Professional Documents
Culture Documents
Objectives
6-2
Understand the purpose of basic financial statements and their contents. Explain why financial statement analysis is important to the firm and to outside suppliers of capital. Define, calculate, and categorize (according to liquidity, financial leverage, coverage, activity, and profitability) the major financial ratios and understand what they can tell us about the firm. Define, calculate, and discuss a firms operating cycle and cash cycle. Use ratios to analyze a firm's health and then recommend reasonable alternative courses of action to improve the health of the firm. Analyze a firms return on investment (i.e., earning power) and return on equity using a DuPont approach. Understand the limitations of financial ratio analysis. Use trend analysis to gain additional insights into a firm's performance.
Statements
Balance Income
6-3
Bondholders
Shareholders
6-4
-- Focus on assessing the current financial position and evaluating potential firm opportunities. -- Focus on return on investment for various assets and asset efficiency.
-- Focus on understanding how suppliers of funds analyze the firm.
Control
Understand
6-5
A summary of a firms financial position on a given date that shows total assets = total liabilities + owners equity. A summary of a firms revenues and expenses over a specified period, ending with net income or loss for the period.
Income Statement
6-6
Cash and C.E. $ 90 Acc. Rec.c 394 Inventories 696 Prepaid Exp d 5 Accum Tax Prepay 10 Current Assetse $1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g (329) Net Fix. Assets $ 701 Investment, LT 50 Other Assets, LT 223 Total Assets b $2,169 6-7
a. How the firm stands on a specific date. b. What BW owned. c. Amounts owed by customers. d. Future expense items already paid. e. Cash/likely convertible to cash within 1 year. f. Original amount paid. g. Acc. deductions for wear and tear.
Notes Payable Acct. Payablec Accrued Taxes d Other Accrued Liab. d Current Liab. e Long-Term Debt f Shareholders Equity Com. Stock ($1 par) g Add Pd in Capital g Retained Earnings h Total Equity a,b 6-8 Total Liab/Equity
a. Note, Assets = Liabilities + Equity. b. What BW owed and ownership position. c. Owed to suppliers for goods and services. d. Unpaid wages, 200 salaries, etc. 729 e. Debts payable < 1 year. 210 f. Debts payable > 1 year. $1,139 g. Original investment. $2,169 h. Earnings reinvested.
. Notes Payable
Acct. Payablec Accrued Taxes d Other Accrued Liab. d Current Liab. e Long-Term Debt f Shareholders Equity Com. Stock ($1 par) g 200 Add Pd in Capital g 729 Retained Earnings h 210 Total Equity $1,139 Total Liab/Equitya,b $2,169
6-12
1. Analysis of the funds needs of the firm. 2. Analysis of the financial condition and profitability of the firm. 3. Analysis of the business risk of the firm.
1. Analysis of the funds needs of the firm. 2. Analysis of the financial condition and profitability of the firm. 3. Analysis of the business risk of the firm.
6-14
Types of Comparisons
Internal Comparisons External Comparisons
Liquidity Ratios
Balance Sheet Ratios
Liquidity Ratios
Current
Current Assets Current Liabilities For Basket Wonders December 31, 2007 $1,195 = 2.39 $500
Shows a firms ability to cover its current liabilities with its current assets. 6-17
2005
6-18
1.91
2.01
Liquidity Ratios
Balance Sheet Ratios
Liquidity Ratios
Acid-Test (Quick)
Current Assets - Inv Current Liabilities For Basket Wonders December 31, 2007 $1,195 - $696 = 1.00 $500
Shows a firms ability to meet current liabilities with its most liquid assets. 6-19
2005
6-20
1.11
1.25
BW 2.39 1.00
Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account. Note that this industry has a relatively high level of inventories.
6-21
2.3 2.1 1.9 1.7 1.5 2005 2006 Analysis Year 2007 BW Industry
6-22
2007
6-23
The current ratio for BW has been rising at the same time the acid-test ratio has been declining.
The current ratio for the industry has been rising slowly at the same time the acid-test ratio has been relatively stable. This indicates that inventories are a significant problem for BW.
6-24
Debt-to-Equity
Total Debt Shareholders Equity For Basket Wonders December 31, 2007 $1,030 = .90 $1,139
2005
6-26
.81
.89
Debt-to-Total-Assets
Total Debt Total Assets For Basket Wonders December 31, 2007 $1,030 = .47 $2,169
Shows the percentage of the firms assets that are supported by debt financing.
6-27
2005
6-28
.45
.47
Coverage Ratios
Income Statement Ratios Coverage Ratios
Interest Coverage
EBIT+ Depreciation Interest Charges For Basket Wonders December 31, 2007 $210 = 3.56 $59
2005
10.30
4.66
BW has below average interest coverage relative to the industry average. 6-30
Ratio Value
BW Industry
2007
The interest coverage ratio for BW has been falling since 2005. It has been below industry averages for the past two years. This indicates that low earnings (EBIT) may be a potential problem for BW.
Note, we know that debt levels are in line with the industry averages.
6-32
Activity Ratios
Income Statement / Balance Sheet Ratios
Activity Ratios Indicates quality of receivables and how successful the firm is in its collections.
6-33
Receivable Turnover
(Assume all sales are credit sales.)
Annual Net Credit Sales Receivables For Basket Wonders December 31, 2007 $2,211 = 5.61 $394
Activity Ratios
Income Statement / Balance Sheet Ratios
Activity Ratios Average number of days that receivables are outstanding. (or RT in days)
6-34
= 65 days
2005
6-35
83.6
69.2
BW has improved the average collection period to that of the industry average.
Activity Ratios
Income Statement / Balance Sheet Ratios
Activity Ratios Indicates the effectiveness of the inventory management practices of the firm. 6-36
Inventory Turnover
Cost of Goods Sold Inventory For Basket Wonders December 31, 2007 $1,599 = 2.30 $696
2005
6-37
2.64
3.69
Ratio Value
BW Industry
2007
Activity Ratios
Income Statement / Balance Sheet Ratios
Activity Ratios Indicates the overall effectiveness of the firm in utilizing its assets to generate sales. 6-39
2005
6-40
1.01
1.13
Profitability Ratios
Income Statement / Balance Sheet Ratios
Profitability Ratios Indicates the efficiency of operations and firm pricing policies.
6-41
2005
6-42
31.3
27.6
2007
6-43
Profitability Ratios
Income Statement / Balance Sheet Ratios
Profitability Ratios Indicates the firms profitability after taking account of all expenses and income taxes. 6-44
2005
6-45
9.0
7.6
9 8 7 6 5 4 2005 BW Industry
2007
6-46
Profitability Ratios
Income Statement / Balance Sheet Ratios
Profitability Ratios Indicates the profitability on the assets of the firm (after all expenses and taxes).
6-47
Return on Investment
Net Profit after Taxes Total Assets For Basket Wonders December 31, 2007 $91 = .042 $2,169
2005
6-48
9.1
10.8
10 8 6 4 2005 BW Industry
2007
6-49
Profitability Ratios
Income Statement / Balance Sheet Ratios
Profitability Ratios Indicates the profitability to the shareholders of the firm (after all expenses and taxes).
6-50
Return on Equity
Net Profit after Taxes Shareholders Equity For Basket Wonders December 31, 2007 $91 = .08 $1,139
2005
6-51
16.6
20.4
2007
6-52
Other Ratios
Earnings
per share
EPS = (Net profit after tax pref. Div) No. of equity shares (common shares) The portion of a company's profit allocated to each outstanding share of common stock
6-53
Other Ratios
dividends Payout ratio = earnings
stock price earnings per share
PE Ratio =
6-54
ROI2007
6-55
ROE2007
6-56
The profitability ratios for BW have ALL been falling since 2005. Each has been below the industry averages for the past three years. This indicates that COGS and administrative costs may both be too high and a potential problem for BW. Note, this result is consistent with the low interest coverage ratio.
6-57
6-58