FIN 360: Corporate Finance

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Presentation transcript:

FIN 360: Corporate Finance Topic 3: Analysis of Financial Statements Larry Schrenk, Instructor

Today’s Outline Project and Exam The Ratios Uses of Ratios

1. Project and Exam

1. Course Project Financial Analysis Calculate Ratios See Example for Specific Ratios Perspective: Equity Investor Analysis Three Traditional Ratios (Only) One Custom Ratio One Page

1. Exam 1 Format 10 short answer; 5 calculations Only calculator Coverage: Topics 1-3 Required ratios on Exam 1 Study Guide

2. The Ratios

Classification Short-Term Solvency (Liquidity) Long-Term Solvency (Leverage) Efficiency Profitability Market Value

A. Short-Term Solvency

Short-Term Solvency: Analysis Form Purpose Short-Term Liquidity Can the Firm Meet Current Obligations?

Short-Term Solvency: The Ratios Cash Ratio Quick Ratio Current Ratio

Liquidity Ratio Analysis Liquidity–Ability to Convert Assets to Cash with Significant Loss of Value Differing Time Horizons for Liquidity Cash Ratio??? Quick Ratio??? Current Ratio???

A Custom Ratio Example A New Coverage Ratio Application?

B. Long-Term Solvency

Long-Term Solvency Measures of the Long-Term Viability of the Firm Two Metrics Degree of Leverage Coverage

Long-Term Solvency: Degree of Leverage Analysis Form Purpose Long-Term Liquidity Is the Total Amount of Debt Reasonable? Can the Firm Remain Solvent?

Long-Term Solvency: Degree of Leverage Ratios Total Debt Ratio Debt/Equity Ratio Equity Multiplier Conversions

Long-Term Solvency: Coverage Analysis Form Purpose Short-Term Liquidity Can the Firm Service its Long-Term Obligations? Is Bankruptcy a Concern?

Long-Term Solvency: Coverage Ratios Times Interest Earned (TIE) Cash Coverage

C. Efficiency

Efficiency: Analysis Form Purpose How Efficiently does the Firm Use the Value Invested in each Asset? Balance Sheet Assets as Portfolio Liquidity-Return Trade-Off Turnover versus ‘Days Sales’

Turnover Analysis Sales as Goal Example Total Asset Turnover Ratio–Sales versus a Dollar Spend on Total Assets Example Total Asset Turnover Ratio = 5x $1.00 in Assets Generates $5.00 in Sales on Average.

Efficiency: The Inventory Ratios Inventory Turnover Days’ Sales in Inventory

Efficiency: The Receivables Ratios Receivables Turnover Days’ Sales in Receivables

Efficiency: The Asset Ratios Total Asset Turnover Fixed Asset Turnover

Customized Efficiency Ratios Denominator Any Balance Sheet Asset Numerator Any Firm Goal

D. Profitability

Profitability: Analysis Form Purpose Is the Firm Generating Reasonable Earnings Relative to Total Assets Equity NOTE: Accounting Measures

Profitability: The Ratios Profit Margin Return on Assets (ROA) Return on Equity (ROE)

T-S-P You are considering investing in the bonds of a firm. Which ratio is the most important for your decision: Current Ratio Long-Term Debt Ratio TIE Ratio Cash Coverage Ratio

E. Market Values

Market Value: Analysis No Common Form No Common Purpose Commonality: Market Data

Market Value: Analysis Share Price (Dec. 2002) $31.30 PE Ratio Market-to-Book Ratio

4. Using Ratios

Comparisons Time-Trend Analysis Peer Group Analysis Firm’s Performance over Time Peer Group Analysis Similar Companies or Industry Analysis

My Principles Consider the Perspective Toolbox Approach Annualization Anomalies/Accounting Numbers Red Flags Customized Ratios No Rules

Some Cautions No Underlying Theory Diversified Firms Globalization Varying Accounting Procedures Different Fiscal Years