Transcript Financial Statement Analysis I: Chapter 5 Important Decisions by the Debtor that Affect Credit Risk A.

Financial Statement Analysis I:
Chapter 5
Important Decisions by the Debtor that
Affect Credit Risk
A. The Capital Structure Decision (Debt/Equity)
1. Relative Costs of Debt and Equity Financing
a. Risk and required returns
b. Tax deductibility of interest
2. Effects on Debtor Riskiness
3. Capital Structure Choice and the Small Firm
Slide 5-1
Important Decisions by the Debtor that
Affect Credit Risk (cont.)
B. The Overall Liquidity Decision
1. Tradeoff from the debtor’s standpoint
2. Practical ways the debtor may manage
overall liquidity
1. Holding more cash
2. Extra borrowing capacity
3. Borrowing long-term instead
of short-term
Some General Comments on Ratio Analysis
A. History of Ratio Analysis
B. Centering on Ratios that Are Relevant for You
C. Ways of Using Ratios
1. Comparison to Standards
a. Standards and rules of thumb
b. Standards and “best practice”
2. Trend Analysis
a. Graphing example (slide 5-4)
b. Computing the ratio over time
c. Accounting and other time conventions
Slide 5-3
Graphing and Trend Line Example
Slide 5-4
Comments on Specific Pages from
the Chapter
A. Three Questions in Dealing with Borrowing
1. What is the Cause?
2. What is the Borrower’s Capital Structure?
3. How Will Debt Be Repaid?
B. Sources of Ratio Data and Other Information
1. Sources for Publicly-Traded Firms
2. Minor Notes on the Chapter
a. The Meaning of an Auditor’s Report
b. Financial Analysis Software
c. Sources of Ratio Data on Non-traded Firms
Slide 5-5
Comments on Specific Pages from the
Chapter (cont.)
C. Ratio Types and General Uses
D. Alternative Ways of Computing Ratios: Averages
versus Year-End Figures
E. Important Ratios for the Creditor: Liquidity and Debt
1. The Current Ratio
a. The current ratio and rules of thumb
b. Problems with the current ratio
as a liquidity measure
2. The Quick Ratio
3. The Cash Flow Liquidity Ratio
Slide 5-6
Comments on Specific Pages from the
Chapter (cont.)
E. Important Ratios for the Creditor: Liquidity and Debt (cont.)
4. The Average Collection Period (ACP)
1. ACP and AR turnover: Ratios giving
the same information
AR turns = 365/ACP; ACP = 365/AR turns
2. Accounts receivable management strategies
from the debtor’s perspective
3. AR management from the creditor’s perspective
5. Days Inventory Held (DIH)
6. Days Payable Outstanding and Its Limitations
7. The Cash Conversion Cycle (CCC)
8. Activity Ratios
9. Useful Debt Ratios: Debt/Assets and Debt/Equity
Slide 5-7
Comments on Specific Pages from the
Chapter (cont.)
F. Perspectives in Interpreting Ratios
G. Another Problem in Using Ratios that Are
Ordered by the Accountant’s Method
H. Dealing with Missing Industry Average Ratios
I. Some Ratio Analysis of Sage Inc.
from the Trade Creditor’s Perspective
Slide 5-8
Sage Corporation
Comparison of Current and Quick Ratios
Sage Corp
Current and Quick Ratios
Year
Current Ratio
Quick Ratio
Ind. CR 2013
Ind. QR 2013
2009
2.83
1.20
2010
2.18
1.22
2011
2.26
0.87
2012
2.75
0.95
2013
2.40
0.68
2.53
0.97
3.00
2.50
2.00
Quick Ratio
1.50
Current Ratio
Ind. CR 2013
1.00
Ind. QR 2013
0.50
0.00
2009
2010
2011
2012
Slide 5-9
2013
Sage Corporation
Comparison of DIH and CCC
Sage Corp
Days Inventory Held (DIH) and Cash Conversion Cycle (CCC)
Year
DIH
CCC
Ind. DIH 2013
Ind. CCC 2013
2009
114
89
2010
122
99
2011
134
110
2012
146
133
2013
133
107
117
102
160
140
120
100
CCC
80
DIH
60
Ind. DIH 2013
Ind. CCC 2013
40
20
0
2009
2010
2011
Slide 5-10
2012
2013
Sage Corporation
Debt to Assets Comparison
Sage Corp
Debt to Assets
Year
Debt to Assets (percent)
Ind. Debt/Assets 2013
2009
39.7
2010
40.8
2011
49.2
2012
50.1
2013
51.8
48.7
60
50
40
Debt to Assets
(percent)
30
Ind. Debt/Assets 2013
20
10
0
2009
2010
2011
Slide 5-11
2012
2013
Comments on Specific Pages from the
Chapter (cont.)
J. Profitability Ratios and the Du Pont System
K. Financial Projections
Slide 5-12
Razzle-Dazzle
Some Initial Questions to ask Razzle-Dazzle:
Were the statements prepared using accounting software, and if so,
what software? Did the firm enter the numbers into the software or did
the accountant?
Are any assets or financing used by the business but do not appear on
the financial statements?
How is inventory valued?
Is there a reserve for bad debts?
Slide 5-13
Some Initial Questions to ask
Razzle-Dazzle (cont.)
How are the short term bank loans and the long term debt secured? By
a lien on the property plant and equipment, or by a lien against all
assets?
Have the firm’s owners given a guarantee of account to any creditors?
Slide 5-14
Analysis of Razzle-Dazzle Electronics:
Ratios
Industry
Year
2011 2012
Liquidity
Current Ratio
1.267 1.296
Quick Ratio
0.460 0.493
Cash Flow Liquidity Ratio
0.247
Accounts Receivable:
Accounts Receivable Turnover
21.37 15.29
Average Collection Period (days) 17.08 23.87
Inventory
Inventory Turnover based on CGS 5.38
5.19
Days Inventory Held
67.79 70.28
Sum of ACP and Days Inv. Held
84.87 94.15
Debt Ratios
Total Debt/Total Assets
58.76% 64.49%
Total Debt/Equity
1.43
1.82
2013 Average 2013
1.272
0.483
0.135
1.700
(graph on Slide 5-16)
0.900
(graph on Slide 5-16)
Not Avail.
12.13
30.08
7.80
46.79
4.88
6.00
74.83 60.83
104.91 107.62
69.48% 57.30%
2.28
1.34
Slide 5-15
(graph on Slide 5-18)
(graph on Slide 5-18)
(graph on Slide 5-20)
Razzle-Dazzle
Current and Quick Ratios
Razzle Dazzle Electronics
Current and Quick Ratios
Year
Current Ratio
Quick Ratio
Ind. CR 2013
Ind. QR 2013
2011
1.27
0.46
2012
1.30
0.49
2013
1.27
0.48
1.70
0.90
1.80
1.60
1.40
1.20
Quick Ratio
1.00
Current Ratio
0.80
Ind. CR 2013
0.60
Ind. QR 2013
0.40
0.20
0.00
2011
2012
Slde 5-16
2013
Analysis of Razzle-Dazzle Electronics:
Ratios
Year
2011 2012
Liquidity
Current Ratio
1.267 1.296
Quick Ratio
0.460 0.493
Cash Flow Liquidity Ratio
0.247
Accounts Receivable:
Accounts Receivable Turnover
21.37 15.29
Average Collection Period (days) 17.08 23.87
Inventory
Inventory Turnover based on CGS 5.38
5.19
Days Inventory Held
67.79 70.28
Sum of ACP and Days Inv. Held
84.87 94.15
Debt Ratios
Total Debt/Total Assets
58.76% 64.49%
Total Debt/Equity
1.43
1.82
Industry
2013 Average 2013
1.272
0.483
0.135
1.700
(graph on Slide 5-16)
0.900
(graph on Slide 5-16)
Not Avail.
12.13
30.08
7.80
46.79
4.88
6.00
74.83 60.83
104.91 107.62
69.48% 57.30%
2.28
1.34
Slide 5-17
(graph on Slide 5-18)
(graph on Slide 5-18)
(graph on Slide 5-20)
Razzle-Dazzle Electronics:
ACP and DIH
Razzle Dazzle Electronics
Average Collection Period (ACP and Days Inventory Held (DIH)
Year
DIH
ACP
Ind. DIH 2013
Ind. ACP 2013
2011
67.79
17.08
2012
70.28
23.87
2013
74.83
30.08
60.83
46.79
80
70
60
ACP
50
DIH
40
Ind. DIH 2013
30
20
Ind. ACP
2013
10
0
2011
2012
Slide 5-18
2013
Analysis of Razzle-Dazzle Electronics:
Ratios
Ratios
Year
2011 2012
Liquidity
Current Ratio
1.267 1.296
Quick Ratio
0.460 0.493
Cash Flow Liquidity Ratio
0.247
Accounts Receivable:
Accounts Receivable Turnover
21.37 15.29
Average Collection Period (days) 17.08 23.87
Inventory
Inventory Turnover based on CGS 5.38
5.19
Days Inventory Held
67.79 70.28
Sum of ACP and Days Inv. Held
84.87 94.15
Debt Ratios
Total Debt/Total Assets
58.76% 64.49%
Total Debt/Equity
1.43
1.82
Industry
2013 Average 2013
1.272
0.483
0.135
1.700
(graph on Slide 5-16)
0.900
(graph on Slide 5-16)
Not Avail.
12.13
30.08
7.80
46.79
4.88
6.00
74.83 60.83
104.91 107.62
69.48% 57.30%
2.28
1.34
Slide 5-19
(graph on Slide 5-18)
(graph on Slide 5-18)
(graph on Slide 5-20)
Razzle-Dazzle Electronics
Debt to Assets
Razzle Dazzle Electronics
Debt to Assets
Year
Debt to Assets (percent)
Ind. Debt/Assets 2013
2011
58.76%
2012
64.49%
2013
69.48%
57.30%
80.00%
70.00%
60.00%
50.00%
Debt to Assets
(percent)
40.00%
Ind.
Debt/Assets
2013
30.00%
20.00%
10.00%
0.00%
2011
2012
Slide 5-20
2013
Razzle-Dazzle Electronics:
Cash Flow Analysis
Year
2011-12 2012-13
Cash Flow from Operations Calculations:
Cash flow from income statement
Earnings after Taxes
$144
Depreciation Addback
$125
----$269
Changes in Accounts Receivable
Changes in Inventory
Changes in Trade Payables
Changes in Accruals
Total Adjustments
Cash Flow from Operations
$150
$156
----$306
($142) ($169)
($125) ($174)
$107 $130
$29
$34
--------($131) ($179)
$138
$127
Slide 5-21
Cash Flow Analysis (cont.)
Year
Cash Flows from Investing
Changes in Gross Equipment
Cash Flows from Investing
Cash Flows from Financing
Change in Short Term Bank Debt
Change in Current Long Term Debt
Change in Term Loans
Dividends Paid
Cash Flows from Financing
Change in Cash Balance
2011-12 2012-13
($250) ($312)
--------($250) ($312)
$11
$48
$13
$25
$167 $167
($115) ($120)
--------$76 $120
($36)
Slide 5-22
($65)
Razzle-Dazzle Electronics:
Summary Cash Flow Analysis
Year
Inflows
CFFO
Change in Short Term Bank Debt
Change in Current Long Term Debt
Change in Term Loans
Total Cash Inflows
Outflows
Changes in Gross Equipment
Dividends Paid
2011-12
2012-13
$138 42%
$11
3%
$13
4%
$167 51%
-------$329 100%
$127
$48
$25
$167
----$367
Total Cash Outflows
$250 68%
$115 32%
-------$365 100%
$312
$120
-----$432
Change in Cash
$(36)
$(65)
Slide 5-23
35%
13%
7%
46%
---100%
72%
28%
----100%
Some Post-Analysis Questions to ask
Razzle-Dazzle
Did the firm change policies for accounts receivable
and inventory? Will these new policies continue?
How does the firm intend to finance growth in these
assets?
Will payments of dividends be reduced?
Implications of the Firm’s Strategies and their Effects on
Credit-Worthiness
Slide 5-24