picture of a company’s activities and condition.5-*How the financial accounting “filter” sometimes worksManagers have some discretion over estimates such as “bad debt expense”.Managers have some discretion over the timing of business transactions such as when to buy advertising.Managers can choose any of several different inventory accounting methods.GAAP puts capital leases on the balance sheet, but operating leases are “off-balance-sheet”.5-*Whole Foods Market:Comparative Income Statement5-*Whole Foods Market:Simple Financial Model Representation of Net Income5-*Whole Foods Market:Cause-of-Change Analysis5-*Whole Foods Market:Common-Size Statements5-*Whole Foods Market:Trend Statements5-*Whole Foods Market:Store Analysis5-*Whole Foods Market: Comparative Balance Sheet5-*Whole Foods Market: Comparative Balance Sheet5-*Whole Foods Market: Common-Size Analysis of Assets5-*Whole Foods Market: Trend Analysis of Assets5-*Whole Foods Market: Common-Size Analysis of Liabilities and Shareholders’ Equity5-*Whole Foods Market: Trend Analysis of Liabilities and Shareholders’ Equity5-*Whole Foods Market: Comparative Cash Flow Statements5-*Whole Foods Market: Common-Size and Trend Analysis of Selected Cash Flow Items5-*Financial ratios and profitability analysisReturn on assetsAsset turnoverOperating profit marginAnalysts do not always use the reported earnings, sales and asset figures. Instead, theyoften consider three types of adjustments to the reported numbers:Remove non-operating and nonrecurring items to isolate sustainable operating profits.Eliminate after-tax interest expense to avoid financial structure distortions.Eliminate any accounting quality distortions (e.g., off-balance operating leases).ROA=EBIAverage assets EBI SalesSalesAverage assetsX5-*How can ROA be increased?Asset turnover5-*There are just two ways:Increase the operating profit margin, orIncrease the intensity of asset utilization (turnover rate).Operating profit marginROA =EBIAverage assetsEBISalesSalesAverage assetsROA and competitive advantage:Grocery industryCompetition works to drive down ROA toward the competitive floor. Companies that consistently earn an ROA above the floor are said to have a competitive advantage.However, a high ROA attracts more competition which can lead to an erosion of profitability and advantage.5-*Average ROA is 4.6%Both Harris Teeter Supermarkets (HTSI) and Safeway, Inc. (SWY) both earned about the average industry return of 4.6% but Harris did it with higher margins and lower turnover than SafewayDifferences in business strategies give rise to economic differences that are reflected in differences in operating margin, asset utilization, and profitability (ROA).Different points on the curve have different combinations of margin and turnoverProfitability and financial leverageGood earnings year: ROCE is higher for HiDebt because leverage increased the return to shareholders due to the after-tax interest payment of only 6% (10% x (1-40%)5-*Neutral earnings year: Leverage neither helps nor harms shareholdersBad earnings year: After-tax interest charges wipe out earnings, and ROCE is 0% for HiDebtComponents of ROCEReturn on commonequity (ROCE)Net income available to common shareholders Average common shareholders’ equityReturn on assets (ROA)EBIAverage assetsCommon earnings leverageNet income available to common shareholders EBIFinancial structure leverageAverage assets Average common shareholders’ equityXX5-*Financial statement analysis and accounting qualityFinancial ratios, common-size statements, and trend statements are extremely powerful tools.But they can be no better than the data from which they are constructed.Be on the lookout for accounting distortions when using these tools. Examples include:Nonrecurring gains and lossesDifferences in accounting methodsDifferences in accounting estimatesGAAP implementation differencesHistorical cost convention5-*Liquidity, Solvency, and Credit Analysis: OverviewCredit risk refers to the risk of nonpayment by the borrower.The lender risks losing interest payments and loan principal.A borrower’s ability to repay debt is driven by its capacity to generate cash from operations, asset sales, or external financial markets.A company’s willingness to repay debt depends on which of the competing cash needs management believes is most pressing at the moment.5-*Liquidity, Solvency, and Credit Analysis: Balancing cash sources and needsFigure 5.45-*Liquidity Analysis:Short-term liquidity ratiosShort-termliquidityActivityratiosLiquidityratiosAccounts receivable turnover =Net credit salesAverage accounts receivableInventory turnover =Cost of goods soldAverage inventoryAccounts payable turnover =Inventory purchasesAverage accounts payableCurrent ratio =Current assetsCurrent liabilitiesQuick ratio =Cash + Marketable securities + ReceivablesCurrent liabilities5-*Liquidity Analysis:Comparison of Operating and cash conversion cycle5-*Liquidity Analysis:Credit Risk Analysis: Short-Term Liquidity5-*Liquidity Analysis:Long-term solvencyLong-termsolvencyCoverageratiosDebt ratiosInterest coverage =Operating incomes before taxes and interestInterest expenseOperating cash flow to total liabilitiesCash flow from continuing operationsAverage current liabilities + long-term debt=Long-term debt to assets =Long-term debtTotal assetsLong-term debt to tangible assets =Long-term debtTotal tangible assets5-*Credit risk:Financial ratios and default riskA firm defaults when it fails to make principal or interest payments.Lenders can then:Adjust the loan payment schedule.Increase the interest rate and require loan collateral.Seek to have the firm declared insolvent.Financial ratios play two roles in credit analysis:They help quantify the borrower’s credit risk before the loan is granted.Once granted, they serve as an early warning device for increased credit risk.Default Rates among public companies by S&P credit rating: 1981-20085-*Default frequency:5-*Probability of default within five years among public companies: 1980-1999SummaryFinancial ratios, common-size statements and trend statements are powerful tools.However:There is no single “correct” way to compute financial ratios.Financial ratios don’t provide the answers, but they can help you ask the right questions.Watch out for accounting distortions that can complicate your interpretation of financial ratios and other comparisons.5-*