Agata Kocia Ph D MBA Warsaw University Department
Agata Kocia, Ph. D. , MBA Warsaw University Department of Economic Sciences email: akocia@wne. uw. edu. pl Financial Statement Analysis dr A. Kocia 1
Contact information n Office hours n Department of Economic Sciences (Długa Street 44/50, room 301) Tuesday at 10. 00 n Email: akocia@wne. uw. edu. pl or agatkaak@yahoo. com dr A. Kocia 2
Materials n Presentation and other materials distributed by the lecturer n Additional reading 1: Dariusz Wędzki, “Analiza wskaźnikowa sprawozdania finansowego”, Wolters Kluwers, Kraków 2006 n Additional reading 2: “Rachunkowość finansowa w teorii i praktyce” autorstwa E. Kalwasińska, D. Maciejowska, Warszawa, 2008 - część I: Podstawy Rachunkowości n Financial statements of companies dr A. Kocia 3
Part I Basic information on financial statement analysis dr A. Kocia 4
Factors shaping the financial situation: External (1) n Macro environment n government policy n phase of the economic cycle n financial system n inflationary policy pursued by the national bank n tax system n accounting rules n legal system dr A. Kocia 5
Factors shaping the financial situation: External (2) n Micro environment n phase of sector’s economic cycle n market / bargain power of sellers n market / bargain power of buyers n barriers to entry and exit from the market n competition and its strong points dr A. Kocia 6
Factors shaping the financial situation: Internal (1) n Qualitative n strategic management capabilities n experience and competence of managers n attitude of owners and lenders n level of supervision by the owners n information systems n technical and technological advancement level n culture of the organization n market position dr A. Kocia 7
Factors shaping the financial situation: Internal (2) n Quantitative n value of revenues and expenses n structure of revenues and expenses (variable / fixed) n level and structure of assets n nature and structure of funding dr A. Kocia 8
Factors shaping the financial situation – in summary n Most important are: n company size n market share n performance n productive assets n investment n level of debt dr A. Kocia 9
Factors having impact on the value for owners (1) n Sales factors n market size n company’s market share n sales structure n seasonality of demand n brand of products and level of customer loyalty n distribution channels n marketing dr A. Kocia 10
Factors having impact on the value for owners (2) n Factors related to profitability of sales n pricing policy n level of employment and earnings of labor n prices of materials, goods and services n level for outsourcing dr A. Kocia 11
Factors having impact on the value for owners (3) n Factors related to effective tax rates n tax code shaping tax rates n transfer prices on international sales n amount of tax shield dr A. Kocia 12
Factors having impact on the value for owners (4) n Factors related to fixed assets n technical and technological level n financing of investments n economies of scale effects dr A. Kocia 13
Factors having impact on the value for owners (5) n Factors related to short-term assets n use of inventory management system n ability to manage receivables n risk management n policy of investing surplus cash dr A. Kocia 14
Factors having impact on the value for owners (6) n Factors related to cost of capital n interest rate n structure of capital markets n use of financial leverage dr A. Kocia 15
Part II Basic information on financial statements dr A. Kocia 16
Who prepares financial statements n According to the Accounting Act of 29 September 1994, it applies to entities established or managed in Poland: commercial and civil partnerships n individuals, civil partnerships of individuals, partnerships of natural persons, if their net revenues for the previous financial year amounted to at least equivalent of EUR 1 200 000 in Polish zloty n entities operating under the Banking Law, regardless of the amount of net revenues n foreign natural and legal persons n dr A. Kocia 17
Reporting periods n quarter, half-year, year n Fiscal year n calendar year or other period covering 12 consecutive full calendar months n period longer or shorter than 12 months in the year in which company opens for business dr A. Kocia 18
Financial statements (1) n They are prepared in Polish and in Polish currency n data can be rounded to the thousand n Balance sheet: is a statement of mutually balanced parts – assets and its sources of financing n Profit and loss account (Income statement): shows the result of the company's activities during the period n Cash flow statement: a statement of sources of cash receipts and disbursements dr A. Kocia 19
Financial statements (2) n Statement of changes in equity: a summary of operations increasing and decreasing owners’ capital n Notes to financial statements: a clarification of the items included in the reports dr A. Kocia 20
Announcement of reports (1) n Occurs in the Polish Administrative Journal (Dziennik Urzędowy Monitor Polski B – incomplete), includes: Introduction to the financial statements n Balance sheet n Profit and loss account n Cash flow statement n Statement of changes in equity n Auditor's opinion n Owners’ resolution accepting the report n dr A. Kocia 21
Announcement of reports (2) n Executive director is required to submit to the appropriate court register within 15 days from the date of approval of the annual financial statements: n annual financial report containing an introduction to the financial statements, balance sheet, profit and loss account, statement of changes in equity, cash flow statement n auditor's opinion n copy of the resolution approving the annual financial statements and the distribution of profit or covering of loss n activity report (if required for this unit) dr A. Kocia 22
Approval of reports (1) n After preparing the annual financial statements, but prior to its approval, an entity may receive information having a material impact on the financial statements; if yes, then it should: n change the financial statements by making appropriate entries in the accounts of the financial year, which applies to financial statements n notify the auditor to check the statements n include the clarification in the notes to financial statements n After approval of annual financial statements, the effect of information having a significant impact on them is recognized in the accounts of the financial year in which the information is received dr A. Kocia 23
Approval of reports (2) n If, before approving the financial statements, the entity noticed an error in the previous financial year, it must show the amount of correction in the category of “profit (loss) from previous years” dr A. Kocia 24
Relations between entities (1) n Parent Company: a commercial company or a state enterprise, exercising control over another entity n Control over another entity: an entity’s ability to manage the financial and operating policies of another entity so as to obtain benefits from its activities n Joint control of another entity: the ability of an interdependent joint control of an entity with other partners n Subsidiary: a commercial company or other entity created and operated in accordance with the provisions of the foreign trade law, controlled by a parent company dr A. Kocia 25
Relations between entities (2) n Interdependent entity: entity jointly controlled by the shareholders on the basis of an agreement, the articles of association or statutes between them n Associate entity: a commercial company or an entity created and operated in accordance with the provisions of the foreign trade law over which a significant investor has a significant influence of n Subordinate enitity: a subsidiary, an interdependent entity or an associate entity dr A. Kocia 26
Relations between entities (3) n Entities associated with the entity: parent company, a major investor, its subsidiaries and affiliates and interdependent units located along with a unit under common control and a jointly controlled entities n Significant investor: a commercial company or state enterprise, which has in another entity – a non-subsidiary or interdependent – not less than 20% of the votes in the governing body of the unit and exerting a significant impact on the unit dr A. Kocia 27
Relations between entities (4) n Significant impact on an entity: not having signs of exercising control or joint control over the entity while it gives an ability to influence financial and operating policies of another n Capital Group: the parent company and its subsidiaries dr A. Kocia 28
IAS and IFRS n International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) are applied to companies which: which issue securities allowed for trading or applying for trading in Poland or in one of the regulated markets in the EU n where a subsidiary or affiliated company is a part of a group in which the parent company prepares consolidated financial statements according to IAS / IFRS n dr A. Kocia 29
Consolidation of financial statements n Introduces special and new items into financial statements n It is necessary to correct some values from individual financial reports dr A. Kocia 30
Part III Balance sheet dr A. Kocia 31
Balance sheet: Basic information (1) n Is a set of mutually balancing assets and sources of financing n A “photography" of a company – reflects the situation of the company on a given day dr A. Kocia 32
Balance sheet: Basic information (2) n Assets are ordered by increasing liquidity n Liabilities are ordered by increasing maturity n Balance sheet equation: ASSETS = LIABILITIES dr A. Kocia 33
Balance sheet preparation n Gross method – separately shows the results of all balance sheet accounts n Net method – (used in Poland) shows the value of individual groups of assets based on their adjusted book value: fixed assets net of previously taken depreciation n tangible current assets net of write downs n receivables net of amortisation n dr A. Kocia 34
Balance sheet: Assets n Fixed assets: n assets not classified as current assets n Current assets: n are consumed or used in the normal operating cycle n will expire within 12 months n are in the form of monetary assets dr A. Kocia 35
Balance sheet: Fixed assets (1) n Fixed assets include: n intangible assets n n for example: copyrights, licenses, concessions, patents, know-how, acquired positive value of acompany tangible assets n fixed assets § tangible assets of the expected economic useful life longer than one year, complete, usable and intended for the use by the entity § for example: real estate (land, the right to perpetual usufruct of land, cooperative ownership right to the home premises), machinery, equipment, transportation, § improvements in foreign fixed assets, livestock n fixed assets under construction dr A. Kocia 36
Balance sheet: Fixed assets (2) n Fixed assets also include: n long-term receivables n n a group of receivables which are due later than 12 months from the balance sheet date, with the exception of trade receivables and services for example: public-law claims, amounts due from employees, financial receivables dr A. Kocia 37
Balance sheet: Fixed assets (3) n Fixed assets also include: n Long-term investments n investments are assets held in order to achieve the economic benefits arising from the increase in the value of these assets or in the form of interest income, dividends or other benefits, including in the process of a commercial transaction n for example: real estate, intangible assets, long-term financial assets and other long-term investments n Long-term prepayments n used to match revenues and expenses of more than 12 months n for example: long-term assets, deferred tax and other accruals dr A. Kocia 38
Balance sheet: Current assets (1) n Current assets include those: n held for sale or consumption within 12 months from the balance sheet date or within the normal operating cycle n stock / inventory n n n materials – purchased by the entity for their own use finished products (semi-finished products, work in progress) – manufactured or processed products and services fit for sale goods – tangible assets acquired by an entity for resale without further processing dr A. Kocia 39
Balance sheet: Current assets (2) n Current assets also include: n short-term receivables n n short-term investments n n n receivables from sale of goods and services as well as from other sources not included in financial assets that are due within 12 months from the balance sheet date financial assets and other investments due and payable or intended for sale within 12 months from the balance sheet date for example: shares, other securities, loans, other shortterm financial assets and investments in non-financial assets short-term prepayments n short-term deferred operating and financial prepayments dr A. Kocia 40
Balance sheet: Liabilities and equity n Liabilities and equity – sources of financing of entity’s assets n Stockholders’ equity – the equivalent of the assets contributed to the unit by its owners and retained by the entity in the course of a business n net assets – assets less liabilities n Liabilities – a result of past events and the obligation to pay with a reliably set value which will result use of current or future assets of the unit n foreign capital – the equivalent of an asset that has been brought temporarily to the assets by natural legal persons dr A. Kocia in or 41
Balance sheet: Equity (1) n Share capital: n is created by the business entities in accordance with the principles laid down by law n is a capital entrusted by the owners n is shown in the value declared, but may be adjusted downward by due but not paid-in capital and value of its own shares n Payable share capital: n a difference between the value of capital resulting from the shares’ nominal value and the actual value paid dr A. Kocia 42
Balance sheet: Equity (2) n Treasury shares / Own shares (negative value) own shares bought back by the company from the market n Paid-in / Additional capital n used for adjustement of basic capital n is created in stock companies (joint stock and limited liability companies) n rules governing the creation and use of additional capital are governed by the Commercial Companies Code (Kodeks spółek handlowych) and statutes and resolutions of the General Assembly of Owners n dr A. Kocia 43
Balance sheet: Equity (3) n Revaluation reserve n is used to account for valuation adjustments of fixed assets n special case of the reserve capital n arises from the revaluation of fixed assets, appropriate regulation will be issued if n Other reserves n gathered by the company for specific purposes n is created in capital companies as a result of agreement or statute of the entity dr A. Kocia 44
Balance sheet: Equity (4) n Retained earnings n amount of profit (loss) undivided / unused in previous periods n Net profit (loss) from a current financial year n income of a business unit achieved during the year n is the difference between revenues and expenditures n Deduction from net profit during the financial year (negative value) n advance payment against future dividend dr A. Kocia 45
Balance sheet: Liabilities (1) n Reserves / Provisions for liabilities these are specific obligations whose maturity or amount is not certain n you can not create reserves for liabilities, if the entity has no legal or customary obligation to provide goods or services or if it can not reliably determine the likely amount of the liability n for example: provision for retirement benefits n Long-term liabilities – liabilities other than trade liabilities that become payable in a period of more than 12 months from the balance sheet date n dr A. Kocia 46
Balance sheet: Liabilities (2) n Current liabilities – total trade liabilities and all or part of other obligations that become due within 12 months from the balance sheet date n Deferred income – includes negative goodwill and the equivalent of already received or receivables from customers or the performance of which will be settled in subsequent reporting periods n used to ensure matching of revenues and expenses dr A. Kocia 47
Valuation methods (1) n Historical cost principle – used to include an asset for the first time in the accounting books n n assets are recognized at the acquisition date at a value equal to the amount paid or the fair value of transferred assets liabilities are measured at a value equal to the amount of proceeds received in exchange for a commitment or a value equal to the amount of cash expected to be paid to settle the obligation n Current cost principle n recognition of the assets at a value that would be payable in case of an acquisition of the same or an equivalent item n liabilities are valued at non discounted amount that would be required at the moment to settle the obligation dr A. Kocia 48
Valuation methods (2) n Realizable value principle n assets are valued at realizable cash from the disposal of the asset in a normal scheduled transaction n liabilities are valued at a discounted amount of cash that needs to be paid to settle the obligation n Present value principle – uses the change time value of money concept n n assets are valued at discounted present value of future net cash flows liabilities are disclosed at the discounted present value of future anticipated cash expenses to be paid to settle the obligation dr A. Kocia 49
In practice n In process of preparation of financial statements: the most common method of valuation is historical cost principle n the valuation of financial assets and liabilities is based on the realizable or present value n dr A. Kocia 50
Task 1 n On Balance Sheet where would we include: 1. flour in: n n bakery grocery store mill food warehouse 2. 100 kg of tomatoes in: n n n store / supermarket fruit and vegetable processing company farm 3. set of living room furniture: n n n warehouse furniture manufacturer company president's cabinet furniture store dr A. Kocia 51
Part III Profit and loss account dr A. Kocia 52
Profit and loss account: Basic information n Used to present the financial result of the business in a given period n Is the difference between revenues generated and expenses incurred dr A. Kocia 53
Concept of revenues n Revenues and profits are economic benefits which will probably arise over the reporting period, whose value is reliably certain and lead to increase in assets or reduction in liabilities that will cause an increase in equity capital or reduction in its deficit in a different way than addition of capital by shareholders or owners n revenues arise in the course of business n profit is an increase in earnings or economic benefits arising from the valuation at the balance sheet date n often is presented at a net value after deducting the appropriate costs dr A. Kocia 54
Concept of costs n Costs and losses are probable reductions in economic benefits during the reporting period with a reliably certain value which leads to a reduction in the value of assets or increase in the value of liabilities and provisions that will cause a reduction in equity value or increase the deficit by other means than the withdrawal of funds by shareholders or owners n costs arise in the course of business n loss is a reduction of economic benefits arising from valuation at the balance sheet date dr A. Kocia 55
Inflows and outflows n These categories are related to the settlement of receivables and liabilities or payment for goods and services, consisting of cash flow without causing a change in equity n Remember the following relations: n expense, but still not an outflow: accrued but unpaid interest on loans n expense that will not be an outflow: depreciation n outflow, but not yet an expense: purchase for cash of materials that have not yet been used n outflow that will not be an expense: repayment of loan installment n revenue but not yet inflow: money due from customers for goods sold n income that will not be an inflow: non-monetary donation in the form of fixed assets n inflow, but not a revenue: received an advance on future deliveries of goods n inflow, which will not be income: bank loan dr A. Kocia 56
Profit and loss account – revenue structure (1) n Five segments n Operating activities n includes revenues related to core business of the entity n are realized from the sale of materials, goods and products n amounts due or received, regardless of whether they were paid or not, adjusted for granted rebates, discounts, subsidies and the VAT dr A. Kocia 57
Profit and loss account – revenue structure (2) n Other operating activities n n groups income from various forms of activities not directly and continuously related to operating activities in particular income related to: n n n social welfare activities disposal of fixed assets, fixed assets under construction, intangible assets and assets held as investments maintainance of the property and intangible assets included in investments termination of previously established reserves (other than those related to financial transactions) receipt free of charge (donation) of assets dr A. Kocia 58
Profit and loss account – revenue structure (3) n Investment and financial activities n includes revenues related to investing and financing activities of the company n in particular income related to: n receipt and accrual of interest on loans, funds from bank accounts and foreign bonds held n receipt and accrual of interest on trade sales n income from disposal of investments in financial assets n dividends received n termination of provisions for anticipated financial losses dr A. Kocia 59
Profit and loss account – revenue structure (4) n Extraordinary gains: arising from events which are difficult to predict, beyond the operational activities of the entity and are not connected to the general risk related to the conduct of business n for example: loss of assets due to random events dr A. Kocia 60
Profit and loss account – a generic approach (1) n Depreciation: the cost of use of fixed assets and intangible assets n Materials and energy: the cost of consumption of basic materials and raw materials, office supplies, spare parts for machinery and equipment, packaging, electricity, gas, water, steam and energy in other forms n External services: transport, equipment, storage, repair and maintenance, telecommunications and postal services, supervision of property, renting, leasing, operating leasing, banking services n Taxes and Fees dr A. Kocia 61
Profit and loss account – a generic approach (2) n Salaries: wages in cash and in kind for the work performed regardless of the character of the employment relationship n Social insurance and other benefits: the contribution of social insurance payable by the employer, contributions to the Labour Fund, Guaranteed Employee Benefits Fund, mandatory deductions to the social benefits capital fund, costs associated with health and safety, staff training n Other costs: travel expenses, representation and advertising expenses, property insurance dr A. Kocia 62
Profit and loss account – a calculative approach (1) n In this arrangement, the costs are divided into direct and indirect costs n Direct costs: those that are related directly to the products (goods and services), materials or goods n in particular: n n n direct materials consumed direct wages including fringe benefits other direct costs such as: energy costs, utilities costs, business trips dr A. Kocia 63
Profit and loss account – a calculative approach (2) n Indirect costs: cost items whose linkage to the products (goods and services), materials or goods is impossible, irrelevant or not profitable to determine are initially recognized at origin and then settled on products or on income in the reporting period in which they are incurred n in particular: n indirect product costs n management costs n selling costs n dr A. Kocia 64
Profit and loss account – a calculative approach (3) n General and administrative costs: indirect costs for the operation of the enterprise as a whole n include: n n administrative costs – associated with the maintenance of the administration unit general economic costs – to maintain facilities to ensure the functioning of the whole unit n Cost of sales: the indirect costs incurred in connection with the sale of products, goods and materials n formed after the release of inventory from storage or production n for example: the costs of transportation, loading, unloading, packaging, handling post-production costs and advertising and participation in trade dr A. Kocia 65 fairs
Profit and loss account – a calculative approach (4) n Cost of the period: immediately reduce earnings in the reporting period in which they are incurred n for example: costs as a consequence of unused production capacity and production losses, storage costs dr A. Kocia 66
Profit and loss account – cost structure (1) n Other operating costs: not directly related to core business operations n Are related to: n maintenance of social activities facilities n disposal of fixed assets, fixed assets under construction, intangible assets and assets held as investments n maintenance of property and intangible assets included in investments n writing off bad debts n creation of reserves (other than those related to financial transactions) n payment of damages, penalties and fines n transfer free of charge (donation) of assets dr A. Kocia 67
Profit and loss account – cost structure (2) n Finance costs: related to financing and investment activities of the entity n Include: n costs of disposal of investments in financial assets n interest and fees on loans n interest charges from finance leases n interest or discount on bonds issued by the entity n write offs from value of investments in financial assets n reserves created for certain or probable losses arising from financial operations dr A. Kocia 68
Profit and loss account – cost structure (3) n Extraordinary losses: costs arising from events which are difficult to predict, not related to operational activities of entity and not associated with overall risk of managing the business n Income tax: impact on financial results for the reporting year n includes current tax and deferred tax n n current tax: is a payment to the national budget deferred tax: the difference between the reserves and assets resulting from deferred tax at the beginning and at the end of the reporting period dr A. Kocia 69
Diagram of the profit and loss account (1) Income from operations Cost of sales Earnings (loss) on sales Other operational income Other operational costs Earnings (loss) from operations Financial income Financial costs dr A. Kocia 70
Diagram of the profit and loss account (2) Earnings from all activities Extraordinary losses Extraordinary gains Gross income (loss) = Earnings before taxes (EBT) Income tax Net income (loss) dr A. Kocia 71
Task 1 n In the examples below decide whether we are dealing with expense or outflow, and if an expense of what type: purchased machine n purchased with deferred payment, materials which were immediately used n paid a penalty for late payment by bank transfer n paid in cash the for office rent n paid interest on the loan n TV was stolen n paid by bank transfer for previously purchased materials n dr A. Kocia 72
Task 2 n In the examples below decide whether we are dealing with inflow or income, and if the income of what type of activity: received a payment from the recipient of goods n company sold some goods with deferred payment n received a donation on the current account n bank accrued interest on the account n a transport car was sold for cash n received an invoice for the rental of office space for half a year in advance n dr A. Kocia 73
Part V Cash flow statement dr A. Kocia 74
Cash flow statement: Basic information (1) n It serves to present a financial result of the business in a given period BUT revenues and expenses are measured by the actual inflow and outflow of funds n Difference between all cash receipts and cash disbursements that is cash flows dr A. Kocia 75
Cash flow statement: Basic information (2) n Cash flows are equal to the change in cash balance on balance sheet n For the purposes of the cash flow statement, cash includes cash assets payable only or due within three months of their receipt, issue, purchase or deposit, provided that they are not included in cash flows from investing activities dr A. Kocia 76
Cash flow statement – Structure n Four parts n Operating activities n Investing activities n Financing activities n Reconciliation of net cash flows and the change in cash balance on the balance sheet dr A. Kocia 77
Operating activities n Primary type of business of the entity and other activities not included in investing or financing activities n It shows in particular: dr A. Kocia 78
Investing activities Activities whose purpose is the purchase or sale of tangible fixed assets (fixed assets, fixed assets under construction), intangible assets, long-term investments and short-term financial assets (excluding cash and cash equivalents) and the associated monetary costs and benefits n It shows in particular: n dr A. Kocia 79
Financing activities n n n Activity whose purpose is to attract outside sources of funding for operational purposes or repayment purposes and the associated monetary costs and benefits Do not change the size and the relationship of equity and liabilities in the financial statements of the entity It shows in particular: dr A. Kocia 80
Part VI Statement of changes in equity dr A. Kocia 81
Statement of changes in equity: Basic information n It explains and illustrates in detail the changes in equity not shown in other reports dr A. Kocia 82
Statement of changes in equity – Structure (1) n Four parts n Equity capital at beginning of period n Statement of operations that increased and decreased equity according to groups stated on the balance sheet n Equity capital at end of period n Expected amount of equity capital after the division of earnings among shareholders dr A. Kocia 83
Statement of changes in equity – Structure (2) n Increases n issuance of stock (shares) n increase in the nominal value of existing shares n additions to paid-in capital n transfer from capital reserve to share capital n donation / grant from another state enterprise dr A. Kocia 84
Statement of changes in equity – Structure (3) n Decreases n reduction in the nominal value of stock (shares n donation / grant to another state enterprise n free transfer of state assets to another company n return iof mproperly received a grant from the state budget dr A. Kocia 85
Part VII Notes to financial statements dr A. Kocia 86
Notes to financial statements: Basic information n This is a summary of financial information not included in other parts of financial statements n Two parts: Introduction to the Financial Statements n Additional information and explanations (explanatory notes) n dr A. Kocia 87
Notes to financial statements – Introduction n Company name, the period covered by the report n Indicate method of consolidation consolidated) n Discussion of accounting policies dr A. Kocia (if 88
Notes to financial statements – Explanatory notes n The detailed scope of changes in the value of individual assets groups n Way of distributing of profit or covering of loss n Amounts and types of provisions n Breakdown by type of long-term liabilities n List of essential accruals n Net revenues by type of the business and region n Changes in accounting rules and their impact on the items contained in the reports dr A. Kocia 89
Part VIII Preliminary analysis dr A. Kocia 90
Vertical analysis (1) n Also known as a structure analysis n Specifies what percent of an aggregated financial position constitutes an item n Structure index = (value of i item which is a part of aggregate financial position) / (aggregate financial position) dr A. Kocia 91
Vertical analysis (2) n Two possible versions n generic version useful in a complex analysis n n then an interest of an analyst focuses on all aspects of the entity’s business detailed version useful if a particular component is analyzed n item’s result is difficult to interpret in generic version dr A. Kocia 92
Vertical analysis – example (1) dr A. Kocia 93
Vertical analysis – example (2) dr A. Kocia 94
Horizontal analysis (1) n Also known as time trend analysis n Examines the change in i position over time n Includes a dynamic analysis or a growth for fixed or variable base n Dynamic for fixed base n dynamics of the i-th position according to a fixed base = (value of i position in the w period) / (value of i position derived from the base period) n Dynamics for variable base n dynamics of the i-th position according to a variable base = (value of i position in the w period) / (value of i position in the w-1 period) dr A. Kocia 95
Horizontal analysis (2) n Growth for fixed base n Increase in i position according to a fixed base = (value of i position in the period - the value of i position derived from the base period) / (value of i position derived from the base period) n Growth for variable base n Increase in i position according to a variable base = (value of i position in the period - the value of i position in the w-1 period) / (value of i position in the w-1 period) dr A. Kocia 96
Horizontal analysis (3) n An index value determines the direction of the dynamic of changes in the following way if it is higher than 100% (1. 0) then the value from one period to another is growing n if it is equal to 100% (1. 0) then the value from one period to another is not changing n if it is less than 100% (1. 0) then the value from one period to another is decreasing n interpretation depends on the item considered n n The value of the index expresses the dynamic of changes (intensity) of the position dr A. Kocia 97
Horizontal analysis (4) n An index value determines the direction of the growth of changes in the following way if it is higher than zero then the value from one period to another is growing n if it is equal to zero then the value from one period to another is not changing n if it is less than zero then the value from one period to another is decreasing n interpretation depends on the item considered n n The value of the index expresses the growth of changes (intensity) of the position dr A. Kocia 98
Horizontal analysis (5) n It does not matter whether we choose the dynamic or growth index n However, in practice we use for longer periods we use dynamic according to a fixed base n for shorter periods we use dynamic according to a variable base or a growth according to a fixed base n in practice, we hardly encounter the use of growth according to a fixed base n dr A. Kocia 99
Horizontal analysis – example (1) dr A. Kocia 100
Horizontal analysis – example (2) Analysis of dynamic (in %) according to a fixed and variable base dr A. Kocia 101
Horizontal analysis – example (3) Analysis of growth (in %) according to a fixed and variable base dr A. Kocia 102
Part IX Ratio analysis dr A. Kocia 103
Ratio analysis – Advantages n Characterizes various aspects of business operations n Allows for the assessment of financial condition of an enterprise n It allows you to study trends over the period of at least 3 years n Creates an opportunity for comparing the results with average industry ratios n May explain the decline in earnings and the potential risk dr A. Kocia 104
Ratio analysis – Disadvantages n Figures contained in reports are the result of approximations, estimates, interpretations and judgments n Author of the accounting data is the company's management and the auditor checks the data received from the company n Financial statements present the past, so the analysis is based on historical data dr A. Kocia 105
Ratio analysis – Classification n Liquidity ratios n Debt ratios n Performance ratios n Profitability ratios n Market value ratios dr A. Kocia 106
Ratio analysis – Liquidity ratios (1) n Current ratio: Current assets Current liabilities n Indicator determines the ability of companies to cover its expenses over time (timely payment of obligations) n Tells us how many times current assets cover current liabilities n Standard liquidity ratio should be in a range of 1. 2 - 2. 0. This means that the value of current assets should be about two times greater than current liabilities dr A. Kocia 107
Ratio analysis – Liquidity ratios (2) n Quick ratio: Current assets - inventories Current liabilities n Quick ratio shows the coverage of current assets (most liquid) with current liabilities n This indicator is more accurate than the current ratio n Should range between 1. 0 - 1. 3 dr A. Kocia 108
Ratio analysis – Liquidity ratios (3) n Increased liquidity ratio: Current assets - inventories - receivables Current liabilities n It defines the company's ability to repay current liabilities with the most liquid assets, whose ability to regulate liabilities is immediate or nearly immediate dr A. Kocia 109
Ratio analysis – Debt ratio (1) n Debt ratio: Total liabilities Total assets n It indicates how much zlotych of present and potential liabilities is related to total assets or what percent of liabilities is debt n It illustrates the structure of financing of business assets n It should be between 57 to 67 percent n The higher the level, the higher the debt and so the higher financial risk dr A. Kocia 110
Ratio analysis – Debt ratio (2) n Debt to equity: Total equity Total liabilities n It indicates how much zlotych the current and potential liabilities attribute to equity or what percentage of equity is debt n It illustrates the structure of financing of business assets n It should be between 30 to 40 percent dr A. Kocia 111
Ratio analysis – Debt ratio (3) n Interest coverage: Profit before tax (EBT) Interest n It expresses the ability to timely pay interest n It should be between 50 - 60 percent dr A. Kocia 112
Ratio analysis – Debt ratio (4) n Financial leverage: Total assets Total equity n Higher the ratio, the greater the degree of foreign capital and the higher the risk of activities dr A. Kocia 113
Ratio analysis – Performance ratio (1) n Debt turnover: n n n Loans and advances to customers * 365 days Net sales Determines the number of days during which the settlement is due It is, therefore, information about the extent to which the company credited its customers and the length of the freezing of funds Too long time to pay its dues shows ineffective debt collection policy Short time to pay its dues shows too strict credit policy for customers In many industries the index value stands at about two months dr A. Kocia 114
Ratio analysis – Performance ratio (2) n Inventory turnover: n n Inventory * 365 days Net sales Specifies in how many days the company renews its inventory to achieve a certain level of sales High value indicates a low turover of inventory and is unfavorable, since it can disrupt production Low value of the indicator is desirable and helps to increase company profits There are no universal standards for this indicator dr A. Kocia 115
Ratio analysis – Performance ratio (3) n Asset turnover: Net sales Total assets n Lower value for industries with high capital intensity and higher for industries with low capital and high proportion of human labor n Level indicates the number of turnover of total assets or the value of sales received from one zloty of total assets n Generally, the higher this ratio, the higher the productivity of assets dr A. Kocia 116
Ratio analysis – Performance ratio (4) n Current asset turnover: Net sales Current assets n This indicator shows the current assets turnover rate n The higher the value, the production cycle is shorter or the higher profitability of sales n Index value can be significantly different among various branches and it should be interpreted by examining the dynamics of change or growth within the industry dr A. Kocia 117
Ratio analysis – Profitability ratio (1) n Net Profit Margin: Net profit Net sales n The high value of this index indicates a high possibility of company to generate profits and indirectly of financial soundness n The value of this ratio largely determines whether the company can be defined as viable or not dr A. Kocia 118
Ratio analysis – Profitability ratio (2) n Gross profit margin: Gross income Net sales n The main features of this indicator is that it takes into account all incomes and is independent of tax rate n Its value is also affected by occasional factors such as income from financial activities and extraordinary items dr A. Kocia 119
Ratio analysis – Profitability ratio (3) n Return on assets: n n n Net income Total assets Describes the profitability of all business assets This indicator can be regarded as evaluating the efficiency of the management in comparison to other companies Shows how much profit is the management able to generate using the available assets If the value of profits is high, a low value of this index indicates an inefficient use of company’s assets Return on assets should be higher than the rate of interest paid by a company on loans dr A. Kocia 120
Ratio analysis – Profitability ratio (4) n Return on equity: Net income Total equity n Assessment of this indicator is not possible in isolation from other values of the company's financial n Its low, but positive value may be due to poor profitability but also small business debt n Thus, its value should be interpreted, at least in comparison with the value of company's debt dr A. Kocia 121
Ratio analysis – Market value ratio (1) n Market value to book value (per one stock): Stock price Book value n This indicator gives a clue as to how investors assess the company n The market price should be higher than its book value because the former is based on current prices dr A. Kocia 122
Ratio analysis – Market value ratio (2) n Earnings per share (EPS): Net income Number of stocks issued n Earnings per share should be positive dr A. Kocia 123
Ratio analysis – Market value ratio (3) n Price to earnings: Stock price Earnings per share n Price to earnings should be positive dr A. Kocia 124
Thank you for your attention … … and now let’s look at some case studies dr A. Kocia 125
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