Analyzing Financial Statements

Chapter 3Analyzing FinancialStatementsCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedChapter OverviewReaders of Financial StatementsTypes of Financial AnalysisManagement Decision MakingFinancial TricksCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedReaders of Financial AnalysisOwnersTrack and evaluate management’s performanceLendersDetermine the risk of the business defaulting on its loanManagersCompare actual and budgeted resultsGovernmentEnsure that taxes have been paidCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedReaders of Financial Analysis cont.SuppliersEvaluate the company’s ability to pay its obligationsInvestment AnalystsEvaluate the company’s performanceMergers and AcquisitionsHighlight financial strengths, upside potential, and future valueCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedTypes of AnalysisVertical AnalysisUsed to analyze variable expensesAll accounts are sized using either:Total revenue orDepartmental revenueVariable expenses should increase or decrease with the level of salesCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedSample Vertical AnalysisShae'sIncome StatementFor the month ended June 30, 2008Revenues:AmountPercent Food $ 890,000 78.20 Beverage 220,000 19.33 Others 28,100 2.47 Total Revenues $ 1,138,100 100.00 Cost of Sales: Food $ 320,400 36.00 Beverage 48,400 22.00 Others 15,455 55.00 Total Cost of Sales $ 384,255 33.76 Gross Profit: Food $ 569,600 50.05 Beverage 171,600 15.08 Others 12,645 1.11 Total Gross Profit $ 753,845 66.24 Accounts are divided by total revenues $1,138,100Cost of Sales is divided by its respective revenue amountEX: Food$320,400 / $890,000 = 36%Copyright © 2007 by John Wiley & Sons, Inc. All rights reservedSample Vertical Analysis cont.Operating (Controllable) Expenses:AmountPercent Salaries and Wages $ 352,811 31.00 Employee Benefits 105,843 9.30 Total Labor Cost 458,654 40.30 Direct Operating Expenses 68,286 6.00 Marketing 39,834 3.50 Utilities 44,386 3.90 Administration & General 28,453 2.50 Repairs and Maintenance 25,038 2.20 Music and Entertainment 31,867 2.80 Total Operating Expenses $ 696,517 61.20 Operating Income $ 57,328 5.04 Other (Non-controllable) Expenses: Rent $ 8,000 0.70 Depreciation 20,470 1.80 Interest 4,500 0.40 Total Non-controllable Expenses $ 32,970 2.90 Income Before Income Taxes $ 24,358 2.14 Accounts are divided by total revenues$1,138,100Copyright © 2007 by John Wiley & Sons, Inc. All rights reservedTypes of AnalysisHorizontal AnalysisTracks and Analyzes:Income StatementBalance SheetFocuses on both $$ and % changesAnalyzes changes over timeMonth to MonthYear to YearCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedSample Horizontal AnalysisDanforth HotelsHorizontal Analysis for the Balance SheetsAs of December 31(in millions)20072008$ change% changeCash $ 82 $ 298 $ 216 263.4Accounts Receivable 288 269 (19)-6.6Marketable Securities 100 112 12 12.0Inventory 193 158 (35)-18.1Other current assets 64 90 26 40.6 Total Current Assets 727 927 200 27.5Furniture, Fixture & Equipment, net 3,641 3,520 (121)-3.0Management and Franchise Contracts, net 383 347 (36)-9.4Goodwill 1,230 1,230 - 0.0Long term Investments 568 599 31 5.5Other long term assets 260 328 68 26.2 Long Term Assets 6,082 6,024 (58)-1.0 Total Assets $ 6,809 $ 6,951 $ 142 2.1Copyright © 2007 by John Wiley & Sons, Inc. All rights reservedSample Horizontal Analysis cont.20072008$ change% changeAccounts Payable and Accrued Expenses $ 540 $ 601 $ 61 11.3Current maturities of long-term debt 329 118 (211)-64.1Accrued Taxes 4 4 - 0.0 Total Current Liabilities 873 723 (150)-17.2Long Term Debt 3,709 3,560 (149)-4.0 Total Liabilities 4,582 4,283 (299)-6.5Owner's Equity 1,807 1,998 191 10.6Retained Earnings 420 670 250 59.5 Total Owner's Equity 2,227 2,668 441 19.8 Total Liabilities and Owner's Equity$ 6,809 $ 6,951 $ 142 2.1Copyright © 2007 by John Wiley & Sons, Inc. All rights reservedTypes of AnalysisTrend AnalysisCalculations and data pointsOver a specified period of timePresented on line graphs and bar chartsExamplesRevPARFood CostPayroll CostCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedTypes of AnalysisPublished Industry AveragesManagement can compare operating resultsExamplesSmith Travel Research HOST ReportOperating resultsSmith Travel Research STAR ReportOccupancy, ADR, and RevPARCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedTypes of AnalysisRatio AnalysisUsed to asses financial healthFive categories:LiquiditySolvencyActivityOperatingProfitabilityCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedLiquidity RatiosMeasures ability to meet short-term obligationsCurrent RatioAccounts Receivable TurnoverAverage Collection PeriodOperating Cash to Current LiabilitiesCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedSolvency RatiosMeasure ability to meet long-term obligationsOperating Cash Flow to Long-term DebtLong-term Debt to Total CapitalizationDebt-to-equity RatioTimes Interest Earned (TIE)Fixed Charge CoverageCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedActivity RatiosGauge effectiveness of how assets are managedFood Inventory TurnoverBeverage Inventory TurnoverFixed Asset TurnoverCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedOperating RatiosDetermine how efficient the operation isFood Cost PercentageBeverage Cost PercentageLabor Cost PercentageCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedProfitability RatiosEffectiveness of achieving profit margins and ROI goalsProfit MarginReturn on AssetsReturn on InvestmentReturn on EquityCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedManagement Decision MakingEmployee SchedulingBased on:Accurate revenue forecastsProductivity goalsCustomer service goalsCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedManagement Decision MakingFood and Beverage PricingTrack sales of each menu itemCalculate each items gross profitabilitySet menu pricesRemove unprofitable items from the menuCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedManagement Decision MakingRevenue ManagementGoal is to maximize RevPARStrategiesClose lower levels of pricing during high demandOpen all pricing levels during times of low demandCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedManagement Decision MakingProfit FlexingUtilized when revenues fall behind budgetAdjust pricing and reduce expensesWithout impacting customer serviceMaximize remaining revenue opportunitiesCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedManagement Decision MakingCost-volume-profit ModelingAlso known as Breakeven AnalysisTarget the amount of revenue required to reach the owner’s goalCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedCost-volume-profit EquationsBreakeven Volume of Sales =Fixed costs(sale price – variable cost)Desired Occupancy % =Rooms soldRooms available for saleDesired Volume = Fixed Costs + Desired ProfitsSale Price – Variable CostCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedBreakeven Volume ExampleSale price = $250 a nightFixed costs = $40,000 per monthVariable cost = $35 per roomBreakeven Volume of Sales =Fixed costs(sale price – variable cost)=40,000(250 - 35)=40,000215=186 roomsCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedFinancial TricksWindow DressingMaking a company’s financial statements look more favorableExampleCompany does not pay invoicesMakes year-end balance sheet look betterCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedFinancial TricksOff-balance-sheet FinancingCompany does not show debt associated with real estate joint venturesAs long as it owns a “relatively” minor percentage of the joint ventureLegal under GAAPCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedFinancial TricksCapitalize Current Operating ExpensesReduces current expensesIncreases profitsCopyright © 2007 by John Wiley & Sons, Inc. All rights reservedFinancial TricksImproper Revenue RecognitionRevenues are recorded before they are actually earnedViolates matching principleCopyright © 2007 by John Wiley & Sons, Inc. All rights reserved