Financial Analysis

1
Chapter 3

• Financial Analysis

2
Chapter 3 - Outline

• Financial Analysis
• 4 Categories of Financial Ratios
• Importance of Ratios
• Inflation and its Impact on Profits

3
Financial Analysis and Ratios

• What is financial analysis?
• Evaluating a firms financial performance
• Analyzing ratios or numerical calculations
• Comparing a company to its industry

4
4 Categories of Ratios

• Profitability Ratios
• Asset Utilization Ratios
• Liquidity Ratios
• Debt Utilization Ratios

5
Classification System

• We will separate 13 significant ratios into four
  primary categories.
• A. Profitability Ratios.
• 1. Profit margin.
• 2. Return on assets (investment).
• 3. Return on equity.
• B. Asset utilization ratios.
• 4. Receivable turnover.
• 5. Average collection period.
• 6. Inventory turnover.
• 7. Fixed asset turnover.
• 8. Total asset turnover.
• C. Liquidity ratios.
• 9. Current ratio.
• 10. Quick ratio.
• D. Debt utilization ratios.
• 11. Debt to total assets.
• 12. Times interest earned.
• 13. Fixed charge coverage.

6
TABLE 3-1 Financial statementfor ratio analysis
7
Profitability Ratios

• Show how profitable a company is.
• The ratios express
• Profit Margin or Return on Sales ()
• Return on Assets or Return on Investment ()
• Return on Equity ()

8
Profitability Ratios

• Saxton Company Industry Average
• 1. Profit margin 5 6.7
• 2. Return on assets (investment)
• a. 12.5 10
• b. 5 ? 2.5 12.5 6.7 ? 1.5 10
• 3. Return on equity
• a. 20 15
• b. 20 15

?
9
FIGURE 3-1 Du Pont analysis
10
Return of Wal-Mart versus Macys using the Du
Pont method of analysis, 2007
11
Asset Utilization Ratios

• Show how effectively a company uses its assets.
• The ratios express
• Receivables Turnover (times)
• Average Collection Period (days)
• Inventory Turnover (times)
• Fixed Asset Turnover (times)
• Total Asset Turnover (times)

12
Asset Utilization Ratios
Saxton Company Industry
Average 4. Receivables turnover
11.4 10 times 5. Average
collection period 32 36 days 6.
Inventory turnover 10.8 7 times
Accounts receivable Average daily credit sales
13
Asset Utilization Ratios
Saxton Company Industry Average 7. Fixed
asset turnover 5 5.4
times 8. Total asset turnover 2.5
1.5 times
14
Profitability and Turnover Ratios

• Remember
• Return on X Net Income / X
• X Turnover Sales / X

15
Liquidity Ratios

• Show how liquid a company is or how much it has
  to meet S/T needs.
• The ratios express
• Current Ratio (times)
• Quick Ratio or Acid-Test Ratio (times)

16
Liquidity Ratios

• 
  Saxton Company Industry Average
• 9. Current ratio
• 2.67 2.1
• 10. Quick ratio
• 1.43 1.0

Current assets Current liabilities
800,000 300,000
Current assets - Inventory Current liabilities
430,000 300,000
17
Debt Utilization Ratios

• Show how well a company is managing or using
  debt.
• The ratios express
• Debt-to-Total Assets ()
• Times Interest Earned (times)
• Fixed Charge Coverage (times) (Fixed Charges
  lease payments, i expense)

18
Debt Utilization Ratios
Saxton Company Industry Average 11. Debt
to total asets
37.5 33 12. Times interest earned
11 7 times 13. Fixed charge coverage
6 5.5 times
600,000 1,600,000
550,000 50,000
600,000 100,000
19
TABLE 3-3 Ratio analysis
20
FIGURE 3-2 Trend analysis
21
Trend Analysis in the Computer Industry
22
TABLE 3-7 Comparison of replacementcost
accounting and historicalcost accounting
23
Inflations Impact on Profits

• FIFO (First-In, First-Out) Inventory
• Lowers COGS
• Raises Profits
• LIFO (Last-In, First-Out) Inventory
• Raises COGS
• Lowers Profits

24
Importance of Ratios

• Which ratio is most important?
• It depends on your perspective.
• Suppliers and banks (lenders) are most interested
  in liquidity ratios.
• Stockholders are most interested in profitability
  ratios.
• A long-run trend analysis over a 5-10 year period
  is usually performed by an analyst.