Financial statements analysis Free Cash Flow xx

> involves the assessment and evaluation of the firm’s past

performances, its present condition, and future business potentials. If the starting point is EBIT

Type of information: EBIT x (1 - Tax Rate) xx

1.​ Profitability of the business firm;
Non cash Expense (Depreciation, Amortization,
2.​ The firm’s ability to meet its obligation; (liquidity and
etc.) xx
solvency)
3.​ Safety of the investment in the business; (company Change in (Current Asset - Current Liabilities) (xx)
stability/ going concern):
Capital Expenditure (CAPEX) (xx)
4.​ Effectiveness of management in running the firm;
(turnovers) Free Cash Flow xx
5.​ Over-all company marketability (company shares of stock
If the starting point is net income
Vertical analysis (common-size financial statement)
> the process of comparing figures in the financial statement of
single period Net income xx
>common size financial statement Cash Flow from Operating Activities xx
>downwards
>converting the figures in the statement to a common base Interest Expense xx
>these “converted” statements are called common size statement,
Tax Shield on Interest Expenses (xx)
100 percent statement or component statement
Non cash Expense (Depreciation, Amortization,
illustration​ etc.) xx

Change in (Current Asset - Current Liabilities) (xx)

Sales​ ​ ​ 5,000,000​​ 100%
Cost of good sold​ ​ 1,000,000​ ​ 20% Capital Expenditure (CAPEX) (xx)
Gross profit​ ​ 4,000,000​ ​ 80%
General and Administrative Free Cash Flow xx
​ Expenses​​ 2,000,000​ ​ 40%
Operating income​ ​ 2,000,000​ ​ 40% Interpreting Free cash flow
Taxes (%25)​ ​ 500,000​ ​ 10% ●​ Growing free cash flows are frequently a prelude to
Net income​ ​ 1,500,000​ ​ 30% increased earnings.
●​ By contrast, shrinking fcf might signal that companies are
Horizontal Analysis unable to sustain earning growth.
●​ enables investors and analyst to see what has been ●​ But a shrinking FCF is not necessarily a bad thing,
driving a company’s financial performance over time particularly if increasing capital expenditures
●​ identify trends and growth patterns
●​ the statements for two or more periods are used in Gross profit analysis
horizontal analysis. ●​ It is used to determine the reasons why the gross profit
margin changes from period to period, so that
Formula for Percentage Change management can take steps to bring the gross margin in
line with expextations.
●​ Two primary factors that result in revenue variances are
Most Recent Value - Based Period
Percentage Change Value the price and the physical/quantity factors.
=
Based Period Value Sales price variance (SPV)/sales factor
●​ Measures the change in total sales and gross profit
Statement of cash flows brought about by changes in selling price.
​ Is a financial statement that summarizes the amount of
cash and cash equivalents entering and leaving a company.
Sales Price Variance (SPV / Sales Factor
The main components of the cash flow statement are:
Operating activities:main income generated independent in the = (Selling Price per unit this year - Selling Price per unit last year)
nature of the business x Sales unit this year
Investing Activities: expansions
Financing activities
= total sales this year - Sales this year at last year's price
Free cash flow
●​ Is the cash left over after a company pays for its operating Cost price variance (CPV) / Cost Factor
expenses (OpEx) and capital expenditures (CapEx). ●​ Measures the change in cost of sales and gross profit
●​ Is the cash flow available for the company to repay brought about by changes in unit cost.
creditors or pay dividends and interest to investors.
If the starting point is Cash from Operating Activities
Cost Price Variance (CPV / Cost Factor

Cash Flow from Operating Activities xx = (Unit Cost this year - Unit cost last year) x Sales units this year

Interest Expense xx

Tax Shield on Interest Expenses (xx) = Cost of sales this year - Cost of sales this year at last year's price

Capital Expenditure (CAPEX) (xx)

Sales Quantity Variance Effects of selected transactions to current ratio, working capital, and
●​ Measures the change in total sales and gross profit quick ratio
brought about change in unit sold.
❖​ Purchase of MES for Cash
Sales Quantity Variance ❖​ Disposal of MES for Cash that resulted to
➢​ No gain
➢​ Loss
= (Sales Qty this year - Sales Qty last year) x Selling price last year
➢​ Gain
❖​ Collection of Account Receivable
❖​ Collection of previously written-off receivables
= Sales this Year @ Last Year's Price - Sales Last Year ➢​ Allowance method vs Direct write-off method
❖​ Write-off of receivable
Sales Volume Variance / Quantity Factor ➢​ Allowance method vs Direct write-off method
●​ Measures the net effect on gross profit due to change in
unit sold. ❖​ Purchase of inventories for cash
❖​ Sales of inventories for cash or on account
Sales Volume Variance / Quantity Factor ❖​ Purchase of inventories on account

= (Sales Qty this year - Sales Qty last year) x Gross Profit per unit Assumes​ ​ Before​ ​ After
last year CA​ ​ P10​ ​ P11
CL​ ​ 4​ ​ 5
CR​ ​ 2.5​ ​ 2.2
= Sales Qty Variance + Cost Qty Variance WC​ ​ P6​ ​ P6
QR​ ​ ​ ​ Deacrease
❖​ Settlement of accounts payable
Ratio analysis
➢​ Stock dividends
●​ A quantitative method for gaining insight into a company’s
■​ Date of declaration
liquidity, operational efficiency, and profitability by
■​ Date of record
examining financial statements such as the balance sheet
■​ Date of settlement
and income statement
●​ Ratio analysis is probably the most widely known and
❖​ Cash dividends
most commonly used tool for financial statement analysis.
➢​ Date of declaration
●​ Ratios calculated from these financial statements provide
➢​ Date of record
users of the statements with relevant information about the
➢​ Date of settlement
business firm’s liquidity, solvency and profitability.

❖​ Disposal of non current asset

General rules in interpreting rations
➢​ No gain, No loss
1.​ The higher the ratio the better, except for the debt ratio.
➢​ Gain
2.​ The lower the period the better, for example the operating
➢​ Loss
cycle.
●​ Use the average amount for the Real account
3.​ WORKING CAPITAL ACTIVITY RATIO / TURNOVERS
when compared to a Nominal account
●​ Do not use the average if comparing:
A.​ Receivable turnover
➔​ Real account vs Real account
●​ It is the time required to complete one collection
➔​ Nominal account vs Nominal account
cycle - from the time receivables are recorded,
Test of Liquidity
then collected, to the time new receivables are
1.​ Current ratio
recorded again.
●​ Measures the number of times that the current
●​ Working days - 360 or 365
liabilities could be paid with the available current
asset.
Receivable Net Credit Sales
Current Asset Turnover = Average Receivables
Current Ratio =
Current Liabilities

Average
Receivables = Beginning AR + Ending AR
Working Capital = Current Assets - Current Liabilities
2
2.​ Acid Test Ratio

Average Receivables
Quick Asset Average Age of
Acid Test Ratio =
Receivables = Average daily credit sales
Current Liabilities

# of working days in yr
Cash + Marketable Securities + Receivables Average Age of
Acid Test Ratio =
Receivables = Receivable turnover
Current Liabilities

B.​ Inventory turnover

Cash + Marketable Securities ●​ Measures the number of times that inventory
Cash Ratio = replaced during the period
Current Liabilities
 Cost of Good Sold 2.​ Debt-equity ratio
Inventory Turnover
●​ It is computed by expressing liabilities as a
= Average Merchandise Inventory percentage of total owners or stockholders
equity.
●​ If the resulting debt-equity ratio exactly equal to
Average Beginning Balance + Ending Balance 1, this means that the creditors and owners
Merchandise provided an equal amount of capital.
Inventory 2
Total Liabilities
Debt-equity Ratio =
Total Owners' or Stock holders' Equity
Average Inventory
Average Age of
Inventory = Average daily Cost Of Good Sold 3.​ Debt ratio
●​ Indicates the percentage of total assets
provided by creditors
# of working days in yr
Average Age of Total Liabilities
Inventory = Inventory turnover Debt Ratio =
Total Assets
C.​ Trade Payables Turnover
●​ It measures the time which elapse from the 4.​ Equity ratio
purchase of materials up to the payment of ●​ Indicates the percentage of total assets
accounts or note payable arising from such provided by the owner
purchase
Total SHE
Net Credit Purchase Equity Ratio =
Trade Payables Total Assets
Turnover = Average Trade Payables
5.​ Equity Multiplier

Average Trade Payables

Average Age of Average Total Asset
Equity Multiplier =
trade Payables = Average daily credit purchase
Average Total SHE

TEST OF PROFITABILITY
# of working days in yr
Average Age of
trade Payables = Payables turnover Rate of Return ot Income
Return on
●​ CASH CONVERSION CYCLE Investment = Investment

Average Age of Receivables​ ​ xx

1.​ Return on Sales
Average Age of Inventories​ ​ xx
●​ Return on sales or profit margin, measures the amount of
Average age of Trade Payables​ (xx)
income provided by the average peso sales.
Cash Conversion Cycle​ ​ xx

Note: It is better if it zero or negative Income

Return on Sales
Net sales
D.​ Current Asset Turnover
●​ This turnover measures the movement and Gross Profit
Gross Profit Ratio
utilization of current assets to meet operating
Net sales
requirements
Net Profit
Net Profit Ratio
Cost of Sales + operating Expenses Net sales
(excluding depreciation and amortization)
Current Asset
Turnover = Average Current Asset 2.​ Return on Total Assets (ROA)
●​ Measure of operating efficiency. It indicates hoe
well the firm’s management has used the assets
Test of Solvency under its control to generate income
​ It refers to the company’s ability to pay its debts, whether
such liabilities are current or non current. It is therefore somewhat Income before Interest and Tax (EBIT)
similar to liquidity, except that solvency involves a longer time Return on Assets
horizon. Average Total Asset
1.​ Interest Earn Ratio or
●​ Time interest earned determines the extent to
which operations cover interest expense. Net Income +Interest Expense + Income Tax

Average Total Asset

Time Interest Income before tax + Interest expense (EBIT)
Earned = Interest Expense 3.​ Return on Owners’ Equity
●​ Measures the amount earned on the owners’
investment
 Retun on Owners' Net Income / Earnings after Tax
Equity Avarage Owners' Equity

Retun on Common Net Income - Preffered Dividends

Equity Average Common Stockholders' Equity

MARKET TEST
●​ Stock holders and investors are usually interested in the
market price of corporation’s common stock and the ratios ADDITIONAL FUND NEEDED
that indicate the stocks’ performance or attractiveness in ​ AFN is a way of calculating how much new funding will
the market. be required, so that the firm can realistically look at whether or not
1.​ Price-earnings Ratio P/E / Times Earnings Ratio they will be able to generate the additional funding and therefore be
able to achieve the higher sales level.

Price -Earnigns Price Per Share

The simplified formula is:
Ratio Earning Per Share ​ Projected Increase in asset​ ​ xx
​ Spontaneous increase in liabilities​ xx
​ Any increase in retained earnings​ xx
2.​ Dividend Yield
●​ To measure the rate of return in the investor’s
common stock investment

Dividend per Share

Dividend yield =
Price per Share

3.​ Dividend Payout

●​ The payout ratio or dividend ratio of dividends
per share to earning per share

Common Dividend per Share

Dividend Payout =
Earning per Share

Plow-back
Ratio 1-payout Ratio

DU PONT EQUATION
●​ Dupont analysis is a useful technique used to decompose
the different drivers of return on equity (ROE).
●​ Operating efficiency is represented by net profit margin.
●​ Asset use efficiency is measured by the asset turnover
ratio
●​ Leverage is measured by the equity multiplier.

=Net Profit Margin x Asset Turnover x Equity

Du Pont Equation Multiplier

or

EAT x Total Sales x Ave Total Asset

Total Sales Ave. Total Asset Ave. SHE