Financial Statement Analysis

Course Outline I. 

Basics of Accounting

II. 

Selected topics

III. 

Financial Statement Analysis

1.  2.  3. 

Objectives Horizontal and vertical analysis Financial Ratios 2.1. Liquidity, cash conversion cycle, cash is king 2.2. Solvency and debt ratio 2.3. Profitability and return on investment

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Cash Flow Analysis



II. 

Selected topics

III. 


1.  2.  3. 


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Cash Flow Analysis

Financial statement analysis

1. Objectives Definition §  Using financial statements to assess a company’s performance §  Focuses on past performance to predict future performance Objective Different users of the financial statements might be interested in different information. à They all however want to make good decisions. 17/11/2015 | pag. 3


1. Objectives – different users Objectives §  Creditors want to know about short-term liquidity and long-term solvency. •  Short-term liquidity - an organization’s ability to meet current payments as they become due (e.g. interest payable – A/P)

•  Long-term solvency - an organization’s ability to generate enough cash to repay long-term debts as they mature (principal) 17/11/2015 | pag. 4


1. Objectives – different users §  Equity investors are more concerned with returns in the form of dividends and increased market price of the stock. •  These investors are naturally more interested in profitability. •  Profits spur both dividends and increased stock prices (= market’s assessment of the company future prospects).

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II. 

Selected topics

III. 


1.  2.  3. 


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Cash Flow Analysis

Financial statement analysis Course Outline

2. Horizontal Analysis

Horizontal analysis compares financial data over different time period (trend analysis) Time index Base year: index = 100 Time index year t =

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Value year t Value base year

* 100


2. Horizontal Analysis Geherstructureerd schema Balans ABC per 31-12-20X1 en per 31-12-20X2 (in ‘000 €) (in staffelvorm) Activa Passiva 31-12-X1

31-12-X2

(Uitgebreide) vastliggende Activa

30,000

31,700

III. Materiële vaste activa

30,000

31,700

(Beperkt) vlottende Activa

47,026

50,190

Realiseerbare activa VI.A Voorraden VII.A. Handelsvorderingen VIII. Geldbeleggingen Liquide middelen IX. Liquide middelen

44,945 26,470 16,850 1,625 2,081 2,081

47,650 27,530 18,320 1,800 2,540 2,540

TOTAAL VAN DE ACTIVA

77,026

81,890

! 17/11/2015 | pag. 8

§  §  § 

31-12-X1

31-12-X2

Permanent vermogen

56,151

56,367

Eigen vermogen I. Kapitaal V. Overgedragen resultaat

32,151 23,000 9,151

34,367 23,000 11,367

Vreemd vermogen op lange termijn VIII.A. Financiële schulden >1j

24,000

22,000

24,000

22,000

Vreemd vermogen op korte termijn IX.A. Vervallende schulden IX.B. Financiële schulden <1j IX.C. Handelsschulden IX.E. Belastingschulden IX.F. Overige schulden

20,875

25,523

2,000 5,635 8,340 3,150 1,750

2,000 8,500 9,721 3,200 2,102

TOTAAL VAN DE PASSIVA

77,026

81,890

Normal / Representative “+ of -” values: 140/141 Comparable? - Firm structure - Valuation Methods

Horizontale analyse Geherstructureerd schema Balans ABC per 31-12-20X1 en per 31-12-20X2 (in ‘000 €) (in staffelvorm) Activa Passiva 31-12-X1

31-12-X2


100%

105.7%


100%

105.7%

(Beperkt) vlottende activa

100%

106.7%

Realiseerbare activa VI.A Voorraden VII.A. Handelsvorderingen VIII. Geldbeleggingen Liquide middelen IX. Liquide middelen TOTAAL VAN DE ACTIVA

100% 100% 100% 100% 100% 100%

106.0% 104.0% 108.7% 110.8% 122.1% 122.1%

100%

106.3%

31-12-X1

31-12-X2

Permanent vermogen

100%

100.4%


100% 100% 100%

106.9% 100.0% 124.2%


100%

91.7%

100%

91.7%


100%

122.3%

100% 100% 100% 100% 100%

100.0% 150.8% 116.6% 101.6% 120.1%


100%

106.3%


2. Vertical Analysis

§  Vertical analysis determines the relative importance of a particular item in the balance sheet or the income statement -  Items of the balance sheet are expressed as a percentage of total assets (100%). -  Each amount in the income statement is restated as a percentage of sales (100%).

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2. Vertical Analysis Geherstructureerd schema Balans ABC per 31-12-20X1 en per 31-12-20X2 (in ‘000 €) (in staffelvorm) Activa Passiva 31-12-X1

31-12-X2


30,000

31,700


30,000

31,700


47,026

50,190

Realiseerbare activa VI.A Voorraden VII.A. Handelsvorderingen VIII. Geldbeleggingen Liquide middelen IX. Liquide middelen

44,945 26,470 16,850 1,625 2,081 2,081

47,650 27,530 18,320 1,800 2,540 2,540


77,026

81,890

17/11/2015 | pag. 10

Verticale analyse Geherstructureerd schema balans ABC per 31-12-20X1 en per 31-12-20X2 (in ‘000 €) (in staffelvorm) Activa Passiva

31-12-X1

31-12-X2

Permanent vermogen

56,151

56,367


32,151 23,000 9,151

34,367 23,000 11,367


24,000

22,000

24,000

22,000


20,875

25,523


61.1%

2,000 5,635 8,340 3,150 1,750

2,000 8,500 9,721 3,200 2,102

Realiseerbare Activa VI.A Voorraden VII.A. Handelsvorderingen VIII. Geldbeleggingen Liquide middelen IX. Liquide middelen


77,026

81,890


31-12-X1

31-12-X2

31-12-X1

31-12-X2


38.9%

38.7% Permanent vermogen

72.9%

68.8%


38.9%

Eigen vermogen 38.7% I. Kapitaal V. Overgedragen resultaat

41.7% 29.8% 11.9%

42.0% 28.1% 13.9%


31.2%

26.8%

31.2%

26.8%

27.1%

31.2%

58.3% 34.4% 21.9% 2.1% 2.7% 2.7%

61.3% Vreemd vermogen op korte termijn 58.2% IX.A. Vervallende schulden 33.6% IX.B. Financiële schulden <1j 22.4% IX.C. Handelsschulden 2.2% IX.E. Belastingschulden 3.1% IX.F. Overige schulden 3.1%

2.6% 7.3% 10.8% 4.1% 2.3%

2.4% 10.4% 11.9% 3.9% 2.6%

100%

100% TOTAAL VAN DE PASSIVA

100%

100%


2. Vertical Analysis

Verticale analyse Geherstructureerd schema resultatenrekening ABC Omzet Kostprijs van de verkopen (CoS) Brutomarge (GM) Bezoldigingen Brutobedrijfsresultaat Afschrijvingen Nettobedrijfsresultaat (EBIT) Financiële kosten Courante nettowinst voor belastingen (EBT) Belastingen Totale nettowinst (NI)

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100.0% 75.7% 24.3% 12.4% 11.9% 1.7% 10.2% 2.8% 7.4% 3.0% 4.4%



II. 

Selected topics

III. 


1.  2.  3. 


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Cash Flow Analysis


3. Financial Ratios Financial Ratios §  The cornerstone of financial statement analysis is the use of ratios. A financial ratio is calculated by dividing one number of the financial statements accounts (numerator) by another number of the financial statement accounts (denominator): it shows the relationship between two numbers §  Financial ratios are sometimes grouped into categories: •  Short-term liquidity ratios (incl. efficiency ratios) •  Long-term solvency ratios •  Profitability ratios (margin and effectiveness ratios)

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Financial statement analysis 2. Financial Ratios Comparisons 3. Financial Ratios - Evaluating Financial Ratios §  Financial ratios are evaluated using three types of comparisons: •  Time-series comparisons: comparisons of a company’s financial ratios with its own historical ratios. •  Benchmarks: general rules of thumb specifying appropriate levels for financial ratios. •  Cross-sectional comparisons: comparisons of a company’s financial ratios with the ratios of other companies or with industry averages.

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Financial statement analysis Vergaren van informatie

3. Financial Ratios – Gather information -  Central Balance Sheet Office (NBB) (on-line and free consultation of the filed annual accounts; company file (30€))

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3. Financial Ratios – Gather information

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3. Financial Ratios – Gather information -  Central Balance Sheet Office (NBB) (on-line and free consultation of the filed annual accounts; company file (30€)) -  Belfirst cd-rom (for free in the VUB)

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17/11/2015 | pag. 19


3. Financial Ratios – Gather information -  Central Balance Sheet Office (NBB) (on-line and free consultation of the filed annual accounts; company file (30€)) -  Belfirst cd-rom (for free in the VUB) -  Graydon commercial report (not free)

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17/11/2015 | pag. 21


3. Financial Ratios – Gather information -  Central Balance Sheet Office (NBB) (on-line and free consultation of the filed annual accounts; company file (30€)) -  Belfirst cd-rom (for free in the VUB) -  Graydon handelsrapporten (not free) -  CompanyWeb (not free)

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17/11/2015 | pag. 23


3. Financial Ratios – Gather information -  Central Balance Sheet Office (NBB) (on-line and free consultation of the filed annual accounts; company file (30€)) -  Belfirst cd-rom (for free in the VUB) -  Graydon handelsrapporten (not free) -  CompanyWeb (not free) -  Website company (Investor Relations), press,... 17/11/2015 | pag. 24

Financial statement analysis Liquiditeit Hoe Liquidity goed kan een onderneming haar Belgium Standard format 3.1.

How well can a company meet its op payment obligations the short term? (enacted by law, RD 30th January 2001) betalingsverplichtingen korte termijnin nakomen?

BALANCE SHEET Passiva Activa Eigen vermogen Vaste Activa Kapitaal Oprichtingskosten Uitgiftepremies Immateriële vaste activa Herwaarderingsmeerwaarden Materiële vaste activa Reserves Financiële vaste activa Overgedragen resultaat Kapitaalsubsidies Vlottende activa Voorzieningen en uitgestelde belastingen Vorderingen > 1 jaar Voorzieningen Voorraden en bestellingen in Uitgestelde belastingen uitvoering Schulden Vorderingen ≤ 1 jaar Schulden > 1 jaar Geldbeleggingen Schulden ≤ 1 jaar Liquide middelen Overlopende rekeningen Overlopende rekeningen Totaal der passiva Totaal der activa

17/11/2015 | pag. 25

Financial statement analysis 2. Financial Ratios 3.1. Liquidity

Liquidity

How well can a company meet its payment obligations in the short term?

Short term liquidity: an organization’s ability to meet current payments as they become due. Current Ratio =

Current Assets Current Liabilities

G

>1

Assess Quality of the underlying assets (A/R – inventories) Quick Ratio = (acid test ratio)

17/11/2015 | pag. 26

Current Assets - Inventories Current Liabilities

Financial statement analysis 2. Financial Ratios 3.1. Liquidity

Liquidity

Quality of underlying assets – efficiency ratios

§  Inventories: might be slowmoving – obsolete. It is important to know how fast inventory is sold. How many times the inventory is renewed during the year

Avg. inventory turnover =

COGS Avg. inventory

Avg. inventory period =

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365 Avg. inventory turnover

Financial statement analysis 3.1. Liquidity Quality of underlying assets – efficiency ratios

§  A/R (Accounts Receivable): might be using long credit terms – uncollectible. It is important to know how fast A/R are converted into cash How long does it take to collect money after a sale

Avg. daily sales =

Sales 365 days

Avg. collection period =

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Average A/R Avg. daily sales

Financial statement analysis 3.1. Operating and cash conversion cycle

Receipt inventory

Cash receipt From Sale

Sale (on credit)

Operating cycle = The time span during which goods and services enter the company and the company receives cash for it from customers <=> 1 year

Avg. Inventory period Avg. Payment period

+

Avg. collection period

Cash conversion cycle =

the time span during which cash is used to acquire goods and services, which in turn are sold to customers, who in turn pay for their purchases, with cash cfr. working capital needs 17/11/2015 | pag. 29

Financial statement analysis 3.1. Liquidity Quality of underlying assets – efficiency ratios

§  A/P (Accounts Payable): how fast are A/P (and other operating payables e.g. payroll payables) paid with cash

Avg. daily purchases =

Purchases 365 days

Avg. A/P Avg. payment period = Avg. daily purchases

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EI = BI + P – COGS P = COGS + EI - BI

Financial statement analysis 3.1. Example Clicktouch 1/1/2013 – 31/12/2013

Receipt inventory


Sale (on credit)


39

48

Avg. Inventory period 57 Avg. Payment period

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+

Avg. collection period 30

Cash conversion cycle

Financial statement analysis 3.1. Example Colruyt 4/2013 – 3/2014

Receipt inventory


Sale (on credit)


18

26

Avg. Inventory period

+

Avg. collection period -6

50 Avg. Payment period 17/11/2015 | pag. 32

Cash conversion cycle

Financial statement analysis 3.1. Operating and cash conversion cycle

Receipt inventory


Sale (on credit)

Operating cycle =

Influence crisis?

The time span during which goods and services enter the company and the company receives cash for it from customers <=> 1 year

Avg. Inventory period Avg. Payment period

+

Avg. collection period

Cash conversion cycle =

the time span during which cash is used to acquire goods and services, which in turn are sold to customers, who in turn pay for their purchases, with cash cfr. working capital needs 17/11/2015 | pag. 33

Graydon Belgium 3.1. Payment behaviour of Belgian Companies Financial statement analysis Graydon-betaalindex

Source: Graydon (2015) B2B- Studie Betaalgedrag Q2 www.graydon.be 17/11/2015 | pag. 34

Financial statement analysis 3.1. Payment behaviour of Belgian Companies

Bron: Graydon (2015) Studie faillissementen Oktober 2015 17/11/2015 | pag. 35

Financial statement analysis 3.1. Payment behaviour of Belgian Companies Cash is king?! Some rounded figures (www.graydon.be)

700.000 entities - 350.000 companies 2/3 BVBA 1/3 NV

- 350.000 sole propriotorship

8.000 failliet

12.300 (1/80)

2008

2013

6.500

9.800

BVBA (1/54) NV (1/104)

BVBA (1/44) NV (1/86)

1.500 (1/250)

1/5 failures Due to late or non-payment!! 17/11/2015 | pag. 36

2.500 (1/228)

Financial statement analysis Liquiditeit 2.2. 3.1. Solvability Example Clicktouch Hoe goed kan een onderneming haar

Belgium Standard format 1/1/2013 – 31/12/2013

How well a company can meet its long-term commitments (debt and interest)? (enacted by law, RD 30th January betalingsverplichtingen op2001) korte termijn nakomen?

BALANCE SHEET Activa Vaste Activa Oprichtingskosten Immateriële vaste activa Materiële vaste activa Financiële vaste activa

583.081 8.382 466.841 107.859

Vlottende activa Vorderingen > 1 jaar Voorraden en bestellingen in uitvoering Vorderingen ≤ 1 jaar Geldbeleggingen Liquide middelen Overlopende rekeningen

2.075.931

Totaal der activa

2.659.013

17/11/2015 | pag. 37

897.000 684.706 430.761 63.464

Passiva 1.393.133 Eigen vermogen 579.977 Kapitaal Uitgiftepremies Herwaarderingsmeerwaarden 57.998 Reserves 755.159 Overgedragen resultaat Kapitaalsubsidies 140.259 Voorzieningen en uitgestelde belastingen Voorzieningen 140.259 Uitgestelde belastingen Schulden 1.125.620 Schulden > 1 jaar 34.090 Schulden ≤ 1 jaar 1.070.982 Overlopende rekeningen 20.548 Totaal der passiva

2.659.013

Current Ratio = Current Assets Current Liabilities

=

2.075.931 = 1,90 1.091.530

Quick Ratio= Current Assets – Inventories Current Liabilities

=

1.178.931 = 1,08 1.091.530



II. 

Selected topics

III. 


1.  2.  3. 


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Cash Flow Analysis


Liquiditeit

3.2. Solvability Hoewell goed kan een onderneming haar How a company can meet its long-term commitments (debt and interest)? (enacted by law, RD 30th January betalingsverplichtingen op2001) korte termijn nakomen?

Belgium Standard format

BALANCE SHEET Passiva Activa Eigen vermogen Vaste Activa Kapitaal Oprichtingskosten Uitgiftepremies Immateriële vaste activa Herwaarderingsmeerwaarden Materiële vaste activa Reserves Financiële vaste activa Overgedragen resultaat Kapitaalsubsidies Vlottende activa Voorzieningen en uitgestelde belastingen Vorderingen > 1 jaar Voorzieningen Voorraden en bestellingen in Uitgestelde belastingen uitvoering Schulden Vorderingen ≤ 1 jaar Schulden > 1 jaar Geldbeleggingen Schulden ≤ 1 jaar Liquide middelen Overlopende rekeningen Overlopende rekeningen Totaal der passiva Totaal der activa

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Financial statement analysis 2. Financial Ratios 3.2. Solvability

Solvency

Long term solvency: an organization’s ability to generate enough cash to repay long-term debts as they mature !! Definition of solvency ratio!!

Total debt to total assets =

Total debt to equity =

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Total liabilities Total assets

Total liabilities Stockholders’ equity

60%


Solvency 3.2. Solvability

§  The prudent use of debt is a major part of intelligent financial management. •  Debt financing is more attractive than equity financing because: Ø Interest payments are deductible for income tax purposes, but dividends are not deductible. Ø The ownership rights to voting and profits are kept by the present shareholders. Ø using borrowed money at fixed interest rates might enhance the rate of return on common equity (= financial leverage, trading on the equity) 17/11/2015 | pag. 41


Trading on 3.2. Solvability

the Equity

Trading on the Equity

EPS Advantage equity

Equity + Liab

Equity

Advantage liabilities

Indifference point EBIT

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Financial statement analysis 3.2. Solvability

Trading on the Equity Trading on the Equity

•  Benefits: Ø Larger returns to the common shareholders, as long as overall income is large enough to cover the increased interest payments

Interest coverage = Example Clicktouch:

17/11/2015 | pag. 43

EBIT I

127.629 Interest coverage = 8.567 = 15

Financial analysis Optimalstatement debt ratio? 3.2. Solvability Industry Optimal debtrelated! ratio? Industry related!

§  Industry with high level of tangible assets (mortgage!); Bv. Paperindustry (debt / SHE: 1,36) çè Pharmaceutical industry (debt / SHE: ,079) [Kester (1986)]

§  Industry with stable operating income (EBIT); 17/11/2015 | pag. 44

Financial statement analysis Liquiditeit 2.2. 3.2. Solvability Example Clicktouch Hoe goed kan een onderneming haar

Belgium Standard format 1/1/2013 – 31/12/2013

How well a company can meet its long-term commitments (debt and interest)? (enacted by law, RD 30th January betalingsverplichtingen op2001) korte termijn nakomen?

BALANCE SHEET Activa Vaste Activa Oprichtingskosten Immateriële vaste activa Materiële vaste activa Financiële vaste activa

583.081 8.382 466.841 107.859

Vlottende activa Vorderingen > 1 jaar Voorraden en bestellingen in uitvoering Vorderingen ≤ 1 jaar Geldbeleggingen Liquide middelen Overlopende rekeningen

2.075.931

Totaal der activa

2.659.013

17/11/2015 | pag. 45

897.000 684.706 430.761 63.464

Passiva 1.393.133 Eigen vermogen 579.977 Kapitaal Uitgiftepremies Herwaarderingsmeerwaarden 57.998 Reserves 755.159 Overgedragen resultaat Kapitaalsubsidies 140.259 Voorzieningen en uitgestelde belastingen Voorzieningen 140.259 Uitgestelde belastingen Schulden 1.125.620 Schulden > 1 jaar 34.090 Schulden ≤ 1 jaar 1.070.982 Overlopende rekeningen 20.548 Totaal der passiva

2.659.013

Total debt to total assets = Total Debt Total Assets

=

1.125.620 = 0,42 2.659.013

Total debt to total equity = Total Debt Shareholders’ equity

=

1.125.620 = 0,81 1.393.133



II. 

Selected topics

III. 


1.  2.  3. 


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Cash Flow Analysis

Financial statement 2. Financial Ratiosanalysis 3.3. Profitability Profitability 1. Profitability – profit rate

Gross Profit %=

EBIT-to-sales =

Return on sales=

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Gross profit Sales EBIT Sales Net income Sales

!!Definition of profit rate

Financial statement analysis 3.3. Profitability Gross Profit Percentage Gross profit percentage

§  Often the nature of the business of a company affects the gross profit as compared to other types of companies (service vs. production company). §  Retailers often lower their gross profit margins and selling prices and hope that the lower selling prices will increase sales volume enough to compensate for the lower gross profit. Industries with higher gross profit percentages tend to have the lowest inventory turnover. 17/11/2015 | pag. 48

Financial statement analysis 3.3. Profitability 2. Profitability – Rates of return §  Rate of return on investment (operating performance) evaluates the overall success of an investment by comparing what the investment returns with the amount of investment initially made

ROI

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Financial statement analysis 3.3. Profitability Definition!

§  Income may be defined differently for alternative purposes. •  Net earnings •  Earnings before interest and taxes (EBIT)

§  Invested capital may also be defined differently. •  Stockholders’ equity •  Total capital provided by both debt and equity sources

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Financial statement analysis 2. Financial Ratios

2. Financial Ratios 3.3. Profitability Profitability Definition! Profitability

§  Rate of return on Equity (Investor in common stock): Return on Equity (ROE) § 

Rate of return on Assets (Lender): Return on Assets (ROA) How effectively does the company uses its total assets to generate returns for all suppliers of capital?

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Financial statement analysis 2. Financial Ratios

2. Financial Ratios 3.3. Profitability Profitability Definition! Profitability § 

Rate of return on Assets (Lender): Return on Assets (ROA) How effectively does the company uses its total assets to generate returns for all suppliers of capital?

Return on assets (ROA) =

EBIT Sales

x

Sales Average total assets

Return on assets (ROA) = Profit Margin x Rotation total assets

17/11/2015 | pag. 52



II. 

Selected topics

III. 


1.  2.  3. 


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Cash Flow Analysis

Financial statement analysis 4. Cash Flow Analysis Cash Flow Statement

§  Balance sheet – shows financial position on a given day §  Income statement – shows performance over a given period §  Statement of cash flows – shows performance over a given period

The statement of cash flows provides a thorough explanation of the changes that occurred in a firm’s cash balance during the entire accounting period. 17/11/2015 | pag. 54

Financial statement analysis 3. Understanding financial statements 4. Cash Flow Analysis Retained earnings: Relationship between the link between the balance sheet and the income statement Balance Sheet / Income statement / Statement of cash flows Balance Sheet 31/12/X2

Balance Sheet 1/1/X2 Assets Cash 1/1

Owners’ equity Paid-in capital RE1/1

Assets Cash 31/12

Owners’ equity Paid-in capital RE31/12

Liabilities

Liabilities Income statement 1/1/X2 – 31/12/X2 Revenues 1/1-31/12 - Expenses1/1-31/12 RE 1/1+

net income 1/1-31/12 – Dividends = RE 31/12

Statement of Cash Flows 1/1/X2 – 31/12/X2 cash31/12 = cash1/1+ net cashflow1/1-31/12 17/11/2015 | pag. 55

Accrual Matching

Cash

Financial statement analysis 4. Cash Flow Analysis Cash Flow Statement CASH FLOWS FROM OPERATING ACTIVITIES Net income Adjustments to reconcile net income to net cash provided by operating activities Depreciation Net increase in accounts receivable Net increase in inventory Net increase in accounts payable Net increase in wages and salaries payable = Net cash provided by operating activities (1)

CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of fixed assets Proceeds from sale of fixed assets = Net cash used by investing activities (2)

= FREE CASH FLOW (1) + (2) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issue of long-term debt Proceeds from issue of common stock Dividends paid = Net cash provided by financing activities (3)

= Net increase or decrease in cash 17/11/2015 | pag. 56

FCF = net cash flow from operating and from investing activities = net cash flow available for the financing parties of the company (= debtors and stockholders) Used in company valuation

Relating Cash Flow and Cash Net Relating FlowIncome and Net Income Financial statement analysis 4. Cash Flow Analysis

§  Four possible combinations of net income and cash flows exists. Relationship 1 2 3 4 Cash flow from operations + + – – Net income + – + –

§  Four possible situations: •  Situation 1 confirms the profitability of the company. •  Situation 2 can occur where a company has large noncash expenses such as depreciation. •  Situation 3 is often an indication of trouble but may also be an indication of a rapidly growing company. •  Situation 4 confirms the lack of profitability of the company. 17/11/2015 | pag. 57

Thank you for your attention!

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Financial Statement Analysis

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