Business Finance

(MGT 232)

Lecture 20

4-1
Financial
FinancialStatement
StatementAnalysis
Analysis

4-2
 Overview of the Last Lecture
• Cash Management
• Cash management System
• Collection float
• Mail float
• Processing float
• Availability float
• Deposit float
• Lock Box system
• Cash Budget

4-3
 Financial Statement Analysis

• Financial Statements
• A Possible Framework for Analysis
• Ratio Analysis
• Trend Analysis
• Common-Size and Index Analysis

4-4
 Examples of External Uses of
Statement Analysis
• Trade Creditors -- Focus on the liquidity of the
firm.
• Bondholders -- Focus on the long-term cash
flow of the firm.
• Shareholders -- Focus on the profitability and
long-term health of the firm.

4-5
 Examples of Internal Uses of
Statement Analysis

• Plan -- Focus on assessing the current financial

position and evaluating potential firm
opportunities.
• Control -- Focus on return on investment for
various assets and asset efficiency.
• Understand -- Focus on understanding how
suppliers of funds analyze the firm.

4-6
 Primary Types of Financial
Statements

Balance Sheet
 A summary of a firm’s financial position on a
given date that shows total assets = total
liabilities + owners’ equity.
Income Statement
– A summary of a firm’s revenues and expenses over
a specified period, ending with net income or loss
for the period.
4-7
 Basket Wonders’ Balance
Sheet (Asset Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a

Cash and C.E. Rs. 90 a. How the firm stands on a

Acct. Rec.c 394 Inventories specific date.
696 b. What BW owned.
Prepaid Exp d 5 c. Amounts owed by
Accum Tax Prepay 10 customers.
Current d. Future expense items
Assets e Rs. 1,195 Fixed already paid.
Assets (@Cost) f 1030 Less: Acc.
e. Cash/likely convertible to
Depr. g (329) Net Fix. Assets
Rs. 701 Investment, LT cash within 1 year.
50 Other Assets, LT f. Original amount paid.
223 Total Assetsb g. Acc. deductions for wear and
Rs.2,169 tear. 4-8
 Basket Wonders’ Balance
Sheet (Liability Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2013

Notes Payable Rs. 290 a. Note, Assets = Liabilities +

Acct. Payablec 94 Accrued Equity.
Taxes d 16 Other Accrued Liab. d b. What BW owed and
100 Current Liab. e ownership position.
Rs. 500 Long-Term Debt f
c. Owed to suppliers for goods
530 Shareholders’ Equity
Com. Stock (Rs.1 par) g 200 and services.
Add Pd in Capital g 729 Retained d. Unpaid wages, salaries, etc.
Earnings h 210 Total Equity e. Debts payable < 1 year.
Rs. 1,139 f. Debts payable > 1 year.
Total Liab/Equitya,b Rs.2,169 g. Original investment.
h. Earnings reinvested.
4-9
 Basket Wonders’ Income
Statement
Basket Wonders Statement of Earnings (in thousands) for Year Ending December
31, 2013a

Net Sales Rs. 2,211 Cost of a. Measures profitability over a

Goods Sold b 1,599 Gross time period.
Profit Rs. 612 SG&A b. Received, or receivable, from
Expenses c 402 customers.
EBITd Rs. 210 c. Sales comm., adv., officers’
Interest Expensee 59 salaries, etc.
EBT f Rs. 151 Income d. Operating income.
Taxes 60 EATg e. Cost of borrowed funds.
Rs. 91 Cash
f. Taxable income.
Dividends 38
g. Amount earned for
Increase in RE Rs. 53
shareholders. 4-10
 Framework for Financial
Analysis
Trend / Seasonal Component
How much funding will be required in the
future?

1. Analysis of the funds Is there a seasonal component?

needs of the firm.

Analytical Tools Used

Sources and Uses Statement
Statement of Cash Flows
Cash Budgets

4-11
 Framework for Financial
Analysis

Health of a Firm

1. Analysis of the funds Financial Ratios

needs of the firm.
2. Analysis of the financial
condition and profitability 1. Individually
of the firm. 2. Over time
3. In combination
4. In comparison

4-12
 Framework for Financial
Analysis

Business risk relates to

the risk inherent in the
1. Analysis of the funds
needs of the firm.
operations of the firm.
2. Analysis of the financial Examples:
condition and profitability
of the firm. Volatility in sales
3. Analysis of the business Volatility in costs
risk of the firm.
Proximity to break-even
point
4-13
 Framework for Financial
Analysis
A Financial
Manager
must consider
1. Analysis of the funds
needs of the firm. Determining all three
the jointly when
2. Analysis of the financial
financing
condition and profitability
needs of
determining
of the firm. the financing
the firm.
3. Analysis of the business
risk of the firm.
needs of the
firm.

4-14
 Framework for Financial
Analysis

1. Analysis of the funds

needs of the firm. Determining Negotiations
the with
2. Analysis of the financial suppliers of
financing
condition and profitability capital.
needs of
of the firm.
the firm.
3. Analysis of the business
risk of the firm.

4-15
 Use of Financial Ratios

A Financial Ratio is an Types of

index that relates two Comparisons
accounting numbers
and is obtained by Internal
dividing one number by Comparisons
the other. External
Comparisons
4-16
 What are the five major categories of ratios,
and what questions do they answer?
• Liquidity: Can we make required payments in the
short run?
• Asset management: right amount of assets vs. sales?
• Debt management, leverage: Right mix of debt and
equity?
• Profitability: Do sales prices exceed unit costs, and
are sales high enough as reflected in PM, ROE, and
ROA?
• Market value: Do investors like what they see as
reflected in P/E and M/B ratios?

4-17
 External Comparisons and
Sources of Industry Ratios
This involves comparing the ratios of one firm with
those of similar firms or with industry averages.

Similarity is important as one should compare

“apples to apples.”

4-18
 Summary
• Financial Statements
• A Possible Framework for Analysis
• Ratio Analysis
– Liquidity Ratios
» Current ratio
» Quick-asset ratio
» Net working Capital

4-19