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Chapter 11 Analysis of Financial Statements

Chapter 11 Analysis of Financial Statements . © 2005 Thomson/South-Western. Financial Statements and Reports. The Income Statement The Balance Sheet Statement of Cash Flows Statement of Retained Earnings. Unilate Textiles: Comparative IS . Unilate Textiles: Comparative BS.

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Chapter 11 Analysis of Financial Statements

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  1. Chapter 11Analysis of Financial Statements © 2005 Thomson/South-Western

  2. Financial Statements and Reports • The Income Statement • The Balance Sheet • Statement of Cash Flows • Statement of Retained Earnings

  3. Unilate Textiles: Comparative IS

  4. Unilate Textiles: Comparative BS

  5. Unilate Textiles: Liabilities and Equity

  6. Ratio Analysis • Analysis of a firm’s ratios is generally the first step in financial analysis. • Ratios are designed to show relationships between financial statement accounts within firms and between firms.

  7. What is the Purpose of Ratio Analysis? • Give idea of how well the company is doing • Standardize numbers; facilitate comparisons • Used to highlight weaknesses and strengths

  8. What Are the Five Major Categories of Ratios?What Questions Do They Answer? • Liquidity: Can we make required payments in the current period? • Asset mgt.: Right amount of assets vs. sales? • Debt mgt.: Right mix of debt and equity? • Profitability: Do sales prices exceed unit costs, and are sales high enough as reflected in PM, ROE, and ROA? • Market values: Do investors like what they see as reflected in P/E and M/B ratios?

  9. Industry Average Data

  10. Current Ratio = Current Assets Current Liabilities $465.0 $130.0 = = 3.6 times Industry average = 4.1 times What is Unilate’sCurrent Ratio?

  11. Quick Ratio = Current Assets- Inventories Current Liabilities $195.0 $130.0 $465.0 - $270.0 $130.0 = = = 1.5 times Industry average = 2.1 times What is Unilate’sQuick, or Acid Test, Ratio?

  12. Unilate’s Liquidity Position • Ratios is slightly below industry average. • Inventories are the least liquid of Unilate’s assets and they are the assets that suffer losses in the event of a forced sale. • The quick ratio shows that, if receivables are collected in full, Unilate can payoff its current liabilities without having to liquidate its inventory.

  13. 4.6 . 6 times $1,230.0 = = $270.0 Industry average = 7.4 times What is Unilate’s Inventory Turnover Ratio? • Compares poorly with industry • May be holding excess inventories • May be holding old/obsolete inventory.

  14. Industry average = 32.1 days What is Unilate’s Days Sales Outstanding Ratio?

  15. $1,500.0 = = 3.9 times $380.0 Industry Average 4.0 times = What is Unilate’s Fixed Assets Turnover Ratio?

  16. $1,500.0 = 1.8 times = $845.0 Industry Average 2.1 times = What is Unilate’s Total Assets Turnover Ratios? • TA turnover is below industry average. • Unilate might have excess inventories & receivables.

  17. Debt Ratio = Total debt Total assets $430.0 $130.0 . + $300.0 . = = 0.509 = 50.9% = $845.0 $845.0 Industry Average = 45.0% Calculate the Debt Ratio

  18. TIE = EBIT Interest charges $130.0 3.3 times = = $40.0 Industry Average = 6.5 times Calculate the Times-Interest-Earned Ratio

  19. Calculate theFixed Charge Coverage Ratio Industry Average = 5.8x All three previous ratios reflect use of debt, but focus on different aspects.

  20. $54.0 $1,500 = = 0.036 = 3.6% Industry Average = 4.7% Unilate’s Profitability Ratios--Profit Margin, ROA, and ROE

  21. = 0.064 = 6.4% $54.0 $845.0 = = $54.0 $415.0 - 0 = 0.130 = 13.0% Industry Average = Industry Average = 12.6% 17.2% Unilate’s ROA, and ROE

  22. $23.00 10.6 times = = $2.16 Industry Average = 13.0 times Unilate’s Market Value Ratios Price/Earnings Ratio

  23. 1.4 times $23.00 $16.00 = = Industry Average = 2.0 times Unilate’s Market Value Ratios Market/Book Ratio

  24. ROA = Net Profit Margin X Total Assets Turnover Sales Total Assets Net Income Sales X = $54.0 $1,500.0 X $1,500.0 $845.0 = = 3.6% X 1.8 = 6.4% Summary of Ratio Analysis:The DuPont Equation

  25. DuPont Equation Provides Overview • Firm’s profitability (measured by ROA) • Firm’s expense control (measured by profit margin) • Firm’s asset utilization (measured by total asset turnover)

  26. Limitations of Ratio Analysis? • Comparison with industry averages is difficult if the firm operates many different divisions. • “Average” performance not necessarily good. • Inflation distorts balance sheets. • Seasonal factors can distort ratios. • “Window dressing” techniques can make statements and ratios look better. • Different operating and accounting practices distort comparisons. • Sometimes hard to tell if a ratio is “good” or “bad” • Difficult to tell whether company is, on balance, in strong or weak position

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