Financial Analysis Chapter 3

1
Financial Analysis(Chapter 3)

• Ratio Analysis
• Liquidity
• Asset Utilization
• Debt Utilization
• Profitability
• Market Value
• DuPont Relationships
• Ratio Analysis and Wealth Maximization
• Some Analytical Problems

2
RATIO ANALYSIS

• Ratio Defined
• Simply one number divided by another.
• Why Calculate Ratios?
• Make data more meaningful.
• High - Low - Avg How do you judge?
• Industry Averages
• Dun Bradstreet
• Robert Morris Associates
• Trade Associations

3
Ratio Analysis (Continued)

• Prior Period Ratios
• Calculated from the firms previous financial
  statements (e.g., trend analysis)
• Current Goals
• Often, goals are stated in the form of ratios.
• Benchmarking
• A group of selected companies (e.g., form your
  own industry).

4
Common Size Ratios

• Common Size Balance Sheet
• Each item is stated as a of total assets.
• Common Size Income Statement
• Each item is stated as a of sales.

5
Liquidity Ratios

• Liquidity Ratios
• Ability to meet short-term obligations

6
Asset Utilization Ratios

• Effective use of assets in the process of
  generating sales.
• Receivables Ratios
• Note Ideally, credit sales should be used for
  the receivables ratios. However, only total sales
  are available at times.

AKA Days Sales Outstanding
7
Asset Utilization Ratios (Continued)

• Inventory Turnover
• Note COGS is sometimes used in lieu of sales,
  and average inventories may replace ending
  inventories.

8
Asset Utilization Ratios (Continued)

• Asset Turnover Ratios
• Note Net fixed assets equals gross fixed assets
  minus accumulated depreciation.

9
Debt Utilization Ratios(Use of Financial
Leverage)

• Leverage Ratios

10
Debt Utilization Ratios (Continued)

• Fixed Charge Coverage Ratio

Could also be adjusted to include principal
payments on loans.
11
Profitability Ratios(Ability to Earn an Adequate
Return)

• Profit Margins

12
Profitability Ratios(Continued)

• Return on Investment Ratios

AKA ROI
13
DuPont Relationships
(ROA)
14
Market Value Ratios(Investors Reactions)

• Notes (1) Book Value Per Share (Com Equity)/(
  of Shares)
• (2) Cash flow per share equals net income
  plus depreciation or amortization divided by
  the number of shares outstanding.

15
Ratio Analysis andWealth Maximization
Expenses
Net Profit Margin
Return on Assets
Return on Total Equity
Sales
Return on Common Equity
Total Asset Turnover
Debt to Assets Ratio
Preferred Stock Financing
Assets
16
Ratio Analysis and WealthMaximization (Continued)
Return on Common Equity
Book Value Per Share
Earnings Per Share

X
Price Earnings Ratio
Earnings Per Share
X

Price Per Share
17
Some Analytical ProblemsInvolving Asset Quality

• It is possible to increase ROI by avoiding the
  purchase of new plant and equipment (i.e., keep
  the asset base low). Of course, the firm may
  suffer in the long run.
• A high level of accounts receivable may improve
  the current ratio, but what if a large percentage
  of accounts are uncollectible?

18
Some Additional Analytical Problems

• Inflation
• Sales and profits may increase simply because of
  rising prices, even without an increase in
  physical volume.
• Replacement costs of assets may be higher than
  historical costs.
• Inventory Accounting
• If firms employ different techniques (e.g., LIFO,
  FIFO), comparability of ratios is impaired.
• Industry Averages
• Some firms operate in more than one.