Transcript Ratio Analysis, PowerPoint Show

CHAPTER 3
Analysis of Financial Statements
1
Topics in Chapter





Ratio analysis
Du Pont system
Effects of improving ratios
Limitations of ratio analysis
Qualitative factors
2
Financial Analysis Procedure



Examine the statement of cash flows
Return on invested capital (ROIC) vs.
WACC
Ratio Analysis
3
Why ratio analysis (1)
Firm A
2010
2011
Net Income
50
70
Total Asset
500
800
10.0%
8.8%
ROA
4
Why ratio analysis (2)
Net Income
Total Asset
ROA
Firm A
2010
65
500
13.0%
Firm B
2010
90
800
11.3%
5
Why ratio analysis (3)

Ratios facilitate comparison of:



One company over time
One company versus other companies
Ratios are used by:



Lenders to determine creditworthiness
Stockholders to estimate future cash flows and
risk
Managers to identify areas of weakness and
strength
6
Income Statement
2010
2011
Sales
$5,834,400
$7,035,600
COGS
4,980,000
5,800,000
Other expenses
720,000
612,960
Deprec.
116,960
120,000
5,816,960
6,532,960
17,440
502,640
176,000
80,000
(158,560)
422,640
(63,424)
169,056
($ 95,136)
$ 253,584
Tot. op. costs
EBIT
Int. expense
EBT
Taxes (40%)
Net income
7
Balance Sheets: Assets
Cash
S-T invest.
AR
Inventories
Total CA
Net FA
Total assets
2010
$
7,282
20,000
632,160
1,287,360
1,946,802
939,790
$2,886,592
2011
$
14,000
71,632
878,000
1,716,480
2,680,112
836,840
$3,516,952
8
Balance Sheets: Liabilities &
Equity
Accts. payable
Notes payable
Accruals
Total CL
Long-term debt
Common stock
Ret. earnings
Total equity
Total L&E
2010
$ 324,000
720,000
284,960
1,328,960
1,000,000
460,000
97,632
557,632
$2,886,592
2011
$ 359,800
300,000
380,000
1,039,800
500,000
1,680,936
296,216
1,977,152
$3,516,9529
Other Data
Stock price
# of shares
EPS
DPS
Book val. per sh.
Lease payments
Tax rate
2010
$6.00
100,000
-$0.95
$0.11
$5.58
$40,000
0.4
2011
$12.17
250,000
$1.01
$0.22
$7.91
$40,000
0.4
10
Liquidity Ratios

Can the company meet its short-term
obligations using the resources it
currently has on hand?
11
Current and Quick Ratios
$2,680
= $1,040
CR11
CA
= CL
QR11
CA - Inv.
=
CL
$2,680 - $1,716
=
$1,040
= 2.58.
= 0.93.
12
Comments on CR and QR


2011
2010
Ind.
CR
2.58
1.46
2.7
QR
0.93
0.5
1.0
Expected to improve but still below the
industry average.
Liquidity position is weak.
13
Asset Management Ratios


How efficiently does the firm use its
assets?
How much does the firm have tied up in
assets for each dollar of sales?
14
Inventory Turnover Ratio vs.
Industry Average
Inv. turnover
Sales
= Inventories
$7,036
=
= 4.10.
$1,716
15
Comments on Inventory
Turnover



Inventory turnover is below industry
average.
Firm might have old inventory, or its
control might be poor.
No improvement is currently forecasted.
Inv. T.
2011
2010
2009
Ind.
4.1
4.5
4.8
6.1
16
DSO: average number of days from
sale until cash received. (or ACP)
DSO =
Receivables
Average sales per day
$878
= Receivables =
$7,036/365
Sales/365
= 45.5 days.
17
Appraisal of DSO


Firm collects too slowly, and situation is
getting worse.
Poor credit policy.
DSO
2011
45.5
2010
39.5
2009
37.4
Ind.
32.0
18
Fixed Assets and Total Assets
Turnover Ratios (1)
Fixed assets
turnover
Sales
=
Net fixed assets
$7,036
=
= 8.41.
$837
Total assets
turnover
Sales
=
Total assets
$7,036
=
= 2.00.
$3,517
19
Fixed Assets and Total Assets
Turnover Ratios (2)


FA turnover exceed industry average. Good.
TA turnover not up to industry average. May be
caused by excessive current assets (A/R and
inventory).
2011
2010
2009
Ind.
FA turnover
8.4
6.2
10.0
7.0
TA turnover
2.0
2.0
2.3
2.5
20
Debt Management Ratios


Does the company have too much
debt?
Can the company’s earnings meet its
debt servicing requirements?
21
Debt Ratio
Total liabilities
Debt ratio =
Total assets
$1,040 + $500
=
$3,517
= 43.8%.
22
Debt to Equity Ratio
Debt to equity ratio
= Total liabilities/(Total assets – Total liabilities)
23
Times-interest-earned (TIE)
EBIT
TIE = Int. expense
$502.6
=
= 6.3.
$80
24
Debt Management Ratios vs.
Industry Averages
D/A
TIE
2011 2010 2009
Ind.
43.8% 80.7% 54.8% 50.0%
6.3
0.1
3.3
6.2
25
Profitability Ratios

What is the company’s rate of return
on:


Sales?
Assets?
26
Profit Margins
Net profit margin (PM):
NI
$253.6
PM = Sales = $7,036 = 3.6%.
Operating profit margin (OM):
EBIT
$503
OM = Sales = $7,036 = 7.1%.
(More…)
27
Profit Margins
(Continued)
Gross profit margin (GPM):
Sales − COGS
$7,036 − $5,800
GPM =
=
Sales
$7,036
$1,236
= $7,036 = 17.6%.
28
Profit Margins vs. Industry
Averages
PM
OPM
GPM
2011
3.6%
7.1
17.6
2010
-1.6%
0.3
14.6
2009
Ind.
2.6% 3.6%
6.1
7.1
16.6 15.5
Very bad in 2010, but meet or exceed
industry average in 2011.
29
Basic Earning Power (BEP)
EBIT
BEP =
Total assets
$502.6
=
$3,517
= 14.3%.
(More…)
30
Basic Earning Power vs.
Industry Average
BEP removes effect of taxes and
financial leverage. Useful for
comparison.
 Projected to be below average.
 Room for improvement.
2011 2010 2009 Ind.
BEP 14.3% 0.6% 14.2% 17.8%

31
Return on Assets (ROA)
NI
ROA =
Total assets
$253.6
=
$3,517
= 7.2%.
32
Return on Equity (ROE)
ROE =
NI
Common Equity
$253.6
=
$1,977
= 12.8%.
33
ROA and ROE vs. Industry
Averages
ROA
ROE
2011
7.2%
12.8%
2010 2009 Ind.
-3.3% 6.0% 9.0%
-17.1% 13.3% 18.0%
Both below average but improving.
34
Effects of Debt on ROA and
ROE


ROA is lowered by debt--interest
expense lowers net income, which also
lowers ROA.
However, the use of debt lowers equity,
and if equity is lowered more than net
income, ROE would increase.
35
Effect of debt on ROE, ROA
(in $ million)
assets
operating income
r=10%
quity
debt
EBIT
less: interest
Taxable income
less: tax (30%)
Net Income
Return on Equity
Return on Assets
12
5
case 1
12
0
case 2
10
2
case 3
1
11
case 4
5
7
5
0
5
1.5
3.5
5
0.2
4.8
1.44
3.36
5
1.1
3.9
1.17
2.73
5
0.7
4.3
1.29
3.01
29.2%
29.2%
33.6%
28.0%
273.0%
22.8%
60.2%
25.1%
36
Market Value Ratios

Market value ratios incorporate the:



High current levels of earnings and cash
flow increase market value ratios
High expected growth in earnings and cash
flow increases market value ratios
High risk of expected growth in earnings
and cash flow decreases market value
ratios
37
P/E
Price = $12.17.
NI
$253.6
EPS = Shares out. = 250
Price per share
$12.17
P/E =
=
EPS
$1.01
= $1.01.
= 12.
38
Interpreting Market Based
Ratios

P/E: How much investors will pay for $1
of earnings. Higher is better.
39
Common Size Balance Sheets:
Divide all items by Total Assets
Assets
Cash
ST Inv.
AR
Invent.
Total CA
Net FA
TA
2009
2010
2011
Ind.
0.6%
0.3%
0.4%
0.3%
3.3%
0.7%
2.0%
0.3%
23.9%
21.9% 25.0% 22.4%
48.7%
44.6% 48.8% 41.2%
76.5%
67.4% 76.2% 64.1%
23.5%
32.6% 23.8% 35.9%
100.0% 100.0% 100.0% 100.0%
40
Divide all items by Total
Liabilities & Equity
Assets
2009
2010 2011E
Ind.
AP
9.9% 11.2% 10.2% 11.9%
Notes pay. 13.6% 24.9%
8.5%
2.4%
Accruals
9.3%
9.9% 10.8%
9.5%
Total CL
32.8% 46.0% 29.6% 23.7%
LT Debt
22.0% 34.6% 14.2% 26.3%
Total eq.
45.2% 19.3% 56.2% 50.0%
Total L&E 100.0% 100.0% 100.0% 100.0%
41
Analysis of Common Size
Balance Sheets



Computron has higher proportion of
inventory and current assets than
Industry.
Computron now has more equity (which
means LESS debt) than Industry.
Computron has more short-term debt
than industry, but less long-term debt
than industry.
42
Common Size Income Statement:
Divide all items by Sales
Sales
COGS
Other exp.
Depr.
EBIT
Int. Exp.
EBT
Taxes
NI
2009
100.0%
83.4%
9.9%
0.6%
6.1%
1.8%
4.3%
1.7%
2.6%
2010
100.0%
85.4%
12.3%
2.0%
0.3%
3.0%
-2.7%
-1.1%
-1.6%
2011E
100.0%
82.4%
8.7%
1.7%
7.1%
1.1%
6.0%
2.4%
3.6%
Ind.
100.0%
84.5%
4.4%
4.0%
7.1%
1.1%
5.9%
2.4%
3.6%
43
Analysis of Common Size
Income Statements

Computron has lower COGS (82.4) than
industry (84.5), but higher other
expenses. Result is that Computron
has similar EBIT (7.1) as industry.
44
Explain the Du Pont System

The Du Pont system focuses on:




Expense control (PM)
Asset utilization (TATO)
Debt utilization (EM)
It shows how these factors combine to
determine the ROE.
45
The Du Pont System (1)
(
Profit
margin
NI
Sales
)(
TA
turnover
x
Sales
TA
)(
x
Equity
multiplier
TA
CE
) = ROE
= ROE
46
The Du Pont System (1)
ROE
= ROA x Equity Multiplier
=ROA x 1/(1-debt ratio)
47
Example 1
You are given the following ratios for the XYZ Co.:
Return on equity (ROE) 20%
Return on assets (ROA) 17%
What is the debt ratio?
48
Example 2
If a firm increases its sales but keeps its debt ratio, net
profit margin, and total assets constant, what would be
the impact of this action on ROE?
A.
B.
C.
D.
E.
ROE would decrease.
ROE would increase.
ROE would remain unchanged.
ROE may increase or decrease depending on the
interaction between the equity multiplier and sales.
None of the above answers are necessarily correct.
49
Potential Problems and
Limitations of Ratio Analysis




Comparison with industry averages is
difficult if the firm operates many
different divisions.
Seasonal factors can distort ratios.
Window dressing techniques can make
statements and ratios look better.
Different accounting and operating
practices can distort comparisons.
50
Qualitative Factors

There is greater risk if:







revenues tied to a single customer
revenues tied to a single product
reliance on a single supplier?
High percentage of business is generated
overseas?
What is the competitive situation?
What products are in the pipeline?
What are the legal and regulatory issues?
51
In-class group project

After chapter problem: (3-15) a,b,c,d,e.
52
After Chapter Homework

Problems: 3-1, 3-2, 3-4, 3-5, 3-6, 3-7,
3-8, 3-9, 3-10, 3-11, 3-12, 3-13.
53