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Georgia Banking School

Financial Statement Analysis

Dr. Christopher R Pope

Terry College of Business

University of Georgia

Financial Statement Analysis 2

Introduction

Objective

My objective is to introduce you to the analysis of financial statements. The

goal of the analysis is to obtain information about the timing, magnitude, and

riskiness of future cash flows. This information can then be combined with

other qualitative information to determine a firm’s creditworthiness.

Perspective

Last year, you learned to analyze the financial statements of a commercial

bank to determine the bank’s strengths and weaknesses and to provide

direction for future policy decisions. This year, we will use a similar set of

tools in the assessment of credit risks for commercial loan customers.

We will end our discussion with a loan analysis for Butler Lumber Company,

a small, growing firm that is looking for financing.


Determining Credit Risk

Our objective is to use quantitative analysis to determine the credit

worthiness of the applicant firm. One of the most important questions

from the lender’s perspective is

“Will the customer be able to repay the loan from operating cash flows?”

This analysis provides several benefits:

It helps separate good credits from bad credits.

We do not want to extend credit to a customer who will default.

However, it is also costly to deny credit to a customer who can repay.

It identifies the borrower’s strengths and weaknesses and possible sources

of risk

It provides information to loan officers that helps them set up the terms of

the loan


Analysis of Financial Statements Important Points

It is necessary to compare performance to various benchmarks

Trends: Generally 3 to 5 years worth of data is necessary to ascertain how

the firm’s financial performance is changing over time.

Industry: It is helpful to compare the firm’s performance to that of the

industry (or industries) in which it operates. Although industry averages may

not indicate where a firm wants to be, the comparison is helpful in analyzing

trends.

Competitors: It is also useful to compare the firm’s performance to that of

specific firms, such as the direct competition. These may be more

comparable than the overall industry.

It is extremely important to carefully read and analyze the annual report

- including the footnotes to the financial statements. Often these will

point to other factors, such as contractual obligations, past and future

financing policies, plans for further expansion or restructuring, or the

sale of part of the firm’s assets - that significantly affect the entire

financial analysis.

Off balance-sheet activity


Analysis of Financial Statements Important Points (cont’d)

The analysis may raise further questions for which additional

information must be obtained (either from more in depth analysis or by

asking firm management). The important point is not to view the

financial analysis as an end in itself.

Also note: accounting conventions and window dressing.


Tools of Financial Analysis Common-Size Financial Statements

Common-Size Financial Statements are a popular way to convert

dollar figures to relative (%) figures. They are routinely used with

income statements and balance sheets.

Income Statement

A common-size income statement is constructed by dividing the various

components of the income statement by net sales. Hence, net sales equals

100% and everything else is presented as a percentage of net sales.

Balance Sheet

A common-size balance sheet is calculated in the same manner, except that

all the statement components are divided by total assets to put them on a

common percentage basis.


Common Size Financial Statements Selected Numbers: Barnes & Noble and Borders

Common-Size Balance Sheet

Barnes & Noble Borders Group

2003 2001 2003 2001

Inventory 1,395.9 46.6% 1,238.6 48.4% 1,183.3 52.2% 1,201.2 58.7%

Total Current Assets 1,887.0 48.6% 1,455.2 56.9% 1,543.4 68.0% 1,335.1 65.2%

Property & Equipment 622.3 20.8% 566.2 22.1% 553.8 24.4% 562.3 27.5%

Total Assets 2,995.4 100.0% 2,557.4 100.0% 2,268.2 100.0% 2,047.1 100.0%0.0%

Accounts Payable 711.0 23.7% 582.0 22.8% 565.4 24.9% 623.6 30.5%

Notes Payable 0.0 0.0% 0.0 0.0% 0.0 0.0% 0.0 0.0%

Total Current Liabilities 1,231.5 41.1% 935.0 36.6% 1,087.6 47.9% 1,117.9 54.6%

Long-Term Debt 300.0 10.0% 666.9 26.1% 69.0 3.0% 15.0 0.7%

Total Liabilities 1,967.6 65.7% 1,779.8 69.6% 1,237.6 54.6% 1,200.6 58.6%

Common-Size Income Statement

Barnes & Noble Borders Group

2003 2001 2003 2001

Sales 5,269.0 100.0% 4,375.8 100.0% 3,512.9 100.0% 3,271.2 100.0%

COGS 3,856.0 73.2% 3,169.7 72.4% 2,511.3 71.5% 2,354.5 72.0%

Gross Profit 1,413.0 26.8% 1,206.0 27.6% 1,001.6 28.5% 916.7 28.0%

Interest Expense 21.5 0.4% 53.5 1.2% 12.6 0.4% 13.1 0.4%

Pretax Income 199.0 3.8% -32.9 -0.8% 181.3 5.2% 115.8 3.5%

Taxes 80.2 1.5% 19.9 0.5% 69.6 2.0% 61.4 1.9%

Net Income 119.0 2.3% -51.9 -1.2% 111.7 3.2% 43.6 1.3%


Tools of Financial Analysis Financial Ratio Analysis

Financial Ratio Analysis is the study of the relationships that exist

among and between various financial statement accounts at a given

point in time. It expands the information content of financial statements.

In essence, the financial statements are converted into more useable

information so that a better understanding can be obtained about the

company.

Some uses of financial ratios

Enable an analyst to understand a firm’s risk and future cash flow

generating ability

Enable a banker to asses a firm’s creditworthiness

The mechanics are simple

Selected information is gathered from the financial statements and used to

compute a set of ratios

Ratios are then compared to benchmarks.


Financial Ratio Analysis Benchmarks Revisited

Financial ratios provide useful tools for analysis when compared

against a standard or norm. Two such norms are commonly used.

Trend Analysis

Compare the firm’s financial ratios to a similar set of ratios from previous

financial statements.

Industry Averages

Compare the firm’s financial ratios to a similar set of ratios computed for

a comparable group of firms. Sources of industry average ratios

include:

Dun and Bradstreet publishes annually a set of 14 key ratios for 125

lines of business.

Robert Morris Associates, the national association of bank loan and

credit officers, publishes a set of 16 key ratios for 350 lines of

business.

Many are also available on the internet


Financial Ratios Categories

We will discuss five categories of financial ratios, each representing an

important aspect of the firm’s financial condition.

Internal liquidity

Operating performance

Risk profile

Growth potential

External liquidity

Note: Exact definitions of many ratios (and categories for that matter) vary

from publication to publication and user to user.

To illustrate the ratios, we will use the financial statements of Barnes &

Noble and Borders Group

Two major booksellers


Financial Ratios Categories (cont’d)

Internal Liquidity

Indicates the ability of the firm to meet future short term financial

obligations. These compare near term financial obligations, such as

accounts payable or notes payable to current assets or cash flows that will

be available to meet these obligations.

Examples: current ratio, quick ratio, AR & Inventory turns

Operating performance

Operating efficiency ratios examine how management uses its assets and

capital, measured in terms of the dollars of sales generated by various asset

or capital categories

Examples: Total asset turnover, equity turnover

Operating profitability ratios analyze profits as a percentage of sales and as

a percentage of the assets and capital employed

Examples: gross margin, net profit margin


Financial Ratios Categories (cont’d)

Risk profile

Relates to the uncertainty of income flows for both the entire firm and to

individual providers of capital (equity investors, debt holders, etc).

Comprised of business risk (variability of firm due to industry and economy)

and financial risk (variability brought on by introducing debt into capital

structure).

Growth potential

Indicates how fast a firm can/should grow without raising external capital.

Determined by the amount of resources retained and reinvested in the

business and the rate of return earned on these resources.

External liquidity

Market liquidity is ability to buy or sell an asset quickly with little price

change from the last transactions. Market liquidity is determined by the

number of shares (or dollar value) traded, and a smaller bid – ask spread.

Corporate variables that are proxies for market liquidity are total market

value and number of security holders, along with trading turnover as a % of

shares outstanding that trade in a given year.


Internal Liquidity Ratios

Liquidity ratios help the financial analyst answer the following question:

Does the firm have sufficient cash and liquid assets to pay bills on

time?

Current Ratio

Current liabilities represent the firm’s maturing financial obligations.

The firm’s ability to repay these obligations when due depends largely

on whether it has sufficient cash together with assets that can be

converted into cash before the current liabilities mature. The firm’s

current assets are the primary sources of funds to repay current and

maturing financial obligations.

Current AssetsCurrent Ratio

Current Liabilities


Internal Liquidity Ratios Current Ratio

2003 2002 2001

Barnes & Noble

Borders

Industry 2.4 2.7

Barnes & Noble, 2001:

1,335=1.19

1,11832.1

107,1

455,1

53.1231,1

887,1

42.1088,1

543,1

40.1140,1

591,1 56.1

935

455,1

56.1935

455,1

sLiabilitie Current

Assets CurrentRatio urrentC


Internal Liquidity Ratios Quick Ratio

Quick Ratio

Since inventories are generally the least liquid of the firm’s current assets, it

may be desirable to remove them from the numerator in the current ratio,

thus obtaining a more refined liquidity measure.

sLiabilitieCurrent

sInventorieAssetsCurrentRatioQuick

Cash Mktble Secs + ARQuick Ratio

Current Liabilities


Internal Liquidity Ratios Quick Ratio

2003 2002 2001

Barnes & Noble

Borders

Industry 0.7 0.8


33.0087,1

183,1543,1

25.0

107,1

179,1455,1

12.0

118,1

201,1335,1

40.0231,1

396,1887,1

27.0

140,1

285,1591,1

23.0

935

239,1455,1

23.0935

1239455,1

sLiabilitie Current

Inventory-Assets CurrentRatio uickQ


Internal Liquidity Ratios Cash Ratio

Cash Ratio

The most conservative liquidity measure – only the most liquid assets

Cash Mktble SecsCash Ratio

Current Liabilities


Internal Liquidity Ratios Efficiency: A/R Turnover

How effectively is the firm using its assets to generate sales?

Accounts Receivable Turnover

This ratio allows us to assess whether the firm’s sales are being tied up in

receivables?

How quickly are receivables converted to cash

Net SalesAccounts Receivable Turnover

Avg Accounts Receivable

365Avg Collection Period =

A/R Turnover


Internal Liquidity Ratios Efficiency: Average Collection Period

$4,375.8kA/R Turnover = = 61.3

Avg($84.5k, $58.2)

365 365Average Collection Period = = 6.0

A/R Turnover 61.3

2003 2002 2001

Barnes & Noble

Borders

Industry 5.8 6.6


6.78.47

365 9.6

2.53

365 0.6

3.61

365

4.84.43

365 8.7

6.46

365 7.7

5.47

365


Internal Liquidity Ratios Efficiency: Inventory Turnover


For example, a firm that produces $8 million in sales using $2 million in

inventory is using its inventory more efficiently than a similar firm that had

$4 million invested in inventory.

Inventory Turnover

The efficiency with which a firm is managing its investment in inventories is

reflected in the number of times that its inventories are turned over during

the year.

Cost of Goods SoldInventory Turnover

Avg Inventory

365Days in Inventory=

Inventory Turnover


Efficiency Ratios (continued) Inventory Turnover

2003 2002 2001

Barnes & Noble

Borders

Industry


9.12688.2

365 4.129

82.2

365

8.17113.2

365 9.178

04.2

365 6.176

07.2

365

8.13471.2

365

71.2)m5.102,1,m6.238,1(Avg

m7.169,3

Inventory Avg

COGSTurnover Inventory

8.13471.2

365

Turnover Inventory

365Inventory in Days


Internal Liquidity Ratios Efficiency: A/P Turnover

Accounts Payable Turnover

Note: Purchases = COGS + Ending Inventory – Beginning Inventory

How quickly does the firm pays its bills?

Turnover A/P

365 A/P in sDay

A/P Avg

COGS Turnover Payable Accounts

*

A/P Avg

urchasesP as estimated Sometimes*


Efficiency Ratios (cont’d) Efficiency: A/P Turnover

2003 2002 2001

Barnes & Noble

Borders

Industry


37.5

365

Turnover A/P

365 A/P in sDay

37.57.590

7.169,3

A/P Avg

COGS Turnover Payable Accounts

6.6648.5

365 5.65

57.5

365 0.68

37.5

365

5.8717.4

365 8.94

85.3

365 3.93

91.3

365


Internal Liquidity Ratios Efficiency: Cash Conversion Cycle

Cash Conversion Cycle

Measures how long and where cash is tied up (in days)

Cash Conversion Cycle A/R Days + Inventory Days - A/P Days


Operating Performance Ratios Efficiency: Total Asset Turnover


Total Asset Turnover

This ratio measures the efficiency with which the firm uses all of its assets to

generate sales.

Net SalesTotal Asset Turnover

Avg Total Assets


Operating Performance Ratios Efficiency: Total Asset Turnover

Net SalesTotal Asset Turnover =

Avg Total Assets

4,375.8k = =1.8

2,485.6k

2003 2002 2001

Barnes & Noble

Borders

Industry 2.1 2.2


87.13.2809

3.269,5 88.1

3.590,2

4.870,4 76.1

6.485,2

8.375,4

58.18.223,2

9.512,3 61.1

2.113,2

8.403,3 65.1

0.1981

2.271,3


Operating Performance Ratios Efficiency: Net Fixed Asset Turnover


Net Fixed Asset Turnover

This ratio measures the efficiency with which the firm uses its investment in

fixed assets to generate sales.

Net SalesFixed Asset Turnover

Avg Net Fixed Assets


Efficiency Ratios (continued) Net Fixed Asset Turnover

Net SalesFixed Asset Turnover =

Avg Net Fixed Assets

4,375.8k = =7.7

567.1k

2003 2002 2001

Barnes & Noble

Borders

Industry 22.0 13.1 16.6


65.80.609

3.269,5 38.8

0.581

4.870,4 72.7

1.567

8.375,4

49.66.541

9.512,3 24.6

9.545

8.403,3 84.5

3.560

2.271,3


Operating Performance Ratios Equity Turnover

Equity Turnover

Equity includes preferred and common stock

Could also compute common equity ratio

Measures the level of sales for each dollar of equity investment

Not particularly insightful

Net SalesEquity Turnover

Avg Equity


Operating Performance Ratios Profitability

Profitability ratios help us answer some very important questions

regarding the effectiveness of the firm’s management in producing

profits from the resources entrusted to them.

Profitability ratios often fall under two categories

Profitability in relation to sales

These ratios can be used to asses the ability of the firm’s management

to control various expenses in generating sales. These ratios are

commonly referred to as Profit Margins.

Profitability in relation to investment

These ratios measure firm profits in relation to the funds invested to

generate those profits. They are useful in assessing the overall

effectiveness of the firm’s management.


Operating Performance Ratios Profitability: Gross Profit Margin

Gross Profit Margin

This ratio reflects the firm’s markup on its cost of goods sold (its pricing

policy) as well as the ability of the management to minimize the firm’s cost

of goods sold in relation to sales.

Gross ProfitGross Profit Margin

Net Sales


Operating Performance Ratios Profitability: Gross Profit Margin

Gross Profit 1,206,080Gross Profit Margin= = =27.6%

Net Sales 4,375,804

2003 2002 2001

Barnes & Noble

Borders

Industry 41.4%


%8.263.269,5

5.413,1 %9.26

3.870,4

3.310,1 %6.27

8.375,4

1.206,1

%5.289.512,3

6.001,1 %7.28

8.403,3

8.975 %0.28

2.271,3

7.916


Operating Performance Ratios Profitability: Operating Profit Margin

Operating Profit Margin

Operating Profit is gross profit less SG&A expenses

This margin reflects the firm’s operating expenses as well as its cost of

goods sold.

This ratio serves as an overall measure of operating effectiveness.

Operating ProfitOperating Profit Margin

Net Sales


Operating Performance Ratios Profitability: Operating Profit Margin

Operating ProfitOperating Profit Margin =

Net Sales

133,826 = =3.1%

4,375,804

2003 2002 2001

Barnes & Noble

Borders

Industry 11.3%


%5.59.512,3

9.193 %6.4

8.403,3

0.157 %9.3

2.271,3

9.128

%0.53.269,5

1.264 %0.5

3.870,4

7.245 %1.3

8.375,4

8.133


Operating Performance Ratios Profitability: Net Profit Margin

Net Profit Margin

This margin tells us how much of each sales dollar is converted to profits

after taxes.

This margin reflects the firm’s cost of goods sold, operating expenses,

finance charges, and taxes.

How much of each sales dollar drops to the bottom line?

Should exclude one-time charges

Net IncomeNet Profit Margin =

Net Sales


Operating Performance Ratios Profitability: Net Profit Margin

Net Income -51,966Net Profit Margin = = =-1.2%

Net Sales 4,375,804

2003 2002 2001

Barnes & Noble

Borders

Industry 1.4% 1.1% 1.8%


%3.13.870,4

9.63 %2.1

8.375,4

0.52

%2.39.512,3

7.111 %6.2

8.403,3

4.87 %7.1

2.271,3

4.54

%3.23.269,5

119


Operating Performance Ratios Profitability: Return on Total Capital

Profitability in Relation to Investment: How much profit did the firm earn

on each dollar of assets under its control?

Return on Tot Capital and/or Return on Tot Assets

This ratio provides an indication of the ability of the firm to earn a

satisfactory return on all of the capital it employs.

Capital is debt, preferred stock, common stock

Note: Typically want to use net income before extraordinary items

Net Income + Interest ExpenseReturn on Total Capital =

Avg Total Capital

Net Income + Interest Expense Net IncomeReturn on Assets = or

Avg Total Assets Avg Total Assets


Operating Performance Ratios Profitability: Return on Assets

2003 2002 2001

Barnes & Noble

Borders

Industry 3.3% 2.1% 4.3%

Barnes & Noble, 2001: Net Income + Interest Expense

Return on Assets = Avg Total Assets

Net Income -52.0m or = = -2.1%

Avg Total Assets 2,485.6m

%2.43.809,2

1.119 %5.2

3.590,2

0.64 %1.2

6.485,2

0.52

%0.58.223,2

7.111 %1.4

2.113,2

4.87 %7.2

0.981,1

4.54


Operating Performance Ratios Profitability: Return on Owner’s Equity

Return on Equity

This ratio provides an indication of how effective the management is from all

equity holders point of view.

It is directly affected by the return on total assets and the amount of

financial leverage employed.

This ratio, although helpful, does not focus on the returns that actually flow

to the investor in terms of cash dividends and/or market appreciation. For

this reason, return on equity is not a reliable measure of returns from the

investors’ viewpoint.


Net IncomeReturn on Owner's Equity=

Avg Total Equity



Net Income -52.0kReturn on Owner's Equity = = =-6.4%

Avg Total Equity 812.0k

2003 2002 2001

Barnes & Noble

Borders

Industry


%3.113.990

7.111 %7.9

2.898

4.87 %6.6

6.824

4.54

%4.120.958

1.119 %7.7

9.832

0.64 %4.6

0.812

0.52


Operating Performance Ratios Profitability: Return on Common Equity

Return on Common Equity

This ratio provides an indication of how effective the management is from

the common stockholders’ point of view.

It too is directly affected by the return on total assets and the amount of

financial leverage employed.

This ratio suffers from the same problems as other accounting measures of

return on equity.


Net Income - Preferred DivsReturn on Common Equity=

Avg Common Equity



Net Income - Preferred Divs -52.0kReturn on Common Equity= = =-6.4%

Avg Common Equity 812.0k

2003 2002 2001

Barnes & Noble

Borders

Industry 7.2% 4.1% 8.7%


%9.167.659

7.111 %6.6

4.826

4.54

%3.126.970

1.119 %4.6

3.812

0.52


Risk Analysis Business Risk: Operating Earnings Variability

Business Risk

Defined as the uncertainty of income caused by the firm’s industry.

In turn, this uncertainty is due to the firm’s variability of sales caused by its

products, customers and the way it produces its products.

Generally measured by the variability of the firm’s operating income

over time.

Sales Variability

Prime determinant of earnings variability

Std Dev Oper EarningsBusiness Risk =

Mean Operating Earnings

Std Dev of SalesSales Variability =

Mean Sales


Risk Analysis Business Risk: Operating Leverage

Operating leverage refers to the use of fixed production costs

Fixed production costs cause operating profits to vary more than sales

over the business cycle.

During slow periods, profits decline by a larger percentage than sales;

during an expansion, profits will increase by a larger percentage than sales.

Change in Operating Earnings

Operating Leverage = Change in Sales


Risk Analysis Leverage Ratios

How has the firm financed its assets?

Can the firm afford the level of fixed charges associated with its use of

non-owner supplied funds such as bond interest and principal

repayment?

We define leverage as resulting from the firm’s use of debt, financial

leases, and preferred stock.

These sources all require a fixed cash payment or return for their use.

If the firm earns a return higher than that which is required by the suppliers,

then the excess goes to the owners.

However, should the return of the firm fall below the required return, then

the owners get nothing.


Risk Analysis Leverage Ratios: Debt to Equity Ratio

Where did the firm obtain financing for its investments?

Here we are using information from the balance sheet only.

Debt to Equity Ratio

A measure of risk due to capital structure choices

Higher proportion of debt to equity makes earnings more volatile

If the firm cannot meet its interest payments, it leads to financial distress

Total Long Term DebtDebt to Equity Ratio=

Total Equity


Risk Analysis Leverage Ratios: Debt to Long Term Capital

Debt to Long Term Capital

A different way to measure the debt to equity ratio

Long Term Capital is Debt + Equity

Total Long Term DebtLong Term Debt to Long Term Capital =

Total Long Term Capital


Risk Analysis Leverage Ratios: Debt to Long Term Capital

Total Long Term DebtDebt to Long Term Capital =

Total Long Term Capital

666.9k = =0.46

sum(666.9k, 777.7k)

2003 2002 2001

Barnes & Noble

Borders

Industry


06.06.030,169

69

05.0

9.9497.49

7.49

02.0

5.84615

0.15

23.8.027,1300

0.300

34.

1.888449

0.449

46.

7.7779.666

9.666


Risk Analysis Leverage Ratios: Total Debt Ratios

Total Debt Ratio

Useful for a firm that derives substantial capital from short-term borrowing

Total Interest Bearning DebtTotal Debt Ratio:

Total Capital - Non Interest Bearing Liabilities


Earnings Flow Ratios Leverage: Interest Coverage

Can the firm afford the level of fixed charges associated with its use of

non-owner supplied funds such as bond interest and principal

payments (or lease payments)?

Here we are using earnings information. These ratios are sometimes

referred to as Coverage Ratios.

Interest Coverage

This ratio indicates the firm’s ability to meet its interest payments out of its

annual operating earnings. It measures the number of times the firm is

covering its interest.

Earnings Before Interest and Taxes (EBIT)Interest Coverage =

Interest Charges


Earnings Flow Ratios Leverage: Total Fixed Charge Coverage

Total Fixed Charge Coverage

Measure of all fixed obligations by the firm

Income Before Interest, Taxes and Lease PaymentsTotal Fixed Charge Coverage=

Preferred DivsInterest + Lease Payments +

(1-Tax Rate)


Cash Flow Ratios Leverage: Cash Flow Leverage and Coverage

Cash Flow Ratios are used as alternative to earnings flow ratios

E.g., cash flow to outstanding debt has been used for predicting

bankruptcies and bond ratings.

Cash Flow + Int Exp + 1/3 of Lease PaymentsCash Flow Coverage =

Int Exp + 1/3 of Lease Payments

where Cash Flow = NI + Depr + Change in Deferred Taxes

NI + Depr + Change in Deferred TaxesCash Flow / LT Debt =

BV of Long Term Debt

NI + Depr + Change in Deferred TaxesCash Flow / Total Debt =

BV of Long Total Debt


Growth Potential Sustainable Growth

Long-term Sustainable Growth

Maximum long-term growth rate that can be self-financed

Retention Ratio

Amount of earnings held for reinvestment in the business

Long-term Sustainable Growth = Retention Ratio x ROE

Dividends DeclaredRetention Ratio = 1 -

Operating Income After Taxes


Du Pont Analysis Profitability, Efficiency

Du Pont Analysis

To improve its financial analysis, Du Pont introduced a system that ties

together relationships that might otherwise be missed. It ties:

Net Profit Margin, Total Asset Turnover, and Debt to Total Assets

This system focuses attention on the separate ideas of profitability and

asset utilization (efficiency).

Using Du Pont Analysis, we can also see how the firm’s use of leverage

affects the return on equity. Anything that changes net profit margin, total

asset turnover, or debt to total assets will affect return on equity.

Breaking down ROE (Net Income / Equity)

Net Income Sales Total AssetsROE = × ×

Sales Total Assets Common Equity

= Profit Margin x Total Asset Turnover x Financial Leverage

= ROA×Leverage


DuPont Analysis Profitability, Efficiency

Barnes and NobleROE =

2003:

Profit Margin = Total Asset

Turnover =

Financial

Leverage =

12.4% 2.3% 1.9 2.9

2002:

7.3% 1.3% 1.9 3.0

BordersROE =

2003:

Profit Margin = Total Asset

Turnover =

Financial

Leverage =

11.1% 3.2% 1.6 2.2

2002:

9.5% 2.6% 1.6 2.3


Barnes and Noble, Borders Summary Financial Ratios

Barnes and Noble Borders

2/3/01 02/03/02 02/03/03 1/28/01 1/27/02 1/26/03

Liquiditity Ratios

Current Ratio 1.56 1.40 1.53 1.19 1.32 1.42

Quick Ratio 0.23 0.27 0.40 0.12 0.25 0.33

Cash Ratio 0.03 0.09 0.22 0.05 0.17 0.25

Avg Coll Period 6.0 6.9 7.6 7.7 7.8 8.4

Days in Inventory 134.8 129.4 126.9 176.6 178.9 171.7

Days in A/P (COGS) 68.0 65.5 66.6 93.3 94.8 87.5

Cash Conversion (COGS) 128.1 117.1 108.1 130.8 130.6 127.6

Operating Performance Ratios

Asset Turnover 1.76 1.88 1.88 1.65 1.61 1.58

Net FA Turnover 7.72 8.38 8.65 5.84 6.24 6.49

Gross Profit Margin 27.6% 26.9% 26.8% 28.0% 28.7% 28.5%

Operating Profit Margin 3.1% 5.0% 5.0% 3.9% 4.6% 5.5%

Net Profit Margin -1.2% 1.3% 2.3% 1.7% 2.6% 3.2%

Return on Total Capital 0.1% 7.2% 10.6% 5.5% 8.4% 9.7%

ROA (NI + Int Exp) 0.1% 3.9% 5.0% 2.7% 4.1% 5.0%

ROA (NI) -2.1% 2.5% 4.2% 2.7% 4.1% 5.0%

Return on Owner's Equity -6.4% 7.7% 12.4% 6.6% 9.7% 11.3%

Return on Common Equity -6.4% 7.0% 12.3% 6.6% 9.7% 16.9%


Barnes and Noble, Borders Summary Financial Ratios (cont’d)

Business and Financial Risk

Oper Income Variability 27.9% 26.6% 24.8% 19.2% 11.4% 14.4%

Sales Variability 23.2% 24.0% 22.5% 20.3% 16.3% 11.7%

LT Debt / LT Capital 0.46 0.34 0.23 0.02 0.05 0.06

Interest Coverage 2.5 6.8 12.3 nm nm nm

Growth Ratios

Sustainable growth rate -6.9% 7.3% 12.4% 6.6% 9.5% 11.1%

DuPont Analysis

Net Income / Sales (Profit Margin) -1.2% 1.3% 2.3% 1.7% 2.6% 3.2%

Sales / Total Assets 1.8 1.9 1.9 1.7 1.6 1.6

Total Assets / Equity 3.3 3.0 2.9 2.4 2.3 2.2

= ROE -6.9% 7.3% 12.4% 6.6% 9.5% 11.1%

Barnes and Noble Borders

2/3/01 02/03/02 02/03/03 1/28/01 1/27/02 1/26/03


Barnes and Noble, Borders Summary Financial Ratios - Interpretation

Liquidity

Short-term liquidity is increasing for Borders, increased from 2002 for

Barnes and Noble

Both holding more cash in 2003

Efficiency

BKS appears better at inventory management, both improved in 2003

Possibly the nature of the products they are selling

Borders’ takes longer to pay their bills, although it is paying faster in 2003

than 2002

Also possibly the nature of the products they are selling



Efficiency (cont’d)

Overall takes borders longer to convert products into cash

BKS uses fewer assets per sales dollar

Profitability

From 2001 to 2003 net and operating margins increased for both BKS and

Borders, albeit more dramatically for BKS. Gross margins remained fairly

constant. Borders has slightly higher gross margin (more specialized

products?).

ROA and ROE increase for both firms in 2003 – both have similar ROA for

the year ended in 2003.

Note that BKS uses significantly more leverage than Borders, affecting the

variability of many of these performance measures.



Leverage

BKS uses much more long-term debt than Borders, although this amount

has been decreasing

Borders has very little long-term debt

Summary/DuPont

Borders has somewhat higher margins, uses slightly less leverage and

requires more asset investment as compared to BKS


Limitations of Ratio Analysis

It is sometimes difficult to identify the industry category to which a firm

belongs when the firm engages in multiple lines of business.

Published industry averages are only approximations and provide the

user with general guidelines rather than scientifically determined

averages of the ratios of all or even a representative sample of the

firms within the industry.


Limitations of Ratio Analysis (cont’d)

Accounting practices differ widely across firms and can lead to

differences in computed ratios.

Also note: Definitions of ratios vary slightly from publication to publication

and user to user.

Many firms experience seasonality in their operations.

Some ratios meaningless over short horizons

Window dressing and earnings management


Other measures of cash flow for the firm?

The statement of cash flows for a firms tracks cash in three areas:

operations, financing, and investing.

The cash flow from operations is essentially net income with

adjustments for depreciation and working capital.

Investing cash flow tracks expenditures on plant, property, and

equipment.

Financing cash flow tracks cash from the purchase and sale of

liabilities and equity.

FINANCIAL STATEMENT ANALYSIS EXAMPLE:

Big Dawg Incorporated Consolidated Balance Sheet

2010 2009

Assets Current Assets Cash $4,061 $2,382

Marketable securities 5,272 8,004

Accounts Receivable (Net) 8,960 8,350

Inventories 47,041 36,769

Prepaid expenses 512 759

Total current assets 65,846 56,264

Property, Plant, and Equipment Land 811 811

Buildings and leasehold improvements 18,273 11,928

Equipment 21,523 13,768

40,607 26,507

Less accumulated depreciation and amortization 11,528 7,530

NET Property, plant and equipment 29,079 18,977

Other Assets 373 668

TOTAL ASSETS $95,298 $75,909

Liabilities and Stockholders' Equity Current Liabilities Accounts payable $14,294 $7,591

Notes payable-banks 5,614 6,012

Current maturities of long-term debt 1,884 1,516

Accrued liabilities 5,669 5,313

Total current liabilities 27,461 20,432

Deferred Federal income taxes 843 635

Long term debt 21,059 16,975

Total liabilities 49,363 38,042

Stockholders' equity Common stock, par value $1 4,803 4,594

Additional paid in capital 957 910

Retained Earnings 40,175 32,363

Total stockholders' equity 45,935 37,867

Total liabilities and stockholders' equity $95,298 $75,909

Big Dawg Statements of Earnings for the years ended 12/31/10, 12/31/09,/12/31/08

2010 2009 2008

Net sales $215,600 $153,000 $140,700

Cost of goods sold 129,364 91,879 81,606

Gross Profit 86,236 61,121 59,094

Selling and administrative expenses 45,722 33,493 32,765

Advertising 14,258 10,792 9,541

Depreciation and amortization 3,998 2,984 2,501

Repairs and maintenance 3,015 2,046 3,031

Operating profit 19,243 11,806 11,256

Other income (expense) Interest income 422 838 738

Interest expense (2,585) (2,277) (1,274)

Earnings before income taxes 17,080 10,367 10,720

Income taxes 7,686 4,457 4,824

Net Earnings $9,394 $5,910 $5,896

Basic earnings per common share $1.96 $1.29 $1.33

Diluted earnings per common share $1.92 $1.26 $1.31

GOALS:

Assess liquidity

Assess operating efficiency

Assess capital structure and long term solvency

Assess profitability

Assess cash flow

Assess overall picture of firm’s health

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