FINS1613 Lecture Notes - Lecture 5: Inventory Turnover, Asset Turnover, Financial Statement
Chapter 2: Financial Statement Analysis
Financial Statements: accurate and reliable financial information is critical to financial
market health
- accounting boards- ules hih ops prep financial statements- Australian
aoutig stadads oad, Itl at stadads oad, fiaial at stadads
board (IFRS)
- auditors- neutral third party- rules, reliable
- financial health/postion
o /s: A=L+E ook alue/et oth of fis euity + estimate of the
liquidation value of the firm- total value of equity P*shares)assets- cash +
other marketable securities (ST low risk)
▪ liquidation value: value of firm after assets are sold and liabilities paid
▪ market/price-to-book ratio: ratio of firs aket ap to the BV of
shaeholdes euit: aket alue of euit/BV of euit > alue
stocks- low M/B ratio vs. growth stocks)
▪ leverage: debt-euit atio: fis leeage etet to hih it elies
on debt as a source of financing) = total debt/total equity (+equity
multiplier)
▪ etepise alue: total aket alue of fis euit ad det, less
value of its cash and marketable securities- value of underlying
business (EV= market value of equity + debt – cash)
▪ liquidity: quick ratio= (current assets – inventory)/current liabilities
o statem of changes in equity
- past performance
o Y statem (P&L) (revenues/expenses- et pofit otto lie aual
accounting- rev/exp matched and recognised when incurred, depreciated
matching LT life, taxes based on EBIT. Debt payments are ignored when
evaluating projects- tax benefits of debt addressed through appropriate
discount-rate)
▪ Gross profit, operating expenses, EBIT, net profit before tax
▪ Profitability ratios: gross margin (ability to sell for more than direct
costs), operating margin (EBIT for each dollar of sales- efficiency), net
profit margin (fraction of each dollar in revenue that is available to
equity holders after firm pays its expenses, plus interest and taxes-
quod differences in efficiency+leverage)
▪ EPS = NP/shares outstanding
▪ Asset efficiency ratios: asset turnover = sales/total assets vs. fixed
asset turnover= sales/fixed assets
▪ Working capital ratio: accounts receivable days= accounts
receivable/avg daily sales (accounts payable days accts payable/avg
daily COGS + inventory days= inventory/avg daily COGS), inventory
turnover ratio= sales/inventory
▪ Interest coverage ratio: atio of fis pofit/CF to iteest epese
(financial strength)
▪ EBITDA: reflects cash a firm has earned from operations
▪ Leverage ratios: interest coverage ratio/times interest earned (TIE)
ratio- assessets of fis leeage ailit to oe iteest
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measure of earnings/interest: high means earning more than
necessary to meet repaym
▪ Investment returns: return on equity (ROE/ROA)= net profit/BV of
equit+RO assets
▪ DuPont Identity: drivers of ROE- product of profit margin, asset
turnover and a measure of leverage:
• ROE= (net prof/total equity)*(sales/sales) = (net
prof/sales)*(sales/total equity)= (net prof/sales)*(sales/total
assets)*(total assets/total equity)
• ROE = net profit per dollar of sales (profit margin)* sales per
dollar of sales (asset turnover)* assets per dollar of equity
(measure of leverage equity multiplier)
▪ Valuation ratios: market value of firm P/E ratio (value of equity to
firm earnings): market cap/net profit = share price/EPS – considers
equity sic leverage → PEG atio atio of fis P/E to epeted
earnings growth rate >1 overvalued)
▪ Depreciation: systematic allocation of acquisition cost of long-lived or
fixed assets to expense accounts of particular periods that benefit
from the use of assets (initial acquisition cost of asset, useful life of
the asset, depreciation method)
• Prime cost depreciation (straight-line depreciation): initial
book value=acquisition cost; annual depreciation (initial
BV/depreciation life)- assets ost diided euall oe its life
o CF statem (lists how cash has been allocated over PoT-
operating/investing/financing activities- cash basis- recognised when paid not
matched to when they are incurred))
▪ Tax paym based on Y statem EBIT, debt paym ignored, tax benefits of
debt are addressed through appropriate discount rate
▪ After-tax salvage: cash received for selling an asset adjusted for taxes
over or under paid because the selling $P differs from the book value
(using prime cost depreciation)
• After tax salvage = salvage $P – tax rate*capital gains
▪ Operating activities- direct (gross cash receipts/paym) vs. indirect
(profit adjusted for cash nature)
• Net profit + noncash expenses
• Working capital- deduct increases in acc rec- rep additional
lending by firm to customers and reduces cash available to
firm + add increases in acc payable (rep increase in cash
available) + deduct inventory increases
▪ Investment activities
• Purchases of new PPE- capital expenditures → do not appear
immediately as expenses on Y statem, firm depreciates these
assets and deducts depreciation expenses o/t
• Add back depreciation and subtract actual cap exp and
subtract acquisitions
▪ Financing activities
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Document Summary
Financial statements: accurate and reliable financial information is critical to financial market health. Accounting boards- (cid:396)ules (cid:271)(cid:455) (cid:449)hi(cid:272)h (cid:272)o(cid:396)p(cid:859)s prep financial statements- australian a(cid:272)(cid:272)ou(cid:374)ti(cid:374)g sta(cid:374)da(cid:396)ds (cid:271)oa(cid:396)d, i(cid:374)t(cid:859)l a(cid:272)(cid:272)t sta(cid:374)da(cid:396)ds (cid:271)oa(cid:396)d, fi(cid:374)a(cid:374)(cid:272)ial a(cid:272)(cid:272)t sta(cid:374)da(cid:396)ds board (ifrs) Past performance: y statem (p&l) (revenues/expenses- (cid:374)et p(cid:396)ofit (cid:858)(cid:271)otto(cid:373) li(cid:374)e(cid:859) a(cid:272)(cid:272)(cid:396)ual accounting- rev/exp matched and recognised when incurred, depreciated matching lt life, taxes based on ebit. Mgmt. discussion and analysis (md&a- off b/s transactions), statement of changes in equity, notes. Financial statements- b/s: financial health, a= l+e income statement- net profit measure of a firm profitability over the period cash flow statement: cash generated, and how allocated over a period of time. Income statement: revenue cogs = gross profit: gross profit depreciation = ebit, ebit taxes= net profit. Cape(cid:454): does(cid:374)(cid:859)t appea(cid:396) as pa(cid:396)t of i(cid:374)(cid:272)(cid:396)e(cid:373)e(cid:374)tal ea(cid:396)(cid:374)i(cid:374)gs, (cid:271)ut is a (cid:272)ash i(cid:374)(cid:448)est(cid:373)e(cid:374)t (cid:894)-) Depreciation: appears in incremental earnings, but is a cash recovery of equipment.
