FINS1613 Lecture Notes - Lecture 5: Inventory Turnover, Asset Turnover, Financial Statement

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16 May 2018
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Chapter 2: Financial Statement Analysis
Financial Statements: accurate and reliable financial information is critical to financial
market health
- accounting boards- ules  hih ops prep financial statements- Australian
aoutig stadads oad, Itl at stadads oad, fiaial at stadads
board (IFRS)
- auditors- neutral third party- rules, reliable
- financial health/postion
o /s: A=L+E ook alue/et oth of fis euity + estimate of the
liquidation value of the firm- total value of equity P*shares)assets- cash +
other marketable securities (ST low risk)
liquidation value: value of firm after assets are sold and liabilities paid
market/price-to-book ratio: ratio of firs aket ap to the BV of
shaeholdes euit: aket alue of euit/BV of euit > alue
stocks- low M/B ratio vs. growth stocks)
leverage: debt-euit atio: fis leeage etet to hih it elies
on debt as a source of financing) = total debt/total equity (+equity
multiplier)
etepise alue: total aket alue of fis euit ad det, less
value of its cash and marketable securities- value of underlying
business (EV= market value of equity + debt cash)
liquidity: quick ratio= (current assets inventory)/current liabilities
o statem of changes in equity
- past performance
o Y statem (P&L) (revenues/expenses- et pofit otto lie aual
accounting- rev/exp matched and recognised when incurred, depreciated
matching LT life, taxes based on EBIT. Debt payments are ignored when
evaluating projects- tax benefits of debt addressed through appropriate
discount-rate)
Gross profit, operating expenses, EBIT, net profit before tax
Profitability ratios: gross margin (ability to sell for more than direct
costs), operating margin (EBIT for each dollar of sales- efficiency), net
profit margin (fraction of each dollar in revenue that is available to
equity holders after firm pays its expenses, plus interest and taxes-
quod differences in efficiency+leverage)
EPS = NP/shares outstanding
Asset efficiency ratios: asset turnover = sales/total assets vs. fixed
asset turnover= sales/fixed assets
Working capital ratio: accounts receivable days= accounts
receivable/avg daily sales (accounts payable days accts payable/avg
daily COGS + inventory days= inventory/avg daily COGS), inventory
turnover ratio= sales/inventory
Interest coverage ratio: atio of fis pofit/CF to iteest epese
(financial strength)
EBITDA: reflects cash a firm has earned from operations
Leverage ratios: interest coverage ratio/times interest earned (TIE)
ratio- assessets of fis leeage ailit to oe iteest
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measure of earnings/interest: high means earning more than
necessary to meet repaym
Investment returns: return on equity (ROE/ROA)= net profit/BV of
equit+RO assets
DuPont Identity: drivers of ROE- product of profit margin, asset
turnover and a measure of leverage:
ROE= (net prof/total equity)*(sales/sales) = (net
prof/sales)*(sales/total equity)= (net prof/sales)*(sales/total
assets)*(total assets/total equity)
ROE = net profit per dollar of sales (profit margin)* sales per
dollar of sales (asset turnover)* assets per dollar of equity
(measure of leverage equity multiplier)
Valuation ratios: market value of firm P/E ratio (value of equity to
firm earnings): market cap/net profit = share price/EPS considers
equity sic leverage PEG atio atio of fis P/E to epeted
earnings growth rate >1 overvalued)
Depreciation: systematic allocation of acquisition cost of long-lived or
fixed assets to expense accounts of particular periods that benefit
from the use of assets (initial acquisition cost of asset, useful life of
the asset, depreciation method)
Prime cost depreciation (straight-line depreciation): initial
book value=acquisition cost; annual depreciation (initial
BV/depreciation life)- assets ost diided euall oe its life
o CF statem (lists how cash has been allocated over PoT-
operating/investing/financing activities- cash basis- recognised when paid not
matched to when they are incurred))
Tax paym based on Y statem EBIT, debt paym ignored, tax benefits of
debt are addressed through appropriate discount rate
After-tax salvage: cash received for selling an asset adjusted for taxes
over or under paid because the selling $P differs from the book value
(using prime cost depreciation)
After tax salvage = salvage $P tax rate*capital gains
Operating activities- direct (gross cash receipts/paym) vs. indirect
(profit adjusted for cash nature)
Net profit + noncash expenses
Working capital- deduct increases in acc rec- rep additional
lending by firm to customers and reduces cash available to
firm + add increases in acc payable (rep increase in cash
available) + deduct inventory increases
Investment activities
Purchases of new PPE- capital expenditures do not appear
immediately as expenses on Y statem, firm depreciates these
assets and deducts depreciation expenses o/t
Add back depreciation and subtract actual cap exp and
subtract acquisitions
Financing activities
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Document Summary

Financial statements: accurate and reliable financial information is critical to financial market health. Accounting boards- (cid:396)ules (cid:271)(cid:455) (cid:449)hi(cid:272)h (cid:272)o(cid:396)p(cid:859)s prep financial statements- australian a(cid:272)(cid:272)ou(cid:374)ti(cid:374)g sta(cid:374)da(cid:396)ds (cid:271)oa(cid:396)d, i(cid:374)t(cid:859)l a(cid:272)(cid:272)t sta(cid:374)da(cid:396)ds (cid:271)oa(cid:396)d, fi(cid:374)a(cid:374)(cid:272)ial a(cid:272)(cid:272)t sta(cid:374)da(cid:396)ds board (ifrs) Past performance: y statem (p&l) (revenues/expenses- (cid:374)et p(cid:396)ofit (cid:858)(cid:271)otto(cid:373) li(cid:374)e(cid:859) a(cid:272)(cid:272)(cid:396)ual accounting- rev/exp matched and recognised when incurred, depreciated matching lt life, taxes based on ebit. Mgmt. discussion and analysis (md&a- off b/s transactions), statement of changes in equity, notes. Financial statements- b/s: financial health, a= l+e income statement- net profit measure of a firm profitability over the period cash flow statement: cash generated, and how allocated over a period of time. Income statement: revenue cogs = gross profit: gross profit depreciation = ebit, ebit taxes= net profit. Cape(cid:454): does(cid:374)(cid:859)t appea(cid:396) as pa(cid:396)t of i(cid:374)(cid:272)(cid:396)e(cid:373)e(cid:374)tal ea(cid:396)(cid:374)i(cid:374)gs, (cid:271)ut is a (cid:272)ash i(cid:374)(cid:448)est(cid:373)e(cid:374)t (cid:894)-) Depreciation: appears in incremental earnings, but is a cash recovery of equipment.

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