financial statement analysis

6.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.

Chapter 6Chapter 6

Financial Statement Financial Statement AnalysisAnalysis

Financial Statement Financial Statement AnalysisAnalysis


After Studying Chapter 6, After Studying Chapter 6, you should be able to:you should be able to:

1. Understand the purpose of basic financial statements and their contents.

2. Understand what is meant by “convergence” in accounting standards.

3. Explain why financial statement analysis is important to the firm and to outside suppliers of capital.

4. Define, calculate, and categorize (according to liquidity, financial leverage, coverage, activity, and profitability) the major financial ratios and understand what they can tell us about the firm.

5. Define, calculate, and discuss a firm’s operating cycle and cash cycle.

6. Use ratios to analyze a firm's health and then recommend reasonable alternative courses of action to improve the health of the firm.

7. Analyze a firm’s return on investment (i.e., “earning power”) and return on equity using a DuPont approach.

8. Understand the limitations of financial ratio analysis.

9. Use trend analysis, common-size analysis, and index analysis to gain additional insights into a firm's performance.


• Financial Statements

• A Possible Framework for Analysis

• Balance Sheet Ratios

• Income Statement and Income/Balance Sheet Ratios

• Trend Analysis

• Common-Size and Index Analysis

• Financial Statements

• A Possible Framework for Analysis

• Balance Sheet Ratios

• Income Statement and Income/Balance Sheet Ratios

• Trend Analysis

• Common-Size and Index Analysis

Financial Financial Statement AnalysisStatement AnalysisFinancial Financial Statement AnalysisStatement Analysis


• Trade CreditorsTrade Creditors – Focus on the liquidity of the firm.

• BondholdersBondholders – Focus on the long-term cash flow of the firm.

• ShareholdersShareholders – Focus on the profitability and long-term health of the firm.

• Trade CreditorsTrade Creditors – Focus on the liquidity of the firm.

• BondholdersBondholders – Focus on the long-term cash flow of the firm.

• ShareholdersShareholders – Focus on the profitability and long-term health of the firm.

Examples of External Uses Examples of External Uses of Statement Analysisof Statement AnalysisExamples of External Uses Examples of External Uses of Statement Analysisof Statement Analysis


• PlanPlan – Focus on assessing the current financial position and evaluating potential firm opportunities.

• ControlControl – Focus on return on investment for various assets and asset efficiency.

• UnderstandUnderstand – Focus on understanding how suppliers of funds analyze the firm.

• PlanPlan – Focus on assessing the current financial position and evaluating potential firm opportunities.

• ControlControl – Focus on return on investment for various assets and asset efficiency.

• UnderstandUnderstand – Focus on understanding how suppliers of funds analyze the firm.

Examples of Internal Uses Examples of Internal Uses of Statement Analysisof Statement AnalysisExamples of Internal Uses Examples of Internal Uses of Statement Analysisof Statement Analysis


• Convergence of Accounting StandardsConvergence of Accounting Standards: Aims to narrow or remove differences so that investors can better understand financial statements prepared under different accounting frameworks

• IASB – International Accounting Standards Board has the responsibility of IFRS

• IFRS – International Financial Reporting Standards (EU countries adopted)

• US GAAP – US Generally Accepted Accounting Principles determined by FASB

• FASB – Financial Accounting Standards Board determines accounting standards for financial statements

• Convergence of Accounting StandardsConvergence of Accounting Standards: Aims to narrow or remove differences so that investors can better understand financial statements prepared under different accounting frameworks

• IASB – International Accounting Standards Board has the responsibility of IFRS

• IFRS – International Financial Reporting Standards (EU countries adopted)

• US GAAP – US Generally Accepted Accounting Principles determined by FASB

• FASB – Financial Accounting Standards Board determines accounting standards for financial statements

Global Accounting StandardsGlobal Accounting StandardsGlobal Accounting StandardsGlobal Accounting Standards


Income StatementIncome Statement

• A summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period.

Income StatementIncome Statement

• A summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period.

Balance SheetBalance Sheet

• A summary of a firm’s financial position on a given date that shows total assets = total liabilities + owners’ equity.

Balance SheetBalance Sheet

• A summary of a firm’s financial position on a given date that shows total assets = total liabilities + owners’ equity.

Primary Types of Primary Types of Financial StatementsFinancial StatementsPrimary Types of Primary Types of Financial StatementsFinancial Statements


a. How the firm stands on a specific date.

b. What BW owned.c. Amounts owed by

customers.d. Future expense items

already paid.e. Cash/likely convertible

to cash within 1 year.f. Original amount paid.g. Acc. deductions for

wear and tear.

a. How the firm stands on a specific date.

b. What BW owned.c. Amounts owed by

customers.d. Future expense items

already paid.e. Cash/likely convertible

to cash within 1 year.f. Original amount paid.g. Acc. deductions for

wear and tear.

Cash $ 90 Acct. Rec.cc 394 Inventories 696 Prepaid Exp dd 5 Accum Tax Prepay 10 Current AssetsCurrent Assetsee $1,195 $1,195 Fixed Assets (@Cost)ff 1030 Less: Acc. Depr. gg (329)

Net Fix. AssetsNet Fix. Assets $ 701 $ 701 Investment, LT 50 Other Assets, LT 223

Total AssetsTotal Assetsbb $2,169 $2,169

Basket Wonders Balance Sheet (thousands) Dec. 31, 2007Basket Wonders Balance Sheet (thousands) Dec. 31, 2007a

Basket Wonders’ Balance Basket Wonders’ Balance Sheet (Asset Side)Sheet (Asset Side)Basket Wonders’ Balance Basket Wonders’ Balance Sheet (Asset Side)Sheet (Asset Side)


a. Note, Assets = Liabilities + Equity.

b. What BW owed and ownership position.

c. Owed to suppliers for goods and services.

d. Unpaid wages, salaries, etc.

e. Debts payable < 1 year.f. Debts payable > 1 year.g. Original investment. h. Earnings reinvested.

a. Note, Assets = Liabilities + Equity.

b. What BW owed and ownership position.

c. Owed to suppliers for goods and services.

d. Unpaid wages, salaries, etc.

e. Debts payable < 1 year.f. Debts payable > 1 year.g. Original investment. h. Earnings reinvested.

Notes Payable $ 290 Acct. Payablecc 94 Accrued Taxes dd 16 Other Accrued Liab. dd 100 Current Liab.Current Liab. ee $ $ 500 500 Long-Term Debt ff

530 Shareholders’ Equity Com. Stock ($1 par) gg 200 Add Pd in Capital gg

729 Retained Earnings hh 210 Total Total EquityEquity $ $1,1391,139 Total Liab/EquityTotal Liab/Equitya,ba,b $2,169 $2,169

Basket Wonders Balance Sheet (thousands) Dec. 31, 2007Basket Wonders Balance Sheet (thousands) Dec. 31, 2007

Basket Wonders’ Balance Basket Wonders’ Balance Sheet (Liability Side)Sheet (Liability Side)Basket Wonders’ Balance Basket Wonders’ Balance Sheet (Liability Side)Sheet (Liability Side)


a. Measures profitability over a time period.

b. Received, or receivable, from customers.

c. Sales comm., adv., officers’ salaries, etc.

d. Operating income.e. Cost of borrowed funds.f. Taxable income.g. Amount earned for

shareholders.

a. Measures profitability over a time period.

b. Received, or receivable, from customers.

c. Sales comm., adv., officers’ salaries, etc.

d. Operating income.e. Cost of borrowed funds.f. Taxable income.g. Amount earned for

shareholders.

Net Sales $ 2,211 Cost of Goods Sold bb 1,599

Gross Profit $ 612 SG&A Expenses c c 402 EBITd $ 210 Interest Expensee 59 EBT f f $ 151 Income Taxes 60 EATg $ 91 Cash Dividends 38 Increase in REIncrease in RE $ 53 $ 53

Basket Wonders Statement of Earnings (in thousands) Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2007for Year Ending December 31, 2007a

Basket Wonders’ Basket Wonders’ Income StatementIncome StatementBasket Wonders’ Basket Wonders’ Income StatementIncome Statement


Analytical Tools UsedAnalytical Tools Used

Sources and Uses Statement

Statement of Cash Flows

Cash Budgets

Analytical Tools UsedAnalytical Tools Used

Sources and Uses Statement

Statement of Cash Flows

Cash Budgets

1. Analysis of the funds1. Analysis of the funds needs of the firm.needs of the firm.

Trend/Seasonal ComponentTrend/Seasonal Component

How much funding will be required in the future?

Is there a seasonal component?

Trend/Seasonal ComponentTrend/Seasonal Component

How much funding will be required in the future?

Is there a seasonal component?

Framework for Framework for Financial AnalysisFinancial AnalysisFramework for Framework for Financial AnalysisFinancial Analysis


Health of a Firm

Financial Ratios

1. Individually2. Over time3. In combination4. In comparison

Health of a Firm

Financial Ratios

1. Individually2. Over time3. In combination4. In comparison

1. Analysis of the funds needs of the firm.

2. Analysis of the financial2. Analysis of the financial condition and profitabilitycondition and profitability of the firm.of the firm.



Examples:Examples:

Volatility in sales

Volatility in costs

Proximity to break-even point

Examples:Examples:

Volatility in sales

Volatility in costs

Proximity to break-even point

1. Analysis of the funds needs of the firm.

2. Analysis of the financial condition and profitability of the firm.

3. Analysis of the business3. Analysis of the business risk of the firm.risk of the firm.

Business risk Business risk relates to the risk inherent in the operations of the firm.

Business risk Business risk relates to the risk inherent in the operations of the firm.



A Financial Manager

must consider all three jointly

when determining

the financing

needs of the firm.

A Financial Manager

must consider all three jointly

when determining

the financing

needs of the firm.

DeterminingDeterminingthe the

financingfinancingneeds of needs of the firm.the firm.






NegotiationsNegotiationswithwith

suppliers ofsuppliers ofcapital.capital.

DeterminingDeterminingthe the

financingfinancingneeds of needs of the firm.the firm.






Types of Types of ComparisonsComparisons

Internal Internal ComparisonsComparisons

External External ComparisonsComparisons

Types of Types of ComparisonsComparisons

Internal Internal ComparisonsComparisons

External External ComparisonsComparisons

A Financial Ratio is an index that relates

two accounting numbers and is

obtained by dividing one number by the

other.

Use of Financial RatiosUse of Financial RatiosUse of Financial RatiosUse of Financial Ratios


Examples:

Risk Management Risk Management AssociationAssociation

Dun & BradstreetDun & Bradstreet

Almanac of Almanac of Business and Business and

Industrial Industrial Financial RatiosFinancial Ratios

Examples:

Risk Management Risk Management AssociationAssociation

Dun & BradstreetDun & Bradstreet

Almanac of Almanac of Business and Business and

Industrial Industrial Financial RatiosFinancial Ratios

This involves comparing the ratios of one firm with those of similarsimilar firms or with

industry averages.

SimilaritySimilarity is important as one should

compare “apples to apples.”

External Comparisons and External Comparisons and Sources of Industry RatiosSources of Industry RatiosExternal Comparisons and External Comparisons and Sources of Industry RatiosSources of Industry Ratios


CurrentCurrent

Current AssetsCurrent AssetsCurrent LiabilitiesCurrent Liabilities

For Basket Wonders December 31, 2007

CurrentCurrent

Current AssetsCurrent AssetsCurrent LiabilitiesCurrent Liabilities


Shows a firm’s ability to cover its current liabilities with its current

assets.

Balance Sheet Ratios

Liquidity Ratios

$1,195$1,195$500$500

= 2.392.39

Liquidity RatiosLiquidity RatiosLiquidity RatiosLiquidity Ratios


BW Industry

2.39 2.15

2.26 2.09

1.91 2.01

BW Industry

2.39 2.15

2.26 2.09

1.91 2.01

Year

2007

2006

2005

CurrentCurrent RatioRatio

Ratio is stronger than the industry average.

Liquidity Ratio Liquidity Ratio ComparisonsComparisonsLiquidity Ratio Liquidity Ratio ComparisonsComparisons


Acid-Test (Quick)Acid-Test (Quick)

Current Assets - InvCurrent Assets - InvCurrent LiabilitiesCurrent Liabilities


Acid-Test (Quick)Acid-Test (Quick)

Current Assets - InvCurrent Assets - InvCurrent LiabilitiesCurrent Liabilities


Shows a firm’s ability to meet

current liabilities with its most liquid

assets.


Liquidity Ratios

$1,195 – $696$1,195 – $696$500$500

= 1.001.00

Liquidity RatiosLiquidity RatiosLiquidity RatiosLiquidity Ratios


BW Industry

1.00 1.25

1.04 1.23

1.11 1.25

BW Industry

1.00 1.25

1.04 1.23

1.11 1.25

Year

2007

2006

2005

Acid-Test RatioAcid-Test Ratio

Ratio is weaker than the industry average.

Liquidity Ratio Liquidity Ratio ComparisonsComparisonsLiquidity Ratio Liquidity Ratio ComparisonsComparisons


• Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account.

• Note that this industry has a relatively high level of inventories.

• Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account.

• Note that this industry has a relatively high level of inventories.

RatioRatio BWBW IndustryIndustry

Current 2.39 2.15

Acid-Test 1.00 1.25

Summary of the Liquidity Summary of the Liquidity Ratio ComparisonsRatio ComparisonsSummary of the Liquidity Summary of the Liquidity Ratio ComparisonsRatio Comparisons


Trend Analysis of Current Ratio

1.5

1.7

1.9

2.1

2.3

2.5

2005 2006 2007

Analysis Year

Ra

tio

Va

lue

BW

Industry

Current Ratio – Trend Current Ratio – Trend Analysis ComparisonAnalysis ComparisonCurrent Ratio – Trend Current Ratio – Trend Analysis ComparisonAnalysis Comparison


Trend Analysis of Acid-Test Ratio

0.5

0.8

1.0

1.3

1.5

2005 2006 2007

Analysis Year

Rat

io V

alu

e

BWIndustry

Acid-Test Ratio – Trend Acid-Test Ratio – Trend Analysis ComparisonAnalysis ComparisonAcid-Test Ratio – Trend Acid-Test Ratio – Trend Analysis ComparisonAnalysis Comparison


• The current ratio for the industryindustry has been rising slowly at the same time the acid-test ratio has been relatively stable.

• This indicates that inventoriesinventories are a significant problem for BWBW.

• The current ratio for the industryindustry has been rising slowly at the same time the acid-test ratio has been relatively stable.

• This indicates that inventoriesinventories are a significant problem for BWBW.

• The current ratio for BWBW has been rising at the same time the acid-test ratio has been declining.

• The current ratio for BWBW has been rising at the same time the acid-test ratio has been declining.

Summary of the Liquidity Summary of the Liquidity Trend AnalysesTrend AnalysesSummary of the Liquidity Summary of the Liquidity Trend AnalysesTrend Analyses


Debt-to-EquityDebt-to-Equity

Total DebtTotal DebtShareholders’ EquityShareholders’ Equity


Debt-to-EquityDebt-to-Equity

Total DebtTotal DebtShareholders’ EquityShareholders’ Equity

For Basket Wonders December 31, 2007Shows the extent to

which the firm is financed by debt.


Financial LeverageRatios

$1,030$1,030$1,139$1,139

= 0.900.90

Financial Leverage RatiosFinancial Leverage RatiosFinancial Leverage RatiosFinancial Leverage Ratios


BW Industry

0.90 0.90

0.88 0.90

0.81 0.89

BW Industry

0.90 0.90

0.88 0.90

0.81 0.89

Year

2007

2006

2005

Debt-to-Equity RatioDebt-to-Equity Ratio

BW has average debt utilizationrelative to the industry average.

Financial Leverage Financial Leverage Ratio ComparisonsRatio ComparisonsFinancial Leverage Financial Leverage Ratio ComparisonsRatio Comparisons


Debt-to-Total-AssetsDebt-to-Total-Assets

Total DebtTotal DebtTotal AssetsTotal Assets


Debt-to-Total-AssetsDebt-to-Total-Assets

Total DebtTotal DebtTotal AssetsTotal Assets

For Basket Wonders December 31, 2007Shows the percentage

of the firm’s assets that are supported by

debt financing.



$1,030$1,030$2,169$2,169

= 0.470.47



BW Industry

0.47 0.47

0.47 0.47

0.45 0.47

BW Industry

0.47 0.47

0.47 0.47

0.45 0.47

Year

2007

2006

2005

Debt-to-Total-Asset RatioDebt-to-Total-Asset Ratio

BW has average debt utilizationrelative to the industry average.



Total CapitalizationTotal Capitalization

Total DebtTotal DebtTotal CapitalizationTotal Capitalization


Total CapitalizationTotal Capitalization

Total DebtTotal DebtTotal CapitalizationTotal Capitalization


Shows the relative importance of long-term

debt to the long-term financing of the firm.



$1,030$1,030$1,669$1,669

= 0.620.62

(i.e., LT-Debt + Equity)



BW Industry

0.62 0.60

0.62 0.61

0.67 0.62

BW Industry

0.62 0.60

0.62 0.61

0.67 0.62

Year

2007

2006

2005

Total Capitalization RatioTotal Capitalization Ratio

BW has average long-term debt utilizationrelative to the industry average.



Interest CoverageInterest Coverage

EBITEBITInterest ChargesInterest Charges


Interest CoverageInterest Coverage

EBITEBITInterest ChargesInterest Charges

For Basket Wonders December 31, 2007Indicates a firm’s

ability to cover interest charges.

Income StatementRatios

Coverage Ratios

$210$210$59$59

= 3.563.56

Coverage RatiosCoverage RatiosCoverage RatiosCoverage Ratios


BW Industry

3.56 5.19

4.35 5.02

10.30 4.66

BW Industry

3.56 5.19

4.35 5.02

10.30 4.66

Year

2007

2006

2005

Interest Coverage RatioInterest Coverage Ratio

BW has below average interest coveragerelative to the industry average.

CoverageCoverageRatio ComparisonsRatio ComparisonsCoverageCoverageRatio ComparisonsRatio Comparisons


Trend Analysis of Interest Coverage Ratio

3.0

5.0

7.0

9.0

11.0

2005 2006 2007

Analysis Year

Rat

io V

alu

e

BW

Industry

Coverage Ratio – Trend Coverage Ratio – Trend Analysis ComparisonAnalysis ComparisonCoverage Ratio – Trend Coverage Ratio – Trend Analysis ComparisonAnalysis Comparison


• This indicates that low earnings low earnings (EBIT) may be a potential problem for BWBW.

• Note, we know that debt levels debt levels are in line with the industryindustry averages.

• This indicates that low earnings low earnings (EBIT) may be a potential problem for BWBW.

• Note, we know that debt levels debt levels are in line with the industryindustry averages.

• The interest coverage ratio for BWBW has been falling since 2005. It has been below industryindustry averages for the past two years.

• The interest coverage ratio for BWBW has been falling since 2005. It has been below industryindustry averages for the past two years.

Summary of the Coverage Summary of the Coverage Trend AnalysisTrend AnalysisSummary of the Coverage Summary of the Coverage Trend AnalysisTrend Analysis


Receivable TurnoverReceivable Turnover

Annual Net Credit SalesAnnual Net Credit SalesReceivablesReceivables


Receivable TurnoverReceivable Turnover

Annual Net Credit SalesAnnual Net Credit SalesReceivablesReceivables

For Basket Wonders December 31, 2007Indicates quality of

receivables and how successful the firm is in

its collections.

Income Statement/Balance Sheet

Ratios

Activity Ratios

$2,211$2,211$394$394

= 5.615.61

(Assume all sales are credit sales.)

Activity RatiosActivity RatiosActivity RatiosActivity Ratios


Avg Collection PeriodAvg Collection Period

Days in the YearDays in the YearReceivable TurnoverReceivable Turnover


Avg Collection PeriodAvg Collection Period

Days in the YearDays in the YearReceivable TurnoverReceivable Turnover


Average number of days that receivables are

outstanding.(or RT in days)


Ratios

Activity Ratios

3653655.615.61

= 65 days65 days



BW Industry

65.0 65.7

71.1 66.3

83.6 69.2

BW Industry

65.0 65.7

71.1 66.3

83.6 69.2

Year

2007

2006

2005

Average Collection PeriodAverage Collection Period

BW has improved the average collection period to that of the industry average.

ActivityActivityRatio ComparisonsRatio ComparisonsActivityActivityRatio ComparisonsRatio Comparisons


Payable Turnover (PT)Payable Turnover (PT)

Annual Credit PurchasesAnnual Credit PurchasesAccounts PayableAccounts Payable


Payable Turnover (PT)Payable Turnover (PT)

Annual Credit PurchasesAnnual Credit PurchasesAccounts PayableAccounts Payable


Indicates the promptness of payment to suppliers by the firm.


Ratios

Activity Ratios

$1551$1551$94$94 = 16.516.5

(Assume annual credit purchases = $1,551.)



PT in DaysPT in Days

Days in the YearDays in the YearPayable TurnoverPayable Turnover


PT in DaysPT in Days

Days in the YearDays in the YearPayable TurnoverPayable Turnover


Average number of days that payables are

outstanding.


Ratios

Activity Ratios

36536516.516.5

= 22.1 days22.1 days



BW Industry

22.1 46.7

25.4 51.1

43.5 48.5

BW Industry

22.1 46.7

25.4 51.1

43.5 48.5

Year

2007

2006

2005

Payable Turnover in DaysPayable Turnover in Days

BW has improved the PT in Days.

Is this good?Is this good?



Inventory TurnoverInventory Turnover

Cost of Goods SoldCost of Goods SoldInventoryInventory


Inventory TurnoverInventory Turnover

Cost of Goods SoldCost of Goods SoldInventoryInventory

For Basket Wonders December 31, 2007Indicates the

effectiveness of the inventory management practices of the firm.


Ratios

Activity Ratios

$1,599$1,599$696$696

= 2.302.30



BW Industry

2.30 3.45

2.44 3.76

2.64 3.69

BW Industry

2.30 3.45

2.44 3.76

2.64 3.69

Year

2007

2006

2005

Inventory Turnover RatioInventory Turnover Ratio

BW has a very poor inventory turnover ratio.



Trend Analysis of Inventory Turnover Ratio

2.0

2.5

3.0

3.5

4.0

2005 2006 2007

Analysis Year

Rat

io V

alu

e

BW

Industry

Inventory Turnover Ratio –Inventory Turnover Ratio –Trend Analysis ComparisonTrend Analysis ComparisonInventory Turnover Ratio –Inventory Turnover Ratio –Trend Analysis ComparisonTrend Analysis Comparison


Total Asset TurnoverTotal Asset Turnover

Net SalesNet SalesTotal AssetsTotal Assets


Total Asset TurnoverTotal Asset Turnover

Net SalesNet SalesTotal AssetsTotal Assets

For Basket Wonders December 31, 2007Indicates the overall

effectiveness of the firm in utilizing its assets to

generate sales.


Ratios

Activity Ratios

$2,211$2,211$2,169$2,169

= 1.021.02



BW Industry

1.02 1.17

1.03 1.14

1.01 1.13

BW Industry

1.02 1.17

1.03 1.14

1.01 1.13

Year

2007

2006

2005

Total Asset Turnover RatioTotal Asset Turnover Ratio

BW has a weak total asset turnover ratio.

Why is this ratio considered weak?Why is this ratio considered weak?



Gross Profit MarginGross Profit Margin

Gross ProfitGross ProfitNet SalesNet Sales



Gross ProfitGross ProfitNet SalesNet Sales


Indicates the efficiency of operations and firm

pricing policies.


Ratios

Profitability Ratios

$612$612$2,211$2,211

= 0.2770.277

Profitability RatiosProfitability RatiosProfitability RatiosProfitability Ratios


BW Industry

27.7% 31.1%

28.7 30.8

31.3 27.6

BW Industry

27.7% 31.1%

28.7 30.8

31.3 27.6

Year

2007

2006

2005


BW has a weak Gross Profit Margin.

ProfitabilityProfitabilityRatio ComparisonsRatio ComparisonsProfitabilityProfitabilityRatio ComparisonsRatio Comparisons


Trend Analysis of Gross Profit Margin

25.0

27.5

30.0

32.5

35.0

2005 2006 2007

Analysis Year

Rat

io V

alu

e (%

)

BW

Industry

Gross Profit Margin –Gross Profit Margin –Trend Analysis ComparisonTrend Analysis ComparisonGross Profit Margin –Gross Profit Margin –Trend Analysis ComparisonTrend Analysis Comparison


Net Profit MarginNet Profit Margin

Net Profit after TaxesNet Profit after TaxesNet SalesNet Sales



Net Profit after TaxesNet Profit after TaxesNet SalesNet Sales

For Basket Wonders December 31, 2007Indicates the firm’s

profitability after taking account of all expenses

and income taxes.


Ratios


$91$91$2,211$2,211

= 0.0410.041



BW Industry

4.1% 8.2%

4.9 8.1

9.0 7.6

BW Industry

4.1% 8.2%

4.9 8.1

9.0 7.6

Year

2007

2006

2005


BW has a poor Net Profit Margin.

ProfitabilityProfitability Ratio ComparisonsRatio ComparisonsProfitabilityProfitability Ratio ComparisonsRatio Comparisons


Trend Analysis of Net Profit Margin

4

5

6

7

8

9

10

2005 2006 2007

Analysis Year

Rat

io V

alu

e (%

)

BW

Industry

Net Profit Margin –Net Profit Margin –Trend Analysis ComparisonTrend Analysis ComparisonNet Profit Margin –Net Profit Margin –Trend Analysis ComparisonTrend Analysis Comparison


Return on InvestmentReturn on Investment

Net Profit after TaxesNet Profit after TaxesTotal AssetsTotal Assets



Net Profit after TaxesNet Profit after TaxesTotal AssetsTotal Assets

For Basket Wonders December 31, 2007Indicates the

profitability on the assets of the firm (after all expenses and taxes).


Ratios


$91$91$2,160$2,160

= 0.0420.042



BW Industry

4.2% 9.6%

5.0 9.1

9.1 10.8

BW Industry

4.2% 9.6%

5.0 9.1

9.1 10.8

Year

2007

2006

2005


BW has a poor Return on Investment.



Trend Analysis of Return on Investment

4

6

8

10

12

2005 2006 2007

Analysis Year

Rat

io V

alu

e (%

)

BW

Industry

Return on Investment –Return on Investment –Trend Analysis ComparisonTrend Analysis ComparisonReturn on Investment –Return on Investment –Trend Analysis ComparisonTrend Analysis Comparison


Return on EquityReturn on Equity

Net Profit after TaxesNet Profit after TaxesShareholders’ EquityShareholders’ Equity



Net Profit after TaxesNet Profit after TaxesShareholders’ EquityShareholders’ Equity

For Basket Wonders December 31, 2007Indicates the profitability

to the shareholders of the firm (after all

expenses and taxes).


Ratios


$91$91$1,139$1,139

= 0.080.08



BW Industry

8.0% 18.0%

9.4 17.2

16.6 20.4

BW Industry

8.0% 18.0%

9.4 17.2

16.6 20.4

Year

2007

2006

2005


BW has a poor Return on Equity.



Trend Analysis of Return on Equity

7.0

10.5

14.0

17.5

21.0

2005 2006 2007

Analysis Year

Rat

io V

alu

e (%

)

BW

Industry

Return on Equity –Return on Equity –Trend Analysis ComparisonTrend Analysis ComparisonReturn on Equity –Return on Equity –Trend Analysis ComparisonTrend Analysis Comparison


ROIROI2007 = 0.041 × 1.02 = 0.0420.042 or 4.2%4.2%

ROIROIIndustry = 0.082 × 1.17 = 0.0960.096 or 9.6%9.6%

(Note: values are rounded)(Note: values are rounded)

ROIROI2007 = 0.041 × 1.02 = 0.0420.042 or 4.2%4.2%

ROIROIIndustry = 0.082 × 1.17 = 0.0960.096 or 9.6%9.6%

(Note: values are rounded)(Note: values are rounded)

ROI ROI = Net profit margin × Total asset turnover

Earning Power Earning Power = Sales profitability × Asset efficiency

Return on Investment and Return on Investment and the Du Pont Approachthe Du Pont ApproachReturn on Investment and Return on Investment and the Du Pont Approachthe Du Pont Approach


ROEROE2007 = 0.041 × 1.02 × 1.90 = 0.0800.080

ROEROEIndustry = 0.082 × 1.17 × 1.88 = 0.1800.180(Note: values are rounded)(Note: values are rounded)

ROEROE2007 = 0.041 × 1.02 × 1.90 = 0.0800.080

ROEROEIndustry = 0.082 × 1.17 × 1.88 = 0.1800.180(Note: values are rounded)(Note: values are rounded)

Return On Equity Return On Equity = Net profit margin X Total asset turnover X

Equity Multiplier

Equity Multiplier Equity Multiplier = Total Assets

Shareholders’ Equity

Return on Equity and Return on Equity and the Du Pont Approachthe Du Pont ApproachReturn on Equity and Return on Equity and the Du Pont Approachthe Du Pont Approach


• The profitability ratios for BWBW have ALL been falling since 2005. Each has been below the industryindustry averages for the past three years.

• This indicates that COGSCOGS and administrative costsadministrative costs may both be too high and a potential problem for BWBW.

• Note, this result is consistent with the low interest coverage ratio.

• The profitability ratios for BWBW have ALL been falling since 2005. Each has been below the industryindustry averages for the past three years.

• This indicates that COGSCOGS and administrative costsadministrative costs may both be too high and a potential problem for BWBW.

• Note, this result is consistent with the low interest coverage ratio.

Summary of the Profitability Summary of the Profitability Trend AnalysesTrend AnalysesSummary of the Profitability Summary of the Profitability Trend AnalysesTrend Analyses


• Inventories are too high.

• May be paying off creditors (accounts payable) too soon.

• COGS may be too high.

• Selling, general, and administrative costs may be too high.

• Inventories are too high.

• May be paying off creditors (accounts payable) too soon.

• COGS may be too high.

• Selling, general, and administrative costs may be too high.

Summary of Ratio AnalysesSummary of Ratio AnalysesSummary of Ratio AnalysesSummary of Ratio Analyses


An analysis of percentage financial statements where all

balance sheet items are divided by total assets and all income statement items are divided by

net sales or revenues.

An analysis of percentage financial statements where all

balance sheet items are divided by total assets and all income statement items are divided by

net sales or revenues.

Common-Size AnalysisCommon-Size AnalysisCommon-Size AnalysisCommon-Size Analysis


Regular (thousands of $) Common-Size (%)

Assets 2005 2006 2007 2005 2006 2007

Cash 148 100 90 12.10 4.89 4.15

AR 283 410 394 23.14 20.06 18.17

Inv 322 616 696 26.33 30.14 32.09

Other CA 10 14 15 0.82 0.68 0.69

Tot CA 763 1,140 1,195 62.39 55.77 55.09

Net FA 349 631 701 28.54 30.87 32.32

LT Inv 0 50 50 0.00 2.45 2.31

Other LT 111 223 223 9.08 10.91 10.28

Tot Assets 1,223 2,044 2,169 100.0 100.0 100.0

Basket Wonders’ Common Basket Wonders’ Common Size Balance SheetsSize Balance SheetsBasket Wonders’ Common Basket Wonders’ Common Size Balance SheetsSize Balance Sheets



Liab+Equity 2005 2006 2007 2005 2006 2007

Note Pay 290 295 290 23.71 14.43 13.37

Acct Pay 81 94 94 6.62 4.60 4.33

Accr Tax 13 16 16 1.06 0.78 0.74

Other Accr 15 100 100 1.23 4.89 4.61

Tot CL 399 505 500 32.62 24.71 23.05

LT Debt 150 453 530 12.26 22.16 24.44

Equity 674 1,086 1,139 55.11 53.13 52.51

Tot L+E 1,223 2,044 2,169 100.0 100.0 100.0

Basket Wonders’ Common- Basket Wonders’ Common- Size Balance SheetsSize Balance SheetsBasket Wonders’ Common- Basket Wonders’ Common- Size Balance SheetsSize Balance Sheets



2005 2006 2007 2005 2006 2007

Net Sales 1,235 2,106 2,211 100.0 100.0 100.0

COGS 849 1,501 1,599 68.7 71.3 72.3

Gross Profit 386 605 612 31.3 28.7 27.7

Adm. 180 383 402 14.6 18.2 18.2

EBIT 206 222 210 16.7 10.5 9.5

Int Exp 20 51 59 1.6 2.4 2.7

EBT 186 171 151 15.1 8.1 6.8

EAT 112 103 91 9.1 4.9 4.1

Cash Div 50 50 50 4.0 2.4 2.3

Basket Wonders’ Common- Basket Wonders’ Common- Size Income StatementsSize Income StatementsBasket Wonders’ Common- Basket Wonders’ Common- Size Income StatementsSize Income Statements


An analysis of percentage financial statements where all balance sheet or income statement figures for a

base year equal 100.0 (percent) and subsequent financial statement

items are expressed as percentages of their values in the base year.

An analysis of percentage financial statements where all balance sheet or income statement figures for a

base year equal 100.0 (percent) and subsequent financial statement

items are expressed as percentages of their values in the base year.

Index AnalysesIndex AnalysesIndex AnalysesIndex Analyses


Regular (thousands of $) Indexed (%)

Assets 2005 2006 2007 2005 2006 2007

Cash 148 100 90 100.0 67.6 60.8

AR 283 410 394 100.0 144.9 139.2

Inv 322 616 696 100.0 191.3 216.1

Other CA 10 14 15 100.0 140.0 150.0

Tot CA 763 1,140 1,195 100.0 149.4 156.6

Net FA 349 631 701 100.0 180.8 200.9

LT Inv 0 50 50 100.0 inf. inf.

Other LT 111 223 223 100.0 200.9 200.9

Tot Assets 1,223 2,044 2,169 100.0 167.1 177.4

Basket Wonders’ Basket Wonders’ Indexed Balance SheetsIndexed Balance SheetsBasket Wonders’ Basket Wonders’ Indexed Balance SheetsIndexed Balance Sheets



Liab+Equity 2005 2006 2007 2005 2006 2007

Note Pay 290 295 290 100.0 101.7 100.0

Acct Pay 81 94 94 100.0 116.0 116.0

Accr Tax 13 16 16 100.0 123.1 123.1

Other Accr 15 100 100 100.0 666.7 666.7

Tot CL 399 505 500 100.0 126.6 125.3

LT Debt 150 453 530 100.0 302.0 353.3

Equity 674 1,086 1,139 100.0 161.1 169.0

Tot L+E 1,223 2,044 2,169 100.0 167.1 177.4

Basket Wonders’ Basket Wonders’ Indexed Balance SheetsIndexed Balance SheetsBasket Wonders’ Basket Wonders’ Indexed Balance SheetsIndexed Balance Sheets



2005 2006 2007 2005 2006 2007

Net Sales 1,235 2,106 2,211 100.0 170.5 179.0

COGS 849 1,501 1,599 100.0 176.8 188.3

Gross Profit 386 605 612 100.0 156.7 158.5

Adm. 180 383 402 100.0 212.8 223.3

EBIT 206 222 210 100.0 107.8 101.9

Int Exp 20 51 59 100.0 255.0 295.0

EBT 186 171 151 100.0 91.9 81.2

EAT 112 103 91 100.0 92.0 81.3

Cash Div 50 50 50 100.0 100.0 100.0

Basket Wonders’ Indexed Basket Wonders’ Indexed Income StatementsIncome StatementsBasket Wonders’ Indexed Basket Wonders’ Indexed Income StatementsIncome Statements

financial statement analysis

Economy & Finance