FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

DR. KHALED FOUAD SHERIF SECTOR MANAGER EASTERN EUROPE & CENTRAL ASIA DEPARTMENT THE WORLD BANK WASHINGTON DC Web: http:\\www. !he"#$.%&'

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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

Introduction to Balance Sheets and Income Statements: The balance sheet summarizes the financial position of an organization at a given moment, it is a snapshot of the firm. The balance sheet reflects the status of the organizations assets, (the economic resources owned b the organization!, liabilities (debts owned to creditors!, and e"uit (the owners investment in the organization!.
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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

#s its name implies the balance sheet should indicate that these elements are in balance. Assets = Liabilities + Equity This fundamental relationship must alwa s e$ist, because the assets represent the things owned b the organization and the liabilities and e"uit indicate how much was supplied b both creditors and owners.
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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

In contrast to the balance sheet, the income statement shows the organization%s financial progress over a given period of time. The income statement is also based on e"uation: Revenues - Expenses = Pro it !or Loss"

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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

&evenues are the resources, primaril cash, coming into the organization as a result of goods sold or services rendered. '$penses are the resources used b the organization to provide goods or services. If revenues are greater than e$penses, the business has realized a profit. If e$penses e$ceed revenue the business has realized a loss from operations. #s ou read the following detailed descriptions of balance sheets and income statements, (eep in mind that there is a direct and important relationship between the two. The profit (or loss! realized b a business over a period of time affects the amount of e"uit . '"uit in a business comes from two sources: )irect investment b the owners and profits from business operations. Therefore, the bridge between the income statement and the balance sheet is in the relationship between e"uit and profit or loss.
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Income Statements:

FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

'$hibit * shows a sample income statement (see ne$t page! for a period covering +anuar * to )ecember ,*, *-.-. The compan in "uestion earned revenues from two sources:
N

/et sales: #ll sources earned b the compan from the sale of its products and services. 0ther income: 1enerall resources from sources as interest on ban( accounts, cash dividends from investments in other companies, and interest on bonds.

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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

The following e$penses are subtracted from revenues:
N

2ost of goods sold: all the e$penses incurred in ma(ing the products sold during the period, including the cost of materials, labor, and factor overhead (rent, utilities and maintenance!.

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EXHIBIT 1 SAMPLE INCOME STATEMENT

#o$pany % &or year en'in( De)e$ber *+, +-.!/n LE" Revenues /et Sales 0ther Income 0otal Revenues Expenses 2ost of 1oods Sold #dministrative 8 Selling '$penses Interest '$penses 0otal Expenses 'arnings Before Income Ta$es Income Ta$es Net Earnin(s ,,3.3,45. 54,63*,.1-,.12 4,3-7,567,3,6953,6*7 *,34*,353 ,47,4.4 *64,9,+25,15*

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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

N

#dministrative and selling e$penses: The costs of running and promoting the business, including items li(e the presidents salar , the salaries of all management personnel, advertising costs and sales commissions. Interest e$penses: The interest that the compan paid during the ear on mone that it borrowed.

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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

N

0ther '$penses: This would include an other unusual e$penses incurred b the compan to run the business not otherwise accounted for above (e.g. research and development e$penses, and organizational costs!.

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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

'$penses are subtracted from revenues to ield a figure that indicates the compan s earnings, but this figure still does not reflect the compan s profit. )uring *-.- the compan paid over 57 percent of its earnings to the ta$ department in the form of ta$es. Thus, its net earnings, or the amount of profit the compan earned in *-.-, is :' *35, 45,.

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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

Balance sheets '$hibit 4 is the balance sheet for 2ompan ; as of )ecember ,*, *-.-. The first component is assets, current and fi$ed. 2urrent assets, are those the business e$pects to turn into cash during the ne$t ear. The cash generated from current assets is used to pa e$penses and repa liabilities. 2urrent assets include:
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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

N N

2ash. <ar(etable securities: Temporar investments (generall -9 da s! of e$cess or idle cash= listed at cost, or mar(et value since the are converted into cash within one ear. #ccounts &eceivable: <one owned to the compan b debtors, generall for the purchase of goods and services. Inventories: The value of products that have been completed and are in storage waiting to be sold (finished goods!, products that have been partiall completed (wor( in process!, and raw materials. >repaid '$penses: The value of items that the compan has paid for in advance, such as insurance premiums.
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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

N

?i$ed assets are things of value that will provide benefits to the compan for one or more ears. ?i$ed assets are reported in three categories: land, buildings, machiner and e"uipment. ?i$ed assets are reported on the balance sheet at the cost to purchase or ac"uire the asset minus the depreciation accumulated on the assets since the time of purchase. )epreciation is the estimated decline in the useful value of an asset due to gradual wear and tear. Since this decline in value cannot be estimated with certainl , accountants use various standards methods to appro$imate it.

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SAMPLE BALAN#E 67EE0

#o$pany % De)e$ber *+, +-.-

Assets 2urrent #ssets: 2ash <ar(etable securities #ccounts receivable Inventor >repaid '$penses Total 2urrent #ssets ?i$ed #ssets: :and Buildings <achiner 8 '"uipment :ess allowances for depreciation Total ?i$ed #ssets 0otal Assets

6-,339 .3,577 66-,*55 7*.,*49 5-,-.7 *,,35,5.7 46,.93 3*7,937 *,9*9,339 .99,*9, -64,669 1,*12,4*9

Liabilities8 2urrent :iabilities /otes >a able Trade accounts pa able >a rolls 8 other accurables Income ta$es Total 2urrent :iabilities :ong@Term :iabilities 0otal Liabilties 6:are:ol'ers; Equity

5.,67, 493,..3 5**,,74 *45,7.5 3-4,5-7 5,*,,69 +,11*,.59 +,+4*,+-4

0otal Liabilties < Equity

1,*12,4*9

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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

The second maAor section in a balance sheet is devoted to liabilities. 2urrent liabilities are the debts that a compan must pa off within the coming ear:
N

/otes pa able: <one owned to ban(s or other lending institutions= generall short@ term loans (up to one ear! used to finance short@term needs.

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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

N

#ccounts pa able: <one owed to vendors for the purchase of goods and services. >a rolls and other accurables: <one owed to people for institutions that have performed services, including salaries owed to emplo ees, salaries owed to emplo ees on vacation, attorne fees, insurance premiums, and pension funds. Income ta$es: <one owed to the Ta$ )epartment= ma sometimes be deferred and paid later but must alwa s be paid.
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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

:ong@term liabilities are obligations, usuall loans, that are due to be paid not in the current ear but in some future period. The amount specified in the balance sheet is e"ual to the total amount borrowed.

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FINANCIAL RATIO ANALYSIS FOR NON-FINANCIAL MANAGERS

The final maAor section, the e"uit section summarizes the ownersB investment in the business. Individuals and institutions become owners of a compan b purchasing shares of the compan s stoc(. '"uit increases as more people purchase stoc( and the compan retains increased profit.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

'ach t pe of anal sis of financial data has a purpose or use that determines the different relationships emphasized. Therefore, it is useful to classif ratios into four fundamental t pes:
N

:i"uidit ratios, measure the firms abilit to meet its maturing short@term obligations.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

:everage ratios, measure the e$tent to which the firm has been financed b debt. #ctivit ratios, measure how effectivel the firm is using its resources. >rofitabilit ratios, measure managements overall effectiveness as shown b the returns generated on sales and investment.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

:i"uidit &atios 1enerall , the first concern of the financial anal st is li"uidit . the measures the short@run solvenc of a compan its abilit to meet current debts.
N 2urrent

&atio The current ratio indicates whether there are enough current assets to meet current liabilities. #urrent ratio = #urrent assets #urrent liabilities WORLD BANK

ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

2urrent assets normall include: 2ash, mar(etable securities, accounts receivable, and inventories. 2urrent liabilities consist of: accounts pa able, short@ term notes, pa able, current maturities of long@term debt, accrued income ta$es, and other accrued e$penses (principall wages!.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

Chen is the compan solventD Chen the current ratio is *.9 or greater= that is, the compan should have more current assets than current liabilities. <ethod for 2alculating the 2urrent &atio: #dd cash, mar(etable securities, accounts receivable, and inventories to get current assets.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

#dd notes pa able, trade accounts pa able, pa rolls and other accurables and income ta$es to get current liabilities. )ivide the derived current assets figure b the calculated current liabilities figure.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

Eou have now derived the current ratio. /ow, compare the value derived to *.9. If the current ratio is *.9 or greater, the compan should have more current assets than current liabilities and is financiall viable or solvent. If the current ratio is less than *.9, the compan will have more current liabilities than current assets and is financiall unviable or insolvent.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

?or significance this ratio should be compared to previous ears (e.g. the current ratio for five previous ears should be derived!. This is necessar in order to derive a trend. If the current ratio is rising n an upward fashion, the compan is becoming more financiall viable. If the current ratio is falling and assuming a downward trend, the compan is becoming less financiall viable.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

0ne helpful activit is to also compare the current ratio of the compan in "uestion to the current ratio of similar competing companies. If the compan in "uestion has a higher current ratio on a regular basis over a number of ears than this compan is more financiall viable. 0n the other hand, if the compan in "uestion has a lower current ratio on a regular basis over a number of ears than this compan is less financiall viable.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

b @ Fuic( &atio, or #cid Test The "uic( ratio is calculated b deducting inventor from current assets, and dividing the remainder b current liabilities. Inventories are deducted since the are t picall the least li"uid of a firms current assets. =ui)> ratio = #urrent assets - /nventory #urrent Liabilities
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

Chen is the compan solventD Chen the Fuic( ratio is *.9 or greater. Chich li"uidit ratio is more accurate, the current ratio or the "uic( ratioD The "uic( ratio, since it e$cludes inventor , the least li"uid asset, and the asset on which losses are most li(el to occur in the event of li"uidation.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

<ethod for 2alculating the Fuic( &atio: N #dd cash, mar(etable securities and accounts receivable (items *7, *3, 8 *. on the sample balance sheet on page 7! to get "uic( assets ("uic( assets b definition is current assets @ inventor !.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

#dd notes pa able, trade accounts pa able, pa rolls and other accurables and income ta$es (items ,*, ,4, ,, 8 ,5 on the sample balance sheet on page 7! to get current liabilities. )ivide the derived "uic( assets figure b the calculated current liabilities figure.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

Eou have now derived the "uic( ratio. /ow, compare the value derived to *.9. If the "uic( ratio is *.9 or greater, the compan should have more "uic( assets than current liabilities and is financiall viable or solvent. If the "uic( ratio is less than *.9, the compan will have more current liabilities than "uic( assets and is financiall unviable or insolvent.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

?or significance this ratio should be compared to previous ears (e.g. the "uic( ratio for five previous ears should be derived!. This is necessar in order to derive a trend. If the "uic( ratios is rising in an upward fashion, the compan is becoming more financiall viable. If the "uic( ratio is falling and assuming a downward trend, the compan is becoming less financiall viable.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

0ne helpful activit is to also compare the "uic( ratio of the compan in "uestion to the "uic( ratio of similar competing companies. If the compan in "uestion has a higher "uic( ratio on a regular basis over a number of ears then this compan is more financiall viable.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

:everage &atios :everage ratios measure the funds supplied b owners as compared with the financing provided b the firms creditors.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

Implications of leverage ratios: '"uit , or owner@supplied funds, provide a margin of safet for creditors. Thus, the less e"uit , the more the ris(s of the enterprise to the creditors.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

)ebt funding enables the owners to maintain control of the firm with a limited investment. If the firm earns more on the borrowed funds than it pa s in interest, the return to the owners is magnified. If the firm earns more on the borrowed funds than it pa s in interest, the return to the owners is magnified.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

:ow leverage ratios: Indicate less ris( of loss when the econom is in a downturn, but lower e$pected returns when the econom booms. Gigh leverage ratios: indicate the ris( of large losses, but also have a chance of gaining high profits.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

Therefore, decisions about the use of leverage must balance higher e$pected returns against increased ris(.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

#pproaches to e$amining leverage ratios:
N

)ebt ratio: The debt ratio is the ratio of total debt to total assets and measures the percentage of total funds provided b creditors. The debt ratio is: 0otal 'ebts 0otal assets
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

<ethod for 2alculating the )ebt &atio: N #dd notes pa able to long@term liabilities to get total debts.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

#dd cash, mar(etable securities, accounts receivable, inventories, prepaid e$penses, land, buildings, machiner and e"uipment and subtract depreciation to derive the total assets figure. )ivide the total debts figure b the calculated total assets figure.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

?or significance this ratio should be compared to previous ear (e.g. the debt ratio for five previous ears should be derived!. This is necessar in order to derive a trend. If the debt ratio is rising in an upward fashion, the compan is developing a leverage problem. If the debt ratio is falling and assuming a downward trend, the compan is investing more of its own resources to generate assets and is becoming less dependent on debts.
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

0ne helpful activit is to also compare the debt ratio of the compan in "uestion to the debt ratio of similar competing companies. If the compan in "uestion has a higher debt ratio on a regular basis over a number of ears, then this compan is over leveraged in comparison to its competitors. 0n the other hand, if the compan in "uestion has a lower debt ratio on a regular basis over a number of ears, then this is less dependent on debt as a source of financing in comparison to its competitors.
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

B @ )ebt@to@'"uit @ &atio: This ratio is a variation of the debt ratio that is commonl used. It compares the amount of mone borrowed from creditors to the amount of shareholders investment made within a firm. Debt-to-Equity ratio = 0otal Debts 6:are:ol'er;s invest$ent !equity"

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

<ethod for 2alculating the )ebt@to@'"uit &atio: N #dd notes pa able to long@term liabilities to get total debts.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

:oo( up the shareholders investment or e"uit line item in the blance sheet. )ivide the total debts figure b the calculated shareholders investment figure.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

?or significance this ratio should be compared to previous ears (e.g. the debt to e"uit ratio for five previous ears should be derived!. This is necessar in order to derive a trend. If the debt to e"uit ratio is rising in an upward fashion, the compan is developing a leverage problem. If the debt ito e"uit ratio is falling and assuming a doward trend, the compan is investing more of its owners resources to generate assets and is becoming less dependent on creditors.
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

0ne other helpful activit is to also compare the debt to e"uit ratio of the compan in "uestion to the debt e"uit ratio of similar competing companies. If the compan in "uestion has a higher debt to e"uit ratio on a regular basis over a number of ears, then this compan is over leveraged in comparison to its competitors. 0n the other hand, if the compan in "uestion has lower debt to e"uit ratio on a regular basis over a number of ears, then this compan is less dependent on debt as a source of financing in comparison to its competitors.
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

>rofitabilit ratios >rofitabilit ratios indicate how successful a compan reall is and how effective management is in operating the business.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

# @ &eturn on assets This ratio shows how much mone the compan earned on each dollar it invested in assets. It is a measure of overall compan earning power or profitabilit . Return on Assets !ROA" = Net Earnin(s 0otal Assets

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

<ethod for 2alculating the &eturn on #ssets &atio:
N

)erive the net earnings, or net profit figure from the income statement. /et earnings is simpl total revenues minus total e$penses.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

#dd cash, mar(etable securities, accounts receivable, inventories, prepaid e$penses, land, buildings, machiner and e"uipment and subtract depreciation to derive the total assets figure. )ivide the net earnings figure b the derived total assets figure to get return on assets.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

?or significance this ratio should be compared to previous ears (e.g. the return on assets ratio for five previous ears should be derived!. This is necessar in order to derive a trend. If the return on assets ratio is rising in an upward fashion, the compan is ma(ing a larger return on funds invested in assets. If the return on assets ratio is falling and assuming a downward trend, the compan is ma(ing a lower return on funds invested in assets.
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

0ne other helpful activit is to also compare the return on assets ratio of the compan in "uestion to the return on assets of similar competing companies. If the compan in "uestion has a higher &0# on a regular basis over a number of ears, then this compan is financiall better off in comparison to its competitors. 0n the other hand, if the compan in "uestion has a lower &0# on a regular basis over a number of ears, then this compan is financiall worse off in comparison to its competitors.
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

B @ >rofit <argin:
N

The profit margin is a ratio that shows the relationship between net earnings and net sales and indicates how much profit the compan is earning on each dollar in sales. Pro it ?ar(in = Net Earnin(s Net 6ales

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

<ethod for calculating the profit margin ratio:
N

)erive the net earnings, or net profit figure from the income statement. /et earnings is simpl total revenues minus total e$penses.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

)erive the net sales line item from the income statement. )ivided the net earnings figure b the derived net sales figure to get the profit margin.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

?or significance this ratio should be compared to previous ears (e.g. the profit margin ratio for five previous ears should be derived!. This is necessar in order to derive a trend. If the profit margin ratio is rising in an upward fashion, the compan is ma(ing a larger return on sales. If the profit margin is falling and assuming a downward trend, the compan is ma(ing a lower return on sales.
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

0ne other helpful activit is to also compare the profit margin of the compan in "uestion to the profit margin of similar competing companies. If the compan in "uestion has a higher profit margin on a regular basis over a number of ears, then this compan is ma(ing a larger return on sales in comparison to its competitors. 0n the other hand, if the compan in "uestion has a lower profit margin on a regular basis over a number of ears, then this compan is ma(ing a lower return on sales in comparison to its competitors. WORLD BANK

ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

2 @ &eturn on e"uit (or return on net worth! This ratio indicates the amount of net earnings resulting from investments in e"uit . Shareholders are particularl interested in this ratio, because it shows them how much the are earning on their investments. Return on equity = Net Earnin(s 6:are:ol'ers; invest$ent !Equity"

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

<ethod for calculating the return on e"uit ratio:
N

)erive the net earnings, or net profit figure from the income statement. /et earnings is simpl total revenues minus total e$penses.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

:oo(up the shareholders investment or e"uit line item in the balance sheet. )ivide the net earnings figure b the derived shareholders investment figure to get return on e"uit .

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

?or significance this ratio should be compared to previous ears (e.g. the return on e"uit ratio for five previous ears should be derived!. This is necessar in order to derive a trend. If the return on e"uit ratio is rising in an upward fashion, the compan is ma(ing a larger return on funds invested b shareholders. If the return on e"uit is falling and assuming a downward trend, the compan is ma(ing a lower return on funds invested b shareholders.
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

0ne other helpful activit is to also compare the return on e"uit of the compan in "uestion to the return on e"uit of similar competing companies. If the compan in "uestion has a higher return on e"uit on a regular basis over a number of ears, then this compan is ma(ing a larger return on shareholders investment in comparison to its competitors. 0n the other hand, if the compan in "uestion has a lower return on e"uit on a regular basis over a number of ears, then this compan is ma(ing a lower return on shareholders investment in comparison to its competitors.
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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

#ctivit ratios
N

#ctivit ratios measures how effectivel the firm emplo s its resources. These ratios involve comparisons between the level of sales and the investment in various asset accounts, li(e inventories and accounts receivable.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

# @ Inventor turnover
N

Inventor turnover tells us how man times during the ear the entire stoc( of inventor was sold. Inventor turnover is calculated as follows: /nventory turnover = 6ales /nventory

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

<ethod for calculating the inventor turnover ratio: N )erive the net sales line item from the income statement.
N

)erive the inventor valuation figure from the balance sheet. )ivide the sales figure b the derived inventor figure to get the inventor turnover.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

>roblems in arising in calculating and anal zing this ratio:
N

Sales are at mar(et prices. If inventories are carried at cost, as the generall are, it is more appropriate to use cost of goods sold in place of sales in the numerator of the formula. Sales occur over the entire ear, whereas the inventor figure is for one point in time. This ma(es it better to use an average inventor , computed b adding beginning and ending inventories and dividing b 4.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

B @ #verage collection period: N The average collection period indicates how "uic(l the compan collects its accounts receivable.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

It is computed in the following wa :
N

#nnual sales (derived from the income statement! are divided b ,76 to get average dail sales. #ccounts receivable (derived from the balance sheet! are divided over dail sales to find the number of da s sales is tied up in receivables.

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

The average collection period represents the average length of time the firm must wait to receive cash after ma(ing a sale and is mathematicall defined as follows: Avera(e )olle)tion perio' = A))ounts re)eivables 6ales@*93 'ays

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ANALYSIS OF BALANCE SHEETS AND INCOME STATEMENTS

N

'valuation of this ratio is based upon the terms on which the firm sells its goods. ?or e$ample, if the collection period over the past few ears for a given compan is length while its credit polic did not change, this would be evidence that steps should be ta(en to e$pedite the collection of accounts receivable.

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SUMMARY OF FINANCIAL RATIOS

Ratio :i"uidit 2urrent Fuic( :everage )ebt )ebt@'"uit >rofitabilit &eturn on #ssets &or$ula 2urrent #ssets 2urrent :iabilities Fuic( #ssets 2urrent :iabilities Total )ebt Total #ssets Total '"uit Total #ssets /et 'arnings Total #ssets Exa$ple or #al)ulation 399,999 H 4., ,99,999 599,999 H *., ,99,999 *99,999 H 69I 499,999 *,999,999 H 69I 4,999,999 *49,999 H 7I 4,999,999 /n'ustry Avera(e 4.6 * time ,,I ,,I *9I Evaluation Satisfactor 1ood >oor >oor >oor

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SUMMARY OF FINANCIAL RATIOS (CONTD)

Ratio >rofit@ <argin &eturn on '"uit #ctivit Inventor Turnover #verage 2ollection >eriod Sales Inventor #ccounts &eceivables SalesJ,76 da s ,,999,999 H *9 ,99,999 times 4,99,999 H 45 .,,,, )a s - times 49 )a s Satisfactor Satisfactor &or$ula /et 'arnings /et Sales /et 'arnings Shareholders Inv. Exa$ple or #al)ulation *49,999 H 5I ,,999,999 *49,999 H *4I ,,999,999 /n'ustry Avera(e 6I *6I Evaluation ?air ?air

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FINANCIAL RATIOS
I. &atios Indicating 2urrent position or &elating to #nal sis of Short@Term Solvenc &atio #. Tests of overall solvenc *. 2urrent ratio or wor(ing capital ratio 2urrent #ssets (/et! 2urrent :iabilities >rimar tests of li"uidit indicating abilit to meet current obligations from current assets as a going concern. <easure of ade"uac of wor(ing capital. ?ormula Significance

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FINANCIAL RATIOS
4. #cid@Test ratio or "uic( ratio Fuic( #ssets (/et! 2urrent :iabilities # more severe test of immediate li"uidit than the current ratio. Test of abilit to meet sudden demands from current assets.

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FINANCIAL RATIOS
,. Cor(ing captial to 2urrents #ssets@2urrent :iabilites Indicates relative total assets Total #ssets (/et! li"uidit of total assets and wor(ing capital position= and distributes of resources emplo ed.

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FINANCIAL RATIOS
B. &atios indicating movement of current assets (turnover! 5. @ &eceivable turnover /et 2redit Sale #verage &eceivable (/et! Kelocit of collection of trade accounts and notes. Test of efficienc of collection

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FINANCIAL RATIOS
@ /umber of da s receivables ,76 (da s! &eceivable turnover (computed as above! Kelocit of collection of trade accounts and notes. Test of efficienc of collection.

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FINANCIAL RATIOS
6. Inventor turnover Indicates li"uidit of inventor and will e$hibit tendenc to over@stoc(. 2ost of 1oods Sold #verage <dse. Inventor /umber of times average stoc( moved during the ear.

a. merchancise turnover

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FINANCIAL RATIOS
&atio b. ?inished goods turnover (<anufcturing firm! ?ormula 2ost of 1oods Sold #ve. ?inished 1oods Invt . Significnce #s as (a!.

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FINANCIAL RATIOS
c. &aw <aterial turnover 2ost of &aw <aterials Lsed #ve. &aw <aterial Inventor /umber of times raw material inventor was MusedN on the average during the period.

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FINANCIAL RATIOS
d. )a s suppl in Inventor ,76 (7 da s! Inventor turnover (computed per (a!, (b! or (c!. #verage number of da s suppl in the ending invenor over or undestoc(ing as the case ma be.

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FINANCIAL RATIOS
7. #verage #ge of >a ables #verage #ccount >a able $ ,76 Indicates the aging of #nnual >urchase accounts pa able. this figures can be compared to the credit terms e$tended b the suppliers of the compan to see if an abusees of these terms are being made. Trends anal sis of the ratios ma also be significant.

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FINANCIAL RATIOS
3. Cor(ing capital turnover /et Sales Cor(ing 2apital Indicates ade"uac of wor(ing capital and cash c cle of firm.

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FINANCIAL RATIOS
II. &atios indicating asset relations and capital set@up or relating to anal sis of long@term solvenc #. '"uities related to profits and sales *. Sales to owners e"uit /et Sales 0wners '"uit /umberof times net worth is Mturned overN in sales Indicative of the utilization of owners capital ma reflect over@capitalization in relation to volume of business done.

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FINANCIAL RATIOS
,. 'arning rate of mar(et value per share /et Income per share <ar(et Kalue per share 'arnings rate based on cost of share of stoc( in the mar(et. Indicates profitabilit related to mar(et value of stoc(holders e"uit .

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FINANCIAL RATIOS
5. Times Bond Interest 'arned /et Income before Bond Interest Bond Service re"uirements Income Securit Bonds.

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FINANCIAL RATIOS
6. /et 0perating /et Income before income ta$es Summar of operation Income to and non@operating items position for ear. /et Sales

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FINANCIAL RATIOS
7. 0perating e$pense Total 0peraing '$penses /et Sales Indicates effectivel of mnagement in controlling operating e$penses.

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FINANCIAL RATIOS
IK. :everage and 2apital@Structure &atios These ratios tell us the relative proportions of capital contributed b creditors and b owners. *. )ebt@'"uit &atio 2urrent :iabilities O :ong@term )ebt Total amount of debt Total 2ommon '"uit leverage per peso of common e"uit

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FINANCIAL RATIOS
4. Total )ebt to Total #ssets 2urrent :iabilities O :.T.). >roportion of assets Total #ssets provided b creditors. '$tent of Mtrading on the e"uit N.

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FINANCIAL RATIOS
,. :ong@term )ebt to '"uit &atio :ong@term )ebt Total 2ommon '"uit :ong@term debt leverage per peso of common e"uit .

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FINANCIAL RATIOS
KI. *. #sset@relation &atios >lant and e"uipment to Total assets /et >lant O /et '"uipment >roportion of operating Total #ssets earning assets to total assets.

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FINANCIAL RATIOS
4. Inventor to Total #ssets #verage Inventor Total #ssets Size of inventor and tendenc to overstoc(.

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FINANCIAL RATIOS
,. ?i$ed #ssets to ?i$ed :iabilities ?i$ed assets (net! ?i$ed :iabilities &eflects e$tent of the utilization of resources from long@term debt. Indicative of source for additional funds. If the fi$ed assets are pledged @ degree of securit . It is fre"uentl more useful to use present value rather than boo( value.

WORLD BANK

FINANCIAL RATIOS
5. ?i$ed #ssets to Total '"uit ?i$ed #ssets (net! Total 0wners '"uit >roportion of owners e"uit to fi$ed assets. Indicative of over or under@ investment b owners= also wea(ness in Mtrading on the e"uit N.

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FINANCIAL RATIOS
6. Sales to ?i$ed #ssets (>lant Turnover! /et Sales ?i$ed #ssets (net! turnover inde$ which tests roughtl the efficienc of management in(eeping plant properties emplo ed.

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FINANCIAL RATIOS
7. #ppro$imate #verage #sset :ife /et >lant and '"uipment /ormalized )epreciation #verage life of plant and e"uipment.

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FINANCIAL RATIOS
II. *. 2ommon@Stoc( Securit &atios Boo( value per share of common stoc( 2ommon Stoc( '"uit /umber of peso securit /o. of 0utstanding Shares (at boo( value! per share of common stoc(

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HOW TO ANALYZE FINANCIAL POSITION POTENTIAL FOR BUSINESS FAILURE

Ban(ruptc occurs when the compan is unable to meet maturing financial obligations. Ce are thus particularl interested in predicted cash flow. ?inancial difficulties affect the price@ earnings ratio, and the effective interest rate.

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HOW TO ANALYZE FINANCIAL POSITION POTENTIAL FOR BUSINESS FAILURE

# comprehensive "uantitative indicator used to predict failure is #ltmans MP@score,N which e"uals Wor>in( )apital 0otal assets % +A1 + Retaine' earnin(s 0otal assets % +A5

Operatin( in)o$e ?B o )o$$on < pre erre' % *A* + % 4A9 0otal assets 0otal liabilities + 6ales % 4A---

0otal assets NABA Operatin( in)o$e = Net sales - )ost o (oo's sol'
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THE SCORES AND THE PROBABILITY OF SHORT-TERM ILLIQUIDITY FOLLOW.

6)ore Probability o illiqui'ity or ailure +A.4 or less Bery :i(: +A.+- 1A-Not sure *A4 or (reater Cnli>ely

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EXAMPLE
A )o$pany presents t:e olloDin( in or$ation Wor>in( )apital 1.4,444 0otal assets .23,444 0otal liabilities *14,444 Retaine' earnin(s 1+3,444 6ales -34,444 Operatin( in)o$e +*4,444 #o$$on sto)> Boo> Balue 114,444 ?ar>et Balue *+4,444 Pre erre' sto)> Boo> value ++3,444 ?ar>et value +24,444
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E-s)ore equals 1.4,444 .23,444 5.4,444 *14,444 % +A1 + 1+3,444 .23,444 -34,444 .23,444 % +A5 + +*4,444 .23,444 % *A* +

% 4A9 +

% 4A--- =

4A*.5 + 4A*55 + 4A5-4 + 4A- + +A4.59 = *A1419 0:e probability o ailure is not li>ely

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QUANTITATIVE FACTORS IN PREDICTING CORPORATE FAILURE

N N N N N N N N N N

LoD )as: loD to total liabilitiesA 7i(: 'ebt-to-equity ratio an' :i(: 'ebt to total assetsA LoD return on invest$ent LoD pro it $ar(in LoD retaine' earnin(s to total assets LoD Dor>in( )apital to total assets an' loD Dor>in( )apital to sales LoD ixe' assets to non)urrent liabilities /na'equate interest-)overa(e ratio /nstability in earnin(s 6$all siFe )o$pany $easure' in sales an'@or total assets
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QUANTITATIVE FACTORS IN PREDICTING CORPORATE FAILURE

N N

N N N N

6:arp 'e)line in pri)e o sto)>, bon' pri)e, an' earnin(s A si(ni i)ant in)rease in betaA !Beta is t:e variability in t:e pri)e o t:e )o$pany;s sto)> relative to a $ar>et in'ex" ?ar>et pri)e per s:are is si(ni i)antly less t:an boo> value per s:are A si(ni i)ant rise in t:e )o$pany;s Dei(:te'-avera(e )ost o )apital 7i(: ixe' )ost to total )ost stru)ture !:i(: operatin( levera(e" &ailure to $aintain )apital assetsA !eA(A 'e)line in t:e ratio o repairs to ixe' assets
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QUANTITATIVE FACTORS IN PREDICTING FAILURE

N N N N

NeD )o$pany De)linin( in'ustry /nability to obtain a'equate inan)in(, an' D:en obtaine' t:ere are si(ni i)ant loan restri)tions A la)> in $ana(e$ent quality

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CONSOLIDATED BALANCE SHEETS

De)e$ber *+, 2ash #ccounts receivable less allowances Inventories 0ther current assets 0otal )urrent assets Investments >ropert , plant and e"uipment :and Buildings <achiner 8 '"uipment Total >ropert , >lant 8 '"uipment :ess accumulated depreciation >ropert plant 8 '"uipment net of depreciation Intangibles 0ther assets 0otal Assets L#$%#&#"#! :oans pa able to Ban(s #ccounts pa able 8 #ccrued '$penses Total current liabilities :ong term )ebt 6:are:ol'ers; Equity 0otal 6:are:ol'er;s Equity 0otal Liabilities an' 6:are:ol'ers; Equity +--* A !" -,*69,4*9 7,-64,399 6,366,959 .-3,739 11,233,914 ,95,3*9 ,,7,3.9 5,-59,359 .,3-*,779 *5,97-,*.9 6,536,959 .,6-5,*59 *,-,5,769 ,74,--9 **,-31,++4 6..,799 7,9,9,549 7,7*-,949 5,5*6,6*9 11,-+2,3.4 **,-31,++4 +--1 3,73-,.99 7,5**,539 6,4-,,-*9 .-6,379 14,1.4,-54 *35,759 4-4,5.9 5,433,959 3,3.,,9.9 *4,,64,799 5,767,,39 3,7-7,4,9 *,.4.,6*9 57.,-.9 *4,55-,*44 7*7,959 6,473,339 6,..,,.*9 ,,73-,769 14,..3,.54 *4,55-,*44

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CONSOLIDATED STATEMENTS OF INCOME

De)e$ber *+, Net 6ales 2ost of goods sold Selling, #dmin. 8 1eneral '$pense /n)o$e be ore interest an' taxes Interest /n)o$e be ore taxes Ta$es Net pro it +--* 52,55*,144 *.,,3*,*-9 *7,-6-,7,9 ,6,,,9,.49 +1,++1,*.4 *,*,7,-39 +4,-23,5+4 ,,.95,9*9 2,+2+,544 +--1 53,9.5,494 *3,--6,,39 *6,-55,959 ,,,-,-,5*9 ++,255,934 *,45,,3.9 +4,344,.24 ,,-54,6-9 9,33.,1.4

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I' "()*!'" +, L+'- T!(* F#'$'.!

N

Bond @@@ # long term promissor note <ortgage @@@ # mortgage is a pledge of designated propert for a loan. # mortgage bond is a pledge b the corporation to certain real assets as securit for the bond. )ebenture @@@ Is a long term bond not secured to specific propert

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C+**+' V . P(!,!((!/ S"+.0

N

>referred Stoc( @@@@ avoids the provision of e"ual participation in earnings in comparison to common stoc( 2ommon Stoc( @@@@ does not entail fi$ed charges. There is no legal obligation to pa common stoc( dividends. #lso, common stoc( has no fi$ed maturit date

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P1E R$"#+ C$&.)&$"#+'

N

2ompan ; @@ 'arnings >er Share *-.. 9.*-.9.. *--9 9.7

N N

'arnings >er Share H /et profitJQ of shares issued

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C+*2$'3 X M$(0!" P(#.! P!( S4$(!5 C+**+' S"+.0

*-..
N

*-.6.9 5.9 5.6

*--9 7.9 ,.9 5.6

Gigh :ow

-.9 3.9

#verage ..9

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P(#.! "+ E$('#'- R$"#+

>rice to earnings ratio H >riceJ'arnings *-..
N

*-.6.7

*--9 3.6

>J'

..-

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M$(0!" "+ B++0 R$"#+

N

<ar(et to Boo( &atio H <ar(et valueJboo( <ar(et >rice >er Share @@ 2ommon *-.. *-.*--9 #verage ..9 5.6 5.6 Boo( Kalue 2ommon Stoc( ( ear end! 5.3 5.6.9 <B& H *.3 9.9.-

N N N N

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E$ "!(' C$(2!" - R$"#+ F#'/#'N N N N N N N

Item &0# &0' 2& )& )J' P Score

-5 *4.,I ,-.9I .--5 7.I 4*3I *.76

-6 3.,I 47..I *.94 34.3I 479I *.,.

-7 ..3I 4-.6I .-53 39.,I 4,7I *.,6

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E$ "!(' C$(2!" - I
N

)!

N N N

Cor(ing capital is CITG0LT the negative sign Inventor is missing #ccounts receivables is missing Ch does total current assets appear when accounts receivables and inventor do notD Chere is retained earningsD

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BOO6 CASE ANALYSIS W4#.4 U.S. C+*2$'3 # #"7

*--4 &0# &0' >< 2& F& )& 4*.6I ,*.5I *5.,I ,.5 4.6 *4I *--, 4*I ,*.4I *6I ,.5 4.7 *,I *--4 )J' *.I IT 6.4 P Score 7.46 *--, *-I 6.6.-5

WORLD BANK

D(. 64$&!/ F+)$/ S4!(#,

N N N N N N

Cor( Tel: 494 53, 557* Gome Tel: 494 ,,3 5943 ?a$: 494 644 9996 'mail: RSG'&I?SC0&:)B#/R.0&1 Ceb Site:http:TTwww.(sherif.com #ddress The Corld Ban(, *.*. G Street, /C Cashington )2 4995,

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