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MIDTERM LECTURES

What is analysis of Financial Statements on Income Statements and

Balance Sheet.

Financial statement analysis evaluates a company's performance or

value through a company's balance sheet, income statement, or
statement of cash flows. By using a number of techniques, such as
horizontal, vertical, or ratio analysis, investors may develop a more
nuanced picture of a company's financial profile.
What is a financial analysis of a balance sheet?
Balance sheet analysis is the analysis of the assets, liabilities, and
owner's capital of the company by the different stakeholders to get
the correct financial position of the business at a particular point in
time.

What are Current Assets?

In accounting, a current asset is any asset which can reasonably be

expected to be sold, consumed, or exhausted through the normal
operations of a business within the current fiscal year or operating cycle or
financial year.
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What are types of current assets?

Types of Current Assets

 Cash and cash equivalents - Cash and cash equivalents are the
most liquid current assets found on a business's balance sheet. Cash
equivalents are short-term commitments "with temporarily idle cash
and easily convertible into a known cash amount"

What are examples of cash and cash equivalents?

Examples of Cash Equivalents

 Treasury bills - Treasury Bills or popularly known as T-Bills are

peso-denominated short-term fixed income securities issued by the
Republic of the Philippines through its Bureau of Treasury.

What are Treasury bills example?

Treasury bills are issued at a discount to original value and the buyer
gets the original value upon maturity. For example, a Rs 100
treasury bill can be availed of at Rs 95, but the buyer is paid Rs
100 on the maturity date. The return on treasury bill depends on
liquidity position in the economy.

 Treasury notes - Treasury notes and bonds are securities that pay
a fixed rate of interest every six months until the security
matures, which is when Treasury pays the par value. The only
difference between them is their length until maturity. Treasury notes
mature in more than a year, but not more than 10 years from their
issue date.

What is the difference between Treasury bills and Treasury

notes?
T-notes mature anywhere between two and 10 years, with bi-annual
interest payments, while T-bills have the shortest maturity
terms—from four weeks to a year.

 Commercial paper - is an unsecured promise to pay a certain

amount on a stated maturity date, issued in bearer form.

What is an example of commercial paper?

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There are four types of commercial paper: promissory notes, drafts,

checks, and certificates of deposit (CDs).

Promissory Notes - is a written promise by one party to make a

payment of money at a date in the future. Although they may be
issued by financial institutions.

Drafts - It’s a paper document that looks a lot like a regular

cheque. The main difference is that someone who receives a bank
draft has a guarantee that the funds are available, as opposed to a
regular cheque, which could bounce. Bank drafts are made out to the
person receiving the money.

Checks(cheque) - A check is a written, dated, and signed

instrument that directs a bank to pay a specific sum of money to
the bearer. The person or entity writing the check is known as the
payor or drawer, while the person to whom the check is written is the
payee.
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 Certificates of deposit –

 Money market funds –

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Cash management pools.

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What is meant by cash and cash equivalents?

What is meant by cash equivalents?

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A cash equivalent is a highly liquid investment having a maturity of three

months or less. It should be at minimal risk of a change in value.

Cash and cash equivalents is a line item on the balance sheet, stating the
amount of all cash or other assets that are readily convertible  ...

How do you classify cash and cash equivalents?

Cash equivalents are any short-term investment securities with maturity

periods of 90 days or less. They include bank certificates of deposit, 

Examples of cash equivalents are: Commercial paper; Marketable

securities; Money market funds; Short-term government bonds; Treasury
bills.

Which of the following items is not considered as cash or cash

equivalent?

Investments in liquid securities, such as stocks, bonds, and derivatives,

are not included in cash and equivalents.

Where is cash and cash equivalents in balance sheet?

If a company has cash or cash equivalents, the aggregate of these assets

is always shown on the top line of the balance sheet. This is because
cash and cash equivalents are current assets, meaning they're the most
liquid of short-term assets.

How do you calculate total cash and cash equivalents?

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These cash equivalents are included in the calculation of numerous

measures of liquidity:

Cash Ratio = Cash / Current Liabilities.

Current Ratio = Current Assets / Current Liabilities.

Quick Ratio = (Cash & Equivalents + A/R) / Current Liabilities.

 Marketable securities - Marketable securities are securities that

can easily be sold. On a corporation's balance sheet , they are
assets that can be readily converted into cash - for example,
government securities, banker's acceptances and commercial paper
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 Prepaid expenses – A prepaid expense is an asset on a balance
sheet that results from a business making advanced payments for
goods or services to be received in the future.

 Accounts receivable - are the balance of money due to a firm for
goods or services delivered or used but not yet paid for by customers.

 Inventory - Inventory or stock refers to the goods and materials that
a business holds for the ultimate goal of resale, production or
utilization. Inventory management is a discipline primarily about
specifying the shape and placement of stocked goods.

How do you Analyze income statement and balance sheet?

As with the income statement, the easiest way to analyze a balance sheet
is to look at ratios.

The first ratio we are going to look at is called the current ratio, and
sometimes is referred to as the working capital ratio. It is very easy to
calculate. It is simply current assets divided by current liabilities .

How do you tell if a company is doing well financially?

8 ways to tell if a company is doing well financially

1. Growing revenue. Revenue is the amount of money a company

receives in exchange for its goods and services. ...
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2. Expenses stay flat - that is neither rising nor declining.

3. Cash balance - A cash balance is the amount of money a
company currently has available. This money is kept on hand to
offset any unplanned cash outflows. If not for this safety buffer,
businesses can find themselves unable to pay their bills. Cash
balance is typically used to pay off debt or is returned to investors as
a dividend.
4. Debt ratio - is a metric that measures a company's total debt, as a
percentage of its total assets. A high debt ratio indicates that a
company is highly leveraged, and may have borrowed more money
than it can easily pay back. (Debt Ratio = Total Debts_
Total Assets

What is a good debt ratio?

Do I need to worry about my debt ratio? If your debt ratio does not
exceed 30%, the banks will find it excellent. Your ratio shows that if
you manage your daily expenses well, you should be able to pay off
your debts without worry or penalty. A debt ratio between 30% and
36% is also considered good.
Summary

 Whether it be “good” or “bad,” a debt is problematic when you are no

longer able to pay it back on time.
 By calculating the ratio between your income and your debts, you get
your “debt ratio.” This is something the banks are very interested in.
 A debt ratio below 30% is excellent. Above 40% is critical. Lenders
could deny you a loan.
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5. Profitability ratio - a class of financial metrics that are used to

assess a business's ability to generate earnings relative to its
revenue, operating costs, balance sheet assets, or shareholders'
equity over time, using data from a specific point in time.
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6. Activity ratio –

Example of Total Asset Turnover

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7. New clients and repeat customers - Repeat customer and return

customer are different but related terms. Returning customers are
those who've purchased from your company once before and decide
to buy from you again. Repeat customers are people who buy from
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you time and time again and would be considered loyal

customers.
8. Profit margins are high - A high net profit margin means that a
company is able to effectively control its costs and/or provide
goods or services at a price significantly higher than its costs.
Therefore, a high ratio can result from: Efficient management. Low
costs (expenses) Strong pricing strategies.

Why is it important to analyze the financial statements?

It provides internal and external stakeholders with the opportunity to

make informed decisions regarding investing. Financial statement
analysis also provides lending institutions with an unbiased view of a
business's financial health, which is helpful for making lending decisions.

How are income statements used for financial analysis?

An income statement is a financial statement that shows you the

company's income and expenditures. It also shows whether a company
is making profit or loss for a given period. The income statement, along
with balance sheet and cash flow statement, helps you understand the
financial health of your business.

What is financial statement analysis with the example?

An example of financial analysis is analyzing a company's performance and

trend by calculating financial ratios like profitability ratios, including net
profit ratio, which is calculated by net profit divided by sales.

What are the 3 basic tools for financial statement analysis?

An example of financial analysis is analyzing a company's performance and

trend by calculating financial ratios like profitability ratios, including
net profit ratio, which is calculated by net profit divided by sales.

How would you analyze a company's financial statements?

How to Determine the Financial Health of a Company

1. Analyze the Balance Sheet. The balance sheet is a statement that

shows a company's financial position at a specific point in time. ...
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2. Analyze the Income Statement. ...

3. Analyze the Cash Flow Statement. ...
4. Financial Ratio Analysis.

What does a financial statement analysis report include?

Examples of financial reports include your income statement, cash flow
statements, and balance sheets. Consider also gathering any financial
notes, quarterly or annual records, and government reports (if applicable).
How do you Analyse a balance sheet statement?

The information found in a balance sheet will most often be organized

according to the following equation: Assets = Liabilities + Owners'
Equity. A balance sheet should always balance. Assets must always equal
liabilities plus owners' equity. Owners' equity must always equal assets
minus liabilities.

How do you interpret an income statement?

The income statement communicates how much revenue the company

generated during a period and what costs it incurred in connection
with generating that revenue. The basic equation underlying the income
statement, ignoring gains and losses, is Revenue minus Expenses equals
Net income.

What are the 5 ways to Analyse the financial statements?

Five Financial Statement Analysis Techniques

1. Trend analysis - is a technique used in technical analysis that

attempts to predict future stock price movements based on recently
observed trend data.
2. Common-size financial analysis - also referred as vertical analysis,
is a tool that financial managers use to analyze financial
statements. It evaluates financial statements by expressing each line
item as a percentage of the base amount for that period.
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3. Financial ratio analysis – is the technique of comparing the

relationship (or ratio) between two or more items of financial data
from a company's financial statements. It is mainly used as a way of
making fair comparisons across time and between different
companies or industries.

Debt-to-Asset Ratio

Total Liabilities/Total Assets = $1074/3373 = 31.8%. This means that

31.8% of the firm's assets are financed with debt. In 2021, the debt
ratio is 27.8%. In 2021, the business is using more equity financing
than debt financing to operate the company.

Why is financial ratio analysis important?

Ratio analysis is a useful management tool that will improve your

understanding of financial results and trends over time, and
provide key indicators of organizational performance. Managers
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will use ratio analysis to pinpoint strengths and weaknesses from

which strategies and initiatives can be formed.

What is financial ratio analysis and its importance?

Financial ratio analysis uses the data contained in financial

documents like the balance sheet and statement of cash flows to
assess a business's financial strength. These financial ratios help
business owners and average investors assess profitability, solvency,
efficiency, coverage, market value, and more.

4. Cost volume profit analysis - Cost-volume-profit (CVP) analysis is a

way to find out how changes in variable and fixed costs affect a
firm's profit. Companies can use CVP to see how many units they need
to sell to break even (cover all costs) or reach a certain minimum profit
margin.

5. Benchmarking (industry) analysis - is a process of measuring the

performance of a company's products, services, or processes
against those of another business considered to be the best in the
industry, aka “best in class.” The point of benchmarking is to identify
internal opportunities for improvement.

What is benchmarking and its example?

Benchmarking examples are instances of companies or departments

measuring their results against other departments or others in their
industry, a practice that can help them understand how they're performing
compared to their competitors.

Here are some common examples of areas that may use

benchmarking to achieve their business goals:

Call centres
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Call centres often use benchmarks to understand their customers'

satisfaction levels. They might ask customers to rate their service
experience after interacting with a customer service member or complete a
follow-up survey. Other metrics companies might measure are data related
to waiting times, resolution rate, occupancy, call lengths, and shrinkage.
They can use the data to form conclusions about their service, processes,
and customer satisfaction rates and, ultimately, improve areas they feel
aren't meeting standards.

E-commerce

Online shopping sites often rely on benchmarks to establish helpful metrics

like average cost per conversion. These sites might use a benchmark to
assess the performance of individual product categories, predict seasonal
sales trends, or reevaluate their target markets using customer records and
analytics data. By comparing their performance to their own historical
numbers and others in the industry, e-commerce sites can learn which
areas of their operations are performing well and which aren't.

Technology

Technology companies often need to stay innovative and competitive to

succeed in their industry. Benchmarks can give technology businesses a
better sense of their performance among their competitors. Measuring their
products' life cycles against industry averages and comparing their
products' features and functionality to those similar to their own can provide
helpful indicators of their place within the market.

Hospitality

Various hospitality industry members rely on benchmarks to help them

motivate their teams and assess their performance. For example,
benchmarks for food costs, bar consumables, retention rates, and
employee benefits can help hospitality businesses set their prices, train
their staff and evaluate their processes. Bars, hotels and restaurants often
face fierce competition within the hospitality industry. Understanding their
performance against their competitors can help them make informed
business decisions.

Health care
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Clinics and hospitals often collect benchmarking data to evaluate patient

wait times, recovery times, satisfaction, and quality of care. Measuring
these data points internally against other areas can help those in medical
settings understand their rates of progress. External comparisons can also
help health care professionals understand their organization's position
within the larger medical setting.

Valuation measures of the financial statements

A valuation report represents a Chartered Business Valuator's

professional judgement as to the value of the business. This value will
be based on either the fair market value of the assets, less the liabilities, or
a capitalized value of the cash flows the company is anticipated to generate
in the future.

What are valuation measures?

A valuation ratio shows the relationship between the market value of a

company or its equity and some fundamental financial metric (e.g.,
earnings). The point of a valuation ratio is to show the price you are paying
for some stream of earnings, revenue, or cash flow (or other financial
metric).

What are the 4 main valuation methods?

 Discounted Cash Flow (DCF) Analysis - Discounted cash flow

(DCF) refers to a valuation method that estimates the value of an
investment using its expected future cash flows.

What does a DCF analysis tell you?

Discounted cash flow (DCF) refers to a valuation method that

estimates the value of an investment using its expected future cash
flows. DCF analysis attempts to determine the value of an
investment today, based on projections of how much money
that investment will generate in the future.

What is discounted cash flow DCF explain with example?

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The discounted cash flow method is based on the concept of the

time value of money, which says that the money that an
individual has now is worth more than the same amount in the
future. For example, Rs. 1,000 will be worth more currently than 1
year later owing to interest accrual and inflation.

What is DCF and why it is important?

Discount Cash Flow analysis or DCF analysis is a valuation method

used to assess the present value of a company or an asset. The
valuation is based on the number of cash flows that the company or
asset can generate in the future. Essentially, this method estimates
the company's or asset's future cash flow projections.

 Multiples Method - The multiples approach is a valuation theory

based on the idea that similar assets sell at similar prices. It
assumes that the type of ratio used in comparing firms, such as
operating margins or cash flows, is the same across similar firms.

What multiples are most commonly used in valuation?

The most common multiple used in the valuation of stocks is the P/E
multiple. It is used to compare a company's market value (price) with
its earnings. A company with a price or market value that is high
compared to its level of earnings has a high P/E multiple.

What is P/E multiple?

The price-to-earnings (P/E) ratio is the ratio for valuing a company

that measures its current share price relative to its per-share
earnings.
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 Market Valuation - Market value (also known as OMV, or "open
market valuation") is the price an asset would fetch in the
marketplace, or the value that the investment community gives
to a particular equity or business.
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 Comparable Transactions Method - The comparable transaction is

a method used to value a company set for a merger as well as
acquisition. The comparable transaction helps businesses check out
comparable transactions with the acquisition target, the same as the
business model.

How do you calculate transaction comparables?

The most common approach is to review several sources. These

include: The M&A database of a data provider such as Factset or
Bloomberg which allows screening using multiple search
criteria. Research reports for the sector may provide details of
transactions.