ADVANCED

FINANCIAL
ANALYSIS AND
VALUATION
Understanding the Basic Financial
Statements
► The Statement of Financial Position
► Statement of Comprehensive Income
► Overview of Financial Statement Analysis
► Tools and Techniques of Financial Statement Analysis
The Statement of Financial Position

► The statement of financial position also known as a Balance Sheet represents the
Assets, Liabilities and Equity of a business at a point in time.
► Assets include cash, stock, property, plant or equipment – anything the business owns
► Liabilities are what the business owes to outside parties, eg. suppliers, bank or
business loans.
► Equity is the remaining proportion of the owner’s financial interest in the business
after deducting any liabilities from the total assets in the business.
 Japan Foods
Balance Sheet
For the year ended December 31
(Millions of dollars)
Statement of Comprehensive Income

► Statement of Comprehensive Income refers to the statement which contains the

details of the revenue, income, expenses, or loss of the company that is not
realized when a company prepares the financial statements of the accounting
period and the same is presented after net income on the company's income
statement.
 Japan Food
Income Statement
For the year ended December 31
(Millions of dollars, except for per-share Data)
Statement of Comprehensive Income
Statement of Comprehensive Income

► Earnings per share (EPS) is often called “the bottom line.” EPS is one that is most
important to stockholders.
► Operating income is earnings from operations before interest and taxes.
► Depreciation is the charge to reflect the cost of assets depleted in the production
process.
► Amortization is a noncash charge similar to depreciation except that it represents a
decline in value of intangible assets.
► The income statement reports on operations over a period of time.
► Income statement are prepared monthly, quarterly and annually.
► Income statement is tied to the balance sheet through the retained earnings account
on the balance sheet.
► EBITDA – earnings before interest, taxes, depreciation, and amortization.
Overview of Financial Statement Analysis

► Financial Statement Analysis Is a process which examines past and current

financial data for the purpose of evaluating performance and estimating future
risks and potential
► Means different things to different people depending on their individual interest
Uses of Financial Statement Analysis

► identify major changes or turning points in trends, amounts, and relationships

► yield valuable information about trends and relationships, the quality of a
company’s earnings, and the strengths and weaknesses of its financial position
► assessment of past performance and current position
► assessment of future potential and related risk
Uses of Financial Statement Analysis

► Assist investors and creditors in finding the type of information they require for making
decisions relating to their interests in a particular company (such as risk, return, dividend
or interest yield, safety, liquidity, growth, and others)
► Whether to continue or discontinue its main operation or part of its business;
► What to make or to purchase certain materials in the manufacture of its product
► What to acquire or to rent/lease certain machineries and equipment in the production of its
goods;
► Whether to issue stocks or negotiate for a bank loan to increase its working capital;
► What and when to make decisions regarding investing or lending capital;
► Other decisions that allow management to make an informed selection on various alternatives
in the conduct of its business.
Advantages of Financial Statement
Analysis
► Helps measure Profitability
► Helps measure financial strength
► Helps measure efficiency
► Helps to know the trend
Limitations of Financial Statement
Analysis
► Historical cost
► Inflation adjustment
► Personal Judgement
► Specific Time Period reporting
► Intangible assets
NEED FOR COMPARATIVE
ANALYSIS
►
Every item reported in a financial statement has significance. Comparisons can be
made on a number of different bases. Three are illustrated in this chapter.
► 1. Intracompany basis. This basis compares an item or a financial relationship
within a company in the current year with the same item or relationship in one or
more prior years.
► 2. Industry averages. This basis compares an item or a financial relationship of a
company with industry averages (or norms) published by financial ratings
organizations
► 3. Intercompany basis. This basis compares an item or a financial relationship of
one company with the same item or relationship in one or more competing
companies.
Tools and Techniques of Financial
Statement Analysis
► Horizontal analysis is used in the review of a company's financial statements
over multiple periods. It is usually depicted as percentage growth over the same
line item in the base year. Horizontal analysis allows financial statement users to
easily spot trends and growth patterns.
► Vertical analysis is a method of financial statement analysis in which each line
item is listed as a percentage of a base figure within the statement.
► Ratio analysis is a quantitative procedure of obtaining a look into a firm's
functional efficiency, liquidity, revenues, and profitability by analysing its
financial records and statements. Ratio analysis is a very important factor that
will help in doing an analysis of the fundamentals of equity
Horizontal Analysis

► Horizontal analysis, also called trend analysis, is a technique for evaluating a

series of financial statement data over a period of time. Its purpose is to determine
the increase or decrease that has taken place.
Horizontal Analysis

► Example:
 Vertical Analysis

► Vertical analysis, also called common

size analysis, is a technique for
evaluating financial statement data
that express each item within a
financial statement as a percent of a
base amount.
Vertical Analysis
Vertical Analysis
Ratio Analysis
► Ratio analysis expresses the relationship among selected items of financial statement data.
A ratio expresses the mathematical relationship between one quantity and another. The relationship is
expressed in terms of either a percentage, a rate, or a simple proportion.
1. Liquidity ratios – give an idea of the firm’s ability to pay off debts that are maturing within a
year.
2. Asset management ratios – give an idea of how efficiently the firm is using its assets.
4. Debt management ratios – give an idea of how the firm has financed its assets as well as the
firm’s ability to repay its long-term debt.
5. Profitability ratios – give an idea of how profitability the firm is operating and utilizing its
assets.
6. Market value ratios – give an idea of what investors think about the firm and its future
prospects.
Liquidity Ratio

► The current ratio is a widely used measure for evaluating a company’s liquidity
and short-term debt-paying ability. The ratio is computed by dividing current
assets by current liabilities.

► The acid-test (quick) ratio is a measure of a company’s immediate short-term

liquidity. It is computed by dividing the sum of cash, short-term investments, and
net receivables by current liabilities.
Asset Management Ratio

► Days sales outstanding is also called the average collection period (ACP).
► This ratio is calculated by dividing accounts receivable by average sales per day. It
indicates the average length of time the firm must wait after making a sale before
it receives cash.
Asset Management Ratio

► Inventory turnover measures the number of times, on average, the inventory is

sold during the period. Its purpose is to measure the liquidity of the inventory

► Average Days to sell inventories. A variant of inventory turnover is the average days
to sell the inventory. It is calculated by dividing the inventory turnover into 365.
Asset Management Ratio

► Fixed asset Turnover ratio measures how effectively the firm uses its plant and
equipment.

► Total Asset Turnover ratio Measures the turnover of all of the firm’s assets.
Debt Management Ratio

► Total Debt to Total Capital Measures the percentage of the firm’s capital
provided by debtholders. The ratio of total debt to total capital.

► Times-Interest- Earned Ratio measures the firm’s ability to meet its annual
interest payments. The ratio of earnings before interest and taxes (EBIT) to
interest charges.
Profitability Ratio

► Operating Margin measures operating income, or EBIT, per dollar of sales.

Profit margin is a measure of the percentage of each dollar of sales that results in net
income.
Profitability Ratio

► Return on Total Assets measures overall profitability of assets..

► Return on Common Equity Measures the rate of return on common

stockholders’ investment.
Profitability Ratio

► Return on Invested Capital (ROIC) measures the total return that the company
has provided for its investors.

► Basic Earning Power (BEP) Ratio This ratio shows the raw earning power of the
firm’s assets before the influence of taxes and debt, and it is useful when
comparing firms with different debt and tax situations.
Market Value Ratio

► Price/Earnings Ratio Shows the dollar amount investors will pay for $1 of current
earnings

► Market/Book (M/B) Ratio shows that Companies that are well regarded by
investors – have high M/B ratios.
Market Value Ratio

► Price/Earnings Ratio Shows the dollar amount investors will pay for $1 of current
earnings

► Market/Book (M/B) Ratio shows that Companies that are well regarded by
investors – have high M/B ratios.
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