Financial Statement Analysis. RATIO ANALYSIS Financial statements report both on a firm’s position...

Financial StatementAnalysis

RATIO ANALYSIS

• Financial statements report both on a firm’s position at a point in time and on its operations over some past period.

• From management’s viewpoint, financial statement analysis is useful both as a way to– anticipate future conditions and – more important, as a starting point for planning actions – that will influence the future course of events or – to show whether a firm’s position has been improving or

deteriorating over time.

• Ratio analysis begins – with the calculation of a set of financial ratios– designed to show the relative strengths and – weaknesses of a company as compared to

• Other firms in the industry• Leadings firms in the industry• The previous year of the same firm

• Ratio analysis helps to show whether the firm’s position has been improving or deteriorating

• Ratio analysis can also help plan for the future

Use of Financial RatiosUse of Financial Ratios

Types of Types of ComparisonsComparisons

Internal Internal ComparisonsComparisons

External External ComparisonsComparisons

Types of Types of ComparisonsComparisons

Internal Internal ComparisonsComparisons

External External ComparisonsComparisons

A Financial Ratio is an index that relates two accounting numbers and is obtained by

dividing one number by the other.

External Comparisons and Sources of Industry RatiosExternal Comparisons and Sources of Industry Ratios

Examples:Risk Management Risk Management

AssociationAssociationDun & BradstreetDun & Bradstreet

Almanac of Business and Industrial

Financial Ratios

Examples:Risk Management Risk Management

AssociationAssociationDun & BradstreetDun & Bradstreet

Almanac of Business and Industrial

Financial Ratios

This involves comparing the ratios of one firm with those of similarsimilar firms or with industry averages.

Similarity is important as one should compare “apples to apples.”

Liquidity RatiosLiquidity Ratios

CurrentCurrent

Current AssetsCurrent Liabilities

For Basket Wonders December 31, 2007

CurrentCurrent

Current AssetsCurrent Liabilities


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

Balance Sheet Ratios

Liquidity Ratios

$1,195$1,195$500$500

= 2.392.39

Liquidity Ratio ComparisonsLiquidity Ratio Comparisons

BW Industry2.39 2.152.26 2.091.91 2.01

BW Industry2.39 2.152.26 2.091.91 2.01

Year200720062005

CurrentCurrent RatioRatio

Ratio is stronger than the industry average.

Liquidity RatiosLiquidity Ratios

Acid-Test (Quick)Acid-Test (Quick)

Current Assets - InvCurrent Liabilities


Acid-Test (Quick)Acid-Test (Quick)

Current Assets - InvCurrent Liabilities


Shows a firm’s ability to meet current liabilities

with its most liquid assets.


Liquidity Ratios

$1,195 - $696$1,195 - $696$500$500

= 1.001.00

Liquidity Ratio ComparisonsLiquidity Ratio Comparisons

BW Industry1.00 1.251.04 1.231.11 1.25

BW Industry1.00 1.251.04 1.231.11 1.25

Year200720062005

Acid-Test RatioAcid-Test Ratio

Ratio is weaker than the industry average.

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

Financial Leverage RatiosFinancial Leverage Ratios

Debt-to-EquityDebt-to-Equity

Total DebtShareholders’ Equity


Debt-to-EquityDebt-to-Equity

Total DebtShareholders’ Equity

For Basket Wonders December 31, 2007Shows the extent to

which the firm is financed by debt.


Financial LeverageRatios

$1,030$1,030$1,139$1,139

= .90.90

Financial Leverage Ratio Comparisons


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

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

Year200720062005

Debt-to-Equity RatioDebt-to-Equity Ratio

BW has average debt utilizationrelative to the industry average.


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, 2007Shows the percentage of

the firm’s assets that are supported by debt

financing.



$1,030$1,030$2,169$2,169

= .47.47



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

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

Year200720062005

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

BW has average debt utilizationrelative to the industry average.


Total CapitalizationTotal Capitalization

Long-term DebtTotal Capitalization


Total CapitalizationTotal Capitalization

Long-term DebtTotal Capitalization


Shows the relative importance of long-term debt to the long-term financing of

the firm.



$530$530$1,669$1,669

= .32.32

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



BW Industry .32 .30 .32 .31 .37 .32

BW Industry .32 .30 .32 .31 .37 .32

Year200720062005

Total Capitalization RatioTotal Capitalization Ratio

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

Activity RatiosActivity Ratios

Receivable TurnoverReceivable Turnover

Annual Net Credit SalesReceivables


Receivable TurnoverReceivable Turnover

Annual Net Credit SalesReceivables

For Basket Wonders December 31, 2007Indicates quality of

receivables and how successful the firm is in its

collections.

Income Statement /Balance Sheet

Ratios

Activity Ratios

$2,211$2,211$394$394

= 5.615.61

(Assume all sales are credit sales.)


Avg Collection PeriodAvg Collection Period

Days in the YearReceivable Turnover


Avg Collection PeriodAvg Collection Period

Days in the YearReceivable Turnover


Average number of days that receivables are

outstanding.(or RT in days)


Ratios

Activity Ratios

3653655.615.61

= 65 days65 days

ActivityRatio Comparisons


BW Industry65.0 65.771.1 66.383.6 69.2

BW Industry65.0 65.771.1 66.383.6 69.2

Year200720062005

Average Collection PeriodAverage Collection Period

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


Payable Turnover (PT)Payable Turnover (PT)

Annual Credit PurchasesAccounts Payable


Payable Turnover (PT)Payable Turnover (PT)

Annual Credit PurchasesAccounts Payable

For Basket Wonders December 31, 2007Indicates the promptness of

payment to suppliers by the firm.


Ratios

Activity Ratios

$1551$1551$94$94 = 16.516.5

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


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

Activity Ratios

36536516.516.5

= 22.1 days22.1 days



BW Industry22.1 46.725.4 51.143.5 48.5

BW Industry22.1 46.725.4 51.143.5 48.5

Year200720062005

Payable Turnover in DaysPayable Turnover in Days

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


Inventory TurnoverInventory Turnover

Cost of Goods SoldInventory


Inventory TurnoverInventory Turnover

Cost of Goods SoldInventory


Indicates the effectiveness of the inventory

management practices of the firm.


Ratios

Activity Ratios

$1,599$1,599$696$696

= 2.302.30



BW Industry2.30 3.452.44 3.762.64 3.69

BW Industry2.30 3.452.44 3.762.64 3.69

Year200720062005

Inventory Turnover RatioInventory Turnover Ratio

BW has a very poor inventory turnover ratio.


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

Activity Ratios

$2,211$2,211$2,169$2,169

= 1.021.02



BW Industry1.02 1.171.03 1.141.01 1.13

BW Industry1.02 1.171.03 1.141.01 1.13

Year200720062005

Total Asset Turnover RatioTotal Asset Turnover Ratio

BW has a weak total asset turnover ratio.

Profitability RatiosProfitability Ratios

Gross Profit MarginGross Profit Margin

Gross ProfitGross ProfitNet SalesNet Sales



Gross ProfitGross ProfitNet SalesNet Sales


Indicates the efficiency of operations and firm pricing

policies.


Ratios

Profitability Ratios

$612$612$2,211$2,211

= .277277

ProfitabilityRatio Comparisons

ProfitabilityRatio Comparisons

BW Industry27.7% 31.1%28.7 30.831.3 27.6

BW Industry27.7% 31.1%28.7 30.831.3 27.6

Year200720062005


BW has a weak Gross Profit Margin.


Return on InvestmentReturn on Investment

Net Profit after TaxesNet Profit after TaxesTotal AssetsTotal Assets



Net Profit after TaxesNet Profit after TaxesTotal AssetsTotal Assets

For Basket Wonders December 31, 2007Indicates the profitability on

the assets of the firm (after all expenses and taxes).


Ratios


$91$91$2,160$2,160

= .042.042

Profitability Ratio Comparisons


BW Industry4.2% 9.8%5.0 9.19.1 10.8

BW Industry4.2% 9.8%5.0 9.19.1 10.8

Year200720062005


BW has a poor Return on Investment.


Return on EquityReturn on Equity

Net Profit after TaxesNet Profit after TaxesShareholders’ EquityShareholders’ Equity



Net Profit after TaxesNet Profit after TaxesShareholders’ EquityShareholders’ Equity

For Basket Wonders December 31, 2007Indicates the profitability to

the shareholders of the firm (after all expenses and

taxes).


Ratios


$91$91$1,139$1,139

= .08.08



BW Industry 8.0% 17.9% 9.4 17.216.6 20.4

BW Industry 8.0% 17.9% 9.4 17.216.6 20.4

Year200720062005


BW has a poor Return on Equity.

Financial Statement Analysis. RATIO ANALYSIS Financial statements report both on a firm’s position...

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