Kế toán, kiểm toán - Chapter 5: Using financial statement information

2Chapter 5:Using Financial Statement Information3Describe the two basic uses of financial statements.Learning Objective 14Control and PredictionFinancial accounting numbers are useful in two fundamental ways:They help investors and creditors influence and monitor the business decisions of a company’s managers.They help to predict a company’s future earnings and cash flows.5Financial Accounting Numbers as Prediction AidsFinancial statements do not reflect the company’s prospects within its business environmentStatements are backward looking, not focusing on the future prospects.Financial statements are inherently limitedStatements leave out some current and historical information such as human resources and the effects of inflation.Management prepares the financial statements in a biased mannerManagers often choose accounting methods and estimates that make them look good.6Concept Practice 1 7Describe the four elements of successful companies and how they link to the company’s overall financial performance. Learning Objective 28Overall Financial PerformanceLeverageLooks at capital structureUsing borrowed funds (debt) to produce revenues for the shareholders.SolvencyThe ability to meet payments as they come dueAsset QualityThe extent to which assets generate revenuesExpense ControlExpenses must be managed and minimized where possible9Figure 5-3 Capital Flows10Using borrowed funds to generate returns for shareholders is calleda. leverage.b. profitability.c. taking a bath.d. solvency.11Identify a financial ratio package for each of the four elements of successful companies and use the ratios to analyze company performance. Learning Objective 312Analyzing the Financial StatementsComparisons across timeComparisons within the industryComparisons within the financial statements: common-size statements and ratio analysisLeverage ratiosSolvency ratiosAsset quality ratiosExpense control ratiosOverall performance ratiosOther ratiosDo not view ratios in isolation13Comparisons Across TimeFinancial accounting numbers can be made more meaningful if they are compared across time.GAAP require side-by-side comparison of the current and the preceding years in published financial reports.14Comparisons Within the IndustryFinancial accounting numbers can also be made more meaningful if they are compared to those of similar companies.Comparison of financial accounting numbers with industry averages is also helpful.Sources of industry information include:Dun & BradstreetRobert Morris AssociatesMoodyStandard & Poor15Comparisons Within the Financial StatementsCommon-size financial statementsRatio analysisLeverage ratiosSolvency ratiosAsset quality ratiosExpense control ratiosOverall performance measuresOther ratios16Common-Size Income Statement for La-Z-Boy, Inc. Figure 5-4 dollar amounts are in millionsOn the income statement, cost of goods sold, expenses, and net income are often expressed as percentages of net sales.On the balance sheet, assets and liabilities can be expressed as percentages of total assets.17Leverage RatiosLeverage refers to using borrowed funds to generate returns for stockholders.Leverage is desirable because it creates returns for shareholders without using any of their money.Leverage increases risk by committing the company to future cash obligations.18Leverage RatiosCapital Average Total Assets Structure = Average Shareholders’ EquityLeverageThis ratio measures the extent to which a company relies on borrowings (liabilities).19Leverage Ratios (cont’d)Debt to Equity = Average Total Liabilities Ratio Average Shareholders’ EquityThis ratio compares liabilities to shareholders’ equity and is another measure of capital structure leverage.20Leverage Ratios (cont’d)Common Net IncomeEquity = Net Income + [Interest Expense (1-tax rate)]LeverageThis ratio compares the return available to the shareholders to returns available to all capital providers.21Leverage Ratios (cont’d)Long-Term = Long-Term LiabilitiesDebt Ratio Total AssetsThis ratio measures the importance of long-term debt as a source of asset financing.22Solvency RatiosSolvency refers to a company’s ability to meet its debts as they come due.There is pressure on companies with high levels of leverage to manage their solvency.23Solvency Ratios (cont’d)Current = Current Assets Ratio Current LiabilitiesThis ratio measures solvency in the sense that current assets can be used to meet current liabilities.24Solvency Ratios (cont’d)Quick = Cash + Short-Term Investments + Net A/R Ratio Current LiabilitiesSimilar to the current ratio, this ratio provides a more stringent test of a company’s solvency by removing items not immediately convertible to cash.25Solvency Ratios (cont’d)Interest = Net Income + Tax Expense + Interest ExpenseCoverage Interest ExpenseThis ratio compares the annual funds available to meet interest to the annual interest expense.26Solvency Ratios (cont’d)Accounts = Cost of Goods SoldPayable Average Accounts PayableTurnoverThis ratio measures the extent to which accounts payable is used as a form of financing.27Asset Quality Ratios Asset quality ratios are typically computed for total assets, accounts receivable, inventory, and property, plant and equipment.These ratios measure the speed with which assets move through operations or reflect the number of times during a given period that these specific assets are acquired, used, and replaced.28Asset Quality Ratios (cont’d)Total Asset = Sales Turnover Average Total AssetsThis ratio measures the speed with which all assets are used up in operations.29Asset Quality Ratios (cont’d)Receivables = Net Credit SalesTurnover Average Accounts ReceivableThis ratio reflects the number of times the trade receivables were recorded, collected, and recorded again during the period. 30Asset Quality Ratios (cont’d)Inventory = Cost of Goods SoldTurnover Average InventoryThis ratio measures the speed with which inventories move through operations.31Asset Quality Ratios (cont’d)Long-Term Asset = Sales Turnover Average Property, Plant and EquipmentThis ratio measures the speed with which fixed assets are used up.32Expense Control RatiosTo be profitable companies must minimize expenses as well as generate revenue.Return on Sales = Net Income + [Interest Expense (1 – Tax Rate)]or Profit Margin Net SalesThis ratio provides an indication of a company’s ability to control its expenses. It reflects the number of cents of profit for every dollar of sales. 33Overall Performance MeasuresNet income, the primary measure of the overall success of a company, is compared to measures of investments in assets or investments by the shareholders to assess performance as a percent of investment, or the return on investment.34Return on = Net Income Equity Average Shareholders’ EquityThis ratio measures the efficiency at managing capital provided by the shareholders.Overall Performance Measures – (cont’d)35Overall Performance Measures – (cont’d)Return on = Net Income + [Interest Expense (1-Tax Rate)] Assets Average Total AssetsThis ratio measures the effectiveness at managing capital provided by all investors (stockholders and creditors).36Other Ratios These additional ratios are used by the financial community to assess company performance.37Other Ratios (cont’d)Earnings = Net Income per Share Average Number of Common Shares OutstandingThis ratio, according to the financial press, is the primary measure of a company’s performance. It calculates the amount of income that is earned strictly from the standpoint of the common shareholder.38Other Ratios (cont’d)Price/Earnings (P/E) = Market Price per Share Ratio Earnings per ShareThis ratio is used by many analysts to assess the investment potential of common stocks.39Other Ratios (cont’d)Dividend Yield = Dividends per Share Ratio Market Price per ShareThis ratio indicates the cash return on the shareholder’s investment.40Other Ratios (cont’d)Stock Price = Market Price(end of year) – Market Price(beg of year) + Dividends Return Market Price per Share (beg of year)This ratio provides a measure of pre-tax performance of an investment in a share of common stock. 41Which of the following ratios would be of primary importance to a supplier in deciding to extend credit for goods delivered. a. Earnings per shareb. Debt to equity ratioc. Accounts receivable turnoverd. Quick ratio42Which of the following ratios would be of primary importance to a creditor in deciding to extend long-term credit. a. Current ratiob. Debt to equity ratioc. Inventory turnoverd. Earnings per share43Gretchen Company has a current ratio of .35 and return on equity of .04. Which of the following statements is the best regarding Gretchen’s profitability and solvency?a. Gretchen is very profitable, but not very solvent.b. Gretchen is very profitable and very solvent.c. Gretchen is not very profitable, but very solvent.d. Gretchen is not very profitable and not very solvent.Solvency:Not very solvent—For every dollar of current liabilities, the company has only 35 cents of liquid assets available. It will likely not be able to pay its current debts when they become due.Profitability:Not very profitable— Net income is only 4 percent of the amount of average shareholders’ equity.44List the three areas that along with financial ratio analysis define a complete financial statement analysis.Learning Objective 445Additional Areas of Financial Statement AnalysisAssessing the business environment.Reading and studying the financial statements and footnotes.Assessing earnings quality.46Assessing the Business EnvironmentWhat is the nature of the company’s operations?What strategy is being employed to generate profits?What is the company’s industry?Who are the major players? Competition?Ease of entry into the marketWhat are the relationships between the company and its customers and suppliers?How are the company’s sales and profits affected by changes in the economy?47Reading and Studying the Financial Statements and Notes1. Read the audit report.2. Identify significant transactions and the company’s important segments.major acquisitions, discontinuance or disposal of a business segment, unresolved litigation, major write-downs of receivables or inventories, tender offers, extraordinary gains and losses (eliminated with fiscal years beginning after 12/15/15), or changes in accounting principles3. Read the income statement, balance sheet, statement of cash flows, statement of shareholders’ equity and footnotes.48Assessing Earnings QualityEarnings quality may be affected by a number of strategies managers use to influence accounting numbers. Four major strategies:Overstating operating performance Taking a bath Creating hidden reservesEmploying off-balance-sheet financing49Assessing Earnings QualityOverstating operating performance through the acceleration of recognition of revenue or the deferring of the recognition of expenses. 50Assessing Earnings QualityTaking a bath - large losses and expenses this year may increase income in future years.Rationale: if the current year is going to be disappointing to investors anyway, increase the loss to make next year look better. For example: Excessive write-downs of equipment will lead to lower depreciation expense in future years.Excessive write-downs of inventory will lead to lower cost of goods sold next year.51Assessing Earnings QualityCreating hidden reserves - expenses may be shifted from one year to another year by overestimating expense accrual.Excessive bad debt expense or warranty expense in the current year will lead to reduced estimates in future years, as the “reserve” is used up.Note that these “reserves” have nothing to do with cash reserves; they simply reserve some of the “income” to future periods.52Assessing Earnings QualityEmploying off-balance-sheet financing - this relates to certain economic transactions that are not reflected in the balance sheet.Managers prefer to keep certain liabilities off the balance sheet when GAAP permits it, primarily because of potential debt covenant violations, and because of the effect on certain ratios.Examples include:Enron’s financial fraud did not report billions of dollars of liabilities on its balance sheet.53Concept Practice 4 54Concept Practice 4 (cont) 55Explain the role of financial statement analysis when valuing a company’s equity securities. Learning Objective 556Annual Report Information, Company Value, and Projected Financial StatementsBook value does not reflect market value because market value includes future prospects.Projecting future financial statements is complex but has some basic concepts:Predict future sales.Predict future profit margin.Based on the sales prediction, estimate the level of assets necessary to support that level of sales.Choose a target financing mix (liabilities vs equity).57Comparisons Across Different Countries Investors interested in comparing the financial performance and condition of companies from different countries often must contend with two difficult issues:If the companies use different accounting standards (e.g., U.S. GAAP vs. IFRS), the reported values must be adjusted to a common basis so that reasonable comparisons can be made.Adjusting financial statements to a common basis by itself may not be sufficient to achieve meaningful comparisons. In other words, not only must the financial statements of a foreign-based company be adjusted, but the resulting numbers can only be interpreted through an understanding of the foreign environment.58Identify and analyze the factors (or drivers) causing changes in a company’s return on equity.Learning Objective 6(Appendix 5A)59Shareholder Value, ROE, and Cash Flow Analyses *Appendix 5ATo create shareholder value, ROE must exceed cost of equity. Analyzing return on equity:DuPont (ROE) Model:Return On Equity = Return on Assets X Capital Structure Leverage X Common Equity LeverageReturn on Assets = Profit Margin (Return on Sales) X Asset Turnover60Cash Flow Analysis – *Appendix 5AAnalyzing a company’s cash flow tells us a great deal about company performance and financial position.Operating performanceFinancial flexibilityLiquidity The statement of cash flows can be used to develop a cash flow profile.61Solvency Assessment – *Appendix 5AFigure 5A-6 –Important factorsin solvency assessment62Wiley © 2017