Financial Analysis
1/20/2013
MACC 594: LECTURE NOTES, MODULE I: INTRODUCTION TO ANALYSIS AND REVIEW OF BASIC CONCEPTS PART I. A. REVIEW OF FINANCIAL STATEMENTS ANALYZING THE BALANCE SHEET
• The balance sheet lists the firm’s assets, liabilities and equity accounts and their balances at the end of the period. • What does the balance sheet reveal about a firm? • Size of the company (total assets or net assets) • Major assets owned and proportion of current vs. noncurrent assets: - Is the mix of assets consistent with norms in the industry? - Is it likely that any large assets are overstated (warn of future writedowns)? • Major liabilities and proportion of current vs. noncurrent liabilities: - Is it likely that any liabilities are understated? • Identify trends or abrupt changes in major assets, liabilities and equity during period. Attempt to explain cause of any abrupt changes.
ANALYZING THE BALANCE SHEET--CONTINUED
• How are assets financed? Compare proportions of financing from different sources:
• Internal financing: earned capital / total assets • External financing from shareholders: contributed capital / total assets • External financing from suppliers and creditors: total liabilities / total assets (and total debt / total assets)
• Examine equity and identify major components and red flags: • Retained deficits (i.e., negative retained earnings) and negative stockholders equity are red flags • Has the firm spent exorbitant amounts of money repurchasing shares? Compare treasury stock to contributed capital and earned capital.
• Use balance sheet to assess liquidity and solvency. • Highly leveraged firms (high debt) with problems on the asset side (overstated assets) are likely to have problems. Some problems appear on the balance sheet before they reduce net income.
1
1/20/2013
ANALYZING THE BALANCE SHEET -- CONTINUED
Limitations (weaknesses) of the balance sheet:
For many assets and liabilities, book value is far below market value;
MACC 594: LECTURE NOTES, MODULE I: INTRODUCTION TO ANALYSIS AND REVIEW OF BASIC CONCEPTS PART I. A. REVIEW OF FINANCIAL STATEMENTS ANALYZING THE BALANCE SHEET
• The balance sheet lists the firm’s assets, liabilities and equity accounts and their balances at the end of the period. • What does the balance sheet reveal about a firm? • Size of the company (total assets or net assets) • Major assets owned and proportion of current vs. noncurrent assets: - Is the mix of assets consistent with norms in the industry? - Is it likely that any large assets are overstated (warn of future writedowns)? • Major liabilities and proportion of current vs. noncurrent liabilities: - Is it likely that any liabilities are understated? • Identify trends or abrupt changes in major assets, liabilities and equity during period. Attempt to explain cause of any abrupt changes.
ANALYZING THE BALANCE SHEET--CONTINUED
• How are assets financed? Compare proportions of financing from different sources:
• Internal financing: earned capital / total assets • External financing from shareholders: contributed capital / total assets • External financing from suppliers and creditors: total liabilities / total assets (and total debt / total assets)
• Examine equity and identify major components and red flags: • Retained deficits (i.e., negative retained earnings) and negative stockholders equity are red flags • Has the firm spent exorbitant amounts of money repurchasing shares? Compare treasury stock to contributed capital and earned capital.
• Use balance sheet to assess liquidity and solvency. • Highly leveraged firms (high debt) with problems on the asset side (overstated assets) are likely to have problems. Some problems appear on the balance sheet before they reduce net income.
1
1/20/2013
ANALYZING THE BALANCE SHEET -- CONTINUED
Limitations (weaknesses) of the balance sheet:
For many assets and liabilities, book value is far below market value;