If you don't know the financials, you don't know the business. Financial statements are often an overlooked tool to better understand a business. Financial statements are essentially the scorecard of the business. If you can’t read the scorecard your business may be in jeopardy and you not even know it. Many business owners don’t understand the story they tell. This deck helps you understand the basic financial statements, the importance, steps of an analysis, ratios, and a quick valuation.
FULL ENJOY Call Girls In Majnu Ka Tilla, Delhi Contact Us 8377877756
Understand Your Business Financials with Financial Statement Analysis
1. The Story from your
Financial Statements
L. Brent McClure, CPA
@LBMCPA
2. Agenda for Today • Recognize the need to
understand financial
statements in everyday
business
• Understand the basic financial
statements
• Identify appropriate steps to
conduct an analysis
• Identify the factors that
determine how much external
financing is needed
4. • Financial statements are often an
overlooked tool to better understand
a business
• Financial statements are essentially
the score card of the business
• If you can’t read the score card your
business may be in jeopardy and you
not even know it
• Many business owners don’t
understand the story they tell
Why
should
we care
7. balance
sheet The totals on both sides must equal.
The Assets are listed first or on the left,
Next the liabilities are listed or they are on
the right hand side. Followed by the equity
section.
Assets = liabilities + equity
A snapshot of the business at
a point in time
8. Income
statement Sometimes called a profit & loss
statement or P&L. The P&L or
income statement tracks the
profit or loss of the business
Revenues – expenses = profit
Measures revenues &
expenses over a period of time
9. Statement
of Cash
Flows
Measures the amount of cash
flowing in and out of the
business over period of time
Begins with Net Income/Loss
Starts with Net income or loss
from the income statement and
ends with current cash balance.
Must equal cash on the balance
sheet
11. Balance
sheet
Assets are things that you own. Including things that may even
have debt attached to it
Liabilities are things that you owe
Equity is what is left over, beginning with the amount of contributed
capital
A simple approach
22. Value of a firm’s equity =
3
2
2
21
R1
FCF
R1
FCF
R1
FCF
…
Mathematically this expression can be reduced to
Value =
GR
FCF1
FCF = Funds that can be withdrawn from the business – called free cash flow
R = Risk adjusted rate of return
G = Expected growth rate
Dividend Capitalization
Model
23. Cause versus Effect
Effect ratios measure the results of company actions
not their cause. Things like Liquidity, Leverage, &
Profitability
Causal ratios measure the actions (or lack of actions)
that cause the effects.
24. Liquidity
Measures-
Show Ability of
Firm to Meet
Short-term
Obligations as
They Come Due
• Current ratio
• Quick ratio
• Defensive interval
• Cash conversion cycle
• Inventory/working capital
• Receivables/working
capital
• Net sales/working capital
• Operating cash flow to
current liabilities
25. LiquidityRatios
Liquidity Category Ratios
Quantity of
liquidity
Current ratio
Quick ratio
Timing of liquidity Defensive interval
Cash conversion cycle
Quality of liquidity Inventory/working capital
Receivable/working capital
Early warning Net sales/net worth
Operating cash flow to
current liabilities
26. Current Ratio • Computed as current assets ÷
current liabilities
• Measures the quantity of
liquidity
• Its size is largely determined
by inventory
27. Quick Ratio • Quick assets include cash,
marketable securities, and
receivables
• Ratio measures the quantity of
liquidity
• Differences in quick ratio and
current ratio are largely driven
by inventory
28. Defensive
Interval • Numerator is quick assets
• Denominator is daily cash
operating expenses
• Measures the number of days
the firm’s liquidity will last if no
new sales occur
29. Inventory to
Working Capital
Measures quality of liquidity
Company
A B
Cash $ 2,000 $ 10,000
Accounts receivable 16,000 40,000
Inventory 10,000 60,000
Total 28,000 110,000
Current liabilities 10,000 80,000
Working capital $18,000 $ 30,000
Inventory to working capital 56% 200%
Industry average 60% 60%
30. Trade
Receivables to
Working Capital
Measures quality of liquidity
Company
H J
Cash $ 1,000 $ 5,000
Trade receivables 6,000 50,000
Inventory 7,000 30,000
Total current assets 14,000 85,000
Total current liabilities 4,000 55,000
Working capital $10,000 $ 30,000
Trade receivables to working capital 60.0% 166.7%
Industry average 75.0% 75.0%
31. Net Sales to
Working Capital
Measures the ability of W/C to support
sales and in turn support growth
Company
V W
Current assets $ 25,000 $ 25,000
Current liabilities 24,000 11,000
Working capital 1,000 14,000
Sales $150,000 $150,000
Sales to working capital 150 times 10.7 times
Industry average 10 times 10.0 times
32. • Debt to net worth
• Debt to assets
• Short-term debt to net
worth
• Times interest earned
• Cash times interest
earned
• Fixed charge coverage
Leverage
Measures -
Shows Ability
of Firm to Meet
Obligations as
They Come Due
33. • Return on Equity =
• Net income/Net worth
Profitability
Measures -
Shows Ability
of Firm to Earn
a Return
34. Net Profit to
Net Worth
Company
A B
Net sales $2,000,000 $2,000,000
Net profit 20,000 100,000
Net worth 80,000 1,000,000
Net profit to net sales 1% 5%
Industry average 3.3% 3.3%
Net profit to net worth (ROE) 25% 10%
Industry average 8.8% 8.8%
35. Illustrative
Problem
Suppose that a company’s current ratio was 2.5 last year
and decreased to 2.0 this year. Last year, its quick ratio was
1.0 and stayed constant. What does this trend suggest?
Last Year This Year
Current Ratio 2.5 2.0
Quick Ratio 1.0 1.0
The difference between the current and quick ratios is largely
inventory. We can see that the ratio of inventory to current
liabilities has decreased from 1.5 to 1.0. We can conclude
that there has likely been an inventory decrease this year.
36. If a company has a
debt ratio of 40%;
What is its debt to
equity ratio?
Illustrative
Problem
37. Solution If a company has a debt to asset ratio of 40 percent, what is
its debt to equity ratio?
From the balance sheet equation, we know that assets equal
liabilities plus stockholder’s equity. So if debt to assets is 40
percent, equity to assets is 60 percent.
What this tells us is that the two ratios measure the exact
same thing; they just use a different scale of measurement.
/ 40%
66.7%
/ 60%
debt debt assets
equity equity assets
38. Effect Ratio Summary
Current
ratio
If small, indicates
inadequate liquidity
Quick ratio If small, indicates
inadequate liquidity
Defensive
interval
If small, implies the
company could not survive
very long in a financial
crisis
39. Effect Ratio Summary
Inventory to
working capital
If large, indicates
poor quality of
liquidity
Receivables to
working capital
If large, indicates
poor quality of
liquidity
Net sales to
working capital
If large, indicates
inadequate liquidity to
support sales
40. Effect Ratio Summary
Debt to net
worth
If large, indicates increased
financial risk
Debt to assets If large, indicates increased
financial risk
Tangible debt
ratio
Measures debt usage
proportionate to tangible
assets
Short-term debt
to net worth
If large, implies extremely
high risk situation
41. Times interest
earned
If small, indicates insufficient
financial solvency—high
financial
Fixed charge
coverage
Measures how many times
earnings cover all financial
obligations
Return on
equity
Key profitability ratio is a
measure of the return on
owner’s investment in the
firm
Effect Ratio Summary
42. Earnings
Quality
strong
Earnings quality is strong if we perceive that the
company can continue to earn at the same rate.
Earnings quality is strong if earnings and cash
flow follow similar patterns.
weak
Earnings quality is weak if we perceive that
the company is unlikely to continue earning
at its same rate and/or earnings and cash
flow does not follow the same pattern.
43. Earnings Quality-
Perceived Ability to
Continue in Business
• Strength of the balance sheet
• Presence of one-time transactions
• Age of the assets
• Adequacy of R&D
• Age and incentive of key managers
44. Causal Ratio
Ratio What it measures
Fixed assets to net worth Over-investment in fixed
assets
Collection period Rise in accounts
receivable
Net sales to inventory Rise in inventory
Net sales to net worth Unrestrained growth
Net profit to net sales Profitability
Miscellaneous assets to
net worth
Rise in “other” assets
45. Fixed Assets to
Net Worth
• Measures the extent to which capital
is tied up in nonliquid, permanent,
or depreciable property
• Measures the amount of capital
remaining for investment in more
liquid assets
46. Fixed Assets to
Net Worth
If too much net worth is tied up in fixed
assets
• Too little working capital
• Over-utilize debt
• Profitability suffers
47. How Fixed Assets
Affects Profits
• Interest expense
• Increased depreciation
• Increased property taxes &
insurance costs
• Reduced working capital
• Late charges
• Inventory stockouts
• Reduced bank balances
48. Collection Period
• Measures of credit and collection efficiency
of the firm, the probability of bad debt write-
off, and the company’s receivable position
over time and as compared to the industry
• If this ratio is too high, it can indicate
inefficiency or a decision to allow loose
credit terms.
49. Collection Period
Why is this ratio an important Casual
Ratio
• Sales attainment
• Profitability
• Borrowing
50. Casual Ratio Summary
Problems
Reduced Liquidity
Increased Leverage
Reduced Profits
Casual Ratios
Large Fixed Assets/Net Worth
Large Collection Period
Low Inventory Turnover
Large Net Sales/Net Worth
Low or Negative Profit Margin
Large Misc. Assets/Net Worth
…caused by
52. Types of Analysis
• Industry analysis with industry averages
or comparison to competitors
• Time series analysis with comparison of
current year to past years
53. Conducting an
Analysis
• Determine what problems exist.
• Compare causal ratios to previous
years and to industry averages.
• Determine which of the causal ratios
are at fault.
• Take corrective action.
54. Guidelines to use in
Ratio Analysis
• Ignore isolated figures.
• Compare likes.
• Study any substantial deviation.
• Avoid concentration on high
percentages or variances.
55. Guidelines to use in
Ratio Analysis
• Remember that a ratio measures both
components.
• Recognize the seasonal factor.
• Watch for trends.
• Be alert to compensating advantages.
• Lenders are more Balance Sheet
focused
• Owners/Managers are more Income
Statement driven
59. The Basic Forecasting
Model
MISCRE-S
S
SL
-FAS
S
SA
EFN
EFN = Amount of external funding to maintain its present condition
SA = Ought to increase proportionately as sales increase
∆S = Increase in sales that causes the need for external funding
∆FA = Required to meet increased demand
SL = Increase proportionately as sales increase
S = Existing sales level
∆RE = (S + ∆S)(PM)(1 − PO) or (S + ∆S)(PM) − $Div
MISC = Any other changes to the company’s cash flow in the
other expressions
61. Making Assumptions
• In forecasting we make assumptions about financial
relationships in the future
• Our model assumes that future sales levels are a very
important determinant of the company’s future financial
condition
• One basic assumption of our model is that financial
relationships of many balance sheet items and sales will
remain the same
• We can change assumptions as necessary and useful in the
model
• Testing the importance of assumptions or testing changes in
assumptions is called sensitivity analysis.
62. Methods of EFN
External Sources
Debt
Bank loans
Bonds
Loans from owners or officers
Insurance company
Equity
From existing stockholders
From new stockholders
Internal Sources
Decreased payout
Increased profit margin
Working capital
Fixed assets
Marketable securities
64. What have we
covered?
• Recognize the need to
understand financial
statements in everyday
business
• Understand the basic financial
statements
• Identify appropriate steps to
conduct an analysis
• Identify the factors that
determine how much external
financing is needed
65. 46
don’t hesitate to contact us
contact
address:
202 Gov. St.
Mobile, AL
36608
contact:
brent@brentmcclure.com
www.brentmcclure.com
@LBMCPA
phone:
205 613 9708
Notas del editor
What is a BS. It is essentially a snapshot of the business at a specific point in time, like as of December 31, 2018 or as of June 30, 2019. It also represents the businesses Assets, Liabilities and equity. Generally speaking the assets are listed first or on the left followed by the liabilities and then equity or retained earnings. Assets must equal the liabilities + equity and that’s why it is called a Balance Sheet
The Income Stmt or Profit & Loss or P&L is the best tool for knowing if your business is profitable or if you have sustained losses. A P&L statement measures revenue (also called sales or income) and expenses over a period of time – whether that is a month, quarter or year. With it you know if you have made a profit (and how much) or if you have incurred a loss.
The Stmt of Cash flows is my favorite stmt. It essentially measures the amount of cash flowing in and out of the business over a period of time. Normally the stmt of CF and the P&L or Income Stmt are covering the same period. Like it will say for the 12 months ended December 31, 2018 or for the 6 months ended June 30, 2019 or whatever. This statement generally begins with net Income from the P&L and ends with the current cash balance from the Balance Sheet.
So far I have provided you sort of an overview of the basic financial statements but now I want to take a deeper dive into each and also provide some real life examples…..
First, let’s start with the BS. As I mentioned before it has Assets with are things that you own – like cash, accounts receivable, inventory – those would be considered current assets b/c you can convert them to cash within a year. Property, Plant & equipment or PPE would also be an asset but a long term asset, like notes receivable b/c they aren’t typically converted into cash within 1 year. Then on the liability side we also have current and non-current. These are things we owe, like accounts payable and short term notes payable or a line of credit are all examples of current liab. b/c/ again they are due within 1 year from the BS date. Non-current or long term liab. Could be notes payable and other long term debt or financing arrangements. Next let’s focus on the equity section and it is primarily made up of equity contributed to the business plus the balance of retained earnings.
Amazon…
Now let’s turn our attention to the Income stmt or P&L. Simply put we will have revenues or sales, followed by COGS then operating expenses and then any misc. items such as interest expense and finally or hopefully profits.
Amazon..
Starting on this page is Operating Income from the previous page followed by…..
Now we get to the good part of Cash Flows. We will start with net income followed by cash flows in and out of the business from operating activities like changes in accts receivable, then we have investing activities like purchasing or selling PPE, followed by financing activities as you probably guessed is debt, bonds, movement in stock.
This is Amazon’s stmt of cash flows, which again is a recon of net income to cash. …..
So now we know what financial stmts are important and how to look at them, let’s take a dive into several ways of analyzing a financial stmt.
How much is my business worth? …….. This approach approximates a future dividend stream based on the firm's dividend history and an assumed growth rate, and computes the market capitalization rate that equates it with the current market price. In the case of closely-held firms (such as sole proprietorships and partnerships) which don’t usually distribute profits as dividends, the firms dividend paying capacity is estimated from its average free cash flow and compared with the dividends actually paid by a similar size firm. Also called dividend growth model. Essentially taking FCF and dividing it by the R less the G. so for example….. If your FCF is $2M and your Risk adj. ROR is 10% and your growth rate in perpetuity is 2%, then you are dividing $2m by 8% and getting a business value of $25M
Let’s talk about ratios….. 2 major classes of ratios.. Cause and effect ratios.. Read slide.. A ratio by itself is almost meaningless, but if we have another company or maybe industry averages to compare our business ratios to then it starts to paint a picture….
Read slide..
A look at liquidity ratios again and what category they are measuring…. For example… slide
The current ratio is my favorite. And specifically it is current assets over current liab. And read slide….
Another look at the current ratio without inventory is the Quick ratio, this is another one of my favs.