Transcript Chapter 5 Financial Statement Analysis

Chapter 5
Financial Statement Analysis
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality Industry
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Three Approaches to
Financial Statement Analysis
 Horizontal analysis
 Vertical analysis
 Ratio analysis
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Horizontal Analysis
1.
2.
Compares two financial statements
Shows dollar and percentage differences
Illustration:
Cash
3.
2009
2010
$10,000 $15,000
Differences
Dollar
%
+ $5000 50%
When reviewing financial statements focus on
significant differences!
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Vertical Analysis
1. Financial statements reduced to
percentages
2. Balance sheet:
a. Assets = 100%
b. Liabilities & OE = 100%
3. Income statement:
net revenue = 100%
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
ALPHA Co.
Illustration
Dollars
%
Net revenue
$100,000
100%
Cost of sales
35,000
35
Labor costs
30,000
30
Other expenses
30,000
30
Net income
$5,000
5%
BETA Co.
Dollars
%
$500,000 100%
200,000
40
150,000
30
190,000
28
$10,000
2%
Which company has the best performance?
Why?
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Ratio Analysis

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Comparing two related numbers from
financial statements
Expressed as $, %, times, days, etc.
Purposes for managers:
 Express goals for business
 Track performance of the operation
 Communicate financial performance
Result must be compared to a standard
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Standards
 Budget
 Prior period
 Industry average
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Classes of Ratios
 Liquidity – can the firm meet its short-term
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obligations?
Solvency – can the firm meet its long-term
obligations?
Activity – how is management using the
property’s assets?
Profitability – how profitable is the business?
Operating – how efficient is management in
running the business?
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Liquidity Ratios


Current Ratio – indicates relationship between
current assets and current liabilities
Formula: CR = Current Assets/Current
Liabilities
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Acid-Test Ratio
 Acid-Test Ratio:
Quick Assets
Current Liabilitie s
 A more stringent measure than the CR as
inventories and prepaid expenses are excluded
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Accounts Receivable Turnover



This ratio shows the number of times the average
accounts receivable have been collected.
AR T/O: Total revenue/Average accounts
receivable
Note: When comparing figures from a stock
statement (balance sheet) and a flow statement
(income statement) use an average for the figures
from the balance sheet!
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Average Collection Period (ACP)
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ACP is another to view the collection of
AR
ACP = 365/AR T/O
Expresses average number of days
receivables are outstanding
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Operating Cash Flows to
Current Liabilities Ratio
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
Purpose of ratio is compare operating cash
flows to current debt. (Cash pays the bills, not
CA!)
OCF to CL Ratio = OCF/Average CL
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Liquidity Evaluation Illustration
Selected liquidity ratios for AW Corporation are
as follows:
CR
Acid-test
AR T/O
OCF to CL
2008
1.4
1.2
12
70%
2009
1.45
1.25
11
72%
2010
1.5
1.3
10
74%
Evaluate the change in liquidity for AW
corporation
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Evaluation
The current and acid-test ratios are increasing
throughout the 2008-2010 period. The AR
T/O is decreasing resulting in relatively more
accounts receivable outstanding. ACP was
30.4 days at the end of 2008 and increased to
36.5 days at the end of 2010. This increase
should be further investigated. Operating
cash flows are increasing overtime in relation
to the current obligations. Overall liquidity is
improving; however, there is some concern
regarding accounts receivable.
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Solvency Ratios
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Two major perspectives – balance sheet
and income statement
Balance sheet
 Debt-equity
 LTD to total capitalization
Income statement
 Number of times interest earned (TIE)
 Fixed charge coverage
SCF: OCF to total liabilities ratio
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Debt-Equity Ratio
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Shows amount of debt for each $1 of
owner’s equity
DE Ratio: total liabilities/total owners’
equity
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Long-Term Debt to Total
Capitalization Ratio
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Total capitalization = LTD + Owners’ Equity
Shows LTD as % of total capitalization
LTD to Total Cap. Ratio = LTD/LTD + OE
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Number of Times Interest
Earned (TIE)
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
Indicates the number of times interest can
be covered with income
TIE = EBIT/Interest Expense
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Fixed Charge Coverage Ratio
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
Lease expense is added to the numerator
and denominator of the TIE ratio
FCC Ratio = (EBIT + Lease Expense)/
(Interest + Lease Expense)
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Operating Cash Flows to Total
Liabilities Ratio
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
Uses figures from Balance Sheet and SCF
OCF to TL Ratio = OCF/Average
TotalLiabilities
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Solvency Evaluation Illustration
BC, Inc., has solvency ratios for 2008 – 2010 as
follows:
Debt-Equity
LTD to Total Cap. Ratio
TIE
FCC Ratio
OCF to TL Ratio
2008
70%
41%
4 times
3 times
20%
2009
60%
38%
4.2 times
2.8 times
22%
2010
50%
33%
4.4 times
2.6 times
24%
Evaluate the changing solvency of BC, Inc. over
the three years
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Evaluation
Both the debt-equity and LTD to total capitalization
ratios reveal relatively less debt to equity over the
three years. The increasing TIE and OCF to TL
ratios suggest an increasing ability to pay the longterm liabilities. The decreasing fixed charge
average ratio suggests lease expense (and most
likely the number of leases) are increasing over
time. Overall solvency has improved and in part
this has happened by switching to leasing as a
means of finance.
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Activity Ratios
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Inventory Turnover
Property and Equipment Turnover
Asset Turnover
Non-financial ratio: occupancy
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Inventory Turnover
 This ratio shows how quickly inventory
is moving
 A separate turnover should be
determined for each type of inventory,
i.e., food, beverage, gift shop etc.
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Food Inventory Turnover

Food Inventory Turnover =
Cost of Food Used
Average Food Inventory
 Cost of Food Used: BI + purchases – EI
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Food Inventory Holding Period
(FIHP)

Provides the average number of days inventory is
held prior to sale
 FIHP =
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
365
Food Inventory Turnover
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Property and Equipment
Turnover (PET)

Measures management’s effectiveness in using
property and equipment
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PET =
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
Total Revenue
Average Property and Equipment
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Asset Turnover Ratio
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Measures management’s use of all assets

Asset Turnover Ratio:
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
Total Revenue
Average Total Assets
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Paid Occupancy Percentage
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A non-financial key indicator of management’s
success in selling rooms
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Paid occupancy % =
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Rooms sold include all rooms occupied except for
complimentary rooms

Rooms available include rooms that could be sold
and generally exclude out-of-order rooms
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
Rooms Sold
Rooms Available
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Activity Evaluation Illustration
The Dirk Company’s activity ratios over a three
year period were as follows:
Food inventory T/O
Property and equipment T/O
Asset turnover
Paid occupancy %
2008
12
2
1
72%
2009
13
2.1
1.1
71%
2010
14
2.2
1.2
70%
How has management’s use of the company’s
resources changed over the three year period?
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Evaluation
Food inventory is turning more quickly from
2008 through 2010 as is both property and
equipment and total assets. This result is
considered good. Paid occupancy is
declining slightly. Management appears to
be selling few rooms; however, the ADR
(price per room) could be a major factor.
This requires additional management
attention.
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Profitability Ratios
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These ratios measure the overall
effectiveness of management
Major ratios include:
 Profit Margin
 Operating Efficiency Ratio
 Return on Assets
 Return on Equity
 EPS
 PE Ratio
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Profit Margin
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
Measures the profits from sales
Profit Margin =
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
Net Income
Total Revenue
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Operating Efficiency Ratio

Measures management’s performance based
on expenses they control

Operating Efficiency Ratio:
Incomeafter UndistributedOperatingExpenses
T otalRevenue
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Return on Assets (ROA)
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Indicator of profitability compared to the firm’s
assets
ROA =
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
Net Income
Average Total Assets
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Return on Equity (ROE)
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
Measures profitability of firm compared to
owners’ investment
ROE =
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
Net Income
Average Owners' Equity
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Earnings per Share (EPS)
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Shows the amount earned per each share of
owners’ common stock
EPS =
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
Net Income
AverageCommonShares Outstanding
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Price Earnings Ratio (PE)
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
Reflects the relationship between the market
price per share and the EPS
PE =
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
Market price per share
EPS
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Profitability Evaluation Illustration
The Mellow Motel Corporation’s profitability ratios for 2008
through 2010 were as follows:
Profit Margin
Operating Efficiency Ratio
ROA
ROE
EPS
PE
2008
6%
30%
12%
15%
$2.00
10
2009
6.5%
29%
13%
16%
$2.10
11
2010
7%
28%
14%
17%
$2.20
12
Evaluate the corporation’s changing profitability over the
three-year period.
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Evaluation
Profit margin is increasing each year even though the
operating efficiency ratio is in decline. ROA, ROE,
and EPS are increasing each year. This suggests
that greater profits are being achieved by relative
reductions in fixed charges such as interest expense
and depreciation. The market appears to be reacting
favorably to these changes since the PE ratio has
increased from 10 times in 2008 to 12 times in 2010.
The market price at the end of 2008 was $20 and at
the end of 2010 it was $26.40.
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Operating Ratios
 Assist management in analyzing the

operations of the business
Major ratios covered include
 Average daily rate (ADR)
 REVPAR
 Food Cost Percentage
 Labor Cost Percentage
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Average Daily Rate (ADR)
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Reveals average price per room sold

ADR =
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
Rooms Revenue
Number of Rooms Sold
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
REVPAR

Measures a combination of paid occupancy %
and ADR

REVPAR = Paid OCC % X ADR
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Food Cost Percentage
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
Key food service ratio that compares the cost
of product (food) sold to product (food) sales
Food Cost % =
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
Cost of Food Sold
Food Sales
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Labor Cost Percentage
 Reveals the relationship between
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
labor costs and revenue
Labor cost generally is the highest
single cost of a hospitality organization
Labor costs include salaries, wages,
fringe benefits, and payroll taxes
Ratio should be computed for each
profit center of the operation
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Labor Cost %

Labor Cost % =
Departmental Labor Costs
Departmental Revenues
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Evaluation of Operations
Illustration
The Wisker Restaurant Inn has selected operating ratios
for 2008-2010 as follows:
ADR
REVPAR
Food Cost %
Labor Cost %
2008
$85
$59.50
34%
30%
2009
$86
$59.34
33.5%
29.5%
2010
$87
$59.16
33%
29%
Evaluate the operating activities of the Wisker Restaurant
& Inn over the three-year period based on the above four
ratios
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Evaluation

First, one should be very careful when evaluating any
aspect of business with so few ratios. Even so, these four
ratios suggest
 Prices are increasing but the amount per room available is

decreasing from 2008 through 2010. This appears to
suggest some price resistance and management should
undertake further evaluation.
Both food cost and labor cost percentages are decreasing
over the three year period. If quality is not sacrificed this is
good from a financial perspective.
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Limitations of Ratio Analysis
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Only indicators
Must be based on two related numbers
Most useful when compared to a standard
Be careful when comparing financial ratios
of different firms
 Are they in the same industry?
 Are they using the same or similar
accounting procedures?
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458
Summary
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Financial analysis includes horizontal, vertical
and ratio analysis
Ratios can be used to efficiently communicate,
control and set targets
Major classes of ratios include liquidity,
solvency, activity, profitability, and operating
Ratios vary in importance to major user
groups
Ratios must be compared to a standard to be
meaningful
Andrew, Damitio, Schmidgall
Financial Management for the Hospitality
©2007 Pearson Education, Inc.
Upper Saddle River, NJ 07458