Financial
Statement
Analysis
K R Subramanyam
John J Wild
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Overview of Financial
1-2
Statement Analysis
1
CHAPTER
1-3
Business Analysis
Evaluate Prospects Evaluate Risks
1-4
Information Sources for Business
Analysis
1-5
1-6
Credit Analysis
1-7
Credit Analysis
Credit worthiness: Ability to honor credit obligations
(downside risk)
Liquidity Solvency
Ability to meet short- Ability to meet long-
term obligations term obligations
Focus: Focus:
• Current cash flows • Long-term profitability
• Make up of current • Capital structure
assets and liabilities
• Liquidity of assets
1-8
Equity Analysis
Assessment of downside risk and upside potential
Technical analysis / Fundamental Analysis
Charting
Determine Intrinsic value
• Patterns in price or without reference to
volume history of a price
stock
• Predict future price • Analyze and interpret
movements key factors
– Economy
– Industry
– Company
1-9
1-10
Accounting Analysis
Process to evaluate and adjust financial
statements to better reflect economic reality
Accounting
Risk
1-11
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
1-12
Prospective Analysis
Process to forecast future payoffs
Business Environment
& Strategy Analysis
Accounting Analysis
Financial Analysis
Intrinsic Value
1-13
Dynamics of Business Activities
Business Activities Time
1-14
Business Activities
1-15
Business Activities
Financing activities
• Owner (equity)
• Nonowner (liabilities)
Financing
1-16
Business Activities
Investing activities
• Buying resources
• Selling resources
Investing Financing
Investing = Financing
1-17
Business Activities
Operating Activities
Revenues and expenses from providing
goods and services
1-18
Financial Statements Reflect Business Activities
1-19
Financial Statements
1-20
1-21
Balance Sheet
Total Investing = Total Financing
= Creditor Financing + Owner Financing
1-22
1-23
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
1-25
Statement of Cash Flows
1-26
1-27
Additional Information
(Beyond Financial Statements)
1-28
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
1-30
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
1-31
Analysis Preview
1-32
Analysis Preview
1-33
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
1-34
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)
1-35
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)
1-36
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
1-37
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]
k is the cost of capital
E refers to an expectation
1-38
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)]
k is the cost of capital
E refers to an expectation
1-39
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
1-40
Book Organization
