Week 2 Housekeeping

Quiz open – MyFinanceLab
(opened Wed noon, close Wed 2 weeks later 11:59pm

Journal entry open – LMS
(opened Sunday midnight closes 5‐days later Friday 11:59pm

Lecture 02
Financial Statement Analysis
• Reporting to investors
• Standards: e.g. IFRS, GAAP
• Balance Sheet, Income Statement & Statement of Cash Flows
• Book Values vs. Market Values
• Selection of Financial Ratios
• Valuation principle, Law of one price, Time Value of Money

Chapter 2 & 3:
Intro. to Financial Statement Analysis
Paul Gerrans Intro to Time Value of Money
 Lecture 02
Financial
Statement
• Reporting to investors Analysis
• Standards: e.g. IFRS, GAAP
• Balance Sheet, Income Statement & Statement of Cash Flows
Chapter 2 & 3:
• Book Values vs. Market Values
Intro. to Financial Statement Analysis
• Selection of Financial Ratios Intro to Time Value of Money
• Valuation principle, Law of one price, Time Value of Money
/www.sciencealert.com/this‐is‐what‐the‐covid‐19‐virus‐looks‐like‐under‐electron‐microscopes

Things to have at the back of your mind:

Value Relevance

How does this relate to firm’s objective

Dimensions of information
- historical (past)
-“new”
- Commonwealth Bank vs Commschoice
$129.6 billion                                                         $0.012 billion
 H5N1 avian flu
EttaF 7GET

Source: https://actuaries.asn.au/Library/fsf06_paper_stitt_pandemic.pdf

Could we have identified organisations who were more

75,5k t susceptible to a COVID like event? m

Loss of $315 million … 7th in a row
Qantas Profit $891m  … 5th in a row
Industry with low profit margin (Qantas 4‐6%)
Net operating expenditure  $5,961.7 million (inc. $1,178m fuel)
Net finance costs $160.7 million 
Qantas $16,516m (inc. $3,846m fuel) expenditure
Qantas $185m finance costs
Current liabilities of $3,237m (in $1,263m unearned revenue)
Qantas $8,576m ($4,315m) current liabilities
Cash & equivalents $1,310m (after bond pmt) in current assets of $2,165m
Qantas $2,157m in current assets of $4,193m

So if Virgin lost revenue, can cover ~ 3 mths operating. expenses (exc. fuel)
Qantas ~ 2mths

Was that enough? For “a” 2020 looking like 2019?
UWA Annual Report 2018

TETE ikhaDHEHB.ee
m

2018 Annual report  

$938m Income from Continuing Operations. 
$150m  onshore overseas student fees
$909m  Expenses including ($538m employees)
UWA 2030 – doesn’t mention risk
https://www.uwa.edu.au/uwa2030/‐/media/UWA2030/Docs/UWA‐2030‐Full‐Report.pdf
https://www.annualreport.uwa.edu.au/__data/assets/pdf_file/0008/3399200/Annual‐Report‐2018‐Booklet‐281119.pdf

“Prudent liquidity risk management        
includes the continuing availability of 
Commonwealth maintaining sufficient cash &           
marketable securities to meet short term” p.103
The Group and the parent entity held 
Cash & cash equivalents of $208m and $128m  12/2018 … 
that are expected to readily generate cash inflows for 
managing liquidity risk” p.103
$808 mill. income international students 2018 (onshore)
$2.2b expenses from operations ($1.2b salaries)
The outbreak of COVID-19 is expected to have a significant
impact on the financial result and liquidity … in 2020 and
possibly into 2021 and further. p.140 2019 Annual Report 6/2020
https://www.unsw.edu.au/sites/default/files/uploads/UNSW%20Annual%20Report%2020
18%20170120.pdf
 Mr
254246117 Hq

Source: https://www.afr.com/work‐and‐careers/education/unsw‐to‐cut‐7pc‐of‐staff‐20200715‐p55c6e

Lawn Tennis Association Limited

O
Since SARS in 2002/03
paid £1.5m a year for 17 years for an event that didn’t happen

… Now will receive ~ £114 million from cancellation due to COVID

Source: https://www.lta.org.uk/globalassets/about‐lta/annual‐reports/lta‐annual‐report‐2018.pdf; 
https://www.insurancetimes.co.uk/news/wimbledon‐boss‐confirms‐the‐championship‐will‐not‐have‐
pandemic‐insurance‐in‐2021/1433726.article https://www.theage.com.au/sport/tennis/next‐year‐s‐au
 Etan FETE'S
Timing is important.
9 BE
Tennis Australia also bought a similar insurance coverage.
iikTFIz.BRFq
BUT …it expires in 2020 … without an option for renewal

and  … Australian Open is Jan 2021 

https://www.news.com.au/sport/tennis/australian‐open‐loses‐millions‐in‐coronavirus‐
pandemic‐insurance‐technicality/news‐story/09518ae055df00323d39c45604ff8810

Learning Objectives
1. Identify the role of public corporations major financial statements
2. Contrast book and market values and assess their relevance
3. Compute and interpret profitability, liquidity, efficiency ratios
4. Distinguish between income and cash flow and relevance to
investment decisions and investors
5. Assess the value relevance of these financial statements
Change gear
6. Valuation principle, one-price, TVM
Note1:   The lecture isn’t providing comprehensive statement analysis 
More a perspective on the form, use, interpretation of 
key types of information. Start to build some judgment
Note2 : You are provided with ratios when needed (i.e. Mid‐Sem). So 
calculation & interpretation both relevant.
Note3:  I supplement with examples from BHP using BHP’s Annual 
Statements. These have far more detail than text  example 
(Global Ltd.). Your expected level of detail is text’s Global example.
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2
Financial Statements

Financial statements are accounting reports issued periodically to

present past performance and a snapshot of the firm’s assets and
the financing of those assets.

Publicly available investors at expected times in expected format

Voraciously consumed: financial analysts, managers, creditors rely

on financial statements to obtain reliable information about a
corporation.

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Firms’ Disclosure of Financial Information

Listed public companies must file financial results with the

Australian Securities Exchange (ASX):
https://www.asx.com.au/documents/rules/Chapter04.pdf
https://asic.gov.au/regulatory-resources/financial-reporting-and-audit/preparers-of-financial-
reports/lodgement-of-financial-reports/
• on a quarterly basis (4C) – Listing Rule – cash flows, non-
cash financing and investment activities, loan facilities etc.
• on a half-yearly basis (4D), and
• an annual basis (4E).
Annual report with financial statements must be sent to their
shareholders every year.

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Source: https://www.asx.com.au/listings/listing-with-asx/listing-requirements.htm

Financial Statements

The four financial statements required by the ASX are:

• Balance Sheet
• Income Statement
• Statement of Cash Flows
• Statement of Shareholders’ Equity
Advantages as an information source
• Reliability
– Audited to increase credibility
– Subject to regulatory oversight – ‘true & fair’ view
• Easily available at small cost
– Regular filing with regulators and stock exchanges
Ultimately though, they must be value relevant

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 Financial Statements
Disadvantages as an information source
• Timeliness (past oriented data)
– BUT – continuous disclosure requirements (at least in Aust.
varies by country, e.g. U.S.)
– Amended in Australia due to COVID
https://www.allens.com.au/insights-news/insights/2020/05/treasurer-amends-
continuous-disclosure-laws-during-covid/

• IFRS, GAAP
– Different accounting standards in different countries
• Conflicts in & of interest
– Shareholders vs. lenders
– Management vs. shareholders

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Accounting Standards
Long history: from professional bodies to law (Corp. Act)
- (for interest see Australian Accounting Standards Board
https://www.aasb.gov.au/About-the-AASB/For-students.aspx#qa1445)

AASB standards include Australian equivalents to

International Financial Reporting Standards (IFRSs) and
applies to “reporting entity” (different tiers)
Generally Accepted Accounting Principles (GAAP):
• Set by the Financial Accounting Standards Board (FASB)
to provide common set of rules and a standard format
Corporations are required to hire an auditor to:
– check annual statements, ensure prepared according to AASB
– provide evidence that the information is reliable.
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 Standards change

BHP Annual Report 2019

Balance Sheet – Statement of Financial Position

A snapshot in time of the firm’s financial position.

The Balance Sheet Identity:

Assets = Liabilities + Shareholders’ equity
Assets
• What the company owns (controls)
• Anything that has value.

Liabilities
• What the company owes
• Anything that costs a company money.

Shareholder’s Equity
• The difference between the value of the firm’s assets and liabilities

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Australia
Balance Sheet (current < 1 year)
Current Assets Current Liabilities
• Cash or expected to be turned • Due to be paid within 1 year
into cash in next year

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Balance Sheet (non-current > 1 year)

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 Balance Sheet (non-current > 1 year)

Longer term debt

We can “repackage” information Net Working Capital (NWC)

Capital available in the short term to run the business
Working capital = Current assets – Current liabilities

Low (or negative) net

working capital suggests
Notes comment on possible shortage - unless
*
“quality” of these assets generate cash from their
e.g. likely non‐payment of customer ongoing activities.
How much owed by top 10 (34%)

You use this later:

changes in NWC in
capital budgeting
topic

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Some entries are “inventions” - Depreciation
E.g. Depreciation is a way to recognise loss/reduction in value of non-current
assets (other than land) - wear & tear, obsolescence
• depreciation schedules linked to asset’s life span.
“Invention” in that it is expense that isn’t paid out – no actual cash
• Balance Sheet: BV is acquisition cost - accumulated depreciation.
• Income Statement: depreciation over year - operating expense.
• In Statement of Cash Flows: depreciation added back to income to
estimate the total cash from operating activities.

BUT – depreciation leads to cash flow: reduction in tax

payable. Come back in capital budgeting topic

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Balance Sheet
Shareholder’sEquity: Assets – Liabilities
• Book Value of Equity
– Net worth from accounting perspective
– But remember historical costs, other missing value

Market Value of Equity (Market Capitalization)

– Market Price per Share x Number of Shares Outstanding
– Can (and normally does) differs substantially from book
value
– MV looks ahead, considers risks and return
– BV looks back
(Issues: non-traded shares, management options, convertibles)

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 Source: https://www.forbes.com/profile/jeff‐bezos/#2147a1cd1b23
Source: https://www.forbes.com/real‐time‐billionaires/#78b918213d78

As at 15 July 2020

Enterprise Value
Enterprise value (EV, total enterprise value TEV)
assesses value of the underlying business assets, unencumbered by
debt and separate from any cash and marketable securities.

Enterprise Value = Market Value of Equity Debt Cash

Interpretation - minimum you would pay to buy a company outright

?  Some ratios for financial institutions don’t quite make sense  
Market Value $129b             Enterprise Value $295b 
EV assumes Debt is source of capital – For Banks, raw material?

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 Repackaging Balance Sheet Data

We can learn a great deal from a firm’s balance sheet to assess:

• Leverage: relative use of debt
• Liquidity: capability to meet obligations
• Efficiency: how assets are being “used”
• Profitability/Return: what are we “producing” – including
profit, return to shareholder

We can make lots of comparisons to summarise information

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Leverage: Debt-Equity Ratio March 2020

Debt-equityratio:
Record loan borrowings 
• Common ratio used to assess
of $47.0b
a firm’s leverage.
Total Debt
Debt-Equity Ratio
Total Equity
Non‐financial corporations transactions in  Non‐financial corporations ‐ Debt to equity ratio
loan liability & deposit asset 

https://www.abs.gov.au/AUSSTATS/abs@.nsf/7d12b0f6763c78caca257061001cc588/2cb7ab1e6496f4c4ca257db10016379c!OpenDocument
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 Leverage: Debt-Equity Ratio March 2020
Debt-equityratio: Record loan borrowings 
• Common ratio used to assess of $47.0b
a firm’s leverage.
Total Debt
Debt-Equity Ratio
Total Equity

________=

Source: https://www.macrotrends.net/stocks/stock‐comparison?s=debt‐equity‐ratio&axis=single&comp=FSUGY:BHP:RIO:WMT

Liquidity
Is the company “liquid” enough to meet its obligations

We previously looked net working capital: can do similar as ratio

Current ratio: Liquidity Ratio
Current assets to current liabilities.

________=

Quick ratio: Liquidity ratio
More “liquid” current assets. Take out receivables 

________=

32
Statement of Financial Performance: Income Statement

Flow of revenues & expenses generated by firm over period (e.g. year)
• A.k.a ‘profit & loss statement’ (P&L) statement
• Best guide to the future? Today?

Revenue – Expenses: Net profit (loss), firm’s earnings

• primary measure of its profitability during the period

Profitability Ratios
Operating Profit Profit from operating
Operating Margin Before interest, tax
Total Sales
Net Profit
Net Profit Margin
Total Sales
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OM = ________=

NPM = ________=
(b/tax)

NPM =   ________=
(a/tax)  
 Return ratios*
Return on Equity (ROE) and Return on Asset (ROA)

Return on Equity (ROE)

• Evaluating “return" by comparing net profit to “equity"
Return on Equity = Net Profit/Book Value of Equity (Ave Equity)

Return on Assets (ROA)

• Evaluating “return" by comparing net profit to “assets"

Return on Assets = Net Profit/Total Assets

* These will be referred to in later topics
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ROA =     ________=

ROE =   ________=

ROE =  ________=
Statement of Financial Performance: Income Statement

Can also describe what this (earnings) represents for shareholders

Net Income/Profit
Earnings Per Share: EPS
Number of Shares Outstanding

“Diluted” EPS - make adjustment for “potential” shares (e.g.

management have share options, some debt can be converted to shares)

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EPS = ________=
 Efficiency – what can they do with what is available?

Asset turnover
AT = ________=

Fixed Asset turnover (focus on selected assets)

Accounts receivable days – how long is it taking to collect on sales?

ARD= ________=

39

Another way to view earnings

Valuation Ratio: Price-Earnings Ratio
• What are you buying? What multiple of earnings paid?
PE =   36.75 = 16.5
1.6*1.388

152.48
32.32 10.1

Can be interpreted as under/over pricing

Source: https://www.marketindex.com.au/statistics The University of Western Australia 40

 A curious thing
PE =   36.75 = 16.5
1.6*1.388

BHP  has a “dual listing” ‐ BHP Group Ltd.   BHP Group Plc
Can buy same entitlements on ASX in $AUD  or LSE in £ 
(also can buy BHP (Plc) on JSE & American Depository Receipts ‐ NYSE)

Using the ASX or LSE should give the same? 
No. The price of buying a share on ASX & LSE (after convert  
to same currency) more expensive. Surprising?

Are there Unicorns in financial markets?

Law of One Price
in efficient financial markets two assets with
identical cash flows must trade at the same price
Arbitrage
“simultaneous purchase and sale of equivalent securities in 
two different markets in order to profit from discrepancies in 
their price relationship” (Bodie, Kane and Marcus, 2002).

So why have BHP shares traded at a premium (up to 40% 
more) on the ASX than on the LSE? Why  shouldn’t this exist?
• Currency? Franking credits? Index effects?
Bedi, J., Richards , A. and Tennant, P. (2003). "The Characteristics and Trading Behaviour of Dual‐listed Companies," RBA Research Discussion 
Papers rdp2003‐06, Reserve Bank of Australia. Available from https://www.rba.gov.au/publications/rdp/2003/pdf/rdp2003‐06.pdf 
Grossman, S.J. and Stiglitz, J.E. (1976), "Information and Competitive Price Systems," American Economic Review, 66, 246‐‐252.
Grossman, S.J. and Stiglitz, J.E. (1980), "On the Impossibility of Informationally Efficient Markets," American Economic Review, 70, 393‐‐407.
https://www.pinterest.com.au/pin/401735229233898230/
Market-to-Book Ratio
(aka Price-to-Book Ratio & Book-to-Market)
Market Value of Equity
Market-to-Book Ratio
Book Value of Equity
M/B
– Growth stocks 20.6
–High M/B ratios or Which is Apple’s & 
Low B/M BlueScope Steel’s?
0.9 
–Value stocks
–Low M/B ratios or
High B/M
–
This turns out to be a “risk factor” that can explain
stock returns – come back to in Portfolio Theory
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Statement of Cash Flows

Net Income isn’t (typically) the same as cash
• Income includes non-cash expenses:
• e.g. Depreciation
• Some transaction don’t show in Income Statement
• e.g. Investment/Sale of Property
Statement of cash flows reconstructs information from
income statement & balance sheet to determine:
• cash the firm has generated
• how cash has been allocated
Cash is fundamental
• Pays the bills & source of investors' return
Operating, Investing, Financing Activity sections

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 Financial Ratios and Shareholder Value

Shareholder 
Value

Investment  Financing 
Decisions Decisions

Efficiency  Profitability  Leverage  Liquidity 

Ratios Return Ratios Ratios Ratios

Shareholder value depends on good

investment & financing decisions.

8/2/2020

DuPont Identity

DuPontIdentity:
• The final expression says that ROE is equal to:
• net profit per dollar of sales (profit margin) times
• sales per dollar of assets (asset turnover) times
• assets per dollar of equity (a measure of leverage called the
equity multiplier).

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 Caution when interpreting financial ratios

When comparing ratios be very certain that they have been calculated
using the same definitions or classifications.
• E.g., ending versus average values

Ratios only take on meaning when compared to some norm or

standard. Selecting acceptable benchmark important – many candidates

Ratio analysis does not provide all the answers, hopefully provokes
questions

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So … the story so far

• Goal of corporation
• Maximize shareholder wealth 

• Investment decision
• Choose investments
• Which are expected to increase wealth
• Expected benefits exceed expected costs
• Starting point are the market prices (valuation 
principle)
• Practical issue 
• Invest today and get return later
• Must adjust for time value of money (TVM)

8/2/2020
Interest Rates and the Time Value of Money
Time Value of Money
Investment opportunity provides the following certain cash flows.
Cost: $100,000 today
Benefit: “guaranteed” $105,000 in one year
We need a reward for investing? How much is enough?
Rewarded for inflation, impatience, “risk”

The Interest Rate: An Exchange Rate Across Time

Suppose you had another opportunity for 7%, also no risk
Can exchange $1 today (present value) for $1.07 in 1‐yr (future value)
We compound (multiply) at (1 + rf) to move from PV to FV
We discount (divide ) by (1 + rf) to move from FV to PV (multiple by )

Back to our investment opportunity, doesn’t seem worth it
At a minimum we need better than ___________________as a FV
Alternatively the price of the opportunity should be _____________ $
 Combining Multiple Values
What if we received $108,000 but it was split
$50,000 in one years time, $58,000 in two years time
A timeline helps clarify when each cash flow occurs

$50,000
$46,729
1.07
$58,000
1.07
___________ $50,659
1.07 $68,000
Sum 1.07
Still not worth it! We’d be going backwards! Now worth it! 

Netting out our cost, our Net Present Value Net Present Value

=  8/2/2020 = 
Net Present Value is a useful guide – will return to