Financial Statement Analysis Flashcards
Reasons for analysis
Different Users
- shareholders, bank providers, customers and suppliers, competitors
Different questions
- will they go bust before they pay
- where will they be in ten years time?
- what can we learn and apply to ourselves?
- is it a good investment/borrower?
How to answer the question?
- know about the industry and company first
- variety of techniques
- ratios
- not the only tool
- common size analysis
- comparative techniques
- credit rating methods
Where to the information?
Government statistics Industry sources Company sources Facts and truth does not mean no bias Info has value The accounts should give a true and fair view Governments also have agenda - FSA to ensure confidence in the financial system
Framework for analysis
Context - why
Overview - understanding the industry
Ratios - data issues e.g inflation rates
Evaluation - analyse ratios - answer is?
Normally use published accounts
Limited info: segments/social and environmental/ future orientated/ current values
Snapshot: seasonal factors and year end dates
Accounting polices differences
Annual or semi annual only
Need to look at trend comparators
Few ratios have universal benchmark levels
A trend can reveal the speed of change, but inflation/ impact acquisition or disinvestment, exchange rates etc
problems for comparison and assessment
Published accounts
Seasonal factors and year end dates Accounting policy choice Degree of creativity Cross border comparisons Exchange rates?
Companies can go bust quickly
If you have power in a corporate relationship, ask for a regular management accounts
The cynic would just look at whether they’ve filed and what’s the cash position
Key points in financial analysis
Always trying to learn
We don’t just produce numbers for their own sake
Analysis is flexible
-do what is appropriate
Questions in ratio analysis
Did they make a decent profit
How risky are they
Working capital/liquidity management
Issues in ratio analysis
We are trying to advise on decisions but the future is what matters
All we have is information on the past
A foundation for us to build a forecast on or to base a decision on
Tradeoff between risk and reward
Reward is meaningless without an understanding of the risk
Ratio category - performance
Has the business succeeded in making an acceptable level of profit
Profits, sales, use of assets, productivity of labour
Ratio category- working capital
Have the assets of the business been effectively used and managed?
Inventory, accounts payable, accounts receivable
Ratio category - Financial Status
Can the business meet its debts as they fall due?
Liquidity (short term)
Solvency (long term)
Ratio category - investment ratios/market performance
Is the company a worthwhile investment?
New PPE, profit retention, price/earnings ratio, dividend payout
Return on capital employed
Also return on net assets (RONA)
Key ratio
Gives the % return on the long term funds tied up in the business
How have management performed with the funds available?
The higher the risk, the higher the required return
- with large cash rich companies, handling cash may be considered a normal activity and profit after interest could then be taken.
Sales margin or operating margin
Expressed as a percentage, the margin means how many pence in each £ of sales is profit.
The trend over time would show whether the sales price has been increased more or less than costs.
Different industries will have very different ratios.
Gross margin refers to gross profit (after only allowing for certain direct costs) divided by sales.
Asset turnover
Expressed as a multiple
Shows the number of times the capital “turns over” in a year or how many £s of sales is generated by every £ invested in the business in a year.
Capital intensive companies have a low turnover, however companies using heavily depreciated equipment can have quite high multiples. Retailers can have high multiples.
Working capital
A key area of management performance
Companies go bust because they run out of cash
Companies often run out of cash because of poor working capital control.
Liquidity ratios are also working capital ratios
As little as possible working capital needed
Inventory ratios
Expressed as number of days of inventory held. Multiplying by 52 instead would give inventory weeks.
An alternative is the number of times the stock turns over in a year: this is “cost of sales/inventory”
Includes raw materials, work in progress and finished goods. If this information is available, then analysing these individually may be interesting too.
Can use average inventory.
Debtor ratios
Expressed as days outstanding
A long debtor ratio may be due to long payment terms (e.g. export sales) or to poor collection.
A falling ratio is usually a sign of improving financial management, but it might also imply a shortage of cash with discounts being offered for early payment.
Debtor payment periods are part of the pricing negotiation.
Trade creditor ratios
Expressed as the number of days between the receipt of goods and payment for them.
The ratio should only include those elements of current liabilities where the company has some control over the timing of payment.
Trade creditor ratios
Expressed as the number of days between the receipt of goods and payment for them.
The ratio should only include those elements of current liabilities where the company has some control over timing of payment.
Meaning considering the current liability note rather than taking the balance sheet figure.
If purchases is not available use cost of sales.
- consider including admin costs
A rising ratio may imply a cash shortage. There is an obvious cash advantage to late payment, but there are also downsides
