Chapter 13 Notes.docx

32 views8 pages
10 Apr 2012
Users Perspective
- predict the amount of expected returns
- assess the risks associated with the return
- diff. users have diff. needs diff. needs require diff. ratio analysis
Concerns of Creditors:
- short and long term liquidity
Concerns of Investors:
- profitability
- dividends
- future stock prices
Financial Statement Analysis: Two Benchmarks
Time Series Analysis Trend Analysis
- information for a single company is compared over time on a year over year basis
- MD+A (management discussion + analysis) min. 10 years comparison
- e.g. change in sales volume each year for its existing stores
Comparison with Similar Companies
- -provides insights concerning a company’s relative performance by comparisons with
similar companies within the same industries
- gov. has SIC (standard industry clarifications) info that provides useful metrics for
comparison purposes
Ratio and Percentage Analysis
Ratio (Percentages) Analysis
- analytical tool designed to identify significant relationships; it measures the proportional
relationship b/w 2 F/S amounts
- uses % to allow users to compare results from diff. sizes of companies within the same
- revenue is the base line at 100% (on income statement)
- total assets is base line at 100% (on balance sheet)
Unlock document

This preview shows pages 1-3 of the document.
Unlock all 8 pages and 3 million more documents.

Already have an account? Log in
- may be interpreted by:
o comparison with ratios of other companies
o industry average ratios
- beware of:
o company’s industry characteristics
o nature of operations, size and accounting policies
o seasonality + life cycle
o accruals and deferrals made by management (who are usually biased)
- in addition to financial ratios, special factors that might affect the evaluation of a
company include:
o rapid growth
o uneconomical expansion
o subjective factors requiring professional judgment
o seasonality + life
Financial Statement Analysis
3 Types of Financial Statement Information:
Past Performance
- income, sales volume (market share), cash flow, return on investments, EPS (key metrics
for investors)
- will always give/provide a good indicator for the future
Present Condition
- assets, debt, inventory, various ratios
Future Performance
- sales and earnings trends are good indicators of future performance
Tests of Operating Efficiency and Profitability
- profitability: a primary measure of the overall success of a company and necessary for a
company’s survival
- all of these ratios is a function of profit
- these tests compare profit with one or more primary activities
1) Return on Equity
o ROE = profit (income from continuing operations)
average SE (book value)
o indicates how much income was earned for every dollar invested by owners
o assesses effectiveness of company’s overall business strategy (operating, investing,
o high ROE = high share prices
o increasing ROE failing to invest in R+D or failure in modernization of P+E
Unlock document

This preview shows pages 1-3 of the document.
Unlock all 8 pages and 3 million more documents.

Already have an account? Log in
1) a) Rate of Return on Common Shareholder’s Equity
o (income before discontinued operations preferred dividends)
average C/S equity
o gauges how much income is earned with the money invested by common shareholders
1) b) ROE Profit Driver Analysis
o ROE = Net Profit Margin x Asset Turnover x Financial Leverage
o (net income /average SE = (net income/net sales) x (net sales/average total assets) x
(average total assets/average SE)
o improvement of one of the 3 ratios relates to efficiency in how management manages
costs (cost efficiency)
2) Net Profit Margin
o NPM = net income (before extraordinary items)
net sales revenue
o measures how much profit is earned as a % of revenues generated during the period
o rising NPM = efficient management of sales + expenses
o different NPM among competitors = company’s response to changes in competition,
S+D, managing sales volume, price and costs
o caution: decisions that management makes to maintain the NPPM may have negative
long-run implications; therefore ratio should have additional analysis to identify trends in
each component of revenues + expenses
3) Return on Assets
o ROA = net income + interest expense (net of tax)
average total assets
o better measure of management’s ability to utilize assets effectively b/c it is not affected
by the way in which the assets were financed (reason why interest expense is added)
o ROE measures profitability from shareholder’s perspective while ROA takes into
consideration the resources contributed by shareholders + creditors
o ROE could be very large for companies that are highly leveraged (lots of debt, low levels
of share capital) while ROA could be considerably lower
4) Financial Leverage
o measures advantage/disadvantage that occurs when a company’s ROE differs from its
ROA (i.e. ROE ROA)
o good measure for how companies utilize debt
o positive: rate of return of investment > cost of borrowing
o negative: deterioration to company’s profitability or when equity increases through the
issuance of additional shares
o caution: positive may mean that ROA is increasing as a result of borrowing at high
interest rates
o negative many signal future growth
Unlock document

This preview shows pages 1-3 of the document.
Unlock all 8 pages and 3 million more documents.

Already have an account? Log in

Get OneClass Notes+

Unlimited access to class notes and textbook notes.

YearlyBest Value
75% OFF
$8 USD/m
$30 USD/m
You will be charged $96 USD upfront and auto renewed at the end of each cycle. You may cancel anytime under Payment Settings. For more information, see our Terms and Privacy.
Payments are encrypted using 256-bit SSL. Powered by Stripe.