Financial Statement Analysis

RATIO ANALYSIS Financial statements report both on a firm’s position at a point in time and on its operations over some past period. From management’s viewpoint, financial statement analysis is useful both as a way to – anticipate future conditions and – more important, as a starting point for planning actions – that will influence the future course of events or – to show whether a firm’s position has been improving or deteriorating over time.

Ratio analysis begins – with the calculation of a set of financial ratios – designed to show the relative strengths and – weaknesses of a company as compared to Other firms in the industry Leadings firms in the industry The previous year of the same firm Ratio analysis helps to show whether the firm’s position has been improving or deteriorating Ratio analysis can also help plan for the future

Use of Financial Ratios Types of Comparisons Internal Comparisons External Comparisons Types of Comparisons Internal Comparisons External Comparisons A Financial Ratio is an index that relates two accounting numbers and is obtained by dividing one number by the other.

External Comparisons and Sources of Industry Ratios Examples: Risk Management Association Dun & Bradstreet Almanac of Business and Industrial Financial Ratios Examples: Risk Management Association Dun & Bradstreet Almanac of Business and Industrial Financial Ratios similar This involves comparing the ratios of one firm with those of similar firms or with industry averages. Similarity is important as one should compare “apples to apples.”

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Liquidity Ratios Current Current Assets Current Liabilities For Basket Wonders December 31, 2007Current Current Assets Current Liabilities For Basket Wonders December 31, 2007 Shows a firm’s ability to cover its current liabilities with its current assets. Balance Sheet Ratios Liquidity Ratios $1,195$ = 2.39

Liquidity Ratio Comparisons BW Industry BW Industry Year Current Ratio Ratio is stronger than the industry average.

Liquidity Ratios Acid-Test (Quick) Current Assets - Inv Current Liabilities For Basket Wonders December 31, 2007 Acid-Test (Quick) Current Assets - Inv Current Liabilities For Basket Wonders December 31, 2007 Shows a firm’s ability to meet current liabilities with its most liquid assets. Balance Sheet Ratios Liquidity Ratios $1,195 - $696 $ = 1.00

Liquidity Ratio Comparisons BW Industry BW Industry Year Acid-Test Ratio Ratio is weaker than the industry average.

Summary of the Liquidity Ratio Comparisons Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account. Note that this industry has a relatively high level of inventories. Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account. Note that this industry has a relatively high level of inventories. RatioBWIndustry RatioBWIndustry Current Acid-Test

Financial Leverage Ratios Debt-to-Equity Total Debt Shareholders’ Equity For Basket Wonders December 31, 2007Debt-to-Equity Total Debt Shareholders’ Equity For Basket Wonders December 31, 2007 Shows the extent to which the firm is financed by debt. Balance Sheet Ratios Financial Leverage Ratios $1,030$1, =.90

Financial Leverage Ratio Comparisons BW Industry BW Industry Year Debt-to-Equity Ratio BW has average debt utilization relative to the industry average.

Financial Leverage Ratios Debt-to-Total-Assets Total Debt Total Assets For Basket Wonders December 31, 2007Debt-to-Total-Assets Total Debt Total Assets For Basket Wonders December 31, 2007 Shows the percentage of the firm’s assets that are supported by debt financing. Balance Sheet Ratios Financial Leverage Ratios $1,030$2, =.47

Financial Leverage Ratio Comparisons BW Industry BW Industry Year Debt-to-Total-Asset Ratio BW has average debt utilization relative to the industry average.

Financial Leverage Ratios Total Capitalization Long-term Debt Total Capitalization For Basket Wonders December 31, 2007 Total Capitalization Long-term Debt Total Capitalization For Basket Wonders December 31, 2007 Shows the relative importance of long-term debt to the long-term financing of the firm. Balance Sheet Ratios Financial Leverage Ratios $530 $530$1, =.32 (i.e., LT-Debt + Equity)

Financial Leverage Ratio Comparisons BW Industry BW Industry Year Total Capitalization Ratio BW has average long-term debt utilization relative to the industry average.

Activity Ratios Receivable Turnover Annual Net Credit Sales Receivables For Basket Wonders December 31, 2007 Receivable Turnover Annual Net Credit Sales Receivables For Basket Wonders December 31, 2007 Indicates quality of receivables and how successful the firm is in its collections. Income Statement / Balance Sheet Ratios Activity Ratios $2,211$ = 5.61 (Assume all sales are credit sales.)

Activity Ratios Avg Collection Period Days in the Year Receivable Turnover For Basket Wonders December 31, 2007 Avg Collection Period Days in the Year Receivable Turnover For Basket Wonders December 31, 2007 Average number of days that receivables are outstanding. (or RT in days) Income Statement / Balance Sheet Ratios Activity Ratios days = 65 days

Activity Ratio Comparisons BW Industry BW Industry Year Average Collection Period BW has improved the average collection period to that of the industry average.

Activity Ratios Payable Turnover (PT) Annual Credit Purchases Accounts Payable For Basket Wonders December 31, 2007 Payable Turnover (PT) Annual Credit Purchases Accounts Payable For Basket Wonders December 31, 2007 Indicates the promptness of payment to suppliers by the firm. Income Statement / Balance Sheet Ratios Activity Ratios $1551$ = 16.5 (Assume annual credit purchases = $1,551.)

Activity Ratios PT in Days Days in the Year Payable Turnover For Basket Wonders December 31, 2007 PT in Days Days in the Year Payable Turnover For Basket Wonders December 31, 2007 Average number of days that payables are outstanding. Income Statement / Balance Sheet Ratios Activity Ratios days = 22.1 days

Activity Ratio Comparisons BW Industry BW Industry Year Payable Turnover in Days BW has improved the PT in Days. Is this good?

Activity Ratios Inventory Turnover Cost of Goods Sold Inventory For Basket Wonders December 31, 2007 Inventory Turnover Cost of Goods Sold Inventory For Basket Wonders December 31, 2007 Indicates the effectiveness of the inventory management practices of the firm. Income Statement / Balance Sheet Ratios Activity Ratios $1,599$ = 2.30

Activity Ratio Comparisons BW Industry BW Industry Year Inventory Turnover Ratio BW has a very poor inventory turnover ratio.

Activity Ratios Total Asset Turnover Net Sales Total Assets For Basket Wonders December 31, 2007 Total Asset Turnover Net Sales Total Assets For Basket Wonders December 31, 2007 Indicates the overall effectiveness of the firm in utilizing its assets to generate sales. Income Statement / Balance Sheet Ratios Activity Ratios $2,211$2, = 1.02

Activity Ratio Comparisons BW Industry BW Industry Year Total Asset Turnover Ratio BW has a weak total asset turnover ratio.

Profitability Ratios Gross Profit Margin Gross Profit Net Sales For Basket Wonders December 31, 2007 Gross Profit Margin Gross Profit Net Sales For Basket Wonders December 31, 2007 Indicates the efficiency of operations and firm pricing policies. Income Statement / Balance Sheet Ratios Profitability Ratios $612$2, =.277

Profitability Ratio Comparisons BW Industry 27.7%31.1% BW Industry 27.7%31.1% Year Gross Profit Margin BW has a weak Gross Profit Margin.

Profitability Ratios Return on Investment Net Profit after Taxes Total Assets For Basket Wonders December 31, 2007 Return on Investment Net Profit after Taxes Total Assets For Basket Wonders December 31, 2007 Indicates the profitability on the assets of the firm (after all expenses and taxes). Income Statement / Balance Sheet Ratios Profitability Ratios $91$2, =.042

Profitability Ratio Comparisons BW Industry 4.2% 9.8% BW Industry 4.2% 9.8% Year Return on Investment BW has a poor Return on Investment.

Profitability Ratios Return on Equity Net Profit after Taxes Shareholders’ Equity For Basket Wonders December 31, 2007 Return on Equity Net Profit after Taxes Shareholders’ Equity For Basket Wonders December 31, 2007 Indicates the profitability to the shareholders of the firm (after all expenses and taxes). Income Statement / Balance Sheet Ratios Profitability Ratios $91$1, =.08

Profitability Ratio Comparisons BW Industry 8.0%17.9% BW Industry 8.0%17.9% Year Return on Equity BW has a poor Return on Equity.