Financial Analysis Fundamentals PDF

Financial Analysis Fundamentals corporatefinanceinstitute.com CFI Instructors Meet the global team of CFI instructors Tim Vipond Justin Sanders Scott Powell CEO & Instructor Inst...

Financial Analysis Fundamentals corporatefinanceinstitute.com CFI Instructors Meet the global team of CFI instructors Tim Vipond Justin Sanders Scott Powell CEO & Instructor Instructor Director & Instructor Vancouver London Vancouver Lisa Dorian Ryan Spendelow Director & Instructor Instructor New York Hong Kong corporatefinanceinstitute.com  Vertical and Horizontal Income Statement Analysis corporatefinanceinstitute.com Session objectives Learn the key Perform vertical and components of the horizontal analysis income statement Benchmark against other companies in the industry corporatefinanceinstitute.com Financial analysis There are many important steps, such as trend and ratio analysis, in preparing a financial analysis. The starting point is the financial statements: Income Balance Statement of statement Sheet Cash Flows corporatefinanceinstitute.com Financial analysis There are many important steps, such as trend and ratio analysis, in preparing a financial analysis. The starting point is the financial statements: Financial analysis Interpret financial Trend and ratio Financial statements results analysis Pyramid ratio Basic ratio analysis Using ratio analysis analysis corporatefinanceinstitute.com Components of ratio analysis Ratio analysis covers two basic groups. When analysing the income statement, we use performance ratios – specifically those related to profitability. Ratio analysis Financial leverage Performance ratios ratios Profitability ratios Efficiency ratios corporatefinanceinstitute.com A breakdown of the income statement Tensel Income statement $ millions Year 1 Year 2 Year 3 Year 4 Sales revenues are the most important components of the income statement and are used in several of the ratios seen Sales revenues 81,422 84,698 88,236 90,637 Sales revenues throughout the module. COGS/COS (38,121) (37,756) (36,327) (42,938) Direct costs Cost of good sold relates to direct labor and raw materials Gross profit 43,301 46,942 51,909 47,699 Gross profit needed to create the product or service that is being sold, as well as depreciation on manufacturing equipment used in Research and Research & production. (5,884) (6,421) (7,893) (6,812) development development Gross profit tells us what the gross margin is before we take Marketing (23,507) (26,569) (29,732) (30,009) Marketing into account any other costs needed to keep the company Sales (1,764) (1,931) (2,530) (2,563) Sales running. General and General & Indirect expenses are those required to keep the company (2,960) (2,803) (2,762) (2,947) administration administration going. The most common are: research & development, marketing, sales, and general & administration. EBIT (operating profit) 9,186 9,218 8,992 5,368 Income from ops Interest (1,073) (1,102) (1,147) (1,182) Interest inc/exp Operating income is used to pay the government, creditors, and ultimately the shareholders. Taxes (2,761) (2,429) (2,193) (1,764) Taxes Net income 5,352 5,687 5,652 2,422 Net income Net income is the final part of the income statement and represents what is remaining to be paid to the shareholders. corporatefinanceinstitute.com Vertical analysis Net income Sales Operating Tax income Sales Sales Operating costs Gross profit Sales Sales Personnel Selling Admin Labor Material Work R&D costs costs costs costs costs overhead Sales Sales Sales Sales Sales Sales Sales corporatefinanceinstitute.com Gross profit margin There are three key profitability ratios: Gross Gross profit Sales = profit margin corporatefinanceinstitute.com Operating profit margin Operating EBIT Sales = profit margin corporatefinanceinstitute.com Net profit margin Net Net income Sales = profit margin corporatefinanceinstitute.com Efficiency ratio The tax ratio is the efficiency ratio that demonstrates how well managing tax. Tax expense Pre-tax income = Tax ratio corporatefinanceinstitute.com Solvency ratio The interest coverage ratio tells us whether the company will be able to cover what it owes in interest to its creditors. Interest EBIT(DA) Interest expenses = coverage ratio corporatefinanceinstitute.com Horizontal analysis Tensel Income statement CAD millions Year 1 Year 2 Year 3 Year4 Year 5 Sales revenues 81,422 84,698 88,236 90,637 Sales revenues COGS/COS (38,121) (37,756) (36,327) (42,938) Direct costs Gross profit 43,301 46,942 51,909 47,699 Gross profit Research and development (5,884) (6,421) (7,893) (6,812) Research & development Marketing (23,507) 26,569) (29,732) (30,009) Marketing Sales (1,764) (1,931) (2,530) (2,563) Sales General and administration (2,960) (2,803) (2,762) (2,947) General & administration EBIT (operating profit) 9,186 9,218 8,992 5,368 Income from ops Interest (1,073) (1,102) (1,147) (1,182) Interest inc/exp Taxes (2,761) (2,429) (2,193) (1,764) Taxes Net income 5,352 5,687 5,652 2,422 Net income Use calculations from the past five years to perform trend analysis and predict future performance corporatefinanceinstitute.com Horizontal analysis corporatefinanceinstitute.com Benefits of horizontal analysis Are margins rising or failing? Is performance improving or declining? What is causing margins to fall? Are margins impacted by indirect costs? corporatefinanceinstitute.com Benchmarking There are different ways to benchmark: Compare your company to two or more competing companies Compare your company’s ratios to the industry average Your competitor/ Your company Industry average corporatefinanceinstitute.com Sources of benchmarking information Where can you find a competitor’s statements? Three key online sites including EDGAR, SEDAR and RNS Competitors’ investor relations websites Historical ratios for companies can be found on MSN Money and Google Finance, but allow very little control over the information and provide little insights on the calculation of ratios. Professional sources such as Bloomberg, Capital IQ, and equity research reports provide detailed information but are more costly. corporatefinanceinstitute.com Conclusion Understand past Income statement analysis is performance, to predict just the first step to the overall future success analysis Use vertical and horizontal Make better investment analysis, as well as and credit decisions from benchmarking, to outside the company maximize your company’s performance corporatefinanceinstitute.com  Balance Sheet and Leverage Ratios corporatefinanceinstitute.com Session objectives Determine the financial Use the balance sheet to strength of a company determine how efficiently a by analyzing the company is being run balance sheet corporatefinanceinstitute.com Financial analysis There are many important steps, such as trend and ratio analysis, in preparing a financial analysis. The starting point is the financial statements: Income Balance Statement of statement Sheet Cash Flows corporatefinanceinstitute.com Financial analysis There are many important steps, such as trend and ratio analysis, in preparing a financial analysis. The starting point is the financial statements: Financial analysis Interpret financial Trend and ratio Financial statements results analysis Pyramid ratio Basic ratio analysis Using ratio analysis analysis corporatefinanceinstitute.com Financial analysis Sales Total Assets Sales Sales Capital Assets Working Assets Sales Sales Sales Other FA Inventory Receivables Sales Sales Sales Sales Plant & Land & buildings Payables Cash machinery corporatefinanceinstitute.com Components of ratio analysis Ratio analysis covers two basic groups: Ratio analysis Financial leverage Performance ratios ratios Profitability ratios Efficiency ratios Liquidity ratio Solvency ratio corporatefinanceinstitute.com Short term liquidity ratios Current Quick ratio ratio corporatefinanceinstitute.com Current ratio Accounts receivable Inventory Cash Prepaid expenses 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕𝒔 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔 Generic rule of thumb is 2:1 corporatefinanceinstitute.com Quick ratio or acid test ratio 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕𝒔 − 𝑰𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔 Generic rule of thumb is 1:1 corporatefinanceinstitute.com Asset turnover ratio 𝑺𝒂𝒍𝒆𝒔 𝑹𝒆𝒗𝒆𝒏𝒖𝒆 𝑻𝒐𝒕𝒂𝒍 𝒐𝒓 𝒏𝒆𝒕 𝑨𝒔𝒔𝒆𝒕𝒔 Tells us: How efficient is the company in using assets to generate revenue? For every 1 dollar of assets, how many dollars of revenue the company generates? corporatefinanceinstitute.com Conclusion Always use trend analysis to determine: What are the ratios doing? Are they improving or deteriorating? Short term liquidity ratios are an early warning signal to cash flow issues. corporatefinanceinstitute.com Working capital overview Working capital Current Asset – Current Liabilities corporatefinanceinstitute.com Working capital overview Working capital Inventory Receivables Payables Operating activities corporatefinanceinstitute.com Working capital overview Working capital Accounts Accounts receivable + Inventory - payable Operating activities corporatefinanceinstitute.com Working capital funding gap Company buys Company pays Company sells Customer pays inventory For inventory goods for goods Payables Receivable Inventory Working Capital Funding Gap Cash out Cash in corporatefinanceinstitute.com Working capital funding gap What would happen to the working Company buys Company pays Company sells Customer pays inventory capital fundinggoods For inventory gap? for goods Increase Payables Decrease Receivable Inventory Working capital funding gap Cash out Cash in corporatefinanceinstitute.com Working capital funding gap Company buys Company pays Company sells Customer pays inventory For inventory goods for goods Delay company Payables Receivable Payments Inventory Faster customer Payments Working capital funding gap ”Just-in-time” Cash out Cash in corporatefinanceinstitute.com The working capital efficiency ratios 2 + Ratios for each Working capital Inventory, Accounts efficiency ratio receivable, Accounts payable corporatefinanceinstitute.com Inventory Inventory efficiency ratios 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑋 365 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 Inventory Inventory turnover ratio days ratio corporatefinanceinstitute.com Accounts receivable Accounts receivable efficiency ratios 𝑺𝒂𝒍𝒆𝒔 𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝒓𝒆𝒄. 𝑿 𝟑𝟔𝟓 𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝒓𝒆𝒄. 𝑺𝒂𝒍𝒆𝒔 Receivable Receivable turnover ratio days ratio corporatefinanceinstitute.com Accounts payable Accounts payable efficiency ratios 𝑪𝒐𝒔𝒕 𝒐𝒇 𝒔𝒂𝒍𝒆𝒔 𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝒑𝒂𝒚. 𝑿 𝟑𝟔𝟓 𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝒑𝒂𝒚. 𝑪𝒐𝒔𝒕 𝒔𝒂𝒍𝒆𝒔 Payable Payable turnover ratio days ratio corporatefinanceinstitute.com The funding gap Inventory days plus accounts receivable days minus accounts payable days will leave you with the working capital funding gap expressed as days. +60 -30 +30 =60 Company buys Company pays Company sells Customer pays inventory For inventory goods for goods Payables Receivable Inventory Working capital funding gap Cash out Cash in corporatefinanceinstitute.com PP&E efficiency ratio Property, plant and equipment ratio PP&E Sales PP&E = turnover ratio If the ratio is comparatively low, it means either sales are low or you have invested too much in PP&E. corporatefinanceinstitute.com Conclusion Financial analysis is Use in conjunction with important in understanding information from the income a company’s financial statement to gain valuable condition and performance company insights With ratio and trend Performance can be analysis you can build improved to increase expectations of future operational efficiencies performance corporatefinanceinstitute.com  Cash Flow Statement and Ratios corporatefinanceinstitute.com Session objectives Understand the inflows Calculate solvency and and outflows of cash leverage ratios throughout the year Examine funding options for an organization looking to grow corporatefinanceinstitute.com Financial analysis There are many important steps, such as trend and ratio analysis, in preparing a financial analysis. The starting point is the financial statements: Income Balance Statement of statement Sheet Cash Flows corporatefinanceinstitute.com Analyzing cash flow groups Each category of the statement of cash Cash flow flows enables you to analyze the movement of funds in the company Asset Operational Financing strategy management management Asset management relates specifically to Operational management refers Financing strategy reflects decisions made the management of investment in the to the operational strategy by management in relation to the company and is where commitment to followed by an organization. ”leverage” of the company. growth can be seen. Margin management Debt / Equity Working capital Volume management Long-term / Short-term Absorbing Releasing Operating profit Other instruments Capital expenditure Interest / Dividends >amortization