Learning Objectives

1. Learning Objectives • Calculate 13 financial ratios that measure profitability, asset utilization, liquidity and debt utilization. (LO1) • Assess a company’s source of profitability using the DuPont system of analysis. (LO2) • Examine the ratios in comparison to industry averages. (LO3) • Examine the ratios and company performance by means of trend analysis. (LO4)

2. Asset utilization ratios(a) LO1 and LO3 Saxton Company Industry Average 3-4a. Receivables turnover = = 11.4 10 times 3-4b. Average collection period = = 32 36 days 3-5a. Inventory turnover = Cost of Goods Sold = 8.1 7 times Inventory Sales (credit) Receivables $4,000,000 $350,000 $350,000 $10,959 Accounts receivable Average daily credit sales $3,000,000 $370,000

3. Asset utilization ratios(b) LO1 and LO3 Saxton Company Industry Average 3-5b. Inventory holding period = = 45 52 days 3-6a. Accounts payable turnover = = 60.0 12 times 3-6b. Accounts payable period = Accounts payable= 6 30 days Average daily purchases (COGS) $370,000 $8,219 Inventory Average daily COGS $3,000,000 $50,000 Cost of goods sold Accounts payable $50,000 $8,219

4. Asset utilization ratios(c) LO1 and LO3 Saxton Company Industry Average 3-7. Capital asset turnover = = 5.0 5.4 times 3-8. Total asset turnover = = 2.5 1.5 times Sales Capital assets $4,000,000 $800,000 Sales Total assets $4,000,000 $1,600,000

5. Liquidity ratios LO1/LO3 Saxton Company Industry Average 3-9. Current ratio = = 2.67 2.1 3-10. Quick ratio = = 1.43 1.0 Current assets Current liabilities $800,000 $300,000 Current assets – Inventory Current liabilities $430,000 $300,000

6. Debt utilization ratios LO1/LO3 Saxton Company Industry Average 3-11. Debt to total assets = = 37.5% 33% 3-12. Times interest earned = = 11 7 times 3-13. Fixed charge coverage = = 6 5.5 times Total debt Total 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

7. Table 3-2aRatio analysis(a) Saxton Industry Company Average Comparison A. Profitability 1. Profit margin……………… 5% 6.5% Below average 2. Return on assets………..…. 12.5% 10% Above average due to high 8 3. Return on equity…………. 20% 15% Good due to ratios 2 and 11 B. Asset Utilization 4a. Receivables turnover ……... 11.4 10.0 Good 4b. Average collection period…. 32.0 36.0 Good 5a. Inventory turnover ………... 8.1 7.0 Good 5b. Inventory holding period...... 45 52 Good 6a. Accounts payable turnover... 60 12 Good 6b. Accounts payable period...... 6 30 Good 7. Capital asset turnover ……. 5.0 5.4 Below average 8. Total asset turnover ………. 2.5 1.5 Good LO3

8. Table 3-2bRatio analysis(b) Saxton Industry Company Average Comparison C. Liquidity 9. Current ratio …………… 2.67 2.1 Good 10. Quick ratio ……………….. 1.43 1.0 Good D. Debt Utilization 11. Debt to total assets ……….. 37.5% 33% Slightly more debt 12. Times interest earned ……. 11 7 Good 13. Fixed charge coverage …… 6 5.5 Good LO3

9. Techniques of Ratio Analysis DuPont Analysis Comparative Analysis Trend Analysis Common-Size Statements LO1/LO2/LO3/LO4

10. Comparative vs. Trend Analysis Ratios on their own do not mean a lot Comparing a company’s ratios to those of its industry or its competitors is comparative analysis and may reveal what ratios are out of line with certain standards Comparing the same company’s ratios over a number of years is trend analysis and may reveal whether ratios are improving or worsening LO3 and LO4

11. Table 3-3Trend analysis of competitors LO3 and LO4 Bank of Montreal Royal Bank Return on Assets Return on Equity Return on Assets Return on Equity 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 0.79 18.0 0.81 19.8 0.60 13.8 0.74 16.4 0.56 13.4 0.76 15.5 0.71 16.4 0.73 16.8 0.87 18.1 0.66 15.7 0.81 14.5 0.72 17.1 0.83 17.7 0.88 21.4 0.58 13.9 0.90 22.1 0.50 13.0 0.63 18.1 0.41 9.9 0.59 11.9 Source: Bank of Montreal annual reports www.bmo.com Royal Bank of Canada annual reports www.rbcroyalbank.com

12. LO3 and LO4 Figure 3-2 Trend analysis