1. Chapter 3 Analysis of Financial Statements
© 2005 Thomson/South-Western

2. Financial Statements and Reports
The Income Statement
The Balance Sheet
Statement of Cash Flows
Statement of Retained Earnings

3. Unilate Textiles: Comparative Income Statements

4. Unilate Textiles: Assets

5. Unilate Textiles: Liabilities and Equity

6. Unilate Textiles: Statement of Retained Earnings
Balance of retained earnings Dec. 31, 2004 $260
Add: 2005 Net Income 54
Less: 2005 dividends to stockholders ( 29)
Balance of retained earnings Dec. 31, 2005 $285

7. Unilate Textiles: Statement of Cash Flows 2012

8. Unilate Textiles: Statement of Cash Flows Continued

9. Unilate Textiles: Statement of Cash Flows Continued

10. Ratio Analysis
Analysis of a firm’s ratios is generally the first step in financial analysis.
Ratios are designed to show relationships between financial statement accounts within firms and between firms.

11. What is the Purpose of Ratio Analysis?
Give idea of how well the company is doing
Standardize numbers; facilitate comparisons
Used to highlight weaknesses and strengths

12. What Are the Five Major Categories of Ratios
What Are the Five Major Categories of Ratios? What Questions Do They Answer?
Liquidity: Can we make required payments in the current period?
Asset mgt.: Right amount of assets vs. sales?
Debt mgt.: Right mix of debt and equity?
Profitability: Do sales prices exceed unit costs, and are sales high enough as reflected in PM, ROE, and ROA?
Market values: Do investors like what they see as reflected in P/E and M/B ratios?

13. Industry Average Data

14. What is Unilate’s Current Ratio?
Current Assets
Current Liabilities
$465.0
$130.0 =
3.6 times
Industry average =
4.1 times

15. What is Unilate’s Quick, or Acid Test, Ratio?
$ $270.0
$130.0
Quick Ratio =
Current Assets- Inventories
Current Liabilities =
= 1.5 times
$195.0
Industry average =
2.1 times

16. Unilate’s Liquidity Position
Ratios is slightly below industry average.
Inventories are the least liquid of Unilate’s assets and they are the assets that suffer losses in the event of a forced sale.
The quick ratio shows that, if receivables are collected in full, Unilate can payoff its current liabilities without having to liquidate its inventory.

17. What is Unilate’s Inventory Turnover Ratio?=
$1,230.0
$270.0
4.6 6 .
times
Industry average =
7.4 times

18. Comments on Unilate’s Inventory Turnover
Compares poorly with industry
May be holding excess inventories
May be holding old/obsolete inventory.

19. What is Unilate’s Days Sales Outstanding Ratio?
Industry average =
32.1 days

20. What is Unilate’s Fixed Assets Turnover Ratio?=
$1,500.0
$380.0
3.9 times =
4.0 times
Industry Average

21. What is Unilate’s Total Assets Turnover Ratios?=
$1,500.0
$845.0
1.8 times =
2.1 times
Industry Average

22. Unilate’s Fixed Assets Turnover and Total Assets Turnover
Total asset turnover is below industry average.
Unilate might have excess inventories and receivables.

23. Calculate the Debt Ratio
Debt Ratio = Total debt
Total assets = +
$130.0 .
$300.0
$845.0
45.0%
$430.0
0.509 = 50.9%
Industry Average

24. Calculate the Times-Interest-Earned Ratio
TIE = EBIT
Interest charges
3.3 times
$40.0
$130.0 =
Industry Average =
6.5 times

25. Calculate the Fixed Charge Coverage Ratio
Industry Average = 5.8x
All three previous ratios reflect use of debt, but focus on different aspects.

26. Unilate’s Profitability Ratios-- Profit Margin, ROA, and ROE
$54.0
$1,500
0.036 = 3.6% =
4.7%
Industry Average =

27. Unilate’s ROA, and ROE $54.0 $845.0 = 0.064 = 6.4% = 12.6%
= = 6.4% =
12.6%
Industry Average =
$54.0
$415.0
- 0 = = 13.0% =
17.2%
Industry Average =

28. Unilate’s Market Value Ratios Price/Earnings Ratio
10.6 times
$2.16
$23.00 =
13.0 times
Industry Average =

29. Unilate’s Market Value Ratios Market/Book Ratio=
$23.00
$16.00
1.4 times
2.0 times
Industry Average =

30. Rate of Return on Common Equity 18 17 16 15 14 13 12 11 10
Industry
Unilate

31. Summary of Ratio Analysis: The DuPont Equation
ROA = Net Profit Margin X Total Assets Turnover
Net Income
Sales
Total Assets X =
$54.0
$1,500.0
$845.0
= % X = 6.4%

32. DuPont Equation Provides Overview
Firm’s profitability (measured by ROA)
Firm’s expense control (measured by profit margin)
Firm’s asset utilization (measured by total asset turnover)

33. 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 not necessarily good.
Inflation distorts balance sheets.

34. What are Some Potential Problems and Limitations of Financial Ratio Analysis?
Seasonal factors can distort ratios.
“Window dressing” techniques can make statements and ratios look better.
Different operating and accounting practices distort comparisons.

35. What are Some Potential Problems and Limitations of Financial Ratio Analysis?
Sometimes hard to tell if a ratio is “good” or “bad”
Difficult to tell whether company is, on balance, in strong or weak position