Transcript CHAPTER 3 Financial Statement Analysis
CHAPTER 3
Analysis of Financial Statements
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Ratio analysis
Du Pont system
Effects of improving ratios
Limitations of ratio analysis
Qualitative factors
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Balance Sheet: Assets Cash AR Inventories Total CA Gross FA Less: Deprec.
Net FA Total assets 2001E 85,632 878,000 1,716,480 2,680,112 1,197,160 380,120 817,040 3,497,152 2000 7,282 632,160 1,287,360 1,926,802 1,202,950 263,160 939,790 2,866,592
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Liabilities and Equity Accounts payable Notes payable Accruals Total CL Long-term debt Common stock Retained earnings Total equity Total L & E 2001E 436,800 600,000 408,000 1,444,800 500,000 1,680,936 (128,584) 1,552,352 3,497,152 2000 524,160 720,000 489,600 1,733,760 1,000,000 460,000 (327,168) 132,832 2,866,592
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Sales COGS Other expenses EBITDA Depreciation EBIT Interest exp.
EBT Taxes (40%) Net income Income Statement 2001E 2000 7,035,600 5,834,400 5,728,000 5,728,000 680,000 627,600 116,960 680,000 (573,600) 116,960 510,640 88,000 422,640 169,056 253,584 (690,560) 176,000 (866,560) (346,624) (519,936)
Shares out.
EPS DPS Stock price Lease pmts
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Other Data 2001E 250,000 $1.014
$0.220
$12.17
$40,000 2000 100,000 ($5.199) $0.110
$2.25
$40,000
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Why are ratios useful?
Standardize numbers; facilitate comparisons
Used to highlight weaknesses and strengths
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What are the five major categories of ratios, and what questions do they answer?
Liquidity : Can we make required payments?
Asset management : Right amount of assets vs. sales?
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Debt management : Right mix of debt and equity?
Profitability : Do sales prices exceed unit costs, and are sales high enough as reflected in PM, ROE, and ROA?
Market value : Do investors like what they see as reflected in P/E and M/B ratios?
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Calculate D’Leon’s forecasted current and quick ratios for 2001.
CR 01 CA $2,680 $1,445 1.85x
.
QR 01 = CA - Inv.
CL $2,680 – $1,716 = = 0.67x
.
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Comments on CR and QR CR QR 2001 1.85x
0.67x
2000 1.1x
0.4x
1999 2.3x
0.8x
Ind.
2.7x
1.0x
Expected to improve but still below the industry average.
Liquidity position is weak.
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What is the inventory turnover ratio vs. the industry average?
Inv. turnover = Sales Inventories 2001 Inv. T. 4.1x
2000 4.5x
1999 4.8x
Ind.
6.1x
Comments on Inventory Turnover
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Inventory turnover is below industry average.
D’Leon might have old inventory, or its control might be poor.
No improvement is currently forecasted.
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DSO is the average number of days after making a sale before receiving cash.
DSO = Receivables Average sales per day Receivables $878 $7,036/360
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Appraisal of DSO DSO 2001 44.9
2000 39.0
1999 Ind.
36.8 32.0
D’Leon collects too slowly, and is getting worse.
D’Leon has a poor credit policy.
F.A. and T.A. turnover vs. industry average Fixed assets turnover = Sales Net fixed assets Total assets turnover = = 8.61x.
$817 = Sales Total assets = = 2.01x.
$3,497
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2001 2000 1999 FA TO 8.6x
TA TO 2.0x
6.2x
2.0x
10.0x
2.3x
Ind.
7.0x
2.6x
FA turnover projected to exceed industry average. Good.
TA turnover not up to industry average. Caused by excessive current assets (A/R and Inv.)
Calculate the debt ratio, TIE, and EBITDA coverage ratios.
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Debt ratio = Total debt Total assets = = 55.6%.
$3,497 TIE = EBIT Int. expense = = 5.8x.
$88
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EBITDA coverage = EBITDA + Lease payments (in cash) Interest Lease Loan expense pmt. repayments = = 5.2x.
$88 + $40 + $0
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How do the debt management ratios compare with industry averages?
D/A TIE EBITDA coverage 2001 2000 1999 Ind.
55.6% 95.4% 54.8% 50.0% 5.8x
-3.9x
3.3x
6.2x
5.2x
-3.3x
3.6x
8.0x
Too much debt, but projected to improve.
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Profit margin vs. industry average?
NI $253.6
$7,036 P.M.
2001 3.6% 2000 -8.9% 1999 Ind.
2.6% 3.5% Very bad in 2000, but projected to exceed industry average in 2001. Looking good.
BEP vs. Industry Average?
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BEP = EBIT Total assets $510.6 = = 14.6%.
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BEP 2001 14.6% 2000 1999 -24.1% 14.2% Ind.
19.1%
BEP removes effect of taxes and financial leverage. Useful for comparison.
Projected to be below average.
Room for improvement.
Return on Assets ROA = Net income Total assets $253.6 = = 7.3%.
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ROE = Net income Common equity = = 16.3%.
$1,552 ROA ROE 2001 7.3% 2000 -18.1% 1999 6.0% 16.3% -391.4% 13.3% Ind.
9.1% 18.2% Both below average but improving.
Effects of Debt on ROA and ROE
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ROA is lowered by debt--interest lowers NI, which also lowers ROA = NI/Assets.
But use of debt lowers equity, hence could raise ROE = NI/Equity.
Calculate and appraise the P/E, P/CF, and M/B ratios.
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Price = $12.17.
Price per share $12.17
$1.01
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Typical industry average P/E ratios Industry Banking P/E ratio 17.15
Computer Software Services Drug 33.01
41.81
Electric Utilities (Eastern U.S.) 19.40
Internet Services* Semiconductors Steel Tobacco 290.35
78.41
12.71
11.59
Water Utilities 21.84
* Because many internet companies have negative earnings and no P/E, there was only a small sample of internet companies.
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CF per share = NI + Depr. Shares out.
= = $1.48.
250 P/CF = Price per share Cash flow per share $12.17
= = 8.21x.
BVPS = Com. equity Shares out.
M/B = Mkt. price per share Book value per share $12.17
= = 1.96x.
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P/E 2001 2000 12.0x
-0.4x
1999 9.7x
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Ind.
14.2x
P/CF M/B 8.21x
1.96x
-0.6x
1.7x
8.0x
1.3x
11.0x
2.4x
P/E: How much investors will pay for $1 of earnings. High is good.
P/CF: How much investors will pay for $1 of cash flow. High is good.
M/B: How much paid for $1 of BV. Higher is better.
P/E and M/B are high if ROE is high, risk is low.
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= ROE NI Sales Sales TA CE 1999 Ind.
2.6% x 2.3 x 3.5% x 2.6 x 2.2 = 2.0 = 13.3% 2000 -8.9% x 2.0 x 21.6 = -391.4% 2001 3.6% x 2.0 x 2.3 = 16.3% 18.2%
The Du Pont system focuses on:
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Expense control (P.M.)
Asset utilization (TATO)
Debt utilization (Eq. Mult.) It shows how these factors combine to determine the ROE.
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Simplified D’Leon Data A/R Other CA 878 Debt 1,802 Equity Net FA 817 Total assets $3,497 L&E 1,945 1,552 $3,497 day 360 Q. How would reducing DSO to 32 days affect the company?
Effect of reducing DSO from 44.9 days to 32 days:
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Old A/R = 19,543 x 44.9 = 878,000 New A/R = 19,543 x 32.0 = 625,376 Cash freed up: 252,624 Initially shows up as additional cash.
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New Balance Sheet Added cash A/R Other CA Net FA Total assets $ 253 Debt 625 Equity 1,802 $1,945 1,552 817 $3,497 Total L&E $3,497 What could be done with the new cash? Effect on stock price and risk?
Potential use of freed up cash
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Repurchase stock. Higher ROE, higher EPS.
Expand business. Higher profits.
Reduce debt. Better debt ratio; lower interest, hence higher NI.
All these actions would improve stock price.
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What are some potential problems and limitations of financial ratio analysis?
Comparison with industry averages is difficult if the firm operates many different divisions.
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Average” performance not necessarily good.
Seasonal factors can distort ratios.
“Window dressing” techniques can make statements and ratios look better.
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Different operating and accounting practices distort comparisons.
Sometimes hard to tell if a ratio is “good” or “bad.”
Difficult to tell whether company is, on balance, in strong or weak position.
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What are some qualitative factors analysts should consider when evaluating a company’s likely future financial performance?
Are the company’s revenues tied to 1 key customer?
To what extent are the company’s revenues tied to 1 key product?
To what extent does the company rely on a single supplier?
(More…)
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What percentage of the company’s business is generated overseas?
Competition
Future prospects
Legal and regulatory environment