EM3535E Financial Analysis

 Evaluate financial statements of companies;

 Analyze investment, capital mobilization and income
distribution activities of enterprises;
 Apply tools to analyze financial data of enterprises and
assess the efficiency and risk of investment, capital
mobilization and income distribution activities;
 Develop insights on financial performance and risk; and
 Prepare a financial analysis report for a firm.
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 Business Analysis

 Business analysis is the process of evaluating a company’s economic

prospects and risks. This includes analyzing a company’s business
environment, its strategies, and its financial position and performance.
 An initial step in business analysis is to evaluate a company’s business
environment and strategies.
 Analysis of both qualitative information about a company’s business
plans and quantitative information about its financial position and
performance.
 Major types of business analysis include Credit analysis, Equity analysis,

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Business Activities

 Financing Activities
 External financing – Equity, Debt
 Internal financing – Retained earnings

 Investing Activities
 Operating assets
 Financial assets

 Operating Activities
 Research & Development, Procurement, Production, Marketing,
and Administration
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Financial Statements Reflect Business Activities

 Balance Sheet

 Income Statement

 Statement of Cash Flows

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Information Beyond Financial Statements

 Management’s Discussion and Analysis (MD&A)

 Management Report
 Auditor Report
 Explanatory Notes
 Supplementary Information
 Proxy Statements

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 Financial Reporting Environment (1)

 Statutory Financial Reports

 Financial statements

 Earnings announcements

 Other statutory reports

 Factors Affecting Statutory Financial Reports

 Generally Accepted Accounting Principles (GAAP), known in

Vietnam as Vietnam Accounting Standard (VAS)

 International Financial Reporting Standards (IFRS)

 Managerial judgments
 Communicate private information through their accounting

choices and estimates.

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 Financial Reporting Environment (2)

 Alternative Information Sources

 Economic, Industry, and Company Information
 Data on economic growth, employment, foreign trade, interest

rates, and currency exchanges; commodity price changes,

industry sales data, changes in competitive position; news of
mergers, acquisitions, divestitures, management changes.
 Voluntary Disclosures
 Help to manage market expectations of company performance

and to reduce the probability of being sued by investors.

 Information Intermediaries
 Analysts, Advisors, Debt rating agencies collect, process,

interpret, and disseminate company information

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 Desirable Qualities and Principles of Accounting Information

 Desirable Qualities of Accounting Information

 Relevance – the capacity of information to affect a decision

 Reliability – the information must be verifiable (confirmable), faithful (reflect

reality), and truthful (unbiased).

 Important Principles of Accounting
 Accrual Accounting – recognize revenues when earned, expenses when incurred

 Accruals and Cash Flows differ primarily because of timing differences in

recognizing cash flow consequences of business activities and events

 Accounting income (or reported income) is based on the concept of accrual

accounting. It is different from economic income.

 Historical Cost - actual transaction values

 Fair Value – current market values (mostly of financial / marketable securities)

 Materiality – information impacting decision making

 Conservatism – disclosing the least optimistic information about uncertain events

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 Relevance and Limitations of Financial Accounting Information

 Relevance of Financial Accounting Information

 There is no comparable substitute of financial accounting
 Research found that earnings and book value (combined) were able to explain
between 50% and 75% of stock price changes (see Exhibit 2.2).

 Limitations of Financial Statement Information

 Three important limitations are with regard to Timeliness, Frequency, Forward-
looking nature of financial accounting information.
 Analyst forecasts, reports, and recommendations are typically alternative
information sources.

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 Accounting analysis (1)

 Accounting analysis - the process of evaluating the extent to which a

company’s accounting numbers reflect economic reality - is an
important precondition for effective financial analysis.
 An analyst identifies and assesses accounting distortions (created by
accrual accounting or managerial discretions) in a company’s financial
statements, and makes necessary adjustments to financial statements
that reduce distortions and make the statements amenable to financial
analysis.
Financial reports better reflect economic reality and meet
specific objective of a particular user

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 Accounting analysis (2)

 Some managers exercise discretion to manage (window-dress) earnings

thereby reducing the quality of financial statements.
 Motivations for earnings management come from contracting incentives,
potential impact on stock price or other incentives such as to reduce
political costs and scrutiny from government.
 Three typical strategies used to manage earnings:
 Managers increase current period income by means of Income Shifting - the
process of managing earnings by moving income from one period to another,
achieved by accelerating or delaying the recognition of revenues or expenses.
 Managers record a Big Bath by markedly reducing current period income (taking
large one-time charges / write-offs such as asset impairments and restructuring
charges).
 Managers reduce earnings volatility by income smoothing (decrease or increase
reported income; for example not reporting a portion of earnings in good years
through creating reserves). 13
 Analysis of Capital Mobilization

 Concept and principle of capital mobilization activities

 Analytical process
 Structure and Characteristics of the funds raised
 Efficiency and Risk of fund mobilization
 Readings: Chapters 3 and 10

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 Capital mobilization sources

 Companies operations are financed by various sources:

 Debt / Liabilities – the funds that a company has explicitly borrowed

from investors.
 Capital (Stockholders’ Equity) – funds representing the claims of

owners (shareholders) on company’s net assets.

 Lease - a contractual agreement between a lessor (owner) and a lessee

(user or renter) that gives the lessee the right to use an asset owned by
the lessor for a specific time period while obligating the lessee to make
a series of payments over the period.
 Off balance sheet transactions, that involves non-recording of financing

obligations.

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Two Types of Liabilities

Obligations that arise from operating activities

Operating
– for example, accounts payable, unearned
Liabilities revenue, advance payments, taxes payable.

Financing Obligations that arise from financing activities

Liabilities – for example, short- and long-term loans,
bonds, notes, leases.

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How are liabilities classified in the financial
statements?

Current (Short-term) Noncurrent (Long-term)

Liabilities Liabilities

Obligations whose Obligations not payable

settlement requires use of within one year or the
current assets or the operating cycle,
incurrence of another whichever is longer.
current liability within one
year or the operating cycle,
whichever is longer.
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 Key characteristics of liabilities

 Terms of indebtedness (such as maturity, interest rate,

payment pattern, and amount).
 Restrictions on deploying resources and pursuing business
activities.
 Ability and flexibility in pursuing further financing.
 Obligations for working capital, debt to equity, and other
financial figures.
 Dilutive conversion features that liabilities are subject to.
 Prohibitions on disbursements such as dividends.
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Basic characteristics of Shareholders’ Equity

Equity refers to owner (shareholder) financing; its usual

characteristics include:
• Reflects claims of owners (shareholders) on net assets
• Equity holders usually subordinate to creditors
• Variation across equity holders on seniority
• Exposed to maximum risk and return

Equity Analysis — involves analyzing equity characteristics,

including:
• Classifying and distinguishing different equity sources
• Examining rights for equity classes and priorities in liquidation
• Evaluating legal restrictions for equity distribution
• Reviewing restrictions on retained earnings distribution
• Assessing terms and provisions of potential equity issuances
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Major elements of Shareholders’ Equity

 Capital stock — two basic components:

• Common (or Ordinary) stock - stock with ownership interest and
bearing ultimate risks and rewards (residual interests) of company
performance
• Preferred stock - stock with features like Dividend distribution
preferences, Liquidation priorities, Convertibility (redemption) into
common stock, Call provisions, Non-voting rights
 Paid in capital
 Treasury stock
 Retained earnings
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Shareholders’ Equity: Retained Earnings

Retained Earnings — earned capital of a company; reflects

accumulation of undistributed earnings or losses since inception;
retained earnings is the main source of dividend distributions

Cash and Stock Dividends

• Cash dividend — distribution of cash (or assets) to shareholders
• Stock dividend — distribution of capital stock to shareholders

Prior Period Adjustments — mainly error corrections of prior periods’

statements

Appropriations of Retained Earnings — reclassifications of retained

earnings for specific purposes

Restrictions (or Covenants) on Retained Earnings — constraints or

requirements on retention of retained earnings
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What are the sources of increases and
decreases in shareholders’ equity?

Sources of increases in capital stock outstanding:

• Issuances of stock
• Conversion of debentures
• Issuances of stock in acquisitions and mergers
• Issuances pursuant to stock options and warrants exercised

Sources of decreases in capital stock outstanding:

• Purchases and retirements of stock
• Stock buybacks
• Reverse stock splits

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 Off-Balance-Sheet Financing

Off-Balance-Sheet Financing is the means by which companies finance the acquisition of

assets without presenting the assets and recording related obligations on the balance sheet.

Motivation
To keep debt off the balance sheet (understate true degree of financial leverage).

Transactions sometimes used as off-balance-sheet financing:

• Many long-term leases are accounted as operating leases (so as to make these
indistinguishable from capital leases and thus not shown on the balance sheet)
• Unfunded pension liabilities: firms cut contributions for some years to save cash
• Certain joint ventures and limited partnerships, in which each company reports only its share
of investment, and none of the debt
• Product financing arrangements, where a company sells and agrees to repurchase; earnings
are improved and debt kept off balance sheet
• Sell receivables with recourse and record them as sales rather than liabilities
• Sell receivables as backing for debt sold to the public

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Tools to assess liquidity and solvency

 Liquidity analysis aimed at company’s operating activities,

its ability to generate profits from sale of products &
services, and convert assets into cash or to obtain cash to
meet short-term obligations. Working capital (the excess of
current assets over current liabilities) is a widely used
measure to assess liquidity risk.
 Solvency analysis aimed at company’s long-run financial
viability and its ability to cover long-term obligations.

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 Liquidity ratios

Current assets
Current ratio =
Current liabilities

Current assets – Inventory

Quick ratio =
Current liabilities

Cash and Cash Equivalents

Cash ratio =
Current liabilities
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 Current Ratio - Applications

 Comparative Analysis
 Trend analysis

 Ratio Management (window dressing)

 Toward close of a period, management will occasionally press the
collection of receivables, reduce inventory below normal levels, and
delay normal purchases.
 Rule of Thumb Analysis (2:1)
 Current ratio above 2:1 - superior coverage of current liabilities

 Current ratio below 2:1 - deficient coverage of current liabilities

 Note of caution
 Quality of current assets and the composition of current liabilities
are more important in evaluating the current ratio.
 Working capital requirements vary with industry conditions.
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 Solvency ratios

 Solvency — long-run financial viability and its ability to cover

long-term obligations.
 When the proportion of debt financing is higher, the higher
are the resulting fixed charges and repayment commitments
 Total Debt Ratio
 Total Debt to Equity Capital
 Long-term Debt to Equity Capital

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 Exercise

 Identify Vingroup’s capital mobilization sources in 2023.

 Estimate long-term and short-term debt financing
percentages.
 Did the company issue new debt and equity in last few
years? Was there any change in the number of
outstanding shares?
 Are their protections to creditors?
 Do you think the company has any liquidity or solvency
problem?

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