Working with Financial StatementsCh. 3.docx
- 1. Working with Financial Statements Ch. 3 Review A(n) ______________ asset is one which can be quickly
- 2. converted into cash without significant loss in value. A) current B) fixed C) intangible D) liquid E) long-term 2 Review The financial statement summarizing a firm's performance over a period of time is the: A) Income statement. B) Balance sheet. C) Statement of cash flows. D) Tax reconciliation statement. E) Shareholders' equity sheet. 3
- 3. Focus on .. Know how to standardize financial statements for comparison purposes Know how to compute and interpret important financial ratios Know the determinants of a firm’s profitability and growth 4
- 4. Standardized Financial Statements Common-Size Balance Sheets Compute all accounts as a percent of total assets Common-Size Income Statements Compute all line items as a percent of sales Standardized statements make it easier to compare financial information, particularly as the company grows They are also useful for comparing companies of different sizes, particularly within the same industry 5 Why use ratios? Ratios are not very helpful by themselves; they need to be compared to something Time-Trend Analysis Used to see how the firm’s performance is changing through time Internal and external uses Peer Group Analysis
- 5. Compare to similar companies or within industries SIC and NAICS codes 6 6 5 Categories of Financial Ratios Short-term solvency or liquidity ratios Long-term solvency or financial leverage ratios Asset management or turnover ratios Profitability ratios Market value ratios 7
- 6. Sample Balance SheetCash6,489A/P340,220A/R1,052,606N/P86,631Inventory29 5,255Other CL1,098,602Other CA199,375Total CL1,525,453Total CA1,553,725LT Debt871,851Net FA2,535,072S/E1,691,493Total Assets4,088,797Total Liab. & Equity4,088,797 8 Numbers in thousands 8
- 7. Sample Income StatementRevenues3,991,997Cost of Goods Sold-1,738,125Expenses-1,205,530Depreciation- 308,355EBIT739,987Interest Expense-42,013Taxable Income697,974Taxes-272,210Net Income425,764EPS2.17Dividends per share0.86 9 Numbers in thousands, except EPS & DPS 9 Ratio Analysis 3 Things to do How to calculate? Calculate each ratio. What is measuring? Understand its meaning. Comparing the ratio to the industry average. Conclude whether it is better or worse than the industry average. 10
- 8. Computing Liquidity Ratios Current Ratio = CA / CL 1,553,725 / 1,525,453 = 1.02 times Measuring: how much of current assets for every $1 in current liabilities Higher is better Quick Ratio = (CA – Inventory) / CL (1,553,725 – 295,225) / 1,525,453 = .825 times Measuring: similar to current ratio, except inventory is omitted. Higher is better Cash Ratio = Cash / CL 6,489 / 1,525,453 = .004 times Measuring: how much of cash for every $1 in current liabilities Higher is better 11
- 9. 11 Computing Leverage Ratios Total Debt Ratio = (TA – TE) / TA (4,088,797 – 1,691,493) / 4,088,797 = .5863 times or 58.63% Measuring: The firm finances almost 59% of their assets with debt. Lower is better Debt/Equity = TD / TE (4,088,797 – 1,691,493) / 1, 691,493 = 1.417 times Measuring: how much of debt for every $1 in equity Lower is better Equity Multiplier = TA / TE = 1 + D/E 1 + 1.417 = 2.417 Used in Du Pont Identity 12
- 10. 12 Computing Coverage Ratios Times Interest Earned = EBIT / Interest 739,987 / 42,013 = 17.6 times Measuring: how well a company has its interest obligations covered Higher is better 13 13 Computing Inventory Ratios Inventory Turnover = Cost of Goods Sold / Inventory
- 11. 1,738,125 / 295,255 = 5.89 times Measuring: how many times inventory is turned over per year Higher is better Days’ Sales in Inventory = 365 / Inventory Turnover 365 / 5.89 = 62 days Measuring: how many days inventory sits on average before it is sold Lower is better 14 14 Computing Receivables Ratios Receivables Turnover = Sales / Accounts Receivable 3,991,997 / 1,052,606 = 3.79 times Measuring: how many times a business turns it accounts receivable into cash over per year Higher is better Days’ Sales in Receivables = 365 / Receivables Turnover 365 / 3.79 = 96 days
- 12. Measuring: how many days, on average, to collect the cash from credit sales Lower is better 15 15 Computing Total Asset Turnover Total Asset Turnover = Sales / Total Assets 3,991,997 / 4,088,797 = .98 times Measure of asset use efficiency Not unusual for TAT < 1, especially if a firm has a large amount of fixed assets 16
- 13. 16 Computing Profitability Measures Profit Margin = Net Income / Sales 425,764 / 3,991,997 = .1067 times or 10.67% Measuring: A measure of profit per dollar of sales Higher is better Return on Assets (ROA) = Net Income / Total Assets 425,764 / 4,088,797 = .1041 times or 10.41% Measuring: A measure of profit per dollar of assets Higher is better Return on Equity (ROE) = Net Income / Total Equity 425,764 / 1,691,493 = .2517 times or 25.17% Measuring: A measure of profit per dollar of equity Higher is better 17
- 14. 17 Computing Market Value Measures Market Price = $61.625 per share Shares outstanding = 205,838,594 PE Ratio = Price per share / Earnings per share 61.625 / 2.17 = 28.4 times Measuring: how much investors are willing to pay per dollar of Higher is better Market-to-book ratio = market value per share / book value per share 61.625 / (1,691,493,000 / 205,838,594) = 7.5 times Measuring: the value of a company by comparing its current market price to book value (accounting value) Higher is better 18
- 15. 18 Summary: Table 3.5 19 Deriving the Du Pont Identity ROE = NI / TE Multiply by 1 and then rearrange ROE = (NI / TE) (TA / TA) ROE = (NI / TA) (TA / TE) = ROA * EM Multiply by 1 again and then rearrange ROE = (NI / TA) (TA / TE) (Sales / Sales) ROE = (NI / Sales) (Sales / TA) (TA / TE)
- 16. ROE = PM * TAT * EM So, Du Pont identity is a breakdown of ROE into three components. 20 20 Using the Du Pont Identity ROE = PM * TAT * EM Profit margin is a measure of the firm’s operating efficiency – how well does it control costs Total asset turnover is a measure of the firm’s asset use efficiency – how well does it manage its assets Equity multiplier is a measure of the firm’s financial leverage Back to previous example ROE = PM * TAT * EM = 0.1067 x 0.9763 x 2.417 = 0.2518 21
- 17. 21 Determinants of Growth Profit margin – operating efficiency Total asset turnover – asset use efficiency Financial leverage – choice of optimal debt ratio Dividend policy – choice of how much to pay to shareholders versus reinvesting in the firm 22
- 18. 22 Example You are given: Current Liabilities 300 Long Term Liabilities 700 Shareholder Equity 1,400 Total Assets 2,400 EBIT 400 Depreciation 100 Interest 50 Taxes 60 Debt/Equity, Total Debt ratio, Equity Multiplier? 23
- 19. Example.. If you are given further: Sales 2500 Costs of Goods Sold 1200 Inventory 500 Accounts Receivable 1000 Inventory Turnover, Day’s Sales in Inventory? Receivable Turnover, Day’s Sales in Receivables? Total Assets Turnover? Times Interest Earned? PM? ROA? Du Pont Identity? Show all three parts. 24 Daily Assignment How do you standardize balance sheets and income statements and why is standardization useful? What are the major determinants of a firm’s growth potential?
- 20. Answer slides #2 & #3 Answer slides # 23 & #24 25