04 Ratios and Financial Analysis
Ratios and Financial Analysis Ratios and Financial Analysis
Ratios : Why Comparability among firms of different sizes Provides a profile of the firm Caution: Economic assumption of Linearity Proportionality Nonlinearity can cause problems: Fixed costs, EOQ for inventories Benchmarks: Is high Current ratio good? For whom? Industry-wide norms. Accounting Methods; Timing & Window Dressing Current ratio: 300/200 to 200/100 is it getting better? 1 2
Chapter 4
Negative numbers
Firm A B 33.33% C -20.00% Who has the highest payout ratio ? NOT B $1,000 $(5,000) Payout Ratios 20.00% $1,000 $3,000 Dividend $1,000 Income $5,000
Common Size Statements
All figures divided by the same figure Balance Sheet: Total Assets = Liabilities + Equity Income Statement: Revenue Divide by
Divide by
Analysis across statements (activity analysis) not possible. i.e. can not divide a Income Statement by Balance Sheet number Industry Comparison [Robert Morris Associates] Yahoo Finance
1 Activity Analysis
An Income Statement Inventory Turnover = A Balance Sheet Figure Cost of Goods Sold Average Inventory
Cash Cycle=
2 Liquidity Analysis
Days Inventory Outstanding + Days Receivables Outstanding - Days Payable Outstanding Current Ratio = Quick Ratio = Cash + Marketable Securities + Accounts receivable Current Liabilities
Receivables Turnover = Sales Average Receivables Fixed Asset Turnover = Sales Average Fixed Assets Asset Turnover = Sales Average Total Assets
[365 / Turnover] is days outstanding. More Turnover is it always good / bad Payables Turnover = Purchases Average Payables
5 Cash flow from= Cash flow from operations operations ratio Current Liabilities Dell: 2004 10-K Look at pages 22 and 31 6
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04 Ratios and Financial Analysis
3 Long term Debt and Solvency Analysis
Important for Bond Covenants Debt = Short-term debt + Long-term debt Total capital = Debt + Equity Debt to Equity = Assets Times Interest Earned =
Balance Sheet - reported
Short-term Payables Short-term debt Long-term Payables
e.g. retirement benefits, Deferred taxes
Long-term debt
Debt to total capital = Leverage =
Debt Total capital
Equity
Total Assets Equity
7 8
Balance Sheet - rearrange
Short-term Payables Long-term Payables
e.g: retirement benefits Deferred taxes
Balance Sheet
Cost/return
No Interest Paid Interest Paid
Operating Liabilities
Assets
Short-term debt Long-term debt Equity
Assets
Debt
Int. Exp (1-t) Net Income
Equity
10
Returns
Cost/return Gross Margin
4-1 Profitability Analysis
=
Operating Liabilities
Margin Before Interest & Taxes = Return on Assets =
Int. Exp (1-t) Net Income
Debt
After tax Interest Rate =
Equity
ROE = 11 12
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04 Ratios and Financial Analysis
42 Profitability Analysis
Return on Total capital (ROTC) =
Ratios Integrated Analysis
Economic relationships: higher sales leads to higher inventories Overlap of components: Asset TO ratio is related to individual TO ratios.
Return on Equity
= Equity = Average Equity 13
Debt = average Debt;
14
Ratios as composite of other ratios
ROA = Margin Before Interest & taxes x Asset Turnover x (1-tax)
Cost/return
Returns
Operating Liabilities
x (1-tax)
Int. Exp (1-t) + Net Income
Debt + Equity = Total Capital
ROTC
15
16
M1 MROA: ROE and ROA (Book)
ROE = = = Net Income Equity NI + (1-t) Interest Exp (1-t) Interest Exp Equity Equity NI + (1-t) Interest Exp Assets Assets Equity (1-t) Interest Exp Assets Assets Equity
MROA (Book) 2
(1-t) Interest Exp Assets = ROA Equity :page 142 last Assets [also in 4-12]
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04 Ratios and Financial Analysis
M2 MROTC: ROE AND ROTC
Net Income ROE = Equity = = NI + (1-t) Interest Exp (1-t) Interest Exp Equity Equity NI + (1-t) Interest Exp Equity + Debt Equity + Debt Equity (1-t) Interest Exp Debt Debt Equity
M2: ROTC through ROA
Debt Debt = ROTC 1+ - (1-t) Interest rate Equity Equity Debt = ROTC + ROTC - (1-t) Interest rate Equity
19
20
Total leverage
Total Leverage Change in Net Income Revenue = Net Income Change in Revenue Change in units x CM per unit x (1 - Tax rate) = Net Income Units x Unit price Change in Units X Unit Price Units x CM per unit x (1 - Tax rate) = Net Income Contribution Margin After Tax = Net Income
21
Total leverage Components
Operating Leverage Financial Leverage Contribution Margin After Tax NOPAT NOPAT Net Income Contribution Margin After Tax Net Income
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