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Financial Statement Analysis. P.V. Viswanath Based on Damodaran’s Corporate Finance. Questions we would like answered…. As financial analysts…. However, the information we have comes from the firm’s financial statements…. Basic Financial Statements. - PowerPoint PPT Presentation
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Financial Statement Analysis
P.V. Viswanath
Based on Damodaran’s Corporate Finance
P.V. Viswanath 2
Questions we would like answered…
Assets Liabilities
Assets in Place Debt
Equity
What is the value of the debt?How risky is the debt?
What is the value of the equity?How risky is the equity?
Growth Assets
What are the assets in place?How valuable are these assets?How risky are these assets?
What are the growth assets?How valuable are these assets?
As financial analysts…
However, the information we have comes from the firm’s financial statements…
P.V. Viswanath 3
Basic Financial Statements
The balance sheet, which summarizes what a firm owns and owes at a point in time.
The income statement, which reports on how much a firm earned in the period of analysis
The statement of cash flows, which reports on cash inflows and outflows to the firm during the period of analysis
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The Balance Sheet
Assets Liabilities
Fixed Assets
Debt
Equity
Short-term liabilities of the firm
Intangible Assets
Long Lived Real Assets
Assets which are not physical,like patents & trademarks
Current Assets
Financial InvestmentsInvestments in securities &assets of other firms
Short-lived Assets
Equity investment in firm
Debt obligations of firm
Current Liabilties
Other Liabilities Other long-term obligations
Figure 4.1: The Balance Sheet
This is what we can see from the firm’s balance sheet…
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An example : Maxwell Shoe Company, Inc
Maxwell Shoe Company Inc. designs, develops and markets casual and dress footwear for women and children under multiple brand names, each of which is targeted to a distinct segment of the footwear market. The Company offers casual and dress footwear for women in the moderately priced market segment under the Mootsies Tootsies brand name, in the upper moderately priced market segment under the Sam & Libby and Dockers Khakis Footwear For Women brand names and in the better market segment under the Anne Klein 2 and A Line Anne Klein brand names.
It also sells moderately priced and upper moderately priced children's footwear under both the Mootsies Tootsies and Sam & Libby brand names. In addition, it designs and develops private label footwear for selected retailers under the retailers' own brand names. Maxwell has licensed the J.G. Hook trademark to source and develop private label products for retailers who require brand identification.
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An example of an Accountant’s Balance Sheet
Maxwell Shoe Company, Inc.As of October 31, 2000 (In ‘000s)
ASSETSLIABILITIES AND STOCKHOLDERS' EQUITY
Current assets: Current liabilities:Cash and cash equivalents $48,074 Accounts payable......... $1,863Accounts receivable, trade 34,244 Accrued expenses......... 7,254Inventory, net 12,036 Deferred income taxes..... 479
Prepaid expenses 536Current portion of Capital lease obligations 102
Prepaid income taxes 1,478Deferred income taxes.... 798Total current assets........ 97,166 Total current liabilities... 9,698
Property and equipment, net. $6,605Long-term deferred income taxes........ 1,540
Trademarks, net.. 15,479 Stockholders' equity 88
Other assets..... 185Additional paid-in capital.......... 43,112Deferred compensation.... -251Retained earnings........ 65,248Total stockholders' equity.. 108,197
$119,435 $119,435
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Notes on the Maxwell Balance Sheet
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred tax assets are created when future taxable income is expected to exceed pretax income, while deferred tax liabilities occur in the reverse case.
If more deductions have been taken in the current period for reporting purposes, then tax payable (according to the GAAP income statement) will be lower than the actual tax paid. Hence it will seem like taxes have been prepaid. This is reflected in the balance sheet as an asset.
Deferred tax assets ($798) reflect allowance for doubtful accounts, stock option compensation, inventory capitalization, and inventory reserve. Deferred tax liabilities ($479) reflect amortization of trademarks (long-term) and depreciation of property and equipment (short-term).
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A Financial Analyst’s Balance Sheet
Assets Liabilities
Assets in Place Debt
Equity
Fixed Claim on cash flowsLittle or No role in managementFixed MaturityTax Deductible
Residual Claim on cash flowsSignificant Role in managementPerpetual Lives
Growth Assets
Existing InvestmentsGenerate cashflows todayIncludes long lived (fixed) and
short-lived(working capital) assets
Expected Value that will be created by future investments
This is what we would like to see…
P.V. Viswanath 9
The Income Statement
Figure 4.2: Income Statement
RevenuesGross revenues from sale of products or services
- Operating ExpensesExpenses associates withgenerating revenues
= Operating IncomeOperating income for theperiod
- Financial ExpensesExpenses associated withborrowing and other financing
- TaxesTaxes due on taxable income
= Net Income before extraordinary itemsEarnings to Common & Preferred Equity forCurrent Period
- (+) Extraordinary Losses (Profits)Profits and Losses notassociated with operations
- Income Changes Associated with Accounting ChangesProfits or losses associatedwith changes in accountingrules
- Preferred DividendsDividends paid to preferredstockholders
= Net Income to Common Stockholders
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The Income Statement
Net sales.... $158,205Cost of sales 116,991Gross profit. 41,214Operating expenses:Selling. 11,584General and administrative.. 16,141
27,725Operating income.. 13,489
Other expenses (income)Interest income, net... -3,039Amortization of trademarks.. 367Other, net... -310
-2,982Income before income taxes.. 16,471
Income taxes. 6,589Net income... $9,882
Maxwell Shoe Company, Inc.For the year ended October 31, 2000 (In ‘000s)
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The Income Statement
The Income Statement provides us with information about changes in the balance sheet from one year to another. Hence it is crucial to creating the financial balance sheet that we want.
However, the income statement is prepared according to GAAP.
Underlying GAAP are certain principles, such as revenue recognition when the service for which the firm is being paid has been performed substantially, the matching principle governing recognition of expenses, a historical cost-based approach, and a basic conservatism in the recognition of assets.
This leads to certain accounting practices that need to be corrected, from a financial analyst’s point of view…
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