Topic 3: Analysis of financial statement

1. Industry average
Companys
ratio vs
Ratio Formula Comment
Industry
Average

company will probably

have better luck getting
>
short term loans from
Liquidity lenders

company will probably

< have chance to get a long
term loans from lenders

> Good

Current
< Poor

> Good
Quick
< Poor
the firm is successful in
> managing its assets to
Asset generate sales
Management the firm is not successful in
< managing its assets to
generate sales
Poor (Inventories- worse
performance > the firm
Inventory turnover <
cannot sell inventories as
fast as Industry)
 > Good

Poor ( A/R worse- the firm

> takes a longer time to
Days sales
collect A/R)
outstanding (DSO) /365
< Good

Fixed assets > Good

turnover < Poor

Total assets > High

turnover < Low
company negotiate lower
< interest rates on long-term
loans.
Debt Management
Company cannot negotiate
> lower interest rates on long-
term loans.
Total debt to total > High risky
assets < Low risky

Times interest < Low risky

earned (TIE)
> High risky

company is probably in a
>
healthy financial position.
Profitability
company is probably in a
<
bad financial position.
Operating profit < Low
margin > High

< Poor
Profit margin
> Good
 Return on total < Poor
assets (ROA) > Good

< Poor
Basic earning Good (Firm can use the
power (BEP) > assets to make money
better)
Return on common < Poor
equity (ROE) > Good
paying out more than
> average, which will attract
investors
Market Value
paying out less than
< average, which may be not
attract many investors
< Low
<< Stock price is cheaper
High (Investors think that
Price/earnings > firm has good potential
(P/E) performances)

Stock price is more

>>
expensive

< Low
Market/book (M/B)
> High

2. Benchmarking
- M/B
+ < 1 > High risk of being taken over
+ >1 > Low risk of being taken over
- TIE
+ < 1 > Firm cannot make enough earnings to pay its interest > bankruptcy.
 + > 1 > Firm can make enough earnings to pay its interest.
3. Trend analysis:
- Analyzes a firms financial ratios over time
- Can be used to estimate the likelihood of improvement or deterioration in financial
condition.
4. Dupont Equation:
ROE = ROA * Equity multiplier
= Profit margin * Total Asset Turnover * Equity multiplier
ROE low have to see reason why by checking PM, TA.TO, and EM to see problem.