1. MAYES 2 & 4 Fin. Stmt. & Ratio Analysis
Du Pont system
Effects of improving ratios
Limitations of ratio analysis
Qualitative factors

2. Common Size Financial Statements
Displays info as %, not $;
Provides 2 key benefits:
1. Allows for easy comparison between firms of different sizes.
2. Aids in spotting important trends which otherwise might not be obvious when looking at $ amounts.

3. Common Size Financial Statements
Common size Income Statement: all values a function of Sales $
Common size Balance Sheet: all values a function of Total Assets.

4. Percentage Change Analysis:
Looks at Change rates from period to period between financial categories.
Indicator of +/- growth trends.

5. Analysis of Percent Change Income Statement
i.e., Sales growth v. NI ?
i.e., If NI grows faster than sales, then becoming more profitable.
So becoming (more/less) profitable?

6. Analysis of Percent Change Balance Sheets
i.e., Total assets growth v. sales. If assets grow at faster rate than sales, have asset utilization problem.

7. Why are ratios useful?
Standardize numbers; facilitate comparisons
Used to highlight weaknesses and strengths

8. Liquidity: Can we make required payments as they fall due?
What are the five major categories of ratios, and what questions do they answer?
Liquidity: Can we make required payments as they fall due?
Asset management: Do we have the right amount of assets for the level of sales?
(More…)

9. Debt management: Do we have the right mix of debt and equity
Debt management: Do we have the right mix of debt and equity? (Leverage)
Profitability: Do sales prices exceed unit costs, and are sales high enough as reflected in PM, ROE, and ROA?
Market value: Do investors like what they see as reflected in P/E and M/B ratios?

10. Things to ask? Better? Worse?
Trends?
Vs. Industry?
Causes?
Corrective actions?

11. Calculate the firm’s forecasted current and quick ratiosCL
CR = =
CA - Inv. CL
QR =

12. Comments on CR and QR
Expected to improve/ worsen?
Vs. industry average?
Liquidity position?

13. What is the inventory turnover ratio as compared to the industry average?
Inv. turnover =
CGS
Inventories
Days Sales in Inventory =
365
Inv To

14. Comments on Inventory Turnover
Inventory turnover v. industry average?
Due to?
Improvement forecasted?

15. What is the Accts. Rec. turnover ratio & Average Collection Period?
A/R turnover =
Credit sales
A/R
Ave Collection
Period =
365
A/R TO

16. Appraisal of Ave Collection Period
Firm collects too slowly/quickly?
Improving / worsening?
Implication re: credit policy.

17. Fixed Assets and Total Assets
Turnover Ratios
Fixed assets
turnover
Sales
Net fixed assets =
Total assets

18. Fixed Assets and Total Assets
Turnover Ratios
FA turnover vs. industry?
TA turnover vs. industry average?
Causes? Corrective actions?

19. LEVERAGE
Total liabilities
Total assets
Debt ratio =
L/T Debt ratio =
L/T Debt
Total assets

20. LEVERAGE Total liabilities Total Equity
Debt/Eqty =
ratio
L/T Debt to Total
Capitalization ratio =
_____L/T Debt___________
LTD + Pref Eqty + Cmn Eqty

21. LEVERAGE Total Assets Total Equity
Eqty Multiplier
L/T Debt to Total
Equity =
_____L/T Debt___________
Pref Eqty + Cmn Eqty

22. COVERAGE Ratios EBIT + Deprec Exp Interest Exp EBIT Int. expense
Cash =
Coverage
EBIT
Int. expense
TIE = (

23. How do the debt management ratios compare with industry averages?
2015E Ind.
D/A
TIE
C/Cov
Effects? Reasons?

24. Profitability Ratios (Profit Margins)
Gross Profit Margin = Gross Profit
Sales
OperatingPM = EBIT
Sales
Net PM = Net Income
Trends?
Prospects?

25. Profitability Ratios (Returns)
ROE = Net Income
Total Equity
ROA = Net Income
Total Assets
Return on = NI available to C.S-holders
Cmn Eqty Common Equity
Trends?
Prospects?

26. 2015E Ind.
ROA
ROE
Trends? Vs. Industry? Prospects?.

27. Effects of Debt on ROA and ROE
ROA is lowered by debt--interest expense lowers net income, which also lowers ROA.
However, the use of debt lowers equity, and if equity is lowered more than net income, ROE would increase.

28. ( )( )( ) = ROE The Du Pont System Profit margin TA turnover Equity
multiplier NI
Sales
Sales TA TA CE
= ROE. x x
PM= f(profitability)
TA T/O = f(asset utilization)
EM = f(debt & equity %s)
Shows how these factors combine to
determine the ROE.

29. Economic Profit Measures of Performance
Economic Profit = NOPAT – A/Tax Cost of Op. Capital
Where:
NOPAT = EBIT (1-tax rate)
A/Tax Cost of Op. Capital =
WACC * (Net Op. Working Cap + Net Fixed Assets)
** NOWC = (Non-interest bearing C/A – Non-interest bearing C/L)
Trends?
Prospects?

30. Financial Distress & Z-score
Technique to determine likelihood of financial distress.
Altman shows model 80-90% accurate w/ Z-score cut-off of 2.675; that is Z-score < = distress.
Actually determined 3 levels
Z<1.81 Bankruptcy predicted w/in 1 yr.
1.81<Z<2.675 Financial Distress, poss. Bankruptcy
Z>2.675 No fin. Distress predicted

31. Financial Distress & Z-score Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + X5
Where the variables are the following financial ratios:
X1 = Net Working Capital / Total Assets
X2 = Retained earnings / Total Assets
X3 = EBIT / Total Assets
X4 = Market Value of all equity / book value of Tot. Liabs
X5 = Sales / Total Assets
*For publicly traded companies

32. Calculate and appraise the
P/E, P/CF, and M/B ratios.
Market Price =From the stock exchanges
EPS =
P/E = NI
C.S.Shares out.
Price per share
EPS

33. NI + Depr. Price per share Cash flow per C.S. share
C.S.Shares out.
CF per share =
Price per share
Cash flow per C.S. share
P/CF =

34. Com. equity Mkt. price per share Book value per share
C.S.Shares out.
BVPS =
Mkt. price per share
Book value per share
M/B =

35. 2015E Ind.
P/E
P/CF
M/B
P/E: How much investors will pay for $1 of earnings. High is good.
M/B: How much paid for $1 of book value. Higher is good.
P/E and M/B are high if ROE is high, risk is low.

36. “Average” performance is not necessarily good.
What are some potential problems and limitations of financial ratio analysis?
Comparison with industry averages is difficult if the firm operates many different divisions.
“Average” performance is not necessarily good.
Seasonal factors can distort ratios.
(More…)

37. Window dressing techniques can make statements and ratios look better.
Different accounting and operating practices can distort comparisons.
Sometimes it is difficult to tell if a ratio value is “good” or “bad.”
Often, different ratios give different signals, so it is difficult to tell, on balance, whether a company is in a strong or weak financial condition.

38. Are the company’s revenues tied to a single customer?
What are some qualitative factors analysts should consider when evaluating a company’s likely future financial performance?
Are the company’s revenues tied to a single customer?
To what extent are the company’s revenues tied to a single product?
To what extent does the company rely on a single supplier?
(More…)

39. What percentage of the company’s business is generated overseas?
What is the competitive situation?
What does the future have in store?
What is the company’s legal and regulatory environment?