Financial Analysis & Ratios Chapter 13 Financial Analysis & Ratios

Comparative Analysis There are three types of comparisons to provide decision usefulness of financial information: Intra-company basis Inter-company basis Industry averages

Comparative Analysis Intra-company basis – comparisons within the company. Inter-company basis – comparisons with other companies. Industry averages – comparisons with other companies in the same industry.

Financial Statement Analysis Three basic tools are used in financial statement analysis : 1. Horizontal analysis 2. Vertical analysis 3. Ratio analysis

Horizontal Analysis Is a technique for evaluating a series of financial statement data over a period of time. Did an increase or decrease take place? Pages 613 - 614

Horizontal Analysis P1 – P0 P0 $281 $245 – $281 = (12.81)% The amount of cash for Lowe’s decreased approximately 12.81% from fiscal 2007 to 2008.

Vertical Analysis Expresses each item in a financial statement as a percent of a base amount. Total Assets is the base amount on a Balance Sheet. Common-size balance sheet Net Sales is the base amount on an Income Statement. Common-size income statement Pages 615 - 616

Ratio Analysis Five types: Liquidity ratios Solvency ratios Turnover ratios Profitability ratios Market value ratios

Liquidity Ratios WHO CARES? Measure the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash. WHO CARES? Short-term creditors such as bankers and suppliers

Current Ratio Indicates short-term debt-paying ability Current Assets Current Liabilities

Acid-Test Ratio Indicates immediate short-term debt-paying ability Current Assets - Inventory Current Liabilities

Cash Ratio Indicates short-term debt-paying ability (cash basis) Current Liabilities

Solvency Ratios WHO CARES? Measure the ability of the enterprise to survive over a long period of time WHO CARES? Long-term creditors and stockholders

Debt to Assets Ratio Total Liabilities Total Assets Indicates % of total assets provided by creditors Total Liabilities Total Assets

Times Interest Earned Ratio Indicates company’s ability to meet interest payments as they come due _ EBIT _ Interest Expense

Cash Debt Coverage Ratio Indicates long-term debt-paying ability (cash basis) Cash provided by operations Average total liabilities

Turnover Ratios WHO CARES? Measure how efficiently, or intensively, a firm uses its assets to generate sales . WHO CARES? Short-term creditors such as bankers and suppliers

Inventory Turnover Ratio Indicates liquidity of inventory Cost of Goods Sold Inventory

Average Days in Inventory Inventory Turnover Ratio Indicates liquidity of inventory and inventory management 365 days Inventory Turnover Ratio

Receivables Turnover Ratio Indicates liquidity of receivables Net Sales Accounts Receivable

Average Collection Period Indicates liquidity of receivables and collection success 365 days Receivables Turnover

Asset Turnover Ratio Net Sales Total Assets Indicates how efficiently assets are used to generate sales Net Sales Total Assets

Profitability Ratios Measure the income or operating success of an enterprise for a given period of time WHO CARES? Everybody WHY? A company’s income affects: its ability to obtain debt and equity financing its liquidity position its ability to grow

Profit Margin Ratio Net Income Net Sales Indicates net income generated by each dollar of sales Net Income Net Sales

Return On Assets Net Income Average Total Assets Reveals the amount of net income generated by each dollar invested Net Income Average Total Assets

Return on Equity Net Income Average Total Equity Indicates profitability of common stockholders’ investment Net Income Average Total Equity

Market Value Ratios WHO CARES? Deals with market value of stock. . Stockholder’s

Earnings Per Share (EPS) Indicates net income earned on each share of common stock sales Net Income Shares Outstanding

Price Earnings Ratio Stock Price Earnings Per Share Indicates relationship between market price per share and earnings per share Stock Price Earnings Per Share

Payout Ratio Dividends Net Income Indicates % of earnings distributed in the form of cash dividends Dividends Net Income

Addition to Retained Earnings Retention Ratio Indicates % of earnings plowed back into the corporation. Addition to Retained Earnings Net Income

Limitations Of Financial Analysis Horizontal, vertical, and ratio analysis are frequently used in making significant business decisions. One should be aware of the limitations of these tools and the financial statements.