Chapter 17

Financial Statement Analysis

Topics Covered

Financial Ratios DuPont System Using Financial ratios Measuring Company Performance The Role of Financial Ratios

Ratio Analysis

Examines firm’s management of various facets of the company’s business through its financial statements.

Scales balance sheet and income statement information for easy comparison across time or to other companies.

Two common approaches

Trend Analysis - looks at changes in one company’s ratios over time.

Comparison or Industry Analysis - compares company’s ratios against a similar company or against industry-wide ratios.

We will look at both with Coca-Cola and Pepsi.

Areas Examined by Ratio Analysis

Leverage - measures the use of financial leverage (debt) and its impact

Liquidity - measures the ability to meet short-term obligations

Efficiency - measures the ability to contain the growth of assets, and the ability to effectly utilize assets

Profitability - measures the profitability of various segments of a company

Leverage Ratios

equity+debt termlong

debt termlong=ratiodebt termLong

equity

debt termlong=ratioequity Debt term-Long

Leverage Ratios

Total debt ratio =total liabilities

total assets

Times interest earned =EBIT

interest payments

Cash coverage ratio =EBIT + depreciation

interest payments

Leverage Ratios calculation notes for Target & Wal-Mart Given our Financial Statement (B/S and I/S)

formatting from OneSource/Multitex: Long-term debt = Total long-term debt from the

B/S, which includes long-term borrowing and capital lease obligations.

Equity = Total Equity from B/S EBIT = Operating income + Interest Expense

from I/S Depreciation expense was listed on Target’s I/S,

but had to find Wal-Mart’s depreciation by the annual change in accumulated depreciation from B/S.

Target & Walmart’s Leverage Ratios

Target 2002 2001 2000 1999

Long-term debt ratio 0.519 0.507 0.464 0.435

Debt-equity ratio 1.079 1.029 0.864 0.771

Total debt ratio 0.670 0.675 0.666 0.658

Times interest Earned 5.551 5.666 5.819 5.926

Cash coverage ratio 7.612 7.947 8.026 8.099

Walmart 2002 2001 2000 1999

Long-term debt ratio 0.333 0.348 0.333 0.392

Debt-equity ratio 0.498 0.534 0.499 0.645

Total debt ratio 0.585 0.580 0.599 0.633

Times interest Earned 14.750 10.065 9.465 9.887

Cash coverage ratio 17.214 11.219 11.239 10.756

Best Leverage Management?

Liquidity Ratios

Net working capital

to total assets ratio=

Net working capital

Total assets

Current ratio =current assets

current liabilities

Liquidity Ratios

Cash ratio =cash + marketable securities

current liabilities

Quick ratio =cash + marketable securities + receivables

current liabilities

Liquidity Ratios calculation notes for Target & Wal-Mart

Given our Financial Statement (B/S and I/S) formatting from OneSource/Multitex: Net working capital = total current

assets – total current liabilities Cash and marketable securities are in

one account (cash and short-term investments)

Target & Walmart’s Liquidity Ratios

Target 2002 2001 2000 1999

NWC to assets 0.154 0.107 0.051 0.037

Current ratio 1.586 1.368 1.159 1.108

Quick ratio 0.840 0.614 0.365 0.352

Cash ratio 0.101 0.071 0.056 0.038

Walmart 2002 2001 2000 1999

NWC to assets -0.023 0.007 -0.031 -0.021

Current ratio 0.935 1.022 0.917 0.944

Quick ratio 0.149 0.153 0.132 0.124

Cash ratio 0.085 0.079 0.071 0.072

Best Liquidity Management?

Efficiency Ratios

Asset turnover ratio =Sales

Average total assets

NW Cturnover =sales

average net working capital

Efficiency Ratios

Days' sales in inventory =average inventory

cost of goods sold / 365

Inventory turnover ratio =cost of goods sold

average inventory

Average collection period =average receivables

average daily sales

Efficiency Ratios calculation notes for Target & Wal-Mart Given our Financial Statement (B/S

and I/S) formatting from OneSource/Multitex: Sales = Total Revenue from I/S Cost of Goods Sold = Cost of Revenue,

Total from I/S Average “whatever asset” = (beginning+

ending amounts from B/S)/2 Average Daily Sales or Cost of Goods

Sold = Amount form I/S divided by 365

Target & Walmart’s Efficiency Ratios

Target 2002 2001 2000 1999

Total asset turnover 1.665 1.825 2.012 2.054

Average collection period 39.046 26.450 18.710 18.915

Inventory turnover 6.521 6.348 6.340 6.404

Days' sales in inventories 55.975 57.495 57.575 56.996

Walmart 2002 2001 2000 1999

Total asset turnover 2.767 2.718 2.601 2.772

Average collection period 3.041 3.130 2.938 2.690

Inventory turnover 8.077 7.788 7.288 7.034

Days' sales in inventories 45.193 46.865 50.084 51.893

Best Efficiency Management?

Profitability Ratios

assets totalaverage

Interest IncomeNet =assetson Return

sales

incomenet =marginprofit Net

equity average

incomenet =equityon Return

sales

interest incomenet =marginprofit Operating

Profitability Ratios

Plowback ratio =earnings - dividends

earnings

= 1 - payout ratio

Payout ratio =dividends

earnings

xROEearnings

dividends-earnings=plowback fromequity in Growth

Profitability Ratios calculation notes for Target & Wal-Mart

Given our Financial Statement (B/S and I/S) formatting from OneSource/Multitex: Dividend information listed below the I/S:

Gross dividends = total annual dividends. Also can find EPS and Dividends per share here.

Earnings = Net Income from I/S

Target & Walmart’s Profitability RatiosTarget 2002 2001 2000 1999

Net profit margin 3.8% 3.4% 3.4% 3.4%

Operating profit margin 5.1% 4.6% 4.6% 4.6%

Return on assets 8.5% 8.4% 9.2% 9.4%

Return on equity 19.1% 19.0% 20.4% 20.4%

Payout ratio 13.2% 14.8% 15.3% 16.7%

Plowback ratio 86.8% 85.2% 84.7% 83.3%

Growth in equity from plowback 16.6% 16.2% 17.3% 17.0%

Walmart 2002 2001 2000 1999

Net profit margin 3.3% 3.0% 3.3% 3.2%

Operating profit margin 3.6% 3.6% 3.9% 3.8%

Return on assets 10.1% 9.7% 10.1% 10.6%

Return on equity 21.6% 20.1% 22.0% 22.9%

Payout ratio 16.5% 18.7% 17.0% 16.6%

Plowback ratio 83.5% 81.3% 83.0% 83.4%

Growth in equity from plowback 18.0% 16.3% 18.3% 19.1%

Best Profitability Management?

The DuPont System

A breakdown of ROE and ROA into component ratios

equity

stock commonfor available earnings=ROE

assets

interest IncomeNet =ROA

The DuPont System

sales

interestIncomeNet x

assets

sales=ROA

assetturnover

Operating profitmargin

The DuPont System

interestIncomeNet

IncomeNet x

sales

interestIncomeNet x

assets

salesx

equity

assets=ROE

leverageratio

assetturnover

Operating profitmargin

debtburden

The DuPont System: Simplification of ROE

The last two terms of the 4-part DuPont equation for ROE, operating profit margin and debt burden, can be simplified to one term, net profit margin.

Net profit margin = Net Income/Sales Also assets/equity can be written in terms of the total

debt ratio.

equity

sliabilitie total1

assets totalsliabilitie total

1

1

ratiodebt total1

1

equity

assets

sales

IncomeNet x

assets

salesx

equity

assets=ROE

Target vs. Walmart Du Pont SystemTarget 2002 2001 2000 1999

Asset turnover 1.665 1.825 2.012 2.054

Operating profit margin 5.1% 4.6% 4.6% 4.6%

ROA 8.5% 8.4% 9.2% 9.4%

Leverage ratio 3.049 3.035 2.959 2.930

Asset turnover 1.665 1.825 2.012 2.054

Operating profit margin 5.1% 4.6% 4.6% 4.6%

Debt burden 0.738 0.743 0.748 0.744

ROE 19.1% 19.0% 20.4% 20.4%

Walmart 2002 2001 2000 1999

Asset turnover 2.767 2.718 2.601 2.772

Operating profit margin 3.6% 3.6% 3.9% 3.8%

ROA 10.1% 9.7% 10.1% 10.6%

Leverage ratio 2.394 2.433 2.597 2.563

Asset turnover 2.767 2.718 2.601 2.772

Operating profit margin 3.6% 3.6% 3.9% 3.8%

Debt burden 0.897 0.849 0.840 0.840

ROE 21.6% 20.1% 22.0% 22.9%

Final Du Pont System comments

When a firm uses no debt financing, the leverage term = 1 and ROE = ROA.

Using more financial leverage will increase ROE when the return on new assets (investment) exceeds the interest rate on the new debt.

MVA & Economic Profit

A gauge of how much value management added for the year. Depends upon managerial decisions and stock market forces.

Market Value Added = The difference between the market value of common stock and its book value

MVA for Target and Wal-MartTarget 2002 2001 2000 Wal-

Mart2002 2001 1999

Stock Price

28.05 42.83 36.31 Stock Price

47.56 59.37 55.90

# of Shares

909.8 905.2 897.8 # of Shares

4395 4453 4470

MV of Equity

25520 38770 32599 MV of Equity

209,026 264,375 249,873

Total BV Eq

9443 7860 6519 Total BV Eq

39337 35102 31343

MVA 16,077 30,910 26,080 MVA 169,689 229,273 218,530

MV/BV 2.70 3.93 5.00 MV/BV 5.31 7.53 7.97

Residual Income & EVA

Economic Profit = capital invested multiplied by the spread between return on investment and the cost of capital.

Residual Income or EVA = Net Dollar return after deducting the cost of capital Investment Capital of Cost - Earned Income

required income - Earned Income

Income Residual

EVA

© EVA is copyrighted by Stern-Stewart Consulting Firm and used with permission.

Invested Capital ) (

Profit Economic

r ROI

EP

EVA for Target and Wal-Mart From Stern-Stewart (

www.sternstewart.com) EVA/MVA ranking in millions of dollars.

Target 2002 EVA: 341 2002 MVA rank: 44 1999 EVA: 710 1999 MVA rank: 92

Wal-Mart 2002 EVA: 2,928 2002 MVA rank: 3 1999 EVA: 2,233 1999 MVA rank: 6