9/23/2024

LECTURE 4: FINANCIAL ANALYSIS

Module 1: Common-size and Trend Analysis
Dr. Tien Ng

DIAGNOSTIC TOOLS

COMMON SIZE TREND FINANCIAL BENCHMARK

(vertical) (time-series) RATIOS (cross-comparison)

Spot key financial Compare growth Evaluate relationships Compare to norms

activities rate over time among elements of e.g. industry level
• balance sheet items as % of financial statements
total assets; • Relevance of ratios & acct
• income statement items as % numbers depends on the
of sales state of the firm

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Cross-sectional Analysis

 Comparison with similar companies in the same industry

35

30

25

20

15

10

Gross margin Income as % of sales Growth in sales

Home Deport Lowe's

Common-size & Trend Analysis

Case study:
Home Depot

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- Vertical IS presents the change in - Horizontal IS presents the

composition of costs mix. historical trend/pattern of
- All accounts are presented as revenue, costs and net income
proportion variables (i.e. expresses - All accounts are presented as
each line in term of % of sales) growth variables

Common-size vertical Percentage change horizontal

INCOME STATEMENT INCOME STATEMENT
2006 2005 2004 2003 2002 2006 2005 2004 2003
Net revenue 1.000 1.000 1.000 1.000 1.000 11.4 11.5 12.8 11.3
Cost of sales 0.672 0.665 0.666 0.682 0.689 12.7 11.4 10.0 10.2
Gross margin 0.328 0.335 0.334 0.318 0.311 9.0 11.8 18.7 13.7
SG&A 0.202 0.202 0.209 0.196 0.195 11.3 8.1 20.0 11.8
Depreciation and amortization 0.019 0.018 0.017 0.016 0.016 19.7 17.9 22.2 13.1
Operating income 0.106 0.115 0.108 0.106 0.1 3.3 18.1 15.8 17.4
Interest & investment income 0 0.001 0.001 0.001 0.001 (56.5) 10.7 (5.1) (25.3)
Interest expenses 0.004 0.002 0.001 0.001 0.001 174.1 104.3 12.9 67.6
Earnings before taxes 0.102 0.114 0.108 0.106 0.101 0.3 17.3 15.6 16.5
Income taxes 0.039 0.042 0.04 0.039 0.038 3.0 18.3 14.7 15.0
Net income 0.063 0.072 0.068 0.066 0.063 (1.3) 16.7 16.2 17.5
Diluted EPS 2.6 20.4 20.2 20.5
 side note: side note:
 side note:
- top-line growth slowed down: - declined NI was accompanied
- why increasing SGA?
unusual 2004 or maturity stage? with increased EPS?

- Horizontal BS presents the

- Vertical BS presents the change in
historical trend/pattern of
composition of assets, liabilities & equity
assets, liabilities & equity
- - All accounts are presented as proportion
- All accounts are presented as
variables (i.e. in term of % of assets)
growth variables
Common-size (vertical ) Percentage(horizontal)
BALANCE SHEET BALANCE SHEET
2006 2005 2004 2003 2002 2006 2005 2004 2003
Assets
 side note:
Cash and marketable securities 0.01 0.02 0.06 0.08 0.08 (23.9) (62.7) (24.1) 26.6- change in the mix of assets
Receivables 0.06 0.05 0.04 0.03 0.04 34.5 59.8 36.6 2.3- increase M&A to support
Inventories 0.25 0.26 0.26 0.26 0.28 12.5 13.2 11.0 8.9 maturity stage
Other current assets 0.03 0.01 0.01 0.01 0.01 101.7 24.8 75.9 19.3
PPE 0.51 0.56 0.58 0.58 0.57 6.8 9.6 13.3 16.9
 side note:
Goodwill (M&A activities) 0.12 0.08 0.04 0.02 0.02 71.4 160.9 69.5 44.9 - change in the capital
Other assets 0.03 0.01 0.02 0.01 0.01 143.9 (9.5) 185.9 (39.3) structure: use of D proceeds
Total assets 1.00 1.00 1.00 1.00 1.00 17.7 13.8 13.3 14.7 to MA and repurchase shares
Liabilities and Equity
Payables 0.14 0.14 0.15 0.15 0.15 21.9 4.6 11.8 13.1
Accrued expenses 0.02 0.07 0.08 0.07 0.07 (60.9) 11.4 22.3 8.3
Deferred revenue 0.03 0.04 0.04 0.04 0.03 (7.0) 13.6 20.7 28.4  side note:
Other current liabilities 0.05 0.04 0.00 0.02 0.01 46.9 947.1 (74.9) 192.3 - growth in D is faster than
growth in E
Noncurrent LT debts 0.22 0.06 0.06 0.02 0.04 335.7 24.4 150.9 (35.2)
- change in K structure to
Other LT liabilities 0.06 0.04 0.06 0.05 0.03 54.4 (14.9) 39.4 89.9 support M&A and buy-
Common stock 0.15 0.17 0.17 0.18 0.20 8.7 9.4 7.4 5.5 back
Retained earnings 0.63 0.65 0.61 0.57 0.53 14.2 20.8 21.8 23.2
Treasury stock (0.31) (0.22) (0.17) (0.10) (0.07) 68.7 45.1 86.4 79.5
Total liabilities and equity 1.00 1.00 1.00 1.00 1.00 17.7 13.8 13.3 14.7

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Common-size & Trend Analysis

Case study:
Mai Linh Group

Mai Linh Group

Percentage Change in Common-size Vertical

Balance Sheet Balance Sheet
2006 2007 2008 2009 2010 2011 2006 2007 2008 2009 2010 2011
Sales 356% 64% 16% 15% 11%
Selling exp. 790% 172% 32% 54% -2% 1% 2% 3% 3% 4% 4%
Admin exp. 158% 55% 14% -2% 4% 23% 13% 12% 12% 10% 10%
AR 137% -8% 22% 37% 28% 22% 19% 13% 13% 17% 20%
PPE 335% 109% 25% 4% 12% 18% 28% 43% 45% 45% 47%

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Mai Linh Group

Percentage Change in Common-size Vertical

Balance Sheet Balance Sheet
2006 2007 2008 2009 2010 2011 2006 2007 2008 2009 2010 2011
AR 137% -8% 22% 37% 28% 22% 19% 13% 13% 17% 20%
Fixed assets 335% 109% 25% 4% 12% 18% 28% 43% 45% 45% 47%
ST Debt 94% 181% 44% 19% -3% 12% 9% 18% 21% 24% 22%
LT Debt 130% 30% 26% -9% 0% 46% 38% 36% 39% 34% 32%

LECTURE 4: FINANCIAL ANALYSIS

Module 2: Financial Ratios Analysis and Market Tests
Dr. Tien Ng

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FINANCIAL RATIO ANALYSIS

• Understand the inter-relationships …

• between the financial ratios, themselves, and
• between the ratios and the strategies, business models and industry
environment
• Identify key factors that explain the situation of the firm and focus on them in
your analysis
• Relevance of ratios depends on the state of the firm, E.g.
• P/E & Earnings are more relevant for profitable firms
• Book Value of equity is more relevant for firms in distress

FINANCIAL RATIO ANALYSIS

Evaluating Drivers of Profitability

Overall Profitability
ROE = Profit Margin * Tot Assets T/O * Fin Leverage Assessing Operational Mgt
Gross Profit Margin
= Profit/Sales * Sales/Tot Assets * Tot Assets/Equity OPERATING
SG&A Expenses to Sales

Assessing Operational and

Investing Efficiency
INVESTING FINANCING Assessing Financing Activities
Working Capital Turnover
Short-term liquidity: CCC/Current
Long-term Assets Turnover
Debt & Long-term Solvency: D/E

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FINANCIAL RATIO ANALYSIS

Evaluating Drivers of Profitability

Overall Profitability
ROE = Profit Margin * Tot Assets T/O * Fin Leverage
= Profit/Sales * Sales/Tot Assets * Tot Assets/Equity OPERATING

INVESTING FINANCING

Liquidity & CFS Analysis

Market tests

From your text

• Profitability ratios • Solvency
• Net Profit Margin • Total debt ratio
• ROA • Debt-equity
• ROE • Equity multiplier
• Times interest earned
• Efficiency (Asset • Cash coverage ratio
Management) • Liquidity
• Inventory turnover • Current ratio
• Days sales in inventory • Quick ratio
• Receivables turnover • Cash ratio

• Market Ratios
• Price Earnings Ratio (PE)
• Market to Book (PB)
• EV multiple

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From your text

ASSESSING
OPERATIONAL MANAGEMENT
(Profitability)
Measures to look at:
 Gross Profit Margin
 ROA – Return on Assets
 ROE – Return on Equity

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ASSESSING OPERATIONAL MANAGEMENT

Note: depends on
GROSS PROFIT MARGIN  Degree of competitors
 Customer powers (low)
 Substitution (low)
pricing strategy (uniqueness of the product)
vs. cost structure Note: depends on
• This ratio allows a focus on average unit mark-ups  Supplier power (ability to
access low-cost materials)
Gross_Profit = sales - COGS  Degree of new/updated
GPM  prod. process

Sales

• A high GPM implies that firm has relatively more flexible in product pricing and
less vulnerable to change in cost
• Other margins include: net profit margin (NI/Sales), EBIT margin (EBIT/Sales)

• E.g. Huu Lien Asia JSC. (HOSE: HLA) is a Vietnamese steel manufacturer.
Its historical margin ratios are as follow:

2009 2010 2011 2012 2013

* Gross Profit Margin (GM) 10% 11% 8% 6% 0.3%
* NI Margin (NM) 2.6% 0.5% 0.06% 0.3% Loss

* Sales growth rate 39% 14% 13% 52% -18%

* COGS growth rate 34% 12% 16% 56% -14%
* COGS / sale 90% 89% 92% 94% 99.7%

HLC reported net loss of –VND235b. in 2013

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OVERALL PROFITABILITY
ROE VS. ROA

NI  pref.div NI  int(1  t)
ROE  ROA 
Avg_Common_Shareholders' Equity Avg_Total_Assets

 Rate earned on shareholders’ equity  Rate earned on total assets (ROA):

(ROE): measure a firm’s ability to measure a firm’s ability to generate
generate return on shareholders’ return on total assets
investment

ASSESSING EFFICIENCY
Measures to look at:
 Working Capital Turnover;
 AR Turnover;
 Inventory Turnover
 Fixed Assets Turnover

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ASSESSING EFFICIENCY
OPERATIONAL and INVESTING EFFICIENCY

Measures reflects effectiveness of a firm’s investing management

 How efficiently is the firm using assets?
 What’s the amount of capital required to generate specific sale volumes?

ASSESSING OPERATIONAL EFFICIENCY

credit sale
ACCOUNT RECEIVABLE TURNOVER Net_Sales
AR_turnover 
• measures how soon sales will become cash Avg_AR
• a more intuitive measure of the rate at which AR are being Days_Receivables_Outstanding  365/AR_turnover
collected is the days receivable outstanding (Rule of thumb: DRO < 1.5 x credit term)

INVENTORY TURNOVER
• measures how quickly inventory being sold
COGS
INV_turnover 
Avg_INV
• a more intuitive measure of the rate at which inventory are being
sold is the days inventory held Days_Inventory_held  365/Inv_turnover

FIXED ASSETS TURNOVER

• This ratio measures the relation between sales and the
Sales
Fixed_Assets_turnover 
investment in PPE Avg_Fixed_Assets

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• E.g. The Vietnamese aqua-product industry (category: catfish)

inventory T/O 2018 2019 2020 2021 2022

* VHC (Vinh Hoan Corp) 5.22 4.48 3.99 4.07 3.78

* ANV (Nam Viet JSC) 3.38 2.17 1.56 1.65 1.53

* TS4 (Marine Product No. 4 Co.) 1.91 0.17 0.63 0.16

Avg. industry 4.28 3.14 2.28 2.36

CAD (Cadovimex Co.) 2018 2019 2020 2021

* Inventory T/O 0.37 0.62 42.69 39.68

*Inventory Days Outstanding 910 608 8 9

• E.g. Lamson Sugar Cane (HOSE Ticker: LSS) is a Vietnamese sugar

producer. Historically the company has reported the following turnover ratio.
What do we know about the efficiency?

2010 2011 2012 2013

* Tangible Fixed Assets T/O 6.63 9.02 2.81 1.54

* Sale growth rate 22% 51% -7% -2%

*Tangible fixed assets growth rate 9% 2.93% 363% 17%

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ASSESSING
FINANCING ACTIVITIES
Measures to look at:
 Debt ratio,
 Interest coverage
 Leverage (capital structure)

ASSESSING FINANCING ACTIVITIES

LONG-TERM SOLVENCY

• Measure a firm’s ability to meet interest and principal payments on LT debt when
they come due
• Common measures should include:
• firm’s capital structure, and
• its ability to generate earnings over a period of years

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ASSESSING FINANCING ACTIVITIES

* DEBT RATIOS:
int_bearing_Debt
Debt_ratio 
int_bearing_Debt  Shareholders' Equity 
int_bearing_Debt
Debt/Equity_ratio 
Shareholders' Equity Measures how many times a
firm’s NI before interest expense
total_liabilities
Liabilities/Assets_ratio  and income taxes (EBIT) exceeds
total_assets its interest expense.

* INTEREST COVERAGE RATIO:

NI  Interest_Expense  IncomeTax_Expense
Interest_Coverage 
Interest_Expense

• E.g. Hoa Phat Corp. (HOSE: HPG) is a Vietnamese steel-maker, accounted

for roughly 32% of market share in construction steel and steel pipes in
2021. The capital structure and its interest coverage are as follow:

Ticker: HPG 2018 2019 2020 2021 2022

* Debt / Equity 59.83 76.76 91.43 63.02 60.24

* LT Debt / Equity 31.54 41.52 29.29 14.83 14.86

* Total Liabilities / Total Assets 48.07 53.05 54.97 49.06 43.57

2018 2019 2020 2021 2022

* Interest Coverage 19.65 10.71 8.01 15.67 4.22

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DUPONT ANALYSIS

OVERALL PROFITABILITY
DUPONT ANALYSIS

• ROE = ROA x LEVERAGE

NI NI ASSETS
= x
EQUITY ASSETS EQUITY

NI NI SALES ASSETS
= x x
EQUITY SALES ASSETS EQUITY

LEVERAGE
PROFITABILITY EFFICIENCY
PROFIT MARGIN ASSETS T/O ROE > ROA
when ROA exceeds
DIFFERENTIATION LOW-COST the cost of debt

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Analysis of LEVERAGE

Profitable if:
Cost of capital < rate of return
Kd + Ke < Re

• Leverage shows the extent to which firm relies on debt financing in its capital
structure
• Since cost of debt is typically less than cost of equity, it is optimal for firm to use
some debt in their capital structure to take advantage of leverage

tax shield + less risk

+ without losing control over BOD

Analysis of LEVERAGE
default
Profitable if:
Cost of capital < rate of return
Kd + Ke < Re

• Given that increases in financial leverage increase ROE, why are all companies
not 100% debt financed?
• The answer is that: debt is risky
• Increased risk increases the expected return investors require to provide
capital to the firm
• Higher financial leverage also results in a higher interest rate on the
company’s debt
• S&P’s and Moody’s ratings partly determine the debt’s interest rate: lower quality ratings yield
higher interest rates.
• If all else equal, higher financial leverage lowers a company’s debt rating and increases the
interest rate it must pay

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Using of DUPONT IDENTITY

Table. The DUPONT breakdown for Vietnam Airline (HVN) and Vietjet Air (VJC)
ROE = Profit margin Asset turnover Equity Multiplier
HVN
2016 0.1296 0.0300 0.7265 5.9392
2017 0.1525 0.0321 0.9368 5.0795
2018 0.1392 0.0268 1.1750 4.4124
2019 0.1364 0.0258 1.2848 4.1088

ROE = Profit margin Asset turnover Equity Multiplier

VJC
2016 0.5272 0.0908 1.3707 4.2380
2017 0.4789 0.1199 1.3362 2.9883
2018 0.3800 0.0996 1.3707 2.7842
2019 0.2555 0.0752 1.0357 3.2785

Using of DUPONT IDENTITY (cont.)

Table. The DUPONT breakdown for Vietnam Airline (HVN) and Vietjet Air (VJC)
ROE = Profit margin Asset turnover Equity Multiplier
HVN
2019 0.1364 0.0258 1.2848 4.1088
2020 -1.8409 -0.2757 0.6480 10.3034
2021 -25.3416 -0.4758 0.4426 120.3397
2022 1.0151 -0.1594 1.1612 -5.4844
2023 0.3308 -0.0615 1.5860 -3.3899
ROE = Profit margin Asset turnover Equity Multiplier
VJC
2019 0.2555 0.0752 1.0357 3.2785
2020 0.0046 0.0038 0.4031 3.0176
2021 0.0047 0.0062 0.2493 3.0648
2022 -0.1518 -0.0563 0.5900 4.5669
2023 0.0151 0.5900 0.6712 5.6989

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ASSESSING LIQUIDITY







ASSESSING LIQUIDITY MANAGEMENT

SHORT-TERM LIQUIDITY

• Sheds light on a firm’s ability to pay for obligations that come due
during its operating cycle (e.g. wages, purchases of inventory, ..)
• Common measures used include:
• Current ratio
• Quick ratio
• CCC
• CFO to liabilities

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ASSESSING LIQUIDITY MANAGEMENT

CURRENT RATIO & QUICK RATIO

Current_Assets
CR 
Current_Liabilities
• CR matches cash and other current assets that will become cash within 1 year against the obligations
that come due in the next year.
• Generally, firms prefer a higher CR. However, an excessively high CR indicates inefficient asset use..

cash  MktSecurit ies  AR CA  Inv cash  AR

QR   
Current_Liabilties CL CL
• a variation of the CR is quick ratio (or Acid-test ratio), i.e. include in the numerator only those
current assets that the firm could convert quickly into cash (Rule of thumb 0.6 – 0.8)

• E.g. Pomina Steel (HOSE: POM), a Vietnamese steel-maker. The current ratio of the
company are as follow. What can you say about the liquidity of the company?

2018 2019 2020 2021

* Current ratio 1.05 1.01 0.94 0.93

* Quick ratio 0.49 0.39 0.39 0.27

* Inventory T/O 5.75 4.13 3.69 4.00

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ASSESSING LIQUIDITY MANAGEMENT

CASH CONVERSION CYCLE

CCC = days inventory held + days sale outstanding – payables deferred period
• CCC measures the financing gap in term of time. As CCC increases, the firm’s
financing needs grow larger.
• E.g.,

inventory stock 52 days inventory sold 15 days cash received

Days inventory held Days sales outstanding

Days payables outstanding Cash conversion period

cash disbursed
40 days 27 days

Cash Operating Cycle for Apple and 3M

 The negative cash cycle for Apple implies that it can invest the cash it
receives from sales for 52.7 days before making payment to suppliers.
 3M is a more typical cash operating cycle.

© Cambridge Business Publishers, 2018

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ASSESSING LIQUIDITY MANAGEMENT

CASH CONVERSION CYCLE

CCC = days inventory held + days sale outstanding – payables deferred period

• How to use CCC:

 Track over multiple periods
 Compare to its competitors, using a combination of factors
 Internal management of AR and AP
 Apply to specific industry only

ASSESSING LIQUIDITY MANAGEMENT

CFO TO LIABILITIES

CFO
Avg_Current_Liabilities

• The advantage is that this measure is based on cash flow AFTER the funding
needs for working capital (i.e. AR and inventory) been made

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CASH FLOW
STATEMENT ANALYSIS

RELEVANT OF CASH FLOW STATEMENT

• Undo the current period accrual adjustments affecting

• Help users address questions such as:
• How much cash is generated from or used in operations?
• What expenditures are made with cash from operations?
• How are dividends paid when confronting an operation loss?
• What is the source for debt payment, stock redemption, or investment?
• Why is cash lower when income increased?
• What is the use of cash received from new financing?

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RELEVANT OF CASH FLOW STATEMENT

• Cash flows from Operating activities (CFO):

• Are there significant discrepancy between NI and CFO? Does this gap
change over time?
• Is it possible to identify the source of this difference?

RELEVANT OF CASH FLOW STATEMENT

• Cash flows from Investing activities (CFI):

 Management’s expectation:
• increased investments only if high growth is forecast
 Effect of the nature of business:
• capital intensive vs. Distribution/retailing
 What does cash largest flows come from? Does it provide useful
information about “operational” investments?
• E.g. Compare ROS FLC 2017 – 2020 for Sale and Purchase of
marketable securities.

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• E.g. ROS 2017 - 2020

• What does it tell us about “cash-burn” & “operational”?

FLC Faros Construction JSC (Ticker: ROS)

Consolidated Statement of Cash Flows
(in thousands)
2020 2019 2018 2017
Purchase of fixed assets (153,852) (1,130,846) (1,256,211) (1,281,305)
Purchase of marketable securities (4,721) (1,210,483) (2,903,862) (1,236,827)
Sales and maturity of marketable securities 51,439 910,826 2,370,681 1,644,867
Investments / Di-investment in affiliates 233,400 707,267 1,404,000 (1,634,383)
Interest from investment in securities 41,914 113,315 182,065 813,048
Net cash flows from investing activities 168,180 (609,921) (203,327) (1,694,600)

RELEVANT OF CASH FLOW STATEMENT

• Cash flows from Financing activities (CFF):

• Related to current operating performance
• Growth associated with investing and financing
• Effect of the nature of business
• E.g. Amazon 1999
• What type of financing do you expect?

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• E.g. Amazon 1999

• What type of financing do you expect?
• Is this debt financing?
AMAZON.COM, INC.
CONSOLIDATED STATEMENTS OF CASHFLOWS
(in thousands)

Year Ended December 31,

2000 1999 1998
CONVERTIBLE
FINANCING ACTIVITIES: NOTES
Proceeds from exercise stock options 44,697 64,469 14,366
Proceeds from long-term debt 681,499 1,263,639 325,987
Repayment of long-term debt (16,927) (188,886) (78,108)
Financing costs (16,122) (35,151) (7,783)
Net cash provided by financing activities 693,147 1,104,071 254,462

OTHER SUGGESTIONS

Cash Flows Cash Flows Cash Flows

General
from from from
Explanation
Operating Investing Financing
Building up pile of cash. Possibly mature
1. + + +
looking for acquisition.

Operating cash flow being used to

2. + – – expansion
buy fixed assets and pay down debt.

Operating cash flow and sale of fixed

3. + + –
assets being used to pay down debt. mature

Operating cash flow and borrowed expansion

4. + – +
money being used to expand.

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OTHER SUGGESTIONS

Cash Flows Cash Flows Cash Flows

General
from from from
Explanation
Operating Investing Financing
Operating cash flow problems
5. – + + covered by sale of fixed assets,
borrowing, and contributions.
Rapid growth, short falls in operating
6. – – + cash flow, and purchase of fixed
assets.
Sale of fixed assets is financing
7. – + – operating cash flow shortages.

Company is using cash reserves to

8. – – – finance cash flow short falls and pay
creditors.

MARKET TESTS
Measures to look at:
 PE
 PB
 Dividend yield

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RATIOS for STOCK PICKING

PRICE-TO-EARNINGS (PE) ratio: How it is derived:

• Compare the stock price to the firm’s EPS
• The EPS can be either for the past 12
months (historical or trailing PE) or the
coming 12 months (forward or leading PE)
• Is usually expressed in terms of x, which
simply means “times.”
• For instance, a P/E ratio of 5x means that a firm’s
stock price is five times its annual EPS
NI  DIV_Pref. shares
where: EPS 
# outstandin g_common shares

RATIOS for STOCK PICKING

PRICE-TO-EARNINGS (PE) ratio: How it is derived:

What are PE ratios useful for?
• Reflects the value/worth of a firm’s stock
compared to similar stocks across an industry or to
the market
• A high PE: implies either a firm’s stock
is overvalued by the market, or the market expects
it to perform well in the future.
• A low PE: implies either a firm’s stock
is undervalued by the market, or the market expects
it to perform poorly in the future NI  DIV_Pref. shares
where: EPS 
# outstandin g_common shares

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RATIOS for STOCK PICKING

PRICE-TO-BOOK (PB) ratio: How it is derived:

• Compare the price of the stock to the
firm’s book value (BVE)
• The book value is the net value of the
company's total assets minus its total
liabilities. That is, what the shareholders
may be left with if the company goes
bankrupt.
• Is usually expressed in terms of x, which
simply means “times.”

RATIOS for STOCK PICKING

DIVIDEND YIELD ratio: How it is derived:

• Measure the percentage return received
from dividends relative to its market price
• Is usually expressed in terms of
percentage

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END OF LECTURE 4

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