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Business Finance (MGT 232)

Business Finance (MGT 232). Lecture 21. Financial Statement Analysis. Overview of the Last Lecture. Financial Statements A Possible Framework for Analysis Ratio Analysis Five major categories of ratios. What are the five major categories of ratios, and what questions do they answer?.

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Business Finance (MGT 232)

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  1. Business Finance(MGT 232) Lecture 21

  2. Financial Statement Analysis

  3. Overview of the Last Lecture • Financial Statements • A Possible Framework for Analysis • Ratio Analysis • Five major categories of ratios

  4. What are the five major categories of ratios, and what questions do they answer? • Liquidity: Can we make required payments in the short run? • Asset management: right amount of assets vs. sales? • Debt management, leverage: 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 value: Do investors like what they see as reflected in P/E and M/B ratios?

  5. Current Ratio Current Assets Current Liabilities For Basket Wonders December 31, 2013 Shows a firm’s ability to cover its current liabilities with its current assets. Liquidity Ratios Balance Sheet Ratios Liquidity Ratios

  6. Cash and C.E. Rs. 90 Acct. Rec.c 394 Inventories 696 Prepaid Expd5 Accum Tax Prepay 10Current Assetse Rs. 1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g(329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223Total AssetsbRs.2,169 Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a Notes Payable Rs. 290 Acct. Payablec 94 Accrued Taxesd 16 Other Accrued Liab.d 100Current Liab.e Rs. 500 Long-Term Debtf530Shareholders’ Equity Com. Stock (Rs.1 par)g 200Add Pd in Capitalg 729 Retained Earningsh210 Total Equity Rs. 1,139 Total Liab/Equitya,b Rs.2,169

  7. BW Industry 2.15 2.26 2.09 1.91 2.01 Year 2013 2012 2011 Liquidity Ratio Comparisons CurrentRatio Ratio is stronger than the industry average.

  8. Acid-Test (Quick) Current Assets - Inv Current Liabilities For Basket Wonders December 31, 2013 Shows a firm’s ability to meet current liabilities with its most liquid assets. Liquidity Ratios Balance Sheet Ratios Liquidity Ratios

  9. BW Industry 1.25 1.04 1.23 1.11 1.25 Year 2013 2012 2011 Liquidity Ratio Comparisons Acid-Test Ratio Ratio is weaker than the industry average.

  10. Net Working Capital Current - Current Assets Liabilities For Basket Wonders December 31, 2013 Shows a safety cushion for the firm. +ive NWC is a good sign that firm can sell assets to pay debts Liquidity Ratios Balance Sheet Ratios Liquidity Ratios

  11. Cash and C.E. Rs. 90 Acct. Rec.c 394 Inventories 696 Prepaid Expd5 Accum Tax Prepay 10Current Assetse Rs. 1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g(329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223Total AssetsbRs.2,169 Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a Notes Payable Rs. 290 Acct. Payablec 94 Accrued Taxesd 16 Other Accrued Liab.d 100Current Liab.e Rs. 500 Long-Term Debtf530Shareholders’ Equity Com. Stock (Rs.1 par)g 200Add Pd in Capitalg 729 Retained Earningsh210 Total Equity Rs. 1,139 Total Liab/Equitya,b Rs.2,169

  12. BW Industry 654 550575 428445 Year 2013 2012 2011 Liquidity Ratio Comparisons Net Working Capital Ratio is stronger than the industry average.

  13. 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. RatioBWIndustry Current 2.39 2.15 Acid-Test 1.00 1.25 Summary of the Liquidity Ratio Comparisons

  14. Current Ratio -- Trend Analysis Comparison

  15. Acid-Test Ratio -- Trend Analysis Comparison

  16. The current ratio for the industry has been rising slowly at the same time the acid-test ratio has been relatively stable. This indicates that inventories are a significant problem for BW. Summary of the Liquidity Trend Analysis • The current ratio for BW has been rising at the same time the acid-test ratio has been declining.

  17. Debt-to-Equity Total Debt Shareholders’ Equity For Basket Wonders December 31, 2013 Shows the extent to which the firm is financed by debt. Financial Leverage Ratios Balance Sheet Ratios Financial Leverage Ratios Rs.1,030 Rs.1,139 = .90

  18. Cash and C.E. Rs. 90 Acct. Rec.c 394 Inventories 696 Prepaid Expd5 Accum Tax Prepay 10Current Assetse Rs. 1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g(329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223Total AssetsbRs.2,169 Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a Notes Payable Rs. 290 Acct. Payablec 94 Accrued Taxesd 16 Other Accrued Liab.d 100Current Liab.e Rs. 500 Long-Term Debtf530Shareholders’ Equity Com. Stock (Rs.1 par)g 200Add Pd in Capitalg 729 Retained Earningsh210 Total Equity Rs. 1,139 Total Liab/Equitya,b Rs.2,169

  19. BW Industry .90 .90 .88 .90 .81 .89 Year 2013 2012 2011 Financial Leverage Ratio Comparisons Debt-to-Equity Ratio BW has average debt utilization relative to the industry average.

  20. Debt-to-Total-Assets Total Debt Total Assets For Basket Wonders December 31, 2013 Shows the percentage of the firm’s assets that are supported by debt financing. Financial Leverage Ratios Balance Sheet Ratios Financial Leverage Ratios Rs.1,030 Rs.2,169 = .47

  21. Cash and C.E. Rs. 90 Acct. Rec.c 394 Inventories 696 Prepaid Expd5 Accum Tax Prepay 10Current Assetse Rs. 1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g(329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223Total AssetsbRs.2,169 Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a Notes Payable Rs. 290 Acct. Payablec 94 Accrued Taxesd 16 Other Accrued Liab.d 100Current Liab.e Rs. 500 Long-Term Debtf530Shareholders’ Equity Com. Stock (Rs.1 par)g 200Add Pd in Capitalg 729 Retained Earningsh210 Total Equity Rs. 1,139 Total Liab/Equitya,b Rs.2,169

  22. BW Industry .47 .47 .47 .47 .45 .47 Year 2013 2012 2011 Financial Leverage Ratio Comparisons Debt-to-Total-Asset Ratio BW has average debt utilization relative to the industry average.

  23. Total Capitalization Total Debt Total Capitalization For Basket Wonders December 31, 2013 Shows the relative importance of long-term debt to the long-term financing of the firm. Financial Leverage Ratios Balance Sheet Ratios (i.e., LT-Debt + Equity) Financial Leverage Ratios Rs.1,030 Rs.1,669 = .62

  24. Cash and C.E. Rs. 90 Acct. Rec.c 394 Inventories 696 Prepaid Expd5 Accum Tax Prepay 10Current Assetse Rs. 1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g(329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223Total AssetsbRs.2,169 Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a Notes Payable Rs. 290 Acct. Payablec 94 Accrued Taxesd 16 Other Accrued Liab.d 100Current Liab.e Rs. 500 Long-Term Debtf530Shareholders’ Equity Com. Stock (Rs.1 par)g 200Add Pd in Capitalg 729 Retained Earningsh210 Total Equity Rs. 1,139 Total Liab/Equitya,b Rs.2,169

  25. BW Industry .62 .60 .62 .61 .67 .62 Year 2013 2012 2011 Financial Leverage Ratio Comparisons Total Capitalization Ratio BW has average long-term debt utilization relative to the industry average.

  26. Interest Coverage EBIT Interest Charges For Basket Wonders December 31, 2013 Indicates a firm’s ability to cover interest charges. Coverage Ratios Income Statement Ratios Coverage Ratios Rs.210 Rs.59 = 3.56

  27. 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 Rs. 2,211 Cost of Goods Soldb1,599 Gross Profit Rs. 612 SG&A Expensesc402EBITdRs. 210 Interest Expensee59 EBTfRs.151Income Taxes60 EATgRs. 91 Cash Dividends 38 Increase in RE Rs. 53 Basket Wonders’ Income Statement Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2013a

  28. BW Industry 3.56 5.19 4.35 5.02 10.30 4.66 Year 2013 2012 2011 Coverage Ratio Comparisons Interest Coverage Ratio BW has below average interest coverage relative to the industry average.

  29. Coverage Ratio -- Trend Analysis Comparison

  30. This indicates that low earnings (EBIT) may be a potential problem for BW. Note, we know that debt levels are in line with theindustryaverages. Summary of the Coverage Trend Analysis • The interest coverage ratio for BW has been falling since 2011. It has been below industryaverages for the past two years.

  31. Receivable Turnover Annual Net Credit Sales Receivables For Basket Wonders December 31, 2013 Indicates quality of receivables and how successful the firm is in its collections. Asset Management ratios Income Statement / Balance Sheet Ratios (Assume all sales are credit sales.) Asset Management ratios Rs.2,211 Rs.394 = 5.61

  32. Cash and C.E. Rs. 90 Acct. Rec.c 394 Inventories 696 Prepaid Expd5 Accum Tax Prepay 10Current Assetse Rs. 1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g(329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223Total AssetsbRs.2,169 Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a Notes Payable Rs. 290 Acct. Payablec 94 Accrued Taxesd 16 Other Accrued Liab.d 100Current Liab.e Rs. 500 Long-Term Debtf530Shareholders’ Equity Com. Stock (Rs.1 par)g 200Add Pd in Capitalg 729 Retained Earningsh210 Total Equity Rs. 1,139 Total Liab/Equitya,b Rs.2,169

  33. 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 Rs. 2,211 Cost of Goods Soldb1,599 Gross Profit Rs. 612 SG&A Expensesc402EBITdRs. 210 Interest Expensee59 EBTfRs.151Income Taxes60 EATgRs. 91 Cash Dividends 38 Increase in RE Rs. 53 Basket Wonders’ Income Statement Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2013a

  34. Avg Collection Period Days in the Year Receivable Turnover For Basket Wonders December 31, 2013 Average number of days that receivables are outstanding. (or RT in days) Asset Management ratios Income Statement / Balance Sheet Ratios Asset Management ratios 365 5.61 = 65 days

  35. Cash and C.E. Rs. 90 Acct. Rec.c 394 Inventories 696 Prepaid Expd5 Accum Tax Prepay 10Current Assetse Rs. 1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g(329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223Total AssetsbRs.2,169 Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a Notes Payable Rs. 290 Acct. Payablec 94 Accrued Taxesd 16 Other Accrued Liab.d 100Current Liab.e Rs. 500 Long-Term Debtf530Shareholders’ Equity Com. Stock (Rs.1 par)g 200Add Pd in Capitalg 729 Retained Earningsh210 Total Equity Rs. 1,139 Total Liab/Equitya,b Rs.2,169

  36. 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 Rs. 2,211 Cost of Goods Soldb1,599 Gross Profit Rs. 612 SG&A Expensesc402EBITdRs. 210 Interest Expensee59 EBTfRs.151Income Taxes60 EATgRs. 91 Cash Dividends 38 Increase in RE Rs. 53 Basket Wonders’ Income Statement Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2013a

  37. BW Industry 65.0 65.7 71.1 66.3 83.6 69.2 Year 2013 2012 2011 Asset Management Comparisons Average Collection Period BW has improved the average collection period to that of the industry average.

  38. Payable Turnover (PT) Annual Credit Purchases Accounts Payable For Basket Wonders December 31, 2013 Indicates the promptness of payment to suppliers by the firm. Asset Management ratios Income Statement / Balance Sheet Ratios (Assume annual credit purchases = Rs.1,551.) Asset Management ratios Rs.1551 Rs.94 = 16.5

  39. Cash and C.E. Rs. 90 Acct. Rec.c 394 Inventories 696 Prepaid Expd5 Accum Tax Prepay 10Current Assetse Rs. 1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g(329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223Total AssetsbRs.2,169 Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a Notes Payable Rs. 290 Acct. Payablec 94 Accrued Taxesd 16 Other Accrued Liab.d 100Current Liab.e Rs. 500 Long-Term Debtf530Shareholders’ Equity Com. Stock (Rs.1 par)g 200Add Pd in Capitalg 729 Retained Earningsh210 Total Equity Rs. 1,139 Total Liab/Equitya,b Rs.2,169

  40. 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 Rs. 2,211 Cost of Goods Soldb1,599 Gross Profit Rs. 612 SG&A Expensesc402EBITdRs. 210 Interest Expensee59 EBTfRs.151Income Taxes60 EATgRs. 91 Cash Dividends 38 Increase in RE Rs. 53 Basket Wonders’ Income Statement Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2013a

  41. PT in Days Days in the Year Payable Turnover For Basket Wonders December 31, 2013 Average number of days that payables are outstanding. Asset Management ratios Income Statement / Balance Sheet Ratios Asset Management ratios 365 16.5 = 22.1 days

  42. BW Industry 22.1 46.7 25.4 51.1 43.5 48.5 Year 2013 2012 2011 Asset Management Ratio Comparisons Payable Turnover in Days BW has improved the PT in Days. Is this good?

  43. Inventory Turnover Cost of Goods Sold Inventory For Basket Wonders December 31, 2013 Indicates the effectiveness of the inventory management practices of the firm. Asset Management ratios Income Statement / Balance Sheet Ratios Asset Management ratios Rs.1,599 Rs.696 = 2.30

  44. Cash and C.E. Rs. 90 Acct. Rec.c 394 Inventories 696 Prepaid Expd5 Accum Tax Prepay 10Current Assetse Rs. 1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g(329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223Total AssetsbRs.2,169 Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a Notes Payable Rs. 290 Acct. Payablec 94 Accrued Taxesd 16 Other Accrued Liab.d 100Current Liab.e Rs. 500 Long-Term Debtf530Shareholders’ Equity Com. Stock (Rs.1 par)g 200Add Pd in Capitalg 729 Retained Earningsh210 Total Equity Rs. 1,139 Total Liab/Equitya,b Rs.2,169

  45. 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 Rs. 2,211 Cost of Goods Soldb1,599 Gross Profit Rs. 612 SG&A Expensesc402EBITdRs. 210 Interest Expensee59 EBTfRs.151Income Taxes60 EATgRs. 91 Cash Dividends 38 Increase in RE Rs. 53 Basket Wonders’ Income Statement Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2013a

  46. BW Industry 2.30 3.45 2.44 3.76 2.64 3.69 Year 2013 2012 2011 Asset Management Ratio Comparisons Inventory Turnover Ratio BW has a very poor inventory turnover ratio.

  47. Inventory Turnover Ratio --Trend Analysis Comparison

  48. Total Asset Turnover Net Sales Total Assets For Basket Wonders December 31, 2013 Indicates the overall effectiveness of the firm in utilizing its assets to generate sales. Asset Management ratios Income Statement / Balance Sheet Ratios Asset Management ratios Rs.2,211 Rs.2,169 = 1.02

  49. Cash and C.E. Rs. 90 Acct. Rec.c 394 Inventories 696 Prepaid Expd5 Accum Tax Prepay 10Current Assetse Rs. 1,195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. g(329) Net Fix. Assets Rs. 701 Investment, LT 50 Other Assets, LT 223Total AssetsbRs.2,169 Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a Notes Payable Rs. 290 Acct. Payablec 94 Accrued Taxesd 16 Other Accrued Liab.d 100Current Liab.e Rs. 500 Long-Term Debtf530Shareholders’ Equity Com. Stock (Rs.1 par)g 200Add Pd in Capitalg 729 Retained Earningsh210 Total Equity Rs. 1,139 Total Liab/Equitya,b Rs.2,169

  50. 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 Rs. 2,211 Cost of Goods Soldb1,599 Gross Profit Rs. 612 SG&A Expensesc402EBITdRs. 210 Interest Expensee59 EBTfRs.151Income Taxes60 EATgRs. 91 Cash Dividends 38 Increase in RE Rs. 53 Basket Wonders’ Income Statement Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2013a

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