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Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. 

McGraw-Hill/Irwin 

Financial Statement Analysis 

K R Subramanyam

John J Wild


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CHAPTER 

Overview of Financial  
Statement Analysis


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Information Sources for Analysis


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Operating Activities

Revenues and expenses from providing

goods and services 

Business Activities


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Financial Statements Reflect Business Activities


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Major aspects of financial statement analysis 

  1. Market measures
  2. Financial distress and bankruptcy analysis
 

Special analysis topics 

  1. Profitability analysis
  2. Credit analysis
  3. Cash flow analysis
 

Basic analysis 

  1. Financial forecast
  2. Equity valuation
 

Prospective analysis


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Analysis Process


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Comparative analysis 

  • Why we need to compare?
  • What we need to compare?
    • Period-to-period
    • Firm-to-firm
    • Division-to-division
  • Difference types:
    • In dollars:     ∆A = A1 – A0
    • In percentages:
 

A1 

A0 

x 100 (%) 

8


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Time 

To compare a company’s financial position and performance between periods. 

Horizontal analysis


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10  
 
 
 

Trend analysis is used for comparison of the same item over a significantly long period to detect general pattern of a relationship between associated factors and project the future direction of this pattern.  

Trend analysis


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Trend analysis


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Technique for identifying relationship between items in the same financial statement by expressing all amounts as the percentage of the total amount taken as 100 (a common-size financial statement). 

Vertical analysis


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Common-size graph 

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Common-size Balance sheets


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Common-size balance sheets


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In  mil. US$ 

2000 

2001 

2002 

2003 

2004 

 

2010 

2011 

2012 

Account receivables 

17.301 

28.155 

30.759 

1.956  

1.239  

  

689  

695  

635 

Inventories 

5.618 

4.912. 

5.115 

5.335  

5.549  

  

8.951  

8.407  

7.558 

Total assets 

36.889 

44.317 

50.409 

27.723  

22.474  

  

24.360  

21.381  

19.340


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Ratio analysis 

  • To evaluate relationships among financial statement items
  • Four groups:
    • Liquidity
    • Solvency
    • Efficiency
    • Profitability

 


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Equity Valuation 

      Purpose:  Estimate intrinsic value of a

           company (or stock)

      Basis:  Present value theory (time value of

      money) 

Valuation - an important goal of many types

of business analysis


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(1 + r)n 

P = Fn 


Present value theory 

P = A x     x  1 -  

(1 + r)n 




P: Present value

Fn: Future value at period n

A: Annual cash flows (from period 1 to period n)

r: discounted rate

 


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Equity valuation –  
 Residual Income Model
 

Expected Income = Required rate of equity x Book value of equity

Residual Income = Actual Income – Expected Income 

Fair value of Equity  =  Book value of Equity +

                   PV{Expected Residual Incomes} 

 
 

Investors should pay more than book value if actual income is higher than expected and less than book value if actual income is lower than expected.


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Equity valuation   
 Residual Income Model
 

BVt is the book value at the end of period t

Rit+n is the residual income in period t + n [defined as   net income, NI, minus a charge on beginning   book value, BV, or RIt = NIt - (k x BVt-1)]

k  is the cost of capital

E refers to an expectation


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Example 

In VND mil. 

2013 

2014 

2015 

2016 

2017 

2018 

Net income 

609 

628 

639 

702 

773 

773 

Dividends 

357 

433 

370 

407 

448 

448 

Beginning book value of equity 

2917 

3169 

3364 

3633 

3928 

4253 

Cost of equity 13%


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Example 

2013 

2014 

2015 

2016 

2017 

2018 

1. Beginning book value of equity BVE  

2. Required Income    (rE= 13%) 

3. Projected Income 

4. Residual Income 

5. Discounted factor (rE = 13%) 

6. PV {RI20132018

Fair value of equity VE =


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Equity valuation   
  Dividend model
 

Vt is the value of an equity security at time t

Dt +n is the dividend in period t+n

k is the cost of capital

E refers to expected dividends


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Equity Valuation   
 Free cash flow to equity model
 

FCFEt+n is the free cash flow to equity in the period t + n [often defined as cash flow from operations less capital expenditures]

k  is the cost of capital

E refers to an expectation


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