4-1 Business Finance (MGT 232) Lecture 21. 4-2 Financial Statement Analysis.

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Business Finance(MGT 232)

Lecture 21

4-24-2

Financial Statement AnalysisFinancial Statement AnalysisFinancial Statement AnalysisFinancial Statement Analysis

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• Financial Statements• A Possible Framework for Analysis• Ratio Analysis• Five major categories of ratios

Overview of the Last Lecture

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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?

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Liquidity RatiosLiquidity Ratios

Current RatioCurrent Ratio

Current AssetsCurrent AssetsCurrent LiabilitiesCurrent Liabilities

For Basket Wonders December 31, 2013

Current RatioCurrent Ratio

Current AssetsCurrent AssetsCurrent LiabilitiesCurrent Liabilities


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

Balance Sheet Ratios

Liquidity Ratios

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Basket Wonders’ Balance Sheet (Asset Side)


Cash and C.E. Rs. 90 Acct. Rec.cc 394 Inventories 696 Prepaid Exp dd 5 Accum Tax Prepay 10 Current Current AssetsAssetsee Rs. 1,195 Rs. 1,195 Fixed Assets (@Cost)ff 1030 Less: Acc. Depr. gg

(329) Net Fix. AssetsNet Fix. Assets

Rs. 701 Rs. 701 Investment, LT 50 Other Assets, LT 223 Total AssetsTotal Assetsbb Rs.2,169Rs.2,169

Basket Wonders Balance Sheet (thousands) Dec. 31, 2013Basket Wonders Balance Sheet (thousands) Dec. 31, 2013a

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

530 Shareholders’ Equity Com. Stock (Rs.1 par) g g

200 Add Pd in Capital gg

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

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Liquidity Ratio ComparisonsLiquidity Ratio Comparisons

BW Industry 2.152.26 2.091.91 2.01

BW Industry 2.152.26 2.091.91 2.01

Year201320122011

CurrentCurrent RatioRatio

Ratio is stronger than the industry average.

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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

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BW Industry1.25

1.04 1.231.11 1.25

BW Industry1.25

1.04 1.231.11 1.25

Year201320122011

Acid-Test RatioAcid-Test Ratio

Ratio is weaker than the industry average.

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Net Working CapitalNet Working Capital

Current - Current - Current Current AssetsAssets Liabilities Liabilities



Current - Current - Current Current AssetsAssets Liabilities Liabilities


Shows a safety cushion for the firm.

+ive NWC is a good sign that firm can sell assets

to pay debts


Liquidity Ratios

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BW Industry654

550 575428 445

BW Industry654

550 575428 445

Year201320122011


Ratio is stronger than the industry average.

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Summary of the Liquidity Ratio Comparisons

Summary of the Liquidity Ratio Comparisons

• 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 IndustryIndustryCurrent 2.39 2.15Acid-Test 1.00 1.25

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Current Ratio -- Trend Analysis Comparison

Current Ratio -- Trend Analysis Comparison

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Acid-Test Ratio -- Trend Analysis Comparison

Acid-Test Ratio -- Trend Analysis Comparison

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Summary of the Liquidity Trend Analysis

Summary of the Liquidity Trend Analysis

• 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.

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Financial Leverage RatiosFinancial Leverage Ratios

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, 2013Shows the extent to

which the firm is financed by debt.


Financial LeverageRatios

Rs.1,030Rs.1,030Rs.1,139Rs.1,139

= .90.90

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Financial Leverage Ratio Comparisons


BW Industry .90 .90 .88 .90 .81 .89

BW Industry .90 .90 .88 .90 .81 .89

Year201320122011

Debt-to-Equity RatioDebt-to-Equity Ratio

BW has average debt utilizationrelative to the industry average.

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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, 2013Shows the percentage of

the firm’s assets that are supported by debt

financing.



Rs.1,030Rs.1,030Rs.2,169Rs.2,169

= .47.47

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BW Industry .47 .47 .47 .47 .45 .47

BW Industry .47 .47 .47 .47 .45 .47

Year201320122011

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

BW has average debt utilizationrelative to the industry average.

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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.



Rs.1,030Rs.1,030Rs.1,669Rs.1,669

= .62.62

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

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BW Industry .62 .60 .62 .61 .67 .62

BW Industry .62 .60 .62 .61 .67 .62

Year201320122011

Total Capitalization RatioTotal Capitalization Ratio

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

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Coverage RatiosCoverage Ratios

Interest CoverageInterest Coverage

EBITEBITInterest ChargesInterest Charges


Interest CoverageInterest Coverage

EBITEBITInterest ChargesInterest Charges

For Basket Wonders December 31, 2013Indicates a firm’s ability

to cover interest charges.

Income StatementRatios

Coverage Ratios

Rs.210Rs.210Rs.59Rs.59

= 3.563.56

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Basket Wonders’ Income Statement


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.





shareholders.

Net Sales Rs. 2,211 Cost of Goods Sold bb 1,599 Gross Profit Rs. 612 SG&A Expenses cc 402 EBITd Rs. 210 Interest Expensee 59 EBT ff Rs. 151 Income Taxes 60 EATg

Rs. 91 Cash Dividends 38 Increase in REIncrease in RE Rs. 53 Rs. 53

Basket Wonders Statement of Earnings (in thousands) for Year Ending Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2013December 31, 2013a

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Coverage Ratio ComparisonsCoverage Ratio Comparisons

BW Industry 3.56 5.19 4.35 5.0210.30 4.66

BW Industry 3.56 5.19 4.35 5.0210.30 4.66

Year201320122011

Interest Coverage RatioInterest Coverage Ratio

BW has below average interest coveragerelative to the industry average.

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Coverage Ratio -- Trend Analysis Comparison

Coverage Ratio -- Trend Analysis Comparison

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Summary of the Coverage Trend Analysis

Summary of the Coverage Trend Analysis

• 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 2011. It has been below industryindustry averages for the past two years.

The interest coverage ratio for BWBW has been falling since 2011. It has been below industryindustry averages for the past two years.

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Asset Management ratiosAsset Management ratios

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, 2013Indicates quality of

receivables and how successful the firm is in its

collections.

Income Statement /Balance Sheet

Ratios

Asset Management

ratios

Rs.2,211Rs.2,211Rs.394Rs.394

= 5.615.61

(Assume all sales are credit sales.)

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shareholders.





shareholders.




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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

Asset Management

ratios

3653655.615.61

= 65 days65 days

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shareholders.





shareholders.




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Asset Management Comparisons

Asset Management Comparisons

BW Industry65.0 65.771.1 66.383.6 69.2

BW Industry65.0 65.771.1 66.383.6 69.2

Year201320122011

Average Collection PeriodAverage Collection Period

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

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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

For Basket Wonders December 31, 2013Indicates the promptness of

payment to suppliers by the firm.


Ratios

Asset Management

ratios

Rs.1551Rs.1551Rs.94Rs.94= 16.516.5

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

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shareholders.





shareholders.




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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

Asset Management

ratios

36536516.516.5

= 22.1 days22.1 days

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Asset Management Ratio Comparisons


BW Industry22.1 46.725.4 51.143.5 48.5

BW Industry22.1 46.725.4 51.143.5 48.5

Year201320122011

Payable Turnover in DaysPayable Turnover in Days

BW has improved the PT in Days.Is this good?Is this good?

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Inventory TurnoverInventory Turnover

Cost of Goods SoldCost of Goods SoldInventoryInventory


Inventory TurnoverInventory Turnover

Cost of Goods SoldCost of Goods SoldInventoryInventory


Indicates the effectiveness of the inventory

management practices of the firm.


Ratios

Asset Management

ratios

Rs.1,599Rs.1,599Rs.696Rs.696

= 2.302.30

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shareholders.





shareholders.




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BW Industry2.30 3.452.44 3.762.64 3.69

BW Industry2.30 3.452.44 3.762.64 3.69

Year201320122011

Inventory Turnover RatioInventory Turnover Ratio

BW has a very poor inventory turnover ratio.

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Inventory Turnover Ratio --Trend Analysis ComparisonInventory Turnover Ratio --Trend Analysis Comparison

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Total Asset TurnoverTotal Asset Turnover

Net SalesNet SalesTotal AssetsTotal Assets


Total Asset TurnoverTotal Asset Turnover

Net SalesNet SalesTotal AssetsTotal Assets


Indicates the overall effectiveness of the firm in

utilizing its assets to generate sales.


Ratios

Asset Management

ratios

Rs.2,211Rs.2,211Rs.2,169Rs.2,169

= 1.021.02

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shareholders.





shareholders.




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BW Industry1.02 1.171.03 1.141.01 1.13

BW Industry1.02 1.171.03 1.141.01 1.13

Year201320122011

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?

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Summary

A Possible Framework for Analysis• Ratio Analysis – Liquidity Ratios– Leverage Ratio– Asset Management Ratio

4-1 Business Finance (MGT 232) Lecture 21. 4-2 Financial Statement Analysis.

Documents

Transcript of 4-1 Business Finance (MGT 232) Lecture 21. 4-2 Financial Statement Analysis.