Financially Yours Session 2

8/11/2019 Financially Yours Session 2

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Financially Yours

Session II


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Financial Statement Analysis

Comprehensive Summary


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Analyzing financial statements involves Threecharacteristics of a company: 1 its liquidity , 2 itsprofitability , and 3 its solvency .

Every item reported in a financial statement hassignificance.Comparisons can be made on several difference bases

three are illustrated in this chapter: 1 intra-company

basis ,2

industry averages , and3

intercompany basis .


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Three commonly used tools are utilized to evaluate thesignificance of financial statement data.1 Horizontal analysis (trend analysis ) is a technique

for evaluating a series of financial statement dataover a period of time.

2 Vertical analysis is a technique for evaluatingfinancial statement data that expresses each item

in a financial statement in terms of a percent of abase amount.3 Ratio analysis expresses the relationship among

selected items of financial statement data.


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QUALITY DEPARTMENT STORE INC.Condensed Balance Sheet

December 31

2000 1999 Amount Percentage Assets

$ 945,000 Plant assets (net) 800,000 632,500 167,500 26.5%

15,000 Total assets $ 1,595,000 $ 240,000 15.0%

Liabilities $ 344,500 $ 303,000 $ 41,500

Long-term liabilities 497,000 ( 9,500) ( 1.9%) 832,000 4.0%

Common stock, $1 par 275,400 270,000 727,600 525,000 202,600 38.6%

Total stockholders equity 795,000 26.2%

Increase or (Decrease) during 2000

Current assets $ 1,020,000 $ 75,000 7.9%

Intangible assets 17,500 ( 2,500) ( 14.3%) $ 1,835,000

Current liabilities 13.7% 487,500

Total liabilities 800,000 32,000 Stockholders Equity

5,400 2.0% Retained earnings

1,003,000 208,000 Total liabilities and stockholders equity $ 1,835,000 $ 1,595,000 $ 240,000 15.0%

The 2-year condensedbalance sheet of QualityDepartment Store Inc. for2000 and 1999 showingdollar and percentagechanges is displayed on theright. In the asset section,plant assets (net) increased$167,500 or 26.5% . In theliabilities section, currentliabilities increased $41,500or 13.7% . In thestockholders equity section,

retained earnings increased$202,600 or 38.6% . Itappears the companyexpanded its asset baseduring 2000 and financed theexpansion by retainingincome in the firm.


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QUALITY DEPARTMENT STORE INC.Condensed Income Statement

For the Years Ended December 31

Increase or (Decrease)

during 2000 2000 1999 Amount Percentage Sales $ 2,195,000 $ 1,960,000 $ 235,000 12.0% Sales returns and allowances 98,000 123,000 ( 25,000) ( 20.3%)

Net sales 2,097,000 1,837,000 260,000 14.2% Cost of goods sold 1,281,000 1,140,000 141,000 12.4% Gross profit 816,000 697,000 119,000 17.1% Selling expenses 253,000 211,500 41,500 19.6% Administrative expenses 104,000 108,500 ( 4,500) ( 4.1%)

Total operating expenses 357,000 320,000 37,000 11.6% Income from operations 459,000 377,000 82,000 21.8% Other revenues and gains

Interest and dividends 9,000 11,000 ( 2,000) ( 18.2%) Other expenses and losses

Interest expense 36,000 40,500 ( 4,500) ( 11.1%) Income before income taxes 432,000 347,500 84,500 24.3% Income tax expense 168,200 139,000 29,200 21.0%

Net income $ 263,800 $ 208,500 $ 55,300 26.5%

The 2-year comparativeincome statement of QualityDepartment Store Inc. for2000 and 1999 is shown incondensed form on the right.Horizontal analysis of the

comparative incomestatement shows thefollowing changes:1 Net sales increased

$260,000 , or 14.2%($260,000 $1,837,000 ).

2 Cost of goods sold

increased $141,000 , or12.4% ($141,000 $1,140,000 ).

3 Total operating expensesincreased $37,000 , or11.6% ($37,000 $320,000 ).


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Presented on the right is the 2-year comparative balance sheetof Quality Department StoreInc. for 2000 and 1999 .1 Current assets increased

$75,000 from 1999 to 2000 ,they decreased from59.2% to 55.6% of totalassets.

2 Plant assets (net) increasedfrom 39.7% to 43.6% oftotal assets, and

3 Retained earnings increasedfrom 32.9% to 39.7% oftotal liabilities andstockholders equity.

These results reinforce earlierobservations that Quality isfinancing its growth throughretention of earnings.

QUALITY DEPARTMENT STORE INC.Condensed Balance Sheet

December 31

2000 1999 Amount Percent Amount Percent

Assets Current assets $ 1,020,000 55.6% $ 945,000 59.2% Plant assets (net) 800,000 43.6% 632,500 39.7% Intangible assets 15,000 0.8% 17,500 1.1%

Total assets $ 1,835,000 100.0% $ 1,595,000 100.0% Liabilities

Current liabilities $ 344,500 18.8% $ 303,000 19.0% Long-term liabilities 487,500 26.5% 497,000 31.2%

Total liabilities 832,000 45.3% 800,000 50.2% Stockholders Equity

Common stock, $1 par 275,400 15.0% 270,000 16.9% Retained earnings 727,600 39.7% 525,000 32.9%

Total stockholders equity 1,003,000 54.7% 795,000 49.8% Total liabilities and stockholders equity $ 1,835,000 100.0% $1,595,000 100.0%


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Vertical analysis of the 2-year comparative incomestatement of QualityDepartment Store Inc. for2000 and 1999 is shown onthe right.

1 Cost of goods sold as apercentage of net salesdeclined 1% (62.1% versus61.1% ).

2 Total operating expensesdeclined 0.4% (17.4%versus 17.0% ).

3 Net income as a percent ofnet sales thereforeincreased from 11.4% to12.6% .

Quality appears to be aprofitable enterprise that isbecoming more successful.

QUALITY DEPARTMENT STORE INC.Condensed Income Statement

For the Years Ended December 31

2000 1999

Amount Percent Amount Percent Sales $ 2,195,000 104.7% $ 1,960,000 106.7% Sales returns and allowances 98,000 4.7% 123,000 6.7%

Net sales 2,097,000 100.0% 1,837,000 100.0% Cost of goods sold 1,281,000 61.1% 1,140,000 62.1% Gross profit 816,000 38.9% 697,000 37.9% Selling expenses 253,000 12.0% 211,500 11.5% Administrative expenses 104,000 5.0% 108,500 5.9% Total operating expenses 357,000 17.0% 320,000 17.4% Income from operations 459,000 21.9% 377,000 20.5% Other revenues and gains

Interest and dividends 9,000 0.4% 11,000 0.6% Other expenses and losses

Interest expense 36,000 1.7% 40,500 2.2% Income before income taxes 432,000 20.6% 347,500 18.9% Income tax expense 168,200 8.0% 139,000 7.5%

Net income $ 263,800 12.6% $ 208,500 11.4%


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Ratio analysis expresses the relationship among selected items offinancial statement data.

A ratio expresses the mathematical relationship between one

quantity and another. A single ratio by itself is not very meaningful, in the upcoming

illustrations we will use:1 Intra-company comparisons covering two years for the

Quality Department Store.2 Industry average comparisons based on median ratios for

department stores3 Intercompany comparisons based on Sears, Roebuck and Co. as

Quality Department Stores principal competitor.


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Liquidity Ratios

Measures of short-term abilityof the enterprise to pay itsmaturing obligations and tomeet unexpected needs for cash

Profitability Ratios

Measures of the income oroperating success of an

enterprise for a given period oftime

Solvency Ratios

Measures of the ability of theenterprise to survive over a long

period of time

Revenues Expenses

-=

NetIncome

XYZ Co.


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2000 1999

Current assets Cash $ 100,000 $ 155,000 Temporary invest. 20,000 70,000 Receivables (net) 230,000 180,000 Inventory 620,000 500,000 Prepaid expenses 50,000 40,000

Total current assets $ 1,020,000 $ 945,000


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CASH + MARKETABLE SECURITIES + RECEIVABLES (NET) ACID-TEST RATIO = CURRENT LIABILITIES

Quality Department Store

Industry average Sears, Roebuck and Co.

1.3:1 1.3:1

2000 1999

$100,000 + $20,000 + $230,000 $155,000 + $70,000 + $180,000 = 1.0:1 = 1.3:1

$344,500 $303,000

The acid-test ratio (quick ratio ) is a measure of a companys short-term liquidity and is calculated bydividing the sum of cash , marketable securities , and net receivables by current liabilities . The acid-testratios for Quality Department Store and comparative data are shown below.


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6.22 times 4.61 times

COST OF GOODS SOLD

INVENTORY TURNOVER = AVERAGE INVENTORY

2000 1999

$1,281,000 $1,140,000 = 2.3 times = 2.4 times$500,000 + $620,000 $450,000 + $500,000

2 2[ ] [ ]

The inventory turnover ratio measures the number of times, on average, the inventory is soldduring the period which measures the liquidity of the inventory. It is calculated by dividingcost of goods sold by average inventory during the year . The inventory turnover ratio andcomparative data for Quality Department Store for 2000 and 1999 are calculated below.


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3.16% 1.8%

NET INCOMEPROFIT MARGIN ON SALES =

NETSALES

2000 1999

$263,800 $208,500 = 12.6% = 11.4%$2,097,000 $1,837,000

The profit margin ratio is a measure of the percentage of each dollar of salesthat results in net income . It is calculated by dividing net income by net salesfor the period . The profit margin ratios and comparative data for QualityDepartment Store for 2000 and 1999 are calculated below.


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6.2% 7.4%

NET CASH PROVIDED BY OPERATING ACTIVITIESCASH RETURN ON SALES RATIO =

NET SALES

2000 1999

$404,000 $340,000 = 19.3% = 18.5%$2,097,000 $1,837,000

The cash basis counterpart of the profit margin ratio is the cash return on salesratio which uses net cash provided by operating activities as the numerator andnet sales as the denominator. Using net cash provided by operating activities of$404,000 in 2000 and $340,000 in 1999 , Quality Department Stores cash return onsales ratios are calculated and evaluated below.


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2000 1999

$2,097,000 $1,837,000 = 1.2 times = 1.21 times$1,595,000 + $1,835,000 $1,446,000 + $1,595,000

2 2[ ] [ ]


Industry average Sears, Roebuck & Co.


NET SALES ASSET TURNOVER =

AVERAGE ASSETS

The asset turnover ratio measures how efficiently a company uses its asset to generatesales . It is determined by dividing net sales by average assets for the period . QualityDepartment Stores cash return on sales ratios are calculated and evaluated below.


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2000 1999

$263,800 $208,500 = 15.4% = 13.7%$1,595,000 + $1,835,000 $1,446,000 + $1,595,000

2 2[ ] [ ]


Industry average Sears, Roebuck & Co.

7.42% 1.99%

NET INCOMERETURN ON ASSETS =

AVERAGE ASSETS

An overall measure of profitability is the return on assets ratio . It iscalculated by dividing net income by average assets for the period . QualityDepartment Stores return on assets ratios for 2000 and 1999 are calculatedand evaluated below.


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2000 1999

$263,800 $208,500 = 29.3% = 28.5%$795,000 + $1,003,000 $667,000 + $795,000

2 2[ ] [ ]



18.6% 10.9%

RETURN ON COMMON NET INCOMESTOCKHOLDERS EQUITY =

AVERAGE COMMON STOCKHOLDERS EQUITY

A ratio that measures profitability from the viewpoint of the common stockholder isreturn on common stockholders equity . It is calculated by dividing net income byaverage common stockholders equity for the period . Quality Department Stores returnon common stockholders equity for 2000 and 1999 are calculated and evaluated below.


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RATE OF RETURN ON COMMON NET INCOME PREFERRED DIVIDENDSSTOCKHOLDERS EQUITY =

AVERAGE COMMON STOCKHOLDERS EQUITY

When preferred stock is present, preferred dividendrequirements are deducted from net income todetermine income available to commonstockholders . The par value of preferred stock (orcall price if applicable) must be deducted fromtotal stockholders equity to arrive at the amount ofcommon stockholders equity used in this ratio.The ratio then appears as shown below.


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EARNINGS NET INCOMEPER SHARE =

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

2000 1999

$263,000 $208,500 - $.97 - $.77270,000 + 275,400 270,000

2[ ]

Earnings per share (EPS ) of common stock is a measure of net income earned oneach share of common stock. It is calculated by dividing net income by the numberof weighted average common shares outstanding during the year . QualityDepartment Stores EPS for 2000 and 1999 are calculated and evaluated below.


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The price-earnings (PE ) ratio measures the ratio of the market price of each shareof common stock to the earnings per share. It is calculated by dividing the marketprice per share of common stock by earnings per share . Quality DepartmentStores PE ratios for 2000 and 1999 are calculated and evaluated below.


MARKET PRICE PER SHARE OF COMMON STOCKPRICE-EARNINGS RATIO =

EARNINGS PER SHARE

2000 1999

$12.00 $ 8.00 = 12.4 times = 10.4 times$ .97 $ .77


33 times 22 times


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17.5% 44.5%

2000 1999

$61,200 $60,000 = 23.2% = 28.8%$263,800 $208,500

CASH DIVIDENDSPAYOUT RATIO =

NET INCOME

The payout ratio measures the percentage of earnings distributed in theform of cash dividends. It is calculated by dividing cash dividends by netincome . Quality Department Stores payout ratios for 2000 and 1999 arecalculated and evaluated below.


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42.0% 81.7%

2000 1999

$832,000 $800,000 = 45.3% = 50.2%$1,835,000 $1,595,000

TOTAL DEBTDEBT TO TOTAL ASSETS =

TOTAL ASSETS

The debt to total assets ratio measures the percentage of total assetsprovided by creditors, indicating the degree of leveraging. It is calculatedby dividing total debt by total assets . Quality Department Stores total debtto total assets ratios for 2000 and 1999 are calculated and evaluated below.


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TIMES INTEREST INCOME BEFORE INCOME TAXES AND INTEREST EXPENSEEARNED =

INTEREST EXPENSE



2000 1999

$468,000 $388,000 = 13 times = 9.6 times$36,000 $40,500

The times interest earned ratio provides an indication of the companys ability tomeet interest payments as they come due. It is calculated by dividing income beforeincome taxes and interest expense by interest expense . Quality Department Storestimes interest earned ratios for 2000 and 1999 are calculated and evaluated below.


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Negative Working CapitalIs not always badImplies that the company is able to get long creditperiods from their suppliersSeen in industries where customers pay upfront .Eg

FMCGNegative working capital with free cash flow isconsidered good metric for stock selection


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ImpairmentDownward revaluation of fixed assetsPurpose is to bring into the books the fair marketvalue of assets

Also happens when a company pays too much for

acquisitionIs carried out every year as per new accountingrules.


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Capitalization of interest costProcess of adding interest charges to existing loanbalanceThe loan balance increases but the companies donot receive additional funds

Suspect for capitalized interest when loan amountgrows without payment of requisite interest


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ROE vs ROCE vs EPS


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DuPont Analysis


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Ratio Formula Purpose or UseLiquidity Ratios

Current assets 1. Current ratio Measures short-term debt-paying ability.

Current liabilities

Cash + marketablesecurities +

2. Acid-test or quick ratio receivables (net) Measures immediate short-term liquidity. Current liabilities

Net cash provided byoperating activities

3. Current cash debt Measures short-term debt-paying ability coverage ratio Average current (cash basis).

liabilities

Net credit sales 4. Receivables turnover Measures liquidity of receivables.

Average netreceivables

Cost of goods sold 5. Inventory turnover Measures liquidity of inventory.

Average inventory


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Ratio Formula Purpose or UseProfitability Ratios

Net income 6. Profit margin Measures net income generated by each

Net sales dollar of sales.

Net cash provided by 7. Cash return on sales operating activities Measures the net cash flow generated by ratio each dollar of sales.

Net sales

Net sales 8. Asset turnover Measures how efficiently assets are usedAverage assets to generate sales.

Net income 9. Return on assets Measures overall profitability of assets.

Average assets


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Ratio Formula Purpose or UseProfitability Ratios

Net income10. Return on common Measures profitability of owners stockholders equity Average common investment.

stockholders equity

Net income11. Earnings per share Measures net income earned on each

Weighted average share of common stock.common shares

outstanding

Market price per share12. Price-earnings ratio of common stock Measures the ratio of the market price

per share to earnings per share.Earnings per share

Cash dividends13. Payout ratio Measures percentage of earnings

Net income distributed in the form of dividends.


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Ratio Formula Purpose or UseSolvency Ratios

Total debt14. Debt to total assets Measures the percentage of total assets

Total assets provided by creditors.

Income before incometaxes and interest

15. Tmes interest earned expense Measures ability to meet interest payments as they come due.

Interest expense

Net cash provided by16. Cash debt coverage operating activities

ratio

Measures the long-term debt paying

Average totalliabilities

ability (cash basis).

Documents

Financially Yours Session 2