Analysis of Financial Statements

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Chapter 4

• Analysis of Financial Statements

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Learning Objectives

• Measure and interpret financial ratios.
• Analyze trends in financial ratios.
• Manipulate financial ratios to find another ratio.

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Ratio Analysis

• Examines firms management of various facets of
  the companys business through its financial
  statements.
• Scales balance sheet and income statement
  information for easy comparison across time or to
  other companies.

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Two common approaches

• Trend Analysis - looks at changes in one
  companys ratios over time.
• Benchmarking Comparison or Industry Analysis -
  compares companys ratios against a similar
  company or against industry-wide ratios.
• To illustrate trend analysis, we will compare
  Best Buys Feb. 2006 and Feb. 2005 ratios.
• To illustrate benchmarking, we will calculate
  Best Buys Feb. 2006 ratios and will compare to
  Circuit Citys Feb. 2006 ratios.

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Areas Examined by Ratio Analysis

• Liquidity - measures the ability to meet
  short-term obligations
• Asset Management - measures the ability to
  contain the growth of assets, and the ability to
  effectively utilize assets
• Debt Management - measures the use of financial
  leverage (debt) and its impact
• Profitability - measures the profitability of
  various segments of a company

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Liquidity Ratios
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Asset Management Ratios
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Asset Management (Continued)
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Debt Management Ratios
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Profitability Ratios
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Profitability Ratios (Continued)
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Breaking Down ROE DuPont Equation

• ROE(NI/Eq) Return on Assets (NI/TA) x Equity
  Multiplier (TA/Eq)
• ROE Profit Margin on Sales (NI/S) x Total Asset
  Turnover (S/TA) x TA/Eq
• Profit margin is a measure of the firms
  operating efficiency how well does it control
  costs
• Total asset turnover is a measure of the firms
  asset use efficiency how well does it manage
  its assets
• Equity multiplier is a measure of the firms
  financial leverage

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DuPont Equation Best Buy vs. Circuit City

• Since Assets Liabilities Equity, 1 debt
  ratio equity/assets meaning for Circuit City

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Circuit City ROE Catch-up?

• Circuit City would like to improve their ROE to
  15. They anticipate improvement in profit
  margin and total asset turnover to 2.0 and 3.0
  respectively. What total debt to total asset
  ratio would be needed to achieve Circuit Citys
  ROE goal?

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Some DuPont ROE Comparisons
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Market Ratios
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Market Ratios