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Financial Statement Analysis
P.V. Viswanath
Based on Damodaran’s Corporate Finance
Questions we would like answered…
As financial analysts…
Assets
Liabilities
What are the assets in place?
How valuable are these assets? Assets in Place
How risky are these assets?
What are the growth assets?
Growth Assets
How valuable are these assets?
Debt
Equity
What is the value of the debt?
How risky is the debt?
What is the value of the equity?
How risky is the equity?
However, the information we have comes from
the firm’s financial statements…
P.V. Viswanath
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Basic Financial Statements
 The balance sheet, which summarizes what a firm
owns and owes at a point in time.
 The income statement, which reports on how much
a firm earned in the period of analysis
 The statement of cash flows, which reports on cash
inflows and outflows to the firm during the period
of analysis
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The Balance Sheet
Figure 4.1: The Balance Sheet
Assets
Liabilities
Fixed Assets
Current
Liabilties
Current Assets
Debt
Debt obligations of firm
Investments in securities &
assets of other firms
Financial Investments
Other
Liabilities
Other long-term obligations
Assets which are not physical,
like patents & trademarks
Intangible Assets
Equity
Equity investment in firm
Long Lived Real Assets
Short-lived Assets
Short-term liabilities of the firm
This is what we can see from the firm’s balance sheet…
P.V. Viswanath
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An example : Maxwell Shoe Company, Inc
Maxwell Shoe Company Inc. designs, develops and markets casual and dress
footwear for women and children under multiple brand names, each of which is
targeted to a distinct segment of the footwear market. The Company offers
casual and dress footwear for women in the moderately priced market segment
under the Mootsies Tootsies brand name, in the upper moderately priced market
segment under the Sam & Libby and Dockers Khakis Footwear For Women
brand names and in the better market segment under the Anne Klein 2 and A
Line Anne Klein brand names.
It also sells moderately priced and upper moderately priced children's footwear
under both the Mootsies Tootsies and Sam & Libby brand names. In addition, it
designs and develops private label footwear for selected retailers under the
retailers' own brand names. Maxwell has licensed the J.G. Hook trademark to
source and develop private label products for retailers who require brand
identification.
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An example of an Accountant’s
Balance Sheet
Maxwell Shoe Company, Inc.
As of October 31, 2000 (In ‘000s)
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable, trade
Inventory, net
Prepaid expenses
Prepaid income taxes
Deferred income taxes....
Total current assets........
Property and equipment, net.
Trademarks, net..
Other assets.....
$48,074
34,244
12,036
LIABILITIES AND STOCKHOLDERS'
EQUITY
Current liabilities:
Accounts payable.........
Accrued expenses.........
Deferred income taxes.....
Current portion of Capital
lease obligations
536
1,478
798
97,166 Total current liabilities...
Long-term deferred income
$6,605 taxes........
15,479 Stockholders' equity
Additional paid-in
185 capital..........
Deferred compensation....
Retained earnings........
Total stockholders' equity..
$119,435
P.V. Viswanath
$1,863
7,254
479
102
9,698
1,540
88
43,112
-251
65,248
108,197
$119,435
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Notes on the Maxwell Balance Sheet
 Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes. Deferred tax assets are created when future taxable income
is expected to exceed pretax income, while deferred tax liabilities
occur in the reverse case.
 If more deductions have been taken in the current period for reporting
purposes, then tax payable (according to the GAAP income
statement) will be lower than the actual tax paid. Hence it will seem
like taxes have been prepaid. This is reflected in the balance sheet as
an asset.
 Deferred tax assets ($798) reflect allowance for doubtful accounts,
stock option compensation, inventory capitalization, and inventory
reserve. Deferred tax liabilities ($479) reflect amortization of
trademarks (long-term) and depreciation of property and equipment
(short-term).
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A Financial Analyst’s Balance Sheet
Assets
Existing Investments
Generate cashflows today
Includes long lived (fixed) and
short-lived(working
capital) assets
Expected Value that will be
created by future investments
Liabilities
Assets in Place
Debt
Growth Assets
Equity
Fixed Claim on cash flows
Little or No role in management
Fixed Maturity
Tax Deductible
Residual Claim on cash flows
Significant Role in management
Perpetual Lives
This is what we would like to see…
P.V. Viswanath
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The Income Statement
Figure 4.2: Income Statement
Gross revenues from sale
of products or services
Revenues
Expenses associates with
generating revenues
- Operating Expenses
Operating income for the
period
= Operating Income
Expenses associated with
borrowing and other financing
- Financial Expenses
Taxes due on taxable income
- Taxes
Earnings to Common &
Preferred Equity for
Current Period
= Net Income before extraordinary items
Profits and Losses not
associated with operations
- (+) Extraordinary Losses (Profits)
Profits or losses associated
with changes in accounting
rules
- Income Changes Associated with Accounting Changes
Dividends paid to preferred
stockholders
- Preferred Dividends
= Net Income to Common Stockholders
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The Income Statement
Maxwell Shoe Company, Inc.
For the year ended October 31, 2000 (In ‘000s)
Net sales....
Cost of sales
Gross profit.
Operating expenses:
Selling.
General and administrative..
Operating income..
Other expenses (income)
Interest income, net...
Amortization of trademarks..
Other, net...
Income before income taxes..
Income taxes.
Net income...
P.V. Viswanath
$158,205
116,991
41,214
11,584
16,141
27,725
13,489
-3,039
367
-310
-2,982
16,471
6,589
$9,882
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The Income Statement
The Income Statement provides us with information about changes in the
balance sheet from one year to another. Hence it is crucial to creating the
financial balance sheet that we want.
However, the income statement is prepared according to GAAP.
Underlying GAAP are certain principles, such as revenue recognition
when the service for which the firm is being paid has been performed
substantially, the matching principle governing recognition of expenses, a
historical cost-based approach, and a basic conservatism in the recognition
of assets.
This leads to certain accounting practices that need to be corrected, from a
financial analyst’s point of view…
P.V. Viswanath
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P.V. Viswanath
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