LIBR 230 Week 9Company and Financial Statement Analysis

Financial Statement Analysis

Next hour or so…

Learn about the 3 major financial statements that all organizations should use

How to read them and interpret data about them

What they say about an organization’s viability

How they are used to create additional data points for analysis (ratios)

Three main financial statements:

Balance sheet Income statement Statement of Cash flows

All three are based upon the accounting

equation• The accounting equation balances

assets, liabilities and equity

• Can be expressed multiple ways but normally:

• ASSETS = LIABILITIES + EQUITY

• ASSETS – LIABILITIES = EQUITY

• The goal is to balance expenses/costs and assets/earnings in order to understand VALUE

Assets• Current Assets (Cash anything that can

be converted to cash easily like certain investments, accounts receivable, owed money)

• Fixed assets (Stuff that has value and is used to run a business including land, buildings, equipment, fixtures etc.)

• Non-current assets (securities, intellectual property, structured payments)

Liabilities

• Current (due within year)

• Long term (longer term obligations)

Equity

• What’s left over after liabilities are paid off

• Technically it is the owner’s claim against the business or organization or what they are entitled to should the concern fail, collapse or cease to exist

• With a going concern (business still operating) equity is increased by profit or operational reductions and decreased by losses or operational increases

Three financial statements

1. Balance sheet (assets against liabilities at a moment in time)

2. Income statement (summary of results of operations (revenue and espenses) for a year including management/creation of all assets and liabilities)

3. Statement of cash flows (tracks the flow of cash in and out of a business)

Solvency and Liquidity

• Important concepts for evaluating a business or organization’s financial position

• Solvency means do they have enough assets to meet liabilities?

• Liquidity means how much of their assets are liquid/cash and can be called upon to grow the business or be used in an emergency?

• Liquidity and solvency are closely tied to profitability since they indicate inflows (income, operations) and outflows (debt, liabilities, operations)

How do you determine a company’s financial position?

• Read the statements themselves

• Check the balance sheet for assets and liabilities

• Review the income statement to see the trend in terms of sales and income from operations, net income

• Look at the statement of cash flows to see year end cash and change in cash

• Use ratios to look for relationships between portions of the statements to draw deeper conclusions

Balance Sheet

Look at the following:• Current assets • Total Assets• Current Liabilities • Total liabilities• Current compared to total is important in order to

determine short term compare to long term• Give clues to solvency and liquidity

Income Statement

Look at:• Revenue/total revenue• Operating income (profit minus operating

expenses)• Net income (total revenue minus total

expenses)• Good to look at bot of these to “smooth out”

operational events that may be one time• Shows is the business is operating profitably;

Can sales cover expenses?

Cash-flows

Easiest!

• Just look at opening cash and closing cash• Change in cash to see delta/different• Do they have enough cash on hand (judgment call!)

Ratios

• Useful because they help us understand individual items from the financial statements by putting them in context of related items

• Establish relationships between data from various places in order to make judgments

• Can be used to predict and/or establish solvency, liquidity, profitability

Simplest Ratios:• Quick Ratio (acid test ratio)• Current Ratio• Return on assets• Revenue per employee

Horizontal analysis is “trend” analysis

Applied to financial statement items (revenue, assets, liabilities, etc.) and ratios (current, return on assets, etc.)

Look at year to year changes for the same item

Example: What is the three year trend in sales?

Vertical analysis is also called ‘benchmarking’

Also applied to financial statement items or ratios

Compare your company’s financial statements or ratios to industry averages

• Horizontal• Vertical

Analysis Tools