Chapter 13 – Financial Ratios and Firm Performance  Learning Objectives  Create common-size statements  Analyze performance with internal data and financial statements  Calculate and interpret some key financial ratios  Compare different company performances  Analyze performance from historical data  Appreciate the difference across industries of financial ratios

Financial Statements  Review  Income Statement  Balance Sheet  Sources and Uses of Cash  Accounting Identity  Assets ≡ Liabilities + Owner’s Equity  Double entry bookkeeping  Benchmarking – against self or competition

Benchmarking  Against Self  Comparisons across time  Growing Sales?  Growing Costs?  Growing Income?  Against Competition  Common Size Statements  Comparisons of percentages not actual dollars  Which firm is more efficient per sales dollar

Internal Uses of Financial Statements  Analyze firm performance  Comparison of actual performance to forecasts (budgets)  Use standard costs for comparison  Breakdown performance into key areas  Sales  Production  Labor  Overhead

Internal Uses of Financial Statements  Example – Sales Variance Analysis  Price Analysis  Actual Price x Actual Quantity vs. Forecasted Price x Actual Quantity  Actual > Forecast, favorable variance  Volume Analysis  Forecast Price x Actual Quantity vs. Forecast Price x Forecast Quantity  Actual > Forecast, favorable variance  Sum variance for total Sales Analysis

Internal Uses of Financial Statements  Other Variances  Production  Labor and Material  Overhead  EBIT Variance sum of Sales, Production, and Overhead  Be careful with interpreting favorable and unfavorable variances  Variance analysis is an aid to understanding the performance of the business…

Financial Ratios  Comparing accounts for analysis of firm performance or potential strengthens and weaknesses  Five areas  Liquidity  Solvency  Asset Management  Profitability  Market Value

Financial Ratios  Liquidity  Ability to meet short term cash outflow  Poor liquidity sign of trouble ahead in keeping operations going  Common Liquidity Ratios  Current Ratio  Cash Debt Coverage Ratio  Quick Ratio  Cash Ratio

Financial Ratios  Solvency  Long-term ability to meet cash outflow  Indicates borrowing capacity in future  Common Solvency Ratios  Debt Ratio  Times Interest Earned  Cash Coverage Ratio  Capital Expenditure Ratio

Financial Ratios  Asset Management  Utilization of assets by management  How assets are being used to generate profits  Common Asset Management Ratios  Inventory Turnover  Day’s Sales in Inventory  Receivables Turnover  Total Asset Turnover Ratio

Financial Ratios  Profitability  Overall performance of the firm  Return to the owners  Common Profitability Ratios  Profit Margin  Return on Assets  Return on Equity

Financial Ratios  Market Value  Concern of potential investors  DuPont Extension of components of ROE  Common Market Value Ratios  Earnings Per Share (EPS)  Price Earnings Ratio  PEG Ratio  DuPont Analysis  Operating efficiency, management efficiency, and financial leverage  ROE components

External Uses of Financial Statements  Financial Analysts provide external view of performance  Why?  For clients that are seeking to buy (make an investment)  For clients that need to sell (disinvest)  Finance is still about buying and selling  Comparing firms…Cola Wars  Which firm would you buy?  Why?  Across Industries – Ratios reveal operating standards

Homework  Problem 8 – Predict Net Income  Problem 10 – Common-size Statements  Problem 11 – Variance Analysis  Problem 18 – DuPont Identity  Problem 20 – Company Analysis