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04 Chapter model

12/08/11

Chapter 4. Analysis of Financial Statements

This model is STRICTLY OPTIONAL. Neither students nor instructors need to go through it. However, if
someone wants to practice with Excel, then the model can be useful. Also, on the tabs we show solutions
for the within-chapter self-test questions.

This spreadsheet model sets up common size balance sheets and income statements for Allied (2011 and
2012 statements) and conducts a full ratio analysis of Allied's financial statements.

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Common Size Analysis is not illustrated in the text, but we show it because it is so easy to do with Excel.
The common size balance sheet shows each asset and liability item as a percentage of total assets, and
the common size income statement shows the other items as a percentage of sales. Common size
statements are useful for getting an idea of how the various statement items match up, and they are
especially good for comparing companies that differ in size.
INPUT DATA SECTION: Historical Data Used in the Analysis
2012
$23.06
50
40%

Year-end stock price


Shares outstanding (in millions)
Tax rate

2011
$26.00
50
40%

COMMON SIZE BALANCE SHEETS - Allied Food Products - December 31


(in millions of dollars)
2012
Assets
Cash and equivalents
Accounts receivable
Inventories
Total current assets
Net plant and equipment
Other LT assets
Total assets

10 $
375
615
1,000 $
1,000
2,000 $

2011
80
315
415
810
870
1,680

COMMON SIZE
2012
2011
0.50%
18.75%
30.75%
50.00%
50.00%
0.00%
100.00%

4.76%
18.75%
24.70%
48.21%
51.79%
0.00%
100.00%

A
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51
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53
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60
61
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65
66
67
68
69

Liabilities and equity


Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50M shares)
Retained earnings
Total common equity
Total liabilities and equity

$
$

$
$

60
110
140
310
750
1,060
130
810
940
2,000

$
$

$
$

30
60
130
220
580
800
130
750
880
1,680

3.00%
5.50%
7.00%
15.50%
37.50%
53.00%
6.50%
40.50%
47.00%
100.00%

1.79%
3.57%
7.74%
13.10%
34.52%
47.62%
7.74%
44.64%
52.38%
100.00%

INCOME STATEMENTS - Allied Food Products - Years Ending December 31


(in millions of dollars)

Net sales
Oper costs except depr'n & amort.
Depreciation and amortization
Operating income (EBIT)
Less interest
Earnings before taxes (EBT)
Taxes
Net income

2012
$ 3,000.0
2,616.2
100.0
$ 283.8
88.0
$ 195.8
78.3
$ 117.5

2011
$ 2,850.0
2,497.0
90.0
$ 263.0
60.0
$ 203.0
81.2
$ 121.8

Common dividends
Addition to retained earnings

$
$

57.5 $
60.0 $

53.0
68.8

$
$
$

2012
2.35 $
1.15 $
18.80 $

2011
2.44
1.06
17.60

PER-SHARE DATA
Earnings per share (EPS)
Dividends per share (DPS)
Book value per share (BVPS)

2012 FREE CASH FLOW (FCF)


FCF = EBIT(1 T) + Depr'n [Cap Ex + NOWC ]
FCF =
$170.3
+ $100.0
[$230.0 + $150
]

FCF =
$270.3
$380.0
FCF =
($109.7)

COMMON SIZE
2012
2011
100.00%
100.00%
87.21%
87.61%
3.33%
3.16%
9.46%
9.23%
2.93%
2.11%
6.53%
7.12%
2.61%
2.85%
3.92%
4.27%
1.92%
2.00%

1.86%
2.41%

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C
D
70 SECTIONS 4-1 TO 4-6, RATIO ANALYSIS
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98

Here we calculate Allied's ratios for 2011 and 2012. These results are compared across time and to the
industry averages.
Liquidity ratios
Current Ratio
Quick Ratio
Asset Management ratios
Inventory Turnover
Days Sales Outstanding
Fixed Assets Turnover
Total Assets Turnover
Debt Management ratios
Debt Ratio
Times Interest Earned
Profitability ratios
Operating Margin
Profit Margin
Return on Assets
Basic Earning Power
Return on Equity
Market Value ratios
Price-to-Earnings Ratio
Market-to-Book Ratio

2012
3.23
1.24

2011
3.68
1.80

Ind Avg
4.20
2.20

4.88
45.63
3.00
1.50

6.87
40.34
3.28
1.70

10.90
36.00
2.80
1.80

53.00%
3.23

47.62%
4.38

40.00%
6.00

9.46%
3.92%
5.87%
14.19%
12.50%

9.23%
4.27%
7.25%
15.65%
13.84%

10.00%
5.00%
9.00%
18.00%
15.00%

9.81
1.23

10.67
1.48

11.30
1.70

SECTION 4-7. TYING THE RATIOS TOGETHER: THE DuPONT EQUATION


The DuPont equation shows that a firm's ROE depends on three essential components: (1) the profit
margin, (2) the total assets turnover, and (3) the equity multiplier.

ROE =

Profit Margin x

TA Turnover

Equity Multiplier

Sales /
Total
assets

ROE =

Net
income /
Sales

Total
assets /
Equity

ROE =

3.9%

1.5

2.13

12.5%

1.67

15.0%

99
100

101
102 Industry =
x
5.0%
1.8
103
104
Industry Equity Multiplier = 1 / (1 Debt ratio) =
105

= 1/(1-F82)

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B
C
106 SECTION 4-9c, TREND ANALYSIS
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109
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Trend analysis allows you to see how a firm's results are changing over time. For example, Allied's ROE
has been declining for the past 3 years, and it is now below the industry average. Not a good sign.

Allied
14.0%
16.1%
14.8%
13.8%
12.5%

2008
2009
2010
2011
2012

Ind Avg
13.2%
15.0%
16.0%
16.2%
15.0%

Trend Analysis: Allied's ROE

ROE

18.0%

Industry

16.0%
14.0%

Allied

12.0%
10.0%
2008

2009

2010
Year

2011

2012

Table 4.1. Effects of Financial Leverage on Stockholder Returns

Interest rate on debt


Tax rate

12/08/11

10%
40%

FIRM U (UNLEVERAGED, i.e., NO DEBT))


Current Assets
$
50
Fixed Assets
50
Total Assets
$
100

Sales revenues
Oper. costs Fixed
Variable
0.4
Total operating costs
Operating income (EBIT)
Interest
Earnings before taxes (EBT)
Taxes
Net income (NI)
ROEU

FIRM L (LEVERAGED, i.e., SOME DEBT))


Current Assets
$
50
Fixed Assets
50
Total Assets
$
100

Sales revenues
Oper. costs Fixed
Variable
0.4
Total operating costs
Operating income (EBIT)
Interest
Earnings before taxes (EBT)
Taxes
Net income (NI)
ROEL

Debt
Common Equity
Total Liab & Equity

100
100

Business Conditions
Good
Expected
$150.0
$100.0
45.0
45.0
60.0
40.0
105.0
85.0
$45.0
$15.0
0.0
0.0
$45.0
$15.0
18.0
6.0
$27.0
$9.0

Bad
$75.0
45.0
30.0
75.0
$0.0
0.0
$0.0
0.0
$0.0

27.0%

Debt
Common Equity
Total Liab & Equity

9.0%

0.0%

$
$

Business Conditions
Good
Expected
$150.0
$100.0
45.0
45.0
60.0
40.0
105.0
85.0
$45.0
$15.0
5.0
5.0
$40.0
$10.0
16.0
4.0
$24.0
$6.0
48.0%
12.0%

50
50
100

Bad
$75.0
45.0
30.0
75.0
$0.0
5.0
-$5.0
0.0
-$5.0
-10.0%

Good
Expected
Bad

$150.00
$100.00
$75.00

Average

$108.33

ROE
Firm U
Firm L
27.0%
48.0%
9.0%
12.0%
0.0%
-10.0%
12.0%

16.7%

Effect of Leverage
ROE

50.0%

0.0%
$50

Le ve rage
d
Unle ve rage
d
$100
SALES

-50.0%

$150

SECTION 4-2

12/08/11

SOLUTIONS TO SELF-TEST QUESTIONS


4a. A company has current liabilities of $500 million, and its current ratio is 2.0. What is its
level of current assets?
Current liabilities ($M)
Current ratio
Current assets ($M)

$500
2.0 =

CA / CL

= CL CR = CL 2 =

$1,000

4b. A company has current liabilities of $500 million, and its current ratio is 2.0. If this firms
quick ratio is 1.6, how much inventory does it have?
Current liabilities ($M)
Current ratio
Quick ratio = (CA Inventories) / CL
CA Inventories = CL 1.6 =

$500
2.0
1.6
$800.00

Current assets as found in previous question


Inventory =

$1,000

$800

$1,000

$200

SECTION 4-3

12/08/11

SOLUTIONS TO SELF-TEST QUESTIONS


5a. A firm has annual sales of $100 million, $20 million of inventory, and $30 million of accounts
receivable. What is its inventory turnover ratio?
Annual Sales ($M)
Inventory ($M)
Accounts receivable ($M)
Inventory turnover =

$100
$20
$30

Not relevant to this question.

Sales / Inventory =

5.0

5b. A firm has annual sales of $100 million, $20 million of inventory, and $30 million of accounts
receivable. What is its DSO?
Annual Sales ($M)
Inventory ($M)
Accounts receivable ($M)

$100
$20
$30

Days sales outstanding = Receivables / (Sales/365)

109.5

days

SECTION 4-5

12/08/11

SOLUTIONS TO SELF-TEST QUESTIONS


4a. A company has $20 billion of sales and $1 billion of net income. Its total assets are $10
billion, financed half by debt and half by common equity. What is its profit margin?
Sales ($B)
Net income ($B)
Total assets ($B)
Debt ratio

$20
$1
$10
50%

Profit margin = Net Income / Sales =

5.00%

4b. A company has $20 billion of sales and $1 billion of net income. Its total assets are $10
billion, financed half by debt and half by common equity. What is its ROA?
Sales ($B)
Net income ($B)
Total assets ($B)
Debt ratio

$20
$1
$10
50%

ROA = Net income / Total assets

10.00%

4c. A company has $20 billion of sales and $1 billion of net income. Its total assets are $10
billion, financed half by debt and half by common equity. What is its ROE?
Sales ($B)
Net income ($B)
Total assets ($B)
Debt ratio

$20
$1
$10
50%

Equity = (1 Debt ratio) Assets =

$5.0

ROE = Net income / Equity =

20.00%

4d. Would this firm's ROA increase if it used less leverage?


Answer: Yes, because with less debt, interest would be lower, hence net icome would
be higher. That would raise the ROA.
4e. Would its ROE increase if the firm used less leverage?
Answer: In general, the answer would be "maybe and maybe not."
With less debt, interest would be lower, but the firm would have more
equity. So, in the ROE equation both the numerator and the denominator
would change. Therefore, the ROE could end up either higher or lower.
However, in this case, with the ROE > ROA, the interest rate on the
debt must be less than the ROE, which causes leverage to raise the ROE. So,
in this case, lowering the debt ratio would lower the ROE.

Table 4A.1
Income Statement:
Net sales
Operating costs excl. deprec. & amort.
Depreciation & amortization
Total operating costs
Operating income (EBIT)
Interest
EBT
Taxes
Net income

Table 4A.2
Balance Sheet:
Cash & equivalents
Accounts receivable
Inventories
Total current assets
Net fixed assets
Other assets
Total assets
Accounts payable
Accruals
Notes payable
Total current liabilities
Long-term bonds
Total debt
Total common equity
Total liabilities & equity

Table 4A.3
Income Statement:
Base year = 2011
Net sales
Operating costs excl. deprec. & amort.
Depreciation & amortization
Total operating costs
Operating income (EBIT)
Interest
EBT
Taxes
Net income

Allied: Common Size Income Statem 12/08/11


2012
Industry
Composite
100.0%
88.0%
2.0%
90.0%
10.0%
1.7%
8.3%
3.3%
5.0%

2012
100.0%
87.2%
3.3%
90.5%
9.5%
2.9%
6.5%
2.6%
3.9%

2011
100.0%
87.6%
3.2%
90.8%
9.2%
2.1%
7.1%
2.8%
4.3%

Industry
407,333
358,283
8,317
366,600
40,733
6,789
33,944
13,578
20,367

2012
3,000
2,616
100
2,716
284
88
196
78
117

2012

Allied: Common Size Balance Sheets


2012
Industry
Composite
1.4%
17.8%
16.5%
35.7%
64.3%
0.0%
100.0%

2012
0.5%
18.8%
30.8%
50.0%
50.0%
0.0%
100.0%

2011
4.8%
18.8%
24.7%
48.2%
51.8%
0.0%
100.0%

Industry
3,275
40,175
37,370
80,820
145,476
0
226,296

2.3%
3.4%
2.8%
8.5%
31.5%
40.0%
60.0%
100.0%

3.0%
7.0%
5.5%
15.5%
37.5%
53.0%
47.0%
100.0%

1.8%
7.7%
3.6%
13.1%
34.5%
47.6%
52.4%
100.0%

5,098
7,697
6,448
19,243
71,276
90,519
135,778
226,296

10
375
615
1,000
1,000
0
2,000
60
140
110
310
750
1,060
940
2,000

Allied: Income Statement Percentage Change Analysis


Percent
Change in
2012
5.3%
4.8%
11.1%
5.0%
7.9%
46.7%
-3.5%
-3.5%
-3.5%

Allied: Balance Sheet Percentage Change Analysis

Balance Sheet:
Base year = 2011
Cash & equivalents
Accounts receivable
Inventories
Total current assets
Net fixed assets
Other assets
Total assets
Accounts payable
Accruals
Notes payable
Total current liabilities
Long-term bonds
Total debt
Total common equity
Total liabilities & equity

Percent
Change in
2012
-87.5%
19.0%
48.2%
23.5%
14.9%
19.0%
100.0%
7.7%
83.3%
40.9%
29.3%
32.5%
6.8%
19.0%

2011
2,850
2,497
90
2,587
263
60
203
81
122

2011

nge Analysis

80
315
415
810
870
0
1,680
30
130
60
220
580
800
880
1,680

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