Financial Statement Analysis: K R Subramanyam John J Wild

Financial Statement Analysis
K R Subramanyam
John J Wild
Kode & Mata Kuliah Revisi 1.0

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Overview of Financial
Statement Analysis
1
CHAPTER
Kode & Mata Kuliah 2 Revisi 1.0

Business Analysis
Evaluate Prospects Evaluate Risks

Business Decision Makers
Equity investors
Creditors
Managers
Merger and Acquisition Analysts
External Auditors
Directors
Regulators
Employees & Unions
Lawyers

Information Sources for Business Analysis
Quantitative Qualitative
Management discussion & Analysis

Financial Statements
Chairperson’s Letter
Industry Statistics
Press Releases
Economic Indicators
Financial press
Regulatory filings
Vision/Mission Statement
Trade reports Web sites

Credit Analysis Equity Analysis
Management &
Control Labor Negotiations
Types of
Business
Regulation Director Oversight
Analysis
Financial External Auditing

Management
Mergers, Acquisitions
& Divestitures
Credit Analysis
Trade Creditors Non-trade

Creditors
Provide goods Bear risk of Provide major Bear risk of

or services default financing default
Most short- Usually implicit Most long- Usually explicit

term interest term interest

Credit Analysis
Credit worthiness: Ability to honor credit obligations
(downside risk)
Liquidity Solvency
Ability to meet short-term Ability to meet long-term
obligations obligations
Focus: Focus:
• Current cash flows • Long-term profitability
• Make up of current • Capital structure
assets and liabilities
• Liquidity of assets

Equity Analysis
Assessment of downside risk and upside potential
Technical analysis / Charting Fundamental Analysis

• Patterns in price or volume Determine Intrinsic value
history of a stock without reference to price
• Predict future price
movements • Analyze and interpret key
factors
– Economy
– Industry
– Company

Component Processes of
Business Analysis
Business
Environment &
Strategy Analysis
Industry Strategy
Analysis Analysis
Financial
Analysis
Analysis
Accounting of cash Prospective
Analysis flows Risk
Analysis
Profitability
Analysis Analysis
Cost of Capital Estimate Intrinsic Value

Accounting Analysis
Process to evaluate and adjust financial

statements to better reflect economic reality
Comparability problems — across firms and across time
Manager estimation error
Distortion problems Earnings management Accounting

Risk
Accounting Standards

Financial Analysis
Process to evaluate financial position and

performance using financial statements
Profitability analysis — Evaluate return

on investments Common tools
Risk analysis ——— Evaluate riskiness

& creditworthiness Cash
Ratio
flow
analysis
analysis
Analysis of — Evaluate source &
cash flows deployment of funds

Prospective Analysis
Process to forecast future payoffs
Business Environment
& Strategy Analysis
Accounting Analysis
Financial Analysis
Intrinsic Value
Dynamics of Business Activities
Business Activities Time
Beginning of period
Investing Financing
Planning
Operating
Planning
Investing Financing
End of period

Business Activities
Competition Pricing
Market demands Tactics

Planning
Activities:
Distribution Goals Promotion
& Objectives
Projections
Managerial performance
Opportunities Obstacles
Business Activities
Financing activities
• Owner (equity)
• Nonowner (liabilities)
Financing

Business Activities
Investing activities
• Buying resources
• Selling resources
Investing Financing
Investing = Financing
Business Activities
Planning
Investing Activities Financial
Activities Activities
Operating Activities
Revenues and expenses from providing
goods and services
Financial Statements Reflect Business Activities
Planning
Investing Financing
Current: Operating Current:
• Cash • Notes Payable
• Sales Accounts Payable
• Accounts Receivable • Cost of Goods Sold
•
• Inventories • Salaries Payable

• Selling Expense
• Marketable Securities • Income Tax Payable
• Administrative Expense
Noncurrent: Noncurrent:
• Interest Expense
• Land, Buildings, & • Income Tax Expense

• Bonds Payable
Equipment • Common Stock
• Patents • Retained Earnings
Net Income
• Investments
Liabilities & Equity

Income statement
Assets Cash Flow Balance Sheet
Balance Sheet Statement of Statement of

Cash Flows Shareholders’ Equity
Financial Statements
Balance Sheet
Income Statement
Statement of Shareholders’
Equity
Statement of Cash Flows

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Balance Sheet
Total Investing = Total Financing

= Creditor Financing + Owner Financing
Colgate Financing
(in $billions)
$9.138 = $7.727 + $1.410

1-22
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Income Statement
Revenues – Cost of goods sold = Gross Profit

Gross profit – Operating expenses = Operating Profit
Colgate’s Profitability
(in $billions)
$12.238 - $5.536 = $6.701 Gross Profit

$6.701 - $4.5411 = $2.160 Operating profit

1-24
24
Statement of Cash Flows
Net Cash Flows from Operating

Activities
Net Cash Flows from Investing

Activities
Net Cash Flows from Financing

Activities

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Additional Information
(Beyond Financial Statements)
Management’s Discussion & Analysis (MD&A)
Management Report
Auditor Report
Explanatory Notes to Financial Statements
Supplementary Information
Proxy Statement

Analysis Preview
Yr1 Yr2 Yr3
Comparative Analysis
Purpose:Evaluation of consecutive
financial statements
Output: Direction, speed, & extent of any
trend(s)
Types:  Year-to-year Change Analysis
 Index-Number Trend Analysis
1-29
Analysis Preview
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Analysis Preview
Common-Size Analysis
Purpose :  Evaluation of internal makeup
of financial statements
 Evaluation of financial statement
accounts across companies
Output: Proportionate size of assets,
liabilities, equity, revenues, &
expenses
Analysis Preview

Analysis Preview

Analysis Preview
Ratio Analysis
Purpose : Evaluate relation between two or more
economically important items (one
starting point for further analysis)
Output: Mathematical expression of relation
between two or more items
Cautions:  Prior Accounting analysis is important
 Interpretation is key - long vs short
term & benchmarking

Analysis Preview
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)

Analysis Preview
Debt (Bond) Valuation
Bt is the value of the bond at time t

It +n is the interest payment in period t+n
F is the principal payment (usually the debt’s face value)
r is the investor’s required interest rate (yield to maturity)

Analysis Preview
Equity Valuation
Vt is the value of an equity security at time t

Dt +n is the dividend in period t+n
k is the cost of capital
E refers to expected dividends

Analysis Preview
Equity Valuation - Free Cash Flow to Equity
Model
FCFt+n is the free cash flow in the period t + n [often

defined as cash flow from operations less capital
expenditures]
E refers to an expectation

Analysis Preview
Equity Valuation - Residual Income Model
BV is the book value at the end of period t

t
Rit+n is the residual income in period t + n [defined as

net income, NI, minus a charge on beginning
book value, BV, or RIt = NIt - (k x BVt-1)]
E refers to an expectation
Analysis in an Efficient Market
Three assumed forms of market efficiency

Weak Form - prices reflect information in
past prices
Semi-strong - prices reflect all public
Form information
Strong Form - prices reflect all public and
private information

Book Organization
Financial Statement Analysis
Part I Part II Part III

Introduction and Overview Accounting Analysis Financial Analysis
Chapter 3: Analyzing Chapter 7: Cash Flow

Chapter 1: Overview of Analysis
Financial Activities
Financial Statement Chapter 8: Return on
Chapter 4: Analyzing
Analysis Invested Capital
Investing Activities
Chapter 5: Analyzing Chapter 9: Profitability
Chapter 2: Financial Analysis
Investing Activities:
Reporting and Chapter 10: Prospective
Special topic
Analysis Analysis
Chapter 6: Analyzing
Chapter 11: Credit
Operating Activities Analysis
Chapter 12: Equity
Analysis and Valuation

Financial Statement Analysis: K R Subramanyam John J Wild

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Financial Statement Analysis: K R Subramanyam John J Wild

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Financial Statement Analysis

Kode & Mata Kuliah Revisi 1.0

Kode & Mata Kuliah 2 Revisi 1.0

Evaluate Prospects Evaluate Risks

Merger and Acquisition Analysts

Employees & Unions

Kode & Mata Kuliah 3 Revisi 1.0

Management discussion & Analysis

Trade reports Web sites

Financial External Auditing

Trade Creditors Non-trade

Provide goods Bear risk of Provide major Bear risk of

Most short- Usually implicit Most long- Usually explicit

Kode & Mata Kuliah 6 Revisi 1.0

Kode & Mata Kuliah 7 Revisi 1.0

Assessment of downside risk and upside potential

Technical analysis / Charting Fundamental Analysis

Kode & Mata Kuliah 8 Revisi 1.0

Cost of Capital Estimate Intrinsic Value

Process to evaluate and adjust financial

Comparability problems — across firms and across time

Manager estimation error

Distortion problems Earnings management Accounting

Kode & Mata Kuliah 10 Revisi 1.0

Process to evaluate financial position and

Profitability analysis — Evaluate return

Risk analysis ——— Evaluate riskiness

Kode & Mata Kuliah 11 Revisi 1.0

Kode & Mata Kuliah 13 Revisi 1.0

Market demands Tactics

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• Inventories • Salaries Payable

• Land, Buildings, & • Income Tax Expense

Liabilities & Equity

Balance Sheet Statement of Statement of

Statement of Cash Flows

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Total Investing = Total Financing

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Revenues – Cost of goods sold = Gross Profit

$12.238 - $5.536 = $6.701 Gross Profit

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Net Cash Flows from Operating

Net Cash Flows from Investing

Net Cash Flows from Financing

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Purpose: Estimate intrinsic value of a

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Debt (Bond) Valuation

Bt is the value of the bond at time t

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Vt is the value of an equity security at time t

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FCFt+n is the free cash flow in the period t + n [often

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Equity Valuation - Residual Income Model

BV is the book value at the end of period t