Financial Statement Analysis

1
CHAPTER
18
FINANCIAL STATEMENT ANALYSIS Group Presentation
will be either Dec 17 (Wed) or Dec 18 (Thur)
2
Ratio Analysis

• Ratio Analysis expresses the relationships
  between selected financial statement items.
• There are 3 types of ratio analysis
• Liquidity Ratios Measure short-term ability of
  the enterprise to pay its debts and to meet
  unexpected needs for cash.
• Solvency ratios Measure the ability of the
  enter prise to survive over a long period of
  time.
• Profitability ratios Measure the income or
  operating success of an enterprise for a given
  period of time.

3
Liquidity Ratio

• It measures short-term ability of the enterprise
  to pay its debts and to meet unexpected needs for
  cash.
• Who would be interested in finding out liquidity
  ratio of a company?
• Investors, bankers, suppliers, creditors, owners,
  potential buyers

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LIQUIDITY RATIOS

• Working Capital ratio
• Current ratio
• Acid test ratio
• Cash current debt coverage ratio
• Receivables turnover
• Collection period
• Inventory turnover
• Days sales in inventory

5
Working Capital Ratio

• Current assets cash, accounts receivable,
  inventory, marketable securities, prepaid
  expenses and other liquid assets that can be
  readily converted to cash in one year
• Working capital Current Assets Current
  Liabilities
• It shows a companys ability to pay its short
  term debts.
• Example 1 Samsung
• WC 368842 249428 119,414
• Example 2 Apple
• WC 249428 368842 -119,414
• Which company is in better situation?

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CURRENT RATIO

• Measures short-term debt-paying ability

(Discussed in Chapter 4)
7
Current Ratio

• Current Ratio is more useful than working capital
  ratio because it is difficult to compare absolute
  dollar amounts by themselves.
• For example CA 368,842, CL 249,428 then
  current ratio 368,842 / 249,428 1.48
• This means that this company has 1.48 of current
  assets for every dollar of current liabilities.
• Generally speaking higher current ratio indicates
  better liquidity.

8
Current Ratio

• What is a normal current ratio number?
• It depends on the company and the industry, but
  it should be minimum of 1.
• The higher the better it is.
• Ratios should never be interpreted without
  considering certain factors such as
• The ratio should be compared to the ratios for
  other companies in the same or related industries
• Other specific financial information over time
  needs to be consdiered.

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ACID TEST RATIO

• Measures immediate short-term debt-paying ability

Acid test ratio Cash temporary investments
net receivables Current liabilities
(Discussed in Chapter 9)
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Acid Test Ratio

• This ratio is similar to Current Asset Ratio
  except that the numerator does not include
  inventory.
• Numerator current assets - inventory
• A strict indicator that determines whether a firm
  has enough short-term assets to cover its
  immediate liabilities without selling inventory.
  The acid-test ratio is far more strict than the
  working capital ratio, primarily because the
  working capital ratio allows for the inclusion of
  inventory assets. 

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ACCOUNTS RECEIVABLE TURNOVER RATIO

• The ratio used to assess the liquidity of the
  receivables is the receivables turnover ratio.
• This ratio measures the number of times, on
  average, that receivables are collected during
  the period.
• Unfortunatelly, companies rarely report the
  amount of net sales made on credit in their
  financial statements.

Net Credit Average Net Receivables Sales
Receivables Turnover
?

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ACCOUNTS RECEIVABLE TURNOVER RATIO

• As a result, net sales (which includes both cash
  and credit sales) is used as a substitute for Net
  Credit Sales number in the formula.
• In addition, some companies do not report gross
  accounts receivable, so net accounts receivable
  must be used.
• As long as we use same numerator and denominator
  for this ratio (year over year or company over
  company), we can use this ratio.

O
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ACCOUNTS RECEIVABLE TURNOVER RATIO

• Lets do BE8.15 (P436) together.
• 23.96 times (or 24 times) indicates that they
  collected AR 24 times a year.
• If the term they allow for AR is 2,10, net 30
  then you can safely assume that AR Collection
  employees are doing a decent job.
• Only when you compare this number either year
  over year or with competitors AR Turnover ratio
  then we can see that AR collection employees are
  doing a good job or bad job.

O
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COLLECTION PERIOD

• Measures number of days receivables are
  outstanding

(Discussed in Chapter 9)
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COLLECTION PERIOD

• The collection period (in days) is a variant of
  the receivables turnover ratio and makes
  liquidity even more evident.
• The general rule is that the collection period
  should not exceed the credit term period. (such
  as 30 days)

16
Collection Period

• From previous example, the collection period
• 365 days / 23.96 times 15.2 days
• It takes them 15.2 days to collect their AR which
  is shorter than their 30 days credit policy. AR
  collection employees are doing a decent job.
• Both receivables turnover and collection period
  are useful for judging how efficiently a company
  converts its credit sales to cash.
• These measures should be compared to industry
  average number and to previous years number.

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INVENTORY TURNOVER

• Measures liquidity of inventory

(Discussed in Chapter 5)
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Inventory Turnover

• Inventory Turnover ratio measures the number of
  times, on average, inventory is sold during the
  period.
• It is calculated by dividing the cost of goods
  sold by average inventory.
• Inventory Turnover COGS / AI
• AI Average Inventory (BB EB)/2
• Generally speaking, the more times (the higher it
  is) that inventory turns over each year, the more
  efficiently sales are being made.

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DAYS SALES IN INVENTORY

• Measures number of days inventory is on hand

(Discussed in Chapter 5)
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Days Sales in Inventory

• The inventory turnover ratio is complemented by
  the days sales in inventory ratio.
• It converts the inventory turnover ratio into a
  measure of the average age of the inventory on
  hand.
• DSI 365 days / Inventory Turnover
• DSI Days Sales in Inventory

21
Days Sales in Inventory

• Lets say Inventory Turnover 2.7 then what is
  the days sales in inventory?
• DSI 365 days / 2.7 135 days
• What does this 135 days mean?
• It means that it takes 135 days to sell their
  product since purchase date.
• This ratio should be compared to the companys
  ratio in previous years and the industry average.
  
• However, this average number will be different
  for each type of inventory item.

22
Classwork / Homework

• P959 E18.6, E18.7, E18.11(A)
• December 17 (Wed)
• Anne, Xenia, Maryam (Tim Horton) 35 min
• Stefan, Roohulah, Scott (Wal-mart) 35 min
• December 18 (Thu)
• Muss, Sharyar, Michael 25 min
• Imran, Virginia 25 min
• Kalesh, Ameen 25 min