All Rights ReservedChapter 141 F INANCIAL A NALYSIS OF B USINESS O PERATIONS Chapter 12 EBD-301...

All Rights Reserved Chapter 14 1

FINANCIAL ANALYSIS OF BUSINESS OPERATIONS

Chapter 12

EBD-301Accounting and Finance for

Entrepreneurs

All Rights Reserved Chapter 14

Financial Analysis Overview

A. The objective of financial analysis (FA) is to direct owner-manager attention to areas of concern in the financial performance of the business.

B. Solutions will follow problem identification and analysis

C. FA is a series of tools helpful in identifying problem areas

D. FA helps in valuation analysis


Financial Analysis Overview

E. Comparing [current to past] performance1. Where have we improved?

2. Where do we need to improve?

3. How do we compare to the best run business in our industry? [benchmarking]

F. Key Problem Areas1. Cost Management - key to profitability

2. Asset Management – “right-sizing”


Liquidity Management

A. Liquidity ratios measure the company's ability to pay their bills: Accounts Payable, Notes Payable, Accrued Expense

1. Current Ratio: Dollars in current assets per dollar of current liabilities.

2. Quick Ratio: Dollars in quick assets per dollar of current liabilities. (Inventory - low liquidity)

3. Cash Ratio: Cash available per dollar of current liabilities


Asset Management

A. Asset utilization ratios measure the efficiency of asset management.

1. Accounts Receivable Turnover (ARTO)

2. Days Sales Outstanding (DSO)

3. Inventory Turnover (ITO)

4. Total Assets Turnover (TATO)

5. Fixed Assets Turnover (FATO)


Debt Management

A. The extent to which assets and operating expenses are financed by borrowing money.

1. Debt Ratio (DR)

2. Times Interest Earned (TIE)

3. Fixed Charge Coverage (FCC)B. Many financial theorists favor borrowing

1. Method for increasing return on equity

2. Less expensive than equity


Profitability Management

A. Profits result when a firm’s expenses are less than its revenues.

B. Profitability is a proxy measure for the firm’s ability to control costs.

1. Gross Profit Margin (GPM) – direct costs2. Operating Profit Margin (OPM) – all operating costs3. Net Profit Margin (NPM) – how much to bottom line

Investment Performance

A. How well does the business produce a good return on our investment in the business: Gross investment, Equity

B. Return on Assets (ROA) or Investment (ROI)

C. Return of Equity (ROE)D. Basic earning Power (BEP)

1. How efficiently we generate cash from total asset investment



Trend Analysis

A. Trend analysis answers two very important questions:

1. How has the business done over the last x years in a particular area.

2. How does the company’s trend compare to the industry average? Industry benchmark?


Trend Analysis Example

Dec71Dec72

Dec73Dec74

Dec75Dec76

Dec77Dec78

Dec79Dec80

Dec81Dec82

Dec83Dec84

Dec85Dec86

Dec87Dec88

Dec89Dec90

Fiscal Year Ending

0

0.1

0.2

0.3

0.4

0.5

0.6

Per

cent

COGS Cost Rate

SGA Expense Rate

Net Profit Margin

Abbot LaboratoriesFiscal Years 1971 - 1990

COGS, SGA, NI as percent of Sales


DuPont System of Financial Analysis

A. DuPont System: a set of interrelated financial ratios used to measure operating performance.

1. ROE = ROA x (Total Assets/ Common Equity)

a. ROA = NPM * TATO

b. EQTY MULT = TOTAL ASSETS / COM EQTY

c. TATO = Net Sales / Total Assets

4. ROE = NPM * TATO * EQTY. MULT.


DuPont SystemCOGS

Net Inc SGAN.P.M. INTEXP

Net Sales TAXESROA ÷

Net SalesT.A.T.O.

Total AssetsROE x

A/PCurrent Liab N/P

Total Debt + AccrualsL-T Debt Mortgage

1/(1-DR) ÷Current Assets

Total Assets +Fixed Assets

All Rights ReservedChapter 141 F INANCIAL A NALYSIS OF B USINESS O PERATIONS Chapter 12 EBD-301...

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