Chapter 4 Financial Statement Analysis Tools

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Chapter 4Financial Statement Analysis Tools
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Financial Ratios

• Financial Ratio analysis is the calculation and
  comparison of ratios which are derived from the
  information in a firm's financial statements

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Financial Ratios

• Liquidity Ratios
• Describe the ability of a firm to meet its
  current obligations
• Efficiency Ratios
• Describe how well the firm is using its
  investment in assets to produce sales
• Leverage Ratios
• Reveal the degree to which debt has been used to
  finance the firms asset purchases

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Financial Ratios (Cont)

• Coverage Ratios
• Describe the ability of a firm to pay certain
  expenses (similar to Liquidity Ratios)
• Profitability Ratios
• Provide indications of how profitable a firm has
  been over a period of time

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Liquidity Ratios

• Current Ratio
• Quick Ratio (Acid-Test Ratio)

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Efficiency Ratios

• Accounts Receivable Turnover Ratio
• Average Collection Period
• Relationship between ARTR and ACP?

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Efficiency Ratios (Continued)

• Inventory Turnover Ratio
• Fixed Asset Turnover Ratio
• Total Asset Turnover Ratio

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Leverage Ratios

• Total Debt Ratio
• Long-Term Debt (LTD) Ratio
• Long-Term Debt to Total Capitalization Ratio

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Leverage Ratios (Continued)

• Debt to Equity Ratio
• Relationship between TDR DER?
• Long-Term Debt to Equity Ratio

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Coverage Ratios

• Times Interest Earned Ratio
• Cash Coverage Ratio

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Profitability Ratios

• Gross Profit Margin
• Operating Profit Margin
• Net Profit Margin

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Profitability Ratios (Continued)

• Return on Total Assets
• Return on Equity
• Return on Common Equity

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Du Pont Analysis

• Developed by Du Pont
• or

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Financial Distress Prediction

• Original Altmans Z Score
• Developed by Edward Altman in 1968
• where X1 is net working capital/total assets X2
  is retained earnings/total assets X3 is
  EBIT/total assets X4 is market value of all
  equity/book value of total liabilities X5 is
  sales/total assets.
• Z lt 1.81 - bankruptcy predicted within one
  year
• 1.81 lt Z lt 2.675 - Financial distress,
  possible bankruptcy
• Z gt 2.675 - No financial distress predicted

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Altmans Z Score for Private Firms

• all of the variables are identical to the
  original model, except that X4 uses the book
  value of equity instead of market value of equity
  because the market capitalization of private firm
  is not easily available
• Z lt 1.21 - bankruptcy predicted within one
  year
• 1.21 lt Z lt 2.90 - Financial distress,
  possible bankruptcy
• Z gt 2.90 - No financial distress predicted

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Using Financial Ratios

• Trend Analysis
• Involves the examination of ratios over time
• Comparing to Industry Averages
• Compare similar firms within a single industry
• Industry average ratios published by Robert
  Morris Associates and Standard Poors