Principles of Managerial Finance Brief Edition

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Principles of Managerial FinanceBrief Edition

• Chapter 5

Financial Statement Analysis
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Learning Objectives

• Understand the parties interested in performing
  financial ratio analysis and the common types of
  ratio comparisons.
• Describe some of the cautions that should be
  considered in performing financial ratio
  analysis.
• Use popular ratios to analyze a firms liquidity
  and the activity of inventory, accounts
  receivable, accounts payable, and total assets.

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Learning Objectives

• Discuss the relationship between debt and
  financial leverage and the ratios that can be
  used to assess the firms degree of indebtedness
  and its ability to meet interest payments
  associated with debt.
• Evaluate a firms profitability relative to its
  sales, asset investment, and owners equity
  investment.
• Use the DuPont system and a summary of financial
  ratios to perform a complete ratio analysis.

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Using Financial Ratios
Interested Parties

• Ratio analysis involves methods of calculating
  and interpreting financial ratios to assess a
  firms financial condition and performance.
• It is of interest to shareholders, creditors, and
  the firms own management.

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Using Financial Ratios
Types of Ratio Comparisons

• Trend or time-series analysis

Used to evaluate a firms performance over time
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Using Financial Ratios
Types of Ratio Comparisons

• Trend or time-series analysis
• cross-sectional analysis

Used to compare different firms at the same point
in time
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Using Financial Ratios
Types of Ratio Comparisons

• Trend or time-series analysis
• cross-sectional analysis
• industry comparative analysis

One specific type of cross sectional analysis.
Used to compare one firms financial performance
to the industrys average performance
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Using Financial Ratios
Types of Ratio Comparisons

• Trend or time-series analysis
• cross-sectional analysis
• industry comparative analysis
• Combined Analysis

Combined analysis simply uses a combination of
both time series analysis and cross-sectional
analysis
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Using Financial Ratios
Cautions for Doing Ratio Analysis

• Ratios must be considered together a single
  ratio by itself means relatively little.
• Financial statements that are being compared
  should be dated at the same point in time.
• Use audited financial statements when possible.
• The financial data being compared should have
  been developed in the same way.
• Be wary of inflation distortions.

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Ratio Analysis Example
Alco Company
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Ratio Analysis

• Liquidity Ratios
• Current Ratio

Current ratio total current assets
total current liabilities
1998 1999 2000 2.04 2.08 1.97
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Ratio Analysis

• Liquidity Ratios
• Current Ratio
• Quick Ratio

Quick ratio Total Current Assets -
Inventory total current
liabilities
1998 1999 2000 1.32 1.46 1.51
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Inventory Turnover

Inventory Turnover Cost of Goods Sold
Inventory
1998 1999 2000 5.10 5.70
7.20
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Average Collection Period

ACP Accounts Receivable Net
Sales/365
1998 1999 2000 43.90 51.20
58.90
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Average Payment Period

APP Accounts Payable Cost of Goods
Sold/365
1998 1999 2000 75.8 81.2
94.1
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Total Asset Turnover

Total Asset Turnover Net Sales
Total Assets
1998 1999 2000 .94 .79 .85
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios

• Financial Leverage Ratios
• Total Debt to Total Assets Ratio

TD/TA Ratio Total Debt/Total Assets
1998 1999 2000 36.8 44.3 45.7
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
• Times Interest Earned Ratio

Times Interest Earned EBIT/Interest
1998 1999 2000 5.3 6.0 6.7
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Leverage Ratios

• Profitability Ratios
• Common-Size Income Statements

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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Leverage Ratios

• Profitability Ratios
• Gross Profit Margin

GPM Gross Profit/Net Sales
1998 1999 2000 31.4 33.3 32.1
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
• Profitability Ratios
• Operating Profit Margin

OPM EBIT/Net Sales
1998 1999 2000 14.6 11.8 13.6
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
• Profitability Ratios
• Net Profit Margin

NPM Net Income/Net Sales
1998 1999 2000 8.8 5.8 7.5
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Leverage Ratios
• Profitability Ratios
• Return on Total Assets

ROA Net Income/Total Assets
1998 1999 2000 8.3 4.5 6.4
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Ratio Analysis

• Liquidity Ratios
• Activity Ratios
• Leverage Ratios

• Profitability Ratios
• Return on Equity

ROE Net Income/Stockholders Equity
1998 1999 2000 13.1 8.1 11.8
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DuPont System of Analysis

• The DuPont system is used to dissect the firms
  financial statements and to assess its financial
  condition.
• It merges the income statement and balance sheet
  into two summary measures of profitability ROA
  and ROE as shown in figure 5.2 on the following
  slide.
• The top portion focuses on the income statement,
  and the bottom focuses on the balance sheet.
• The advantage of the DuPont system is that it
  allows you to break ROE into a profit on sales
  component, an efficiency-of-asset-use component,
  and a use-of- leverage component.

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Summarizing All Ratios
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Summarizing All Ratios