Chapter 3 Analysis of Financial Statements. Ratio Analysis Please refer to the attached financial statements, and industry average ratios
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1 Chapter 3 Analysis of Financial Statements Ratio Analysis Please refer to the attached financial statements, and industry average ratios In this chapter, we will cover Liquidity ratios Asset management ratios Debt management ratios Profitability ratios Market value ratios Liquidity ratios show the relationship of a firm s cash and other current assets to its current liabilities (liquidity refers to the ease of converting an asset into cash without significant loss) Current ratio indicates the extent to which current liabilities are covered by assets expected to be converted to cash in the near future Current ratio 2006 current assets currnet liabilities Quick (acid test) ratio is a variation of the current ratio-- deducts inventories (generally, the least liquid current asset) from current assets and divides the remainder by current liabilities Quick ratio 2006 current assets inventories currnet liabilities
2 Asset management ratios measure how effectively a firm is managing its assets. Inventory turnover ratio is a rough approximation of how many time inventory is sold out and restocked, or "turned over", per year. Inventory turnover ratio 2006 cos t of goods sold inventories Problems that may arise with inventory turnover measure: Days sales outstanding (DSO), also called the average collection period, represents the average length of time that the firm must wait after making a sale before receiving cash. Days sales outs tan ding 2006 receivables average sales per day receivables sales / 365 An receivables figure could be a better measure than the end-of-year amount.
3 Fixed assets turnover ratio measures how effectively the firm uses its plant an equipment to generate sales Fixed assets turnover ratio 2006 sales net fixed assets Total assets turnover ratio measures how effectively the firm uses all its assets Total assets turnover ratio 2006 sales total assets Debt management ratios analyze the company's use of debt. Financial leverage is the use of debt financing. Debt ratio measures the percentage of the firm's assets financed by creditors Debt ratio 2006 total debt total assets **The debt-to-assets ratio and the debt-to-equity ratios are transformations of each other since total debt pus D / A D / E total equity must equal total assets: D / E and D / A 1 D / A 1 + D / E
4 Times-interest-earned (TIE) ratio measures the extent to which earnings before interest and taxes cover its annual interest costs TIE 2006 EBIT int erest ch arg es In some situations, the TIE ratio is a better measure of debt usage than the debt ratio. For example, a firm might show a high debt ratio, but if its assets are old and largely depreciated, then the debt ratio might be overstating the impact of the debt on the firm's riskiness. EBITDA coverage ratio is similar to the TIE ratio, but it is more inclusive because it recognizes that many firms lease assets and must repay debt on schedule. EBITDA cov erage ratio 2006 int erest EBITDA + Lease payments + lease payments + principal payments Profitability ratios show the effect of liquidity, asset management, and debt management on operating results Profit margin on sales gives the percentage profit per dollar of sales Pr ofit m arg in 2006 net income available to common stockholders sales
5 Basic earning power (BEP) indicates the ability of the firm s assets to genereate operating income BEP 2006 EBIT Total assets Return on total assets (ROA) measures overall return on dollars invested in assets ROA 2006 net income total assets Return on common equity (ROE) measures the rate of return on the common stockholders' investment ROE 2006 net income available to common stockholders common equity Market value ratios relate the firm s stock price to its earnings and book value per share Earnings per share (EPS) EPS 2006 net income available to common shareholders number of common shares outs tan ding
6 Price/Earnings (P/E) ratio shows how much investors are willing to pay per dollar of reported profits Pr ice / earnings (P / E) ratio 2006 market price per share earnings per share Price/Cash Flow ratio show the dollar amount investors will pay for $1 of cash flow Pr ice / cash flow ratio 2006 market price per share Cash flow per share book value per share 2006 common equity number of common shares outs tan ding Market/Book (M/B) ratio gives an indication of how investors regard the company market / book 2006 market price per share book value per share
7 Du Pont Analysis shows that the rate of return on assets is a function of asset turnover and the profit margin ROE profit m arg in Total assets turnover Equity multiplier Net income Sales Sales Total assets Total assets Common equity
8 Balance Sheets Assets Cash Accounts receivable Inventories $ 52, , ,000 $ 57, , ,200 Total current assets $1,290,000 $1,124,000 Gross fixed assets Less accumulated depreciation $527, ,200 $491, ,200 Net fixed assets $360,800 $344,800 Total assets $1,650,800 $1,468,800 Liabilities and Equity Accounts payable Notes payable Accruals $175, , ,000 $145, , ,000 Total current liabilities $540,200 $481,600 Long-term debt Common stock (100,000 shares) Retained earnings $424,612 $460, ,988 $323,432 $460, ,768 Total equity $685,988 $663,768 Total liabilities and equity $1,650,800 $1,468,800 Income Statements Sales Costs of goods sold Other expenses Depreciation $3,850,000 (3,250,000) (430,000) (20,000) $3,432,000 (2,864,000) (340,000) (18,900) Total operating costs ($3,700,300) ($3,222,900) EBIT Interest expense $149,700 (76,000) $209,100 (62,500) EBT Taxes $73,700 (29,480) $146,600 (58,640) Net income $44,220 $87,960 EPS $0.442 $0.880 Ratio Current Quick Inventory turnover Days sales outstanding (DSO) Fixed assets turnover Total assets turnover Debt ratio TIE Fixed charge coverage Profit margin on sales ROA ROE Price/earnings Market/book Industry Average 2.7x 1.0x 6.0x 32.0days 10.7x 2.6x 50.0% 2.5x 2.1x 3.5% 9.1% 18.2% 14.2x 1.4x Other Data December 31 stock price Number of shares Dividends per share Lease payments 2006 $ ,000 $0.22 $40, $ ,000 $0.22 $40,000
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