Financial Ratio Analysis

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Presentation transcript:

Financial Ratio Analysis How can published financial statements be used to assess financial performance?

Financial Ratio Types Market Value Profitability Asset Activity Leverage Liquidity

Market Value Ratios Examples: Market-to-Book; Price-Earnings Questions: How do securities markets value the company’s assets? Earnings?

Profitability Ratios Examples: Return on assets, equity, invested capital; gross, net profit margin Questions: How profitable is the company per dollar invested in the business; per dollar of sales?

Asset Activity Ratios Examples: asset turnover, average collection period, inventory conversion period, payables deferral period Questions: How efficiently does the company use its assets? How long does it take assets or liabilities to turn into cash?

Leverage Ratios Examples: Debt/assets; Debt/equity; Interest coverage Questions: How much of a burden does debt pose relative to assets, equity or cash flow? How risky is the company?

Liquidity Ratios Examples: Current ratio, quick ratio, interval measure Questions: How easily can the company meet its immediate cash requirements? How risky is the company?

Financial Ratios Relative to What? By themselves, financial ratios have no meaning. We need to compare to: Past data for the same company Data for similar companies (e.g., same industry) Other ratios (i.e., DuPont ratios, Cash Conversion Cycle)

A Good Source of Company Ratios A Good Source of Company Ratios www.investor.reuters.com

Dell and Gateway: Margin Trends 2005 2004 2003 2002 2001 2000 1999 1998 1997 Dell Gross Margin 18.6 18.2 17.9 17.7 20.2 20.7 22.5 22.1 21.5 Net Margin 6.6 6.4 6 4 6.8 8 7.7 6.7 Gateway 9.1 13.6 14.1 21.4 20.5 18.3 17.1 Net margin 0.5 -15.1 -7.1 -17.4 2.5 4.8 4.5 1.7 5

Dell, Gateway and Computer Hardware Industry Gross Margin 18.6 9.1 31.1 Net Margin 6.6 0.5 7.2 Asset Turnover 2.4 2.1 1.5 Inventory Turnover 91.6 16.4 45 Rec. Turnover 12.6 11.9 8.6 ROIC 40.8 3.2 19.6 ROE 58.4 44.4 31.9 Quick Ratio 0.9 0.8 1.3 Mkt/Book 13.6 3.7 6.9

DuPont Ratios Net Income x Sales x Assets = Net Income Sales Assets Equity Equity Net profit X Asset x Equity = ROE margin turnover multiplier

DuPont Analysis: Selected Companies ROE S/A NI/S A/E Burlington Northern Santa Fe 0.138 0.128 0.337 3.219 Citicorp 0.165 0.102 0.114 14.121 Consolidated Edison 0.113 0.495 0.098 2.340 Merck 0.375 0.943 0.195 2.038 Safeway 0.334 3.203 0.025 4.209 Wal-Mart Stores 0.198 2.776 0.030 2.384

Cash Conversion Cycle: Selected Companies Company Inv. Conv. Ave. Coll. Op. Cycle Pay. Def. Cash Conv. Hewlett-Packard 89.8 65.1 154.9 65.9 89 Merck 70 42.7 112.7 66 46.7 Boeing 74.1 22 96.1 54.4 41.7 Wal-Mart Stores 64.4 2.8 67.2 37.4 29.8 Safeway 33.9 36.7 35.3 1.4 American Airlines 15.1 24.7 39.8 70.9 -31.1 McDonald's 3.9 7.1 11 62.2 -51.2