Kế toán tài chính 2 - Chapter 18: Financial performance evaluation

Financial Performance EvaluationMultimedia Slides by: Gail A. Mestas, MAcc, New Mexico State UniversityChapter 18Learning ObjectivesDescribe and discuss financial performance evaluation by internal and external users.Describe and discuss the standards for financial performance evaluation.Identify the sources of information for financial performance evaluation.2Copyright © Houghton Mifflin Company. All rights reserved.Learning Objectives (cont’d)Apply horizontal analysis, trend analysis, vertical analysis, and ratio analysis to financial statements.Apply ratio analysis to financial statements in a comprehensive evaluation of a company’s financial performance.3Copyright © Houghton Mifflin Company. All rights reserved.Financial Performance Evaluation by Internal and External UsersObjective 1Describe and discuss financial performance evaluation by internal and external users4Copyright © Houghton Mifflin Company. All rights reserved.Financial Performance Evaluation by Internal and External UsersFinancial performance evaluationAlso called financial statement analysisShows important relationships in the financial statements and relates them to important financial objectivesUsers of financial statements fall into two broad categoriesInternal usersExternal users5Copyright © Houghton Mifflin Company. All rights reserved.Internal UsersManagementUses financial performance evaluation in all stages of the management cyclePrimary objectiveIncrease the wealth of the owners or stockholders of the business6Copyright © Houghton Mifflin Company. All rights reserved.Internal Users (cont’d)Management's primary objective divided into categoriesLiquidityAbility to pay bills when due and to meet unexpected needs for cashProfitabilityAbility to earn a satisfactory net income7Copyright © Houghton Mifflin Company. All rights reserved.Internal Users (cont’d)Management's primary objective divided into categoriesLong-term solvencyAbility to survive for many yearsCash flow adequacyAbility to generate sufficient cash through operating, investing, and financing activitiesMarket strengthAbility to increase the wealth of owners8Copyright © Houghton Mifflin Company. All rights reserved.External UsersCreditorsMake loans in the form of trade accounts, notes, or bondsInvestorsBuy capital stock, from which they hope to receive dividends and an increase in valueBoth groups face risksGoal is to achieve a return that makes up for the risk9Copyright © Houghton Mifflin Company. All rights reserved.External Users and RiskIn general, the greater the risk taken, the greater the return required as compensationAny one loan or any one investment can turn out badlyAs a result, most creditors and investors put their funds into a portfolio, which is a group of loans or investmentsThe portfolio allows creditors and investors to average both the returns and the risks10Copyright © Houghton Mifflin Company. All rights reserved.Assessment of Past Performance and Current PositionPast performanceGood indicator of future performanceLook at trends of past sales, expenses, net income, cash flow, and return on investmentCurrent positionWhat assets the business ownsWhat liabilities the business must payCash positionDebt to equityLevels of inventories and receivables11Copyright © Houghton Mifflin Company. All rights reserved.Assessment of Future Potential and Related RiskInformation about the past is useful only to the extent that it bears on decisions about the futureRiskinessBased on how easily future profitability or liquidity can be predictedWell established, stable companyCan predict future profitability with higher level of confidenceLower riskNewly established, small company Much more difficult to predict future profitabilityHigher risk12Copyright © Houghton Mifflin Company. All rights reserved.Assessment of Future Potential and Related Risk (cont’d)Investors demand higher expected returns for high risk investmentsCreditors demand higher interest rates from high risk companies13Copyright © Houghton Mifflin Company. All rights reserved.The Sarbanes-Oxley ActU.S. Congress passed broad legislation in an attempt to rectify problems with financial reporting In response to financial reporting issues raised by the cases of Enron, WorldCom, and othersDesigned to improve investor confidence in the financial reporting system as it applies to publicly traded companiesThe Sarbanes-Oxley Act does not apply to private (nonpublic) companies14Copyright © Houghton Mifflin Company. All rights reserved.Financial Reporting Under the Sarbanes-Oxley ActPublic Oversight Board established for the accounting professionEstablished auditing standardsOversees other regulations involving auditorsRequires CEO and CFO to take responsibility for accuracy of annual and quarterly financial statementsUnder criminal penalties15Copyright © Houghton Mifflin Company. All rights reserved.Financial Reporting Under the Sarbanes-Oxley Act (cont’d)Requires audit committee of public corporations to be made up of independent (nonofficer) board membersSome of whom must have financial expertiseRequires that the audit committee appoint the company’s auditorThe auditor is not allowed to do any consulting for the company16Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat role does risk play in making loans and investments?Risk refers to the uncertainty of future events. It is associated with the ease of predicting the future performance of a loan or investment The more confident a creditor or investor is in predicting future liquidity or profitability, the less risk is associated with the loan or investment17Copyright © Houghton Mifflin Company. All rights reserved.Standards for Financial Statement AnalysisObjective 2Describe and discuss the standards for financial performance evaluation18Copyright © Houghton Mifflin Company. All rights reserved.Standards for Financial Statement AnalysisDecision makers must judge whether the relationships they have found are favorable or unfavorableThree commonly used standards of comparisonRule-of-thumb measuresPast performance of the companyIndustry norms19Copyright © Houghton Mifflin Company. All rights reserved.Rule-of-Thumb Measures are general standards, used by financial analysts, investors, and lenders, for key financial ratiosExamples found in Dun & Bradstreet’s Industry Norms and Key Business RatiosCurrent debt to tangible net worthInventory to net working capitalMust be used with great care20Copyright © Houghton Mifflin Company. All rights reserved.Past Performance of the Company is the comparison of financial measures or ratios of the same company over a period of timeAn improvement over rule-of-thumb measuresProvides a basis for judging whether the measure or ratio is improving or deterioratingIt may also be helpful in showing possible future trendsTrends reverse at times, so projections must be made with carePast performance may not be a useful indicator of adequacy for the future21Copyright © Houghton Mifflin Company. All rights reserved.Industry Norms tell how the company compares with the average performance of other companies in the same industryIndustry norms probably offer the best available standards for judging current performance as long as they are used with care22Copyright © Houghton Mifflin Company. All rights reserved.Limitations of Industry NormsTwo companies that seem to be in the same industry may not be strictly comparableWhen analyzing consolidated financial statements for diversified companies, there may be no comparable companies A partial solution is that diversified companies must report revenues, income from operations, and identifiable assets for each of their operating segmentsCompanies in the same industry with similar operations may use different acceptable accounting proceduresDiversified companies, or conglomerates, operate in many unrelated industries23Copyright © Houghton Mifflin Company. All rights reserved.Selected Segment Information for Goodyear Tire & Rubber Co.DiscussionWhy would a financial analyst compare the ratios of Steelco, a steel company, with the ratios of other companies in the steel industry? What factors might invalidate such a comparison?Comparisons are made to determine how Steelco’s performance ranks in the industry. This type of analysis might not be valid if Steelco has characteristics that make it different from other steel companies25Copyright © Houghton Mifflin Company. All rights reserved.Sources of InformationObjective 3Identify the sources of information for financial performance evaluation26Copyright © Houghton Mifflin Company. All rights reserved.Sources of InformationMajor sources of information about publicly held corporationsReports published by the companySEC reportsBusiness periodicals and credit and investment advisory services27Copyright © Houghton Mifflin Company. All rights reserved.Reports Published by the CompanyThe annual report of a publicly held corporation is an important source of financial informationThe main parts of an annual reportManagement's analysis of the past year's operationsThe financial statementsThe notes to the statements, including the principal accounting procedures used by the companyThe auditors' reportA summary of operations for a five- or a ten-year period28Copyright © Houghton Mifflin Company. All rights reserved.Interim Financial StatementsMost publicly held companies also publish interim financial statements, usually each quarterPresent limited financial informationIn the form of condensed financial statementsFull audit by independent auditor not requiredAre watched by the financial community for early signs of important changes in a company's earnings trend29Copyright © Houghton Mifflin Company. All rights reserved.SEC ReportsPublicly held corporations must file the following reports with the Securities and Exchange Commission (SEC)Annual report (Form 10-K)Contains more information than the published annual reportQuarterly report (Form 10-Q) Presents important facts about interim financial performanceCurrent report (Form 8-K)Presents important changes that may affect a company’s financial position, such as the sale or purchase of a division30Copyright © Houghton Mifflin Company. All rights reserved.Business Periodicals and Credit and Investment Advisory ServicesNewspapersThe Wall Street JournalMagazinesForbesBarron’sFortuneFinancial TimesOther publications for further details about the financial history of companies Available from services such as Moody's Investors Service, Inc. and Standard & Poor's 31Copyright © Houghton Mifflin Company. All rights reserved.Business Periodicals and Credit and Investment Advisory Services (cont’d)Data on industry norms, average ratios and relationships, and credit ratings Dun & Bradstreet CorpIndustry Norms and Key Business RatiosRobert Morris AssociatesAnnual Statement Studies Specialized financial reportingMoody’s Investor Service, Inc.Handbook of Dividend Achievers32Copyright © Houghton Mifflin Company. All rights reserved.DiscussionFor each of the following pieces of information, indicate the best source Current events affecting the companyReports published by the companySEC reportsBusiness periodicalsCredit and investment advisory servicesMost complete body of financial disclosuresObjective assessment of a company’s financial performanceManagement’s analysis of the past year’s operationsCurrent market value of a company’s stockcad bc33Copyright © Houghton Mifflin Company. All rights reserved.Tools and Techniques for Financial AnalysisObjective 4Apply horizontal analysis, trend analysis, vertical analysis, and ratio analysis to financial statements34Copyright © Houghton Mifflin Company. All rights reserved.Tools and Techniques of Financial AnalysisHorizontal analysisTrend analysisVertical analysisRatio analysisThe tools of financial performance evaluation are intended to show relationships and changesFew numbers are very significant when looked at individuallyIt is the relationship between various numbers or their change from one period to another that is important35Copyright © Houghton Mifflin Company. All rights reserved.Horizontal Analysis computes changes from the previous year to the current year in both dollar amounts and percentagesRequired by GAAP The base year is the first year considered36Copyright © Houghton Mifflin Company. All rights reserved.Comparative Balance Sheets with Horizontal AnalysisTrend Analysis is a type of horizontal analysis in which percentage changes are calculated for several successive years instead of for two yearsImportant because it may point to basic changes in the nature of a businessUses an index number to show changes in related items over a period of time38Copyright © Houghton Mifflin Company. All rights reserved.Trend Analysis39Copyright © Houghton Mifflin Company. All rights reserved.Vertical Analysis is a technique for analyzing financial statements that uses percentages to show the relationship of the different parts to a total in a single statement40Copyright © Houghton Mifflin Company. All rights reserved.Vertical Analysis (cont’d)The total figure in the statement set to equal 100%Each component’s percentage of that total is computedAlso called a common-size statementUseful for comparingThe importance of specific components in the operation of a businessChanges in the components from one year to the next41Copyright © Houghton Mifflin Company. All rights reserved.Common-Size Balance Sheets42Copyright © Houghton Mifflin Company. All rights reserved.Common-Size Balance Sheets Presented Graphically43Copyright © Houghton Mifflin Company. All rights reserved.Common-Size Income Statements44Copyright © Houghton Mifflin Company. All rights reserved.Common-Size Income Statements Presented Graphically45Copyright © Houghton Mifflin Company. All rights reserved.Ratio Analysis is a technique of financial performance evaluation that identifies meaningful relationships between the components of the financial statementsUseful inEvaluating a company’s financial position and operationsMaking comparisons with results in previous years or with other companiesThe primary purpose of ratios is to point out areas needing further investigation46Copyright © Houghton Mifflin Company. All rights reserved.Ratio Analysis (cont’d)Ratios may be expressed in several waysNet income is 1/10 of salesNet income is 10 percent of salesThe ratio of net income to sales is 10 to 1 (10:1)Sales are 10 times net incomeFor every dollar of sales, the company has an average net income of 10 cents47Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat is the difference between horizontal and vertical analysis?Horizontal analysis is a year-to-year analysis of the components of a series of financial statements Vertical analysis is concerned with the relationship of items within a single financial statement48Copyright © Houghton Mifflin Company. All rights reserved.Comprehensive Illustration of Ratio AnalysisObjective 5Apply ratio analysis to financial statements in a comprehensive evaluation of a company’s financial performance49Copyright © Houghton Mifflin Company. All rights reserved.Evaluating LiquidityLiquidity is a company's ability to pay bills when they are due and to meet unexpected needs for cashAll ratios that relate to liquidity involve working capital or some part of it50Copyright © Houghton Mifflin Company. All rights reserved.Evaluating Liquidity (cont’d)Quick ratioAlso measures short-term debt-paying abilityCurrent ratioMeasures short-term debt-paying ability51Copyright © Houghton Mifflin Company. All rights reserved.Evaluating Liquidity (cont’d)Average days’ sales uncollectedMeasures average days taken to collect receivablesReceivable turnoverMeasures relative size of receivables and effectiveness of credit policies52Copyright © Houghton Mifflin Company. All rights reserved.Evaluating Liquidity (cont’d)Average days’ inventory on handMeasures average days taken to sell inventoryInventory turnoverMeasures relative size of inventory53Copyright © Houghton Mifflin Company. All rights reserved.Evaluating ProfitabilityProfitability reflects a company's ability to earn a satisfactory incomeA company's profitability is closely linked to its liquidity because earnings ultimately produce cash flow54Copyright © Houghton Mifflin Company. All rights reserved.Evaluating Profitability (cont’d)Asset turnoverMeasures how efficiently assets are used to produce salesProfit marginMeasures net income produced by each sales dollar55Copyright © Houghton Mifflin Company. All rights reserved.Evaluating Profitability (cont’d)Return on equityMeasures profitability of stockholders’ investmentsReturn on assetsMeasures overall earning power56Copyright © Houghton Mifflin Company. All rights reserved.Evaluating Long-Term Solvency refers to a company's ability to survive for many yearsThe aim of long-term solvency analysis is to detect early signs that a company is headed for financial difficultyDeclining profitability and liquidity ratiosUnfavorable debt to equity ratioUnfavorable interest coverage ratio57Copyright © Houghton Mifflin Company. All rights reserved.Evaluating Long-Term Solvency (cont’d)Interest coverage ratioMeasure of creditors’ protection from default on interest payments58Copyright © Houghton Mifflin Company. All rights reserved.Evaluating Cash Flow AdequacyCash flow measures are closely related to the objectives of liquidity and long-term solvencyBecause cash flows are needed to pay debts when they are due59Copyright © Houghton Mifflin Company. All rights reserved.Evaluating Cash Flow Adequacy (cont’d)Cash flows to salesMeasures ability of sales to generate operating cash flows Cash flow yieldMeasures overall ability to generate operating cash flows in relation to net income Evaluating Cash Flow Adequacy (cont’d)Free cash flowMeasures cash generated or cash deficiency after providing for commitmentsCash flow to assetsMeasures ability of assets to generate operating cash flowsEvaluating Market StrengthMarket pricePrice at which a company’s stock is bought and soldRepresents what investors as a whole think of the company at a point in timeProvides information about how investors view the potential return and risk connected with owning the company's stockIs not very informativeMust be related to earnings by considering the price/earnings ratio and the dividends yield62Copyright © Houghton Mifflin Company. All rights reserved.Evaluating Market Strength (cont.)Dividends yieldMeasures a stock’s current return to an investor in the form of dividendsPrice/earnings ratioMeasures investor confidence in a company63Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat is the difference between liquidity and solvency?Liquidity is a firm’s ability to meet its current obligations, whereas solvency is a firm’s ability to meet all its maturing obligations as they come due, without losing the ability to continue operations64Copyright © Houghton Mifflin Company. All rights reserved.Time for ReviewDescribe and discuss financial performance evaluation by internal and external usersDescribe and discuss the standards for financial performance evaluationIdentify the sources of information for financial performance evaluation65Copyright © Houghton Mifflin Company. All rights reserved. And FinallyApply horizontal analysis, trend analysis, vertical analysis, and ratio analysis to financial statementsApply ratio analysis to financial statements in a comprehensive evaluation of a company’s financial performance66Copyright © Houghton Mifflin Company. All rights reserved.