Financial Statement Anal
We recognize that the balance sheet is a statement of the firms
financial position at a point in time
The income statement shows the result of operation s during an
interval of time
The statement of Retained Earnings indicates how the retained earnings
account on the balance sheet is adjusted between balance sheet dates.
Ratio Analysis
Financial ratios are designed to help evaluate a financial statement.
From an investors view, financial statement analysis is all
about future prediction.
From management standpoint, financial statement analysis is usefu
both to help anticipate future conditions and, more important, as a
starting point planning actions that will improve the firms future pe
Following ratios are useful in financial analysis:
Liquidity ratios
Activity ratios
Debt ratios
Profitability ratios
Market ratios
A liquid asset is one that trades in an active market and hence can be
quickly converted to cash at a fair market price.
Two commonly used liquidity ratios are:
The current ratio
Quick, or Acid Test ratio
Current Ratio (Ability to meet short-term obligations)
Current assets
Current ratio
Current liabilities
Quick, or Acid test ratio
Current assets Inventories
Quick ratio
Current liabilities
Activity Ratios
It measures how effectively the firm is managing its assets
Ratios are analyze the different types of assets are:
The Inventory Turnover ratio
Average collection period ratio
Average payment period ratio
The Inventory Turnover Ratio (Evaluating Inventories)
Sales
Inventory Turnover
Inventories
OR
COGS
Inventory Turnover
Average Inventory
Average Collection Period (Evaluating
Receivables)
Accounts Receivables
Average Collection Period
Average sales per day
Accounts Receivables
Annual Sales
365
Average Payment Period: (Evaluating average age of A/Ps)
Accounts payable
Average Payment Period
Average Purchases per day
Accounts payable
Annual purchases
365
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Total Asset Turnover: (efficiency with which the firm uses its
assets)
Total Asset turnover
Sales
Total assets
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Debt Ratios
Firms use debt financing (external sources) to raise funds
This debt financing (financial leverage) has three important implications:
1) By raising funds through debt, existing stockholders can maintain
control of the firm with out increasing their investment.
2) Creditors look to equity funds (which act as a margin of safety)
3) If the firm earns more on investments with borrowed funds and pays
more interest, the return on owners equity capital is magnified or
leveraged
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Total Debt to Total Assets: (How the firm is financed)
Total liabilities
Debt ratio
Total assets
Times Interest Earned: (Ability to pay interest)
EBIT
Times interest earned (TIE) ratio
Interest charges
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Profitability Ratios
The effectiveness of a firms operations are shown by Profitability Ratios .
Gross Profit Margin
Sales C.O.G.S.
Gross Profit margin
Sales
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Operating Profit Margin
Operating profits
Operating profit margin
Sales
Net Profit Margin
Earnings available for common stockholders
Net profit margin
Sales
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Q. Ace Industries has current assets equal to $3 million. The companys
current ratio is 1.5 and its quick ratio is 1.0. What is the firms level of
current liabilities? What is the firms level of inventories?
Q. The K. Company had a quick ratio of 1.4, a current ratio of 3.0, an inventory
turnover of 6 times, total current assets of $810,000 and cash and marketable
securities of $120,000. What were K. annual sales and its Average collection
period?
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Earning Per Share (EPS)
Earnings available for common stockholders
EPS
No. of shares of common stock outstanding
Return on Total assets (ROA)
Net Income available to common stock holders
Return on total assets
Total assets
17
Return on Common Equity (ROE)
Earnings available
to common stockholders
Return on common equity
Common equity
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Market Value Ratios
These ratios give management an indication of what investors think of
the companys past performance and future prospects in terms of
risk and return.
Price Earning Ratio
Market Price per share
P/E ratio
Earnings per share
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Market/ Book Ratio
Common equity
Book value per share
Shares outstanding
Market price per share
Market/Book ratio
Book value per share
20
Assets (in millions)
2001
2000
Cash and equivalents
$10
$15
Short-term investments
65
Accounts receivable
375
315
Inventories
615
415
$1000
$810
Total current assets
Net plant and equipment 1,000
870
Total assets
$1680
$2000
21
Liabilities and equity
Accounts payable
2001
$60
2000
$30
Notes payable
Accruals
Total current liabilities
110
140
310
60
130
220
Long-term bonds
Total debt
Preferred Stock (40m shares)
Common stock (50m shares)
754
1064
40
130
580
800
40
130
Retained Earnings
Total common equity
766
896
710
840
Total liabilities and equity
$2,000
$1,680
22
2001
$3000
2616.2
383.8
2000
$2850
2497
353
Depreciation and
amortization
100
90
EBIT
Less: Interest
283.8
88
263
60
Earnings before taxes (EBT)
Taxes (40%)
Net Income before Preferred
dividends
195.8
78.3
117.5
203.0
81.2
121.8
Net Income
113.5
117.8
Common dividends
57.5
53.0
Net sales
Operating costs
EBITDA
Perform the possible Ratio analysis on this data and compare the results of 23
year
2000 and 2001.
Du Pont Analysis
Return on Equity (ROE) is affected by asset turnover, the profit
margin and leverage.
This approach is useful for evaluating performance
The profit margin times the total assets turnover is called the
Du Pont Equation and it gives the rate of return on assets (ROA)
ROA Profit margin Total assets turnover
Earnings available for
common stock holders
Sales
Sales
Total assets
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Net Income
Net Income
ROA
and ROE
Total assets
Common Equity
This equality holds only if Total assets = Common equity (i.e. company
uses no debt)
To find the ROE, multiply the rate of return on assets (ROA) by the
Financial Leverage multiplier, which is the ratio of assets to
common equity.
Total assets
Financial Leverage Multiplier
Common equity
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ROE ROA FLM
Net Income
Total assets
Total assets Common equity
OR
ROE (Profit Margin) (Total asset turnover)
(Financial Leverage multiplier)
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Q. Kamas Dealer has an ROA (Return on Asset) of 10%, a 2% profit margin,
and a return on equity equal to 15%? What is the companys Total asset
turnover? What is the firms Financial Leverage multiplier (FLM)?
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