financial analysis chapter 3. chapter 3 - outline financial analysis 4 categories of financial...
TRANSCRIPT
Financial Analysis
Chapter 3
Chapter 3 - Outline
Financial Analysis 4 Categories of Financial Ratios
Importance of RatiosInflation and its Impact on Profits
Financial Analysis and Ratios
What is financial analysis?
Evaluating a firm’s financial performance
Analyzing ratios or numerical calculations
Comparing a company to its industry
4 Categories of Ratios
Profitability RatiosAsset Utilization RatiosLiquidity RatiosDebt Utilization Ratios
Classification System
We will separate 13 significant ratios into four primary categories.
A. Profitability Ratios.1. Profit margin.
2. Return on assets (investment).
3. Return on equity.
B. Asset utilization ratios.4. Receivable turnover.
5. Average collection period.
6. Inventory turnover.
7. Fixed asset turnover.
8. Total asset turnover.
C. Liquidity ratios.9. Current ratio.
10. Quick ratio.
D. Debt utilization ratios.11. Debt to total assets.
12. Times interest earned.
13. Fixed charge coverage.
TABLE 3-1Financial statementfor ratio analysis
Profitability Ratios
Show how profitable a company is.
The ratios express:— Profit Margin or Return on Sales (%)
— Return on Assets or Return on Investment (%)
— Return on Equity (%)
Profitability RatiosSaxton Company Industry
Average
1. Profit margin = = 5% 6.7%
2. Return on assets (investment) =
a. = 12.5% 10%
b. 5% 2.5 = 12.5% 6.7% 1.5 = 10%
3. Return on equity =
a. = 20% 15%
b. = 20% = 15%
Net incomesales
$200,000$4,000,000
Net incomeTotal assets
Net incomeSales
SalesTotal assets
$200,000$1,600,000
Net incomeStockholders’ equity
$200,000$1,000,000
Return on assets (investment)(1 – Debt/Assets)
0.1251 – 0.375
0.101 – 0.33
FIGURE 3-1Du Pont analysis
Return of Wal-Mart versus Macy’s using the Du Pont method of analysis, 2007
Asset Utilization Ratios
Show how effectively a company uses its assets.
The ratios express:— Receivables Turnover (times)— Average Collection Period (days)— Inventory Turnover (times)— Fixed Asset Turnover (times)— Total Asset Turnover (times)
Saxton Company Industry Average
4. Receivables turnover =
= 11.4 10 times
5. Average collection period =
= 32 36 days
6. Inventory turnover =
= 10.8 7 times
Sales (credit)Receivables
$4,000,000$350,000
Accounts receivableAverage daily credit sales
$350,000$11,111
SalesInventory
$4,000,000$370,000
Asset Utilization Ratios
Asset Utilization Ratios
Saxton Company Industry Average
7. Fixed asset turnover =
= 5 5.4 times
8. Total asset turnover =
= 2.5 1.5 times
SalesFixed assets
$4,000,000$800,000
SalesTotal assets
$4,000,000$1,600,000
Profitability and Turnover Ratios
Remember:Return on X = Net Income / X
X Turnover = Sales / X
Liquidity Ratios
Show how liquid a company is or how much $ it has to meet S/T needs.
The ratios express:—Current Ratio (times)—Quick Ratio or Acid-Test Ratio (times)
Liquidity Ratios
Saxton Company Industry Average
9. Current ratio =
= 2.672.1
10. Quick ratio =
= 1.43 1.0
Current assetsCurrent liabilities
$800,000$300,000
Current assets − InventoryCurrent liabilities
$430,000$300,000
Debt Utilization Ratios
Show how well a company is managing or using debt.
The ratios express:—Debt-to-Total Assets (%)—Times Interest Earned (times)—Fixed Charge Coverage (times)
(Fixed Charges = lease payments, i expense)
Debt Utilization RatiosSaxton Company Industry
Average
11. Debt to total asets =
= 37.5% 33%
12. Times interest earned =
= 11 7 times
13. Fixed charge coverage =
= 6 5.5 times
Total debtTotal assets
$600,000$1,600,000
Income before interest and taxes
Interest$550,000$50,000
Income before fixed charges and taxes
Fixed charges$600,000$100,000
TABLE 3-3Ratio analysis
FIGURE 3-2Trend analysis
1-21
Trend Analysis in the Computer Industry
TABLE 3-7Comparison of replacementcost accounting and historicalcost accounting
Inflation’s Impact on ProfitsFIFO (First-In, First-Out) Inventory:—Lowers COGS—Raises Profits
LIFO (Last-In, First-Out) Inventory:—Raises COGS—Lowers Profits
Importance of Ratios
Which ratio is most important?It depends on your perspective.Suppliers and banks (lenders) are most
interested in liquidity ratios.Stockholders are most interested in
profitability ratios.A long-run trend analysis over a 5-10
year period is usually performed by an analyst.