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Financial Statement Analysis. Managers Officers Internal Auditors. Shareholders Lenders Customers. Purpose of Analysis. Financial statement analysis helps users make better decisions. Internal Users. External Users. Purpose of Analysis. Outcomes.
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Managers Officers Internal Auditors Shareholders Lenders Customers Purpose of Analysis Financial statement analysis helps users make better decisions. Internal Users External Users
Outcomes • Describe meaning and usage of financial statement analysis • 3 Types of Analysis • 5 Types of Financial Ratios
numbers versus ratios Ratio Analysis Why? EX : COMPANY AA BB NET INCOME $ 1,000,000 $ 10,000 TOTAL ASSETS $ 5,000,000 $ 20,000 NI / TA 0.20 = 20% 0.50 = 50%
Ratio Analysis • Types of ratio analysis • Industry Comparative You Industry average NI / TA 28 % 22 % To compare with the average of the companies in the same industry (your performance is higher or lower than the mean?)
Ratio Analysis • Types of ratio analysis • Trend or time series YEAR 2001 2002 2003 NI / TA 22 % 23 % 25 % To compare with yourself along the period of time (your performance is improving or getting worse?)
Ratio Analysis • Types of ratio analysis • Cross-sectional COMPANY You C1 C2 C3 NI / TA 28 % 19 % 22 % 36 % To compare with your main competitors (your performance is better or worse than them?)
Types of Financial Ratios • Liquidity • Asset Management (Efficiency) • Debt Management (Financial Leverage) • Profitability • Market Value
1. Liquidity Ratios = Ability to pay current obligations (S-T debts; A/P, N/P) By using current sources of cash (Current Assets) • Current ratio = CA ÷ CL Example You Co1 Co2 Current ratio 1.20 1.00 0.70 Analysis Good Normal Bad • Quick or acid-test ratio = (CA - Inventories) ÷ CL Inventories are the least liquid current assets so exclude it out
2. Asset Management Ratios = Measure how efficient the assets can turn into sales $$$ $$$ $$$$ $$$$ (Investment) $ 1,000,000 (Sales) $ 3,000,000 • Meaning: investing $1 can generate sales $3
2. Asset Management Ratios • Inventory Turnover = COGS ÷ Inventory • Average collection period (ACP) = A/R x 365 ÷ S • Receivables Turnover = S ÷ A/R Example: A/R = $100, Sales = $3,650 ACP = A/R x 365 ÷ S ACP = $100 x 365 days ÷ $3,650 ACP = 10 days 0 10 days • Meaning: Make sales today Collect cash from customer
Inventory Turnover Cost of Goods Sold Average Inventory = Inventory Turnover $140,000 ($10,000 + $12,000) ÷ 2 = = 12.73 times Inventory Turnover Rate This ratio measures the number of times merchandise inventory is sold and replaced during the year.
Accounts Receivable Turnover Net Sales AverageAccounts Receivable = Accounts Receivable Turnover $500,000 ($17,000 + $20,000) ÷ 2 = = 27.03 times Accounts Receivable Turnover Rate This ratio measures how many times a company converts its receivables into cash each year.
Average Collection Period 365 Days Accounts Receivable Turnover = Average Collection Period 365 Days 27.03 Times = = 13.50 days Number of Days to Collect Receivables This ratio measures, on average, how many days it takes to collect an account receivable.
2. Asset Management Ratios • Fixed Asset Turnover = Sales ÷ Fixed Assets • Total Asset Turnover = Sales ÷ Total Assets Example You Co1 Co2 Sales $ 3 m $ 1 m $ 1.4 m Total Assets $ 1 m $ 1 m $ 2 m TATO 3.00 1.00 0.70 Analysis Good Normal Bad
3. Debt Management Ratios = How much the firm has borrowed to make an investment = Ability of a firm to meet total debt obligations (S-T & L-T) • Debt ratio = TL ÷ TA • Total Debt to Equity ratio = TL ÷ TE Brown Co. Green Co. TL TA TL TA TA $100,000 TL $ 80,000 TA $100,000 TL $ 20,000 80 % 20 % = = TE $ 80,000 TL TE TL TE 4x 0.25x = = TE $ 20,000
4. Profitability Ratios = Ability to earn profit generated from sales = Ability to control costs, expenses • Gross Profit Margin • = Gross Profit / Sales • How many %profit left after paying cost of goods sold • Higher good control of cost of goods sold • Lower cost of goods sold are too high
4. Profitability Ratios (cont.) • Operating Profit Margin • = EBIT / Sales • How many %profit left after paying cost of goods sold and operating expense • Higher good control of both CGS and operating exp • Lower CGS and operating expense are too high
4. Profitability Ratios (cont.) • Net Profit Margin (NPM) = NI to CS ÷ S Ex : Co. 1 Co. 2 Sales 100,000 100,000 - expenses - 40,000 - 60,000 NI to CS 60,000 40,000 NPM 60 % 40 %
4. Profitability Ratios (cont.) • Return on Assets (ROA) = NI to CS ÷ TA = How much is the profit from $ 1 total investment Example : Brown Co: TA = $100,000 NICS = $10,000 ROA = 10% Green Co : TA = $100,000 NICS = $20,000 ROA = 20% • Return on Equity (ROE) = NI to CS ÷ CE = How much is the profit from $ 1 owners’ investment CE = Investment from Common Shareholders = CS par + Paid in + RE
5. Market Value Ratios = How much the investors value the firm in the market = Tell you what investors think about the firm’s future • Price to earnings ratio (P/E) = Market price per share Earnings per share **Earnings per share = NI to CS ÷ # of Common Shares = How much the investors are willing to pay for each $ 1 of earnings per share (EPS)
5. Market Value Ratios (cont.) • Dividend Yield (DY) = DPS Market price per share • Dividend per share (DPS) = Dividends to CS # of Common Shares
Dividend Yield Ratio Dividends Per Share Market Price Per Share = Dividend Yield Ratio $1.50 $15.25 = = 9.84% Dividend Yield Babson Builders pays an annual dividend of $1.50 per share of capital stock. The market price of the company’s capital stock was $15.25 at the end of 2007. This ratio identifies the return, in terms of cash dividends, on the current market price of the stock.
