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Nov 18, 2013 (3 years and 6 months ago)

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Chapter 03

Analyzing Financial

Statements

McGraw
-
Hill/Irwin


Copyright © 2012 by The McGraw
-
Hill Companies, Inc. All rights reserved.

Introduction


Financial Statement Use


Analyze firm performance


Plan changes to improve performance


Ratio Analysis


Used to assess firm’s performance

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Five Groups of Financial Ratios



Liquidity


Asset management


Debt management


Profitability


Market value



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Ratios Used to Make Comparisons



Trend


Comparison to the same firm over time



Competitors


Comparison to other firms in the same industry



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Liquidity Ratios


Relationship between firm’s liquid (current)
assets and current liabilities


Commonly
-
used liquidity ratios


Current ratio


Quick (or acid
-
test) ratio


Cash ratio

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Current Ratio



Broadest liquidity measure


Measures current assets available to pay
current liabilities



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Quick Ratio



Excludes inventory in numerator


Measures ability to pay short
-
term obligations
without inventory sales



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Cash Ratio




Measures ability to pay short
-
term obligations
with available cash and marketable securities


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Asset Management Ratios


Measure efficiency of firm’s asset use


Inventory


Accounts receivable


Fixed assets


Accounts payable management

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Inventory Management


Inventory Turnover Ratio


Dollar of sales produced per dollar of inventory


Often uses cost of goods sold instead of sales
because inventory is listed on the balance sheet at
cost

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Inventory Management


Days’ Sales in Inventory Ratio


Measures average number of days inventory held


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Accounts Receivable Management



The Average Collection Period (ACP) Ratio


Measures number of days accounts receivable
held until collected




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Accounts Receivable Management



The Accounts Receivable Turnover Ratio


Measures dollars of sales produced per dollar of
accounts receivable



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Accounts Payable Management


The Average Payment Period (APP) Ratio



Measures the number of days accounts payable held
before extending cash to pay for raw materials





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Accounts Payable Management


Accounts Payable Turnover Ratio


Measures dollar of COGS per dollar of accounts
payable.



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Fixed Asset and Working Capital
Management



The Fixed Asset Turnover Ratio


Measures dollars of sales produced per dollar of
fixed assets





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Fixed Asset and Working Capital
Management



Sales to Working Capital Ratio


Measures dollar of sales produced per dollar of
working capital


(Current assets minus current liabilities)


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Total Asset Management



Total Asset Turnover Ratio


Measures dollars of sales produced per dollar of
total assets




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Total Asset Management



Capital Intensity Ratio


Measures dollars of total assets needed to
produce a dollar of sales



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Debt Management Ratios


Measure how much debt (financial leverage)
versus equity a firm uses to finance assets



Two major ratio types


Measure debt amount


Measure firm’s ability to service debt


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Three related measures


Debt Ratio


Debt
-
to
-
Equity Ratio


Equity Multiplier Ratio


Debt vs. Equity Financing

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Debt vs. Equity Financing



Debt Ratio


Measures percentage of total assets financed with
debt





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Debt vs. Equity Financing



Debt
-
to
-
Equity Ratio


Measures dollars of debt financing for every dollar
of equity financing





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Equity Multiplier Ratio


Measures the dollars of assets on balance sheet
for every dollar of equity financing






Debt vs. Equity Financing


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Coverage Ratios



Times Interest Earned Ratio


Measures operating earnings dollars available to
meet interest obligations





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Coverage Ratios



The Fixed
-
Charge Coverage Ratio


Measures operating earnings available for interest
and other fixed charges




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Cash Coverage Ratio


Measures operating cash available to meet
interest and other fixed charges


Indicates if debt burden is too large







Coverage Ratios


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Profitability Ratios


Show the combined effect of liquidity, asset
management and debt management on firm’s
operating results


Closely monitored by investors


Stock prices react very quickly to unexpected
changes in these ratios

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Percent of sales left after all firm expenses are
paid





Profit Margin

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Basic Earnings Power Ratio


Measures the EBIT earned per dollar of assets
on the balance sheet


Represents operating return on assets
irrespective of financial leverage and taxes


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Return on Assets (ROA)


Measures overall return on firm’s assets
inclusive of leverage and taxes




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Measures return on common stockholders’
investment


Affected by net income and amount of financial
leverage


High ROE is usually a positive sign, unless driven
by excessively high leverage


Return on Equity (ROE)

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Dividend Payout Ratio


Measures fraction of earnings paid out to
common stockholders as dividends





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Market Value Ratios


Market prices of publicly traded firms
incorporate risk


Ratios that incorporate stock market values are
important



Market values reflect what investors think of
the company’s future performance and risk

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Price
-
Earnings Ratio


Best known and most often quoted figure


Measures price investors will pay per dollar of
earnings


High PE ratio usually indicates projected growth


Drives stock classification as
growth
or
value


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DuPont Analysis


Uses Balance Sheet and Income Statements



Breaks ROA and ROE into components to explain
why the ratios are low or high


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DuPont Analysis



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Other Ratios


Spreading the Financial Statement


Divide balance sheet amounts by total assets


Divide all income statement amounts by net sales


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Other Ratios


Internal Growth Rate


Sustainable Growth Rate


Time Series


Cross
-
Sectional Analysis



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