1. 6.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Chapter 6 Financial Statement Analysis

2. 6.2 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. After Studying Chapter 6, you should be able to: 1. Understand the purpose of basic financial statements and their contents. 2. Understand what is meant by “convergence” in accounting standards. 3. Explain why financial statement analysis is important to the firm and to outside suppliers of capital. 4. Define, calculate, and categorize (according to liquidity, financial leverage, coverage, activity, and profitability) the major financial ratios and understand what they can tell us about the firm. 5. Define, calculate, and discuss a firm’s operating cycle and cash cycle. 6. Use ratios to analyze a firm's health and then recommend reasonable alternative courses of action to improve the health of the firm. 7. Analyze a firm’s return on investment (i.e., “earning power”) and return on equity using a DuPont approach. 8. Understand the limitations of financial ratio analysis. 9. Use trend analysis, common-size analysis, and index analysis to gain additional insights into a firm's performance.

3. 6.3 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Financial Statements A Possible Framework for Analysis Balance Sheet Ratios Income Statement and Income/Balance Sheet Ratios Trend Analysis Common-Size and Index Analysis Financial Statements A Possible Framework for Analysis Balance Sheet Ratios Income Statement and Income/Balance Sheet Ratios Trend Analysis Common-Size and Index Analysis Financial Statement Analysis

4. 6.4 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Trade CreditorsTrade Creditors – Focus on the liquidity of the firm. BondholdersBondholders – Focus on the long-term cash flow of the firm. ShareholdersShareholders – Focus on the profitability and long-term health of the firm. Trade CreditorsTrade Creditors – Focus on the liquidity of the firm. BondholdersBondholders – Focus on the long-term cash flow of the firm. ShareholdersShareholders – Focus on the profitability and long-term health of the firm. Examples of External Uses of Statement Analysis

5. 6.5 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. PlanPlan – Focus on assessing the current financial position and evaluating potential firm opportunities. ControlControl – Focus on return on investment for various assets and asset efficiency. UnderstandUnderstand – Focus on understanding how suppliers of funds analyze the firm. PlanPlan – Focus on assessing the current financial position and evaluating potential firm opportunities. ControlControl – Focus on return on investment for various assets and asset efficiency. UnderstandUnderstand – Focus on understanding how suppliers of funds analyze the firm. Examples of Internal Uses of Statement Analysis

6. 6.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Convergence of Accounting StandardsConvergence of Accounting Standards: Aims to narrow or remove differences so that investors can better understand financial statements prepared under different accounting frameworks IASB – International Accounting Standards Board has the responsibility of IFRS IFRS – International Financial Reporting Standards (EU countries adopted) US GAAP – US Generally Accepted Accounting Principles determined by FASB FASB – Financial Accounting Standards Board determines accounting standards for financial statements Convergence of Accounting StandardsConvergence of Accounting Standards: Aims to narrow or remove differences so that investors can better understand financial statements prepared under different accounting frameworks IASB – International Accounting Standards Board has the responsibility of IFRS IFRS – International Financial Reporting Standards (EU countries adopted) US GAAP – US Generally Accepted Accounting Principles determined by FASB FASB – Financial Accounting Standards Board determines accounting standards for financial statements Global Accounting Standards

7. 6.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Income Statement A summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period. Income Statement A summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period. Balance Sheet A summary of a firm’s financial position on a given date that shows total assets = total liabilities + owners’ equity. Balance Sheet A summary of a firm’s financial position on a given date that shows total assets = total liabilities + owners’ equity. Primary Types of Financial Statements

8. 6.8 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. a. How the firm stands on a specific date. b. What BW owned. c. Amounts owed by customers. d. Future expense items already paid. e. Cash/likely convertible to cash within 1 year. f. Original amount paid. g. Acc. deductions for wear and tear. a. How the firm stands on a specific date. b. What BW owned. c. Amounts owed by customers. d. Future expense items already paid. e. Cash/likely convertible to cash within 1 year. f. Original amount paid. g. Acc. deductions for wear and tear. c d Current Assets e $1,195 f g Net Fix. Assets $ 701 Total Assets b $2,169 Cash $ 90 Acct. Rec. c 394 Inventories 696 Prepaid Exp d 5 Accum Tax Prepay 10 Current Assets e $1,195 Fixed Assets (@Cost) f 1030 Less: Acc. Depr. g (329) Net Fix. Assets $ 701 Investment, LT 50 Other Assets, LT 223 Total Assets b $2,169 Basket Wonders Balance Sheet (thousands) Dec. 31, 2007 Basket Wonders Balance Sheet (thousands) Dec. 31, 2007 a Basket Wonders’ Balance Sheet (Asset Side)

9. 6.9 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. a. Note, Assets = Liabilities + Equity. b. What BW owed and ownership position. c. Owed to suppliers for goods and services. d. Unpaid wages, salaries, etc. e. Debts payable < 1 year. f. Debts payable > 1 year. g. Original investment. h. Earnings reinvested. a. Note, Assets = Liabilities + Equity. b. What BW owed and ownership position. c. Owed to suppliers for goods and services. d. Unpaid wages, salaries, etc. e. Debts payable < 1 year. f. Debts payable > 1 year. g. Original investment. h. Earnings reinvested. c d d Current Liab. e $ 500 f g g h Total Equity $1,139 Notes Payable $ 290 Acct. Payable c 94 Accrued Taxes d 16 Other Accrued Liab. d 100 Current Liab. e $ 500 Long-Term Debt f 530 Shareholders’ Equity Com. Stock ($1 par) g 200 Add Pd in Capital g 729 Retained Earnings h 210 Total Equity $1,139 Total Liab/Equity a,b $2,169 Basket Wonders Balance Sheet (thousands) Dec. 31, 2007 Basket Wonders’ Balance Sheet (Liability Side)

10. 6.10 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. a. Measures profitability over a time period. b. Received, or receivable, from customers. c. Sales comm., adv., officers’ salaries, etc. d. Operating income. e. Cost of borrowed funds. f. Taxable income. g. Amount earned for shareholders. a. Measures profitability over a time period. b. Received, or receivable, from customers. c. Sales comm., adv., officers’ salaries, etc. d. Operating income. e. Cost of borrowed funds. f. Taxable income. g. Amount earned for shareholders. b c f Increase in RE $ 53 Net Sales $ 2,211 Cost of Goods Sold b 1,599 Gross Profit $ 612 SG&A Expenses c 402 EBIT d $ 210 Interest Expense e 59 EBT f $ 151 Income Taxes 60 EAT g $ 91 Cash Dividends 38 Increase in RE $ 53 Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2007 Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2007 a Basket Wonders’ Income Statement

11. 6.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Analytical Tools Used Sources and Uses Statement Statement of Cash Flows Cash Budgets Analytical Tools Used Sources and Uses Statement Statement of Cash Flows Cash Budgets 1. Analysis of the funds needs of the firm. needs of the firm. Trend/Seasonal Component How much funding will be required in the future? Is there a seasonal component? Trend/Seasonal Component How much funding will be required in the future? Is there a seasonal component? Framework for Financial Analysis

12. 6.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Health of a Firm Financial Ratios 1. Individually 2. Over time 3. In combination 4. In comparison Health of a Firm Financial Ratios 1. Individually 2. Over time 3. In combination 4. In comparison 1. Analysis of the funds needs of the firm. 2. Analysis of the financial condition and profitability condition and profitability of the firm. of the firm. Framework for Financial Analysis

13. 6.13 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Examples: Volatility in sales Volatility in costs Proximity to break-even pointExamples: Volatility in sales Volatility in costs Proximity to break-even point 1. Analysis of the funds needs of the firm. 2. Analysis of the financial condition and profitability of the firm. 3. Analysis of the business risk of the firm. risk of the firm. Business risk Business risk relates to the risk inherent in the operations of the firm. Framework for Financial Analysis

14. 6.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. A Financial Manager must consider all three jointly when determining the financing needs of the firm. Determiningthefinancing needs of the firm. 1. Analysis of the funds needs of the firm. needs of the firm. 2. Analysis of the financial condition and profitability condition and profitability of the firm. of the firm. 3. Analysis of the business risk of the firm. risk of the firm. Framework for Financial Analysis

15. 6.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Negotiationswith suppliers of capital. Determiningthefinancing needs of the firm. 1. Analysis of the funds needs of the firm. needs of the firm. 2. Analysis of the financial condition and profitability condition and profitability of the firm. of the firm. 3. Analysis of the business risk of the firm. risk of the firm. Framework for Financial Analysis

16. 6.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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. Use of Financial Ratios

17. 6.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 Similarity is important as one should compare “apples to apples.” External Comparisons and Sources of Industry Ratios

18. 6.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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$500 2.39 = 2.39 Liquidity Ratios

19. 6.19 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 2.392.15 2.262.09 1.912.01 BW Industry 2.392.15 2.262.09 1.912.01 Year 2007 2006 2005 Current Ratio Ratio is stronger than the industry average. Liquidity Ratio Comparisons

20. 6.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 $500 1.00 = 1.00 Liquidity Ratios

21. 6.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 1.001.25 1.041.23 1.111.25 BW Industry 1.001.25 1.041.23 1.111.25 Year 2007 2006 2005 Acid-Test Ratio Ratio is weaker than the industry average. Liquidity Ratio Comparisons

22. 6.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 Current2.39 2.15 Acid-Test1.00 1.25 Summary of the Liquidity Ratio Comparisons

23. 6.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Trend Analysis of Current Ratio 1.5 1.7 1.9 2.1 2.3 2.5 200520062007 Analysis Year Ratio Value BW Industry Current Ratio – Trend Analysis Comparison

24. 6.24 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Trend Analysis of Acid-Test Ratio 0.5 0.8 1.0 1.3 1.5 200520062007 Analysis Year Ratio Value BW Industry Acid-Test Ratio – Trend Analysis Comparison

25. 6.25 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. industryThe current ratio for the industry has been rising slowly at the same time the acid-test ratio has been relatively stable. inventories BWThis indicates that inventories are a significant problem for BW. industryThe current ratio for the industry has been rising slowly at the same time the acid-test ratio has been relatively stable. inventories BWThis indicates that inventories are a significant problem for BW. BWThe current ratio for BW has been rising at the same time the acid-test ratio has been declining. Summary of the Liquidity Trend Analyses

26. 6.26 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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$1,139 0.90 = 0.90 Financial Leverage Ratios

27. 6.27 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 0.900.90 0.880.90 0.810.89 BW Industry 0.900.90 0.880.90 0.810.89 Year 2007 2006 2005 Debt-to-Equity Ratio BW has average debt utilization relative to the industry average. Financial Leverage Ratio Comparisons

28. 6.28 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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$2,169 0.47 = 0.47 Financial Leverage Ratios

29. 6.29 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 0.470.47 0.450.47 BW Industry 0.470.47 0.450.47 Year 2007 2006 2005 Debt-to-Total-Asset Ratio BW has average debt utilization relative to the industry average. Financial Leverage Ratio Comparisons

30. 6.30 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Total Capitalization Total Debt Total Capitalization For Basket Wonders December 31, 2007 Total Capitalization Total 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 $1,030$1,669 0.62 = 0.62 (i.e., LT-Debt + Equity) Financial Leverage Ratios

31. 6.31 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 0.620.60 0.620.61 0.670.62 BW Industry 0.620.60 0.620.61 0.670.62 Year 2007 2006 2005 Total Capitalization Ratio BW has average long-term debt utilization relative to the industry average. Financial Leverage Ratio Comparisons

32. 6.32 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Interest Coverage EBIT Interest Charges For Basket Wonders December 31, 2007 Interest Coverage EBIT Interest Charges For Basket Wonders December 31, 2007 Indicates a firm’s ability to cover interest charges. Income Statement Ratios Coverage Ratios $210$59 3.56 = 3.56 Coverage Ratios

33. 6.33 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 3.565.19 4.355.02 10.304.66 BW Industry 3.565.19 4.355.02 10.304.66 Year 2007 2006 2005 Interest Coverage Ratio BW has below average interest coverage relative to the industry average. Coverage Ratio Comparisons

34. 6.34 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Trend Analysis of Interest Coverage Ratio 3.0 5.0 7.0 9.0 11.0 200520062007 Analysis Year Ratio Value BW Industry Coverage Ratio – Trend Analysis Comparison

35. 6.35 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. low earnings BWThis indicates that low earnings (EBIT) may be a potential problem for BW. debt levels industryNote, we know that debt levels are in line with the industry averages. low earnings BWThis indicates that low earnings (EBIT) may be a potential problem for BW. debt levels industryNote, we know that debt levels are in line with the industry averages. BW industryThe interest coverage ratio for BW has been falling since 2005. It has been below industry averages for the past two years. Summary of the Coverage Trend Analysis

36. 6.36 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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$394 5.61 = 5.61 (Assume all sales are credit sales.) Activity Ratios

37. 6.37 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 3655.61 65 days = 65 days Activity Ratios

38. 6.38 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 65.065.7 71.166.3 83.669.2 BW Industry 65.065.7 71.166.3 83.669.2 Year 2007 2006 2005 Average Collection Period BW has improved the average collection period to that of the industry average. Activity Ratio Comparisons

39. 6.39 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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$94 16.5 = 16.5 (Assume annual credit purchases = $1,551.) Activity Ratios

40. 6.40 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 36516.5 22.1 days = 22.1 days Activity Ratios

41. 6.41 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 22.146.7 25.451.1 43.548.5 BW Industry 22.146.7 25.451.1 43.548.5 Year 2007 2006 2005 Payable Turnover in Days BW has improved the PT in Days. Is this good? Activity Ratio Comparisons

42. 6.42 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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$696 2.30 = 2.30 Activity Ratios

43. 6.43 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 2.303.45 2.443.76 2.643.69 BW Industry 2.303.45 2.443.76 2.643.69 Year 2007 2006 2005 Inventory Turnover Ratio BW has a very poor inventory turnover ratio. Activity Ratio Comparisons

44. 6.44 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Trend Analysis of Inventory Turnover Ratio 2.0 2.5 3.0 3.5 4.0 200520062007 Analysis Year Ratio Value BW Industry Inventory Turnover Ratio – Trend Analysis Comparison

45. 6.45 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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$2,169 1.02 = 1.02 Activity Ratios

46. 6.46 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 1.021.17 1.031.14 1.011.13 BW Industry 1.021.17 1.031.14 1.011.13 Year 2007 2006 2005 Total Asset Turnover Ratio BW has a weak total asset turnover ratio. Why is this ratio considered weak? Activity Ratio Comparisons

47. 6.47 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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$2,211 0.277 = 0.277 Profitability Ratios

48. 6.48 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 27.7%31.1% 28.730.8 31.327.6 BW Industry 27.7%31.1% 28.730.8 31.327.6 Year 2007 2006 2005 Gross Profit Margin BW has a weak Gross Profit Margin. Profitability Ratio Comparisons

49. 6.49 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Trend Analysis of Gross Profit Margin 25.0 27.5 30.0 32.5 35.0 200520062007 Analysis Year Ratio Value (%) BW Industry Gross Profit Margin – Trend Analysis Comparison

50. 6.50 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Net Profit Margin Net Profit after Taxes Net Sales For Basket Wonders December 31, 2007 Net Profit Margin Net Profit after Taxes Net Sales For Basket Wonders December 31, 2007 Indicates the firm’s profitability after taking account of all expenses and income taxes. Income Statement/ Balance Sheet Ratios Profitability Ratios $91$2,211 0.041 = 0.041 Profitability Ratios

51. 6.51 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 4.1%8.2% 4.98.1 9.07.6 BW Industry 4.1%8.2% 4.98.1 9.07.6 Year 2007 2006 2005 Net Profit Margin BW has a poor Net Profit Margin. Profitability Ratio Comparisons

52. 6.52 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Trend Analysis of Net Profit Margin 4 5 6 7 8 9 10 200520062007 Analysis Year Ratio Value (%) BW Industry Net Profit Margin – Trend Analysis Comparison

53. 6.53 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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$2,160 0.042 = 0.042 Profitability Ratios

54. 6.54 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 4.2% 9.6% 5.0 9.1 9.110.8 BW Industry 4.2% 9.6% 5.0 9.1 9.110.8 Year 2007 2006 2005 Return on Investment BW has a poor Return on Investment. Profitability Ratio Comparisons

55. 6.55 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Trend Analysis of Return on Investment 4 6 8 10 12 200520062007 Analysis Year Ratio Value (%) BW Industry Return on Investment – Trend Analysis Comparison

56. 6.56 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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$1,139 0.08 = 0.08 Profitability Ratios

57. 6.57 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW Industry 8.0%18.0% 9.417.2 16.620.4 BW Industry 8.0%18.0% 9.417.2 16.620.4 Year 2007 2006 2005 Return on Equity BW has a poor Return on Equity. Profitability Ratio Comparisons

58. 6.58 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Trend Analysis of Return on Equity 7.0 10.5 14.0 17.5 21.0 200520062007 Analysis Year Ratio Value (%) BW Industry Return on Equity – Trend Analysis Comparison

59. 6.59 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. ROI0.0424.2% ROI 2007 = 0.041 × 1.02 = 0.042 or 4.2% ROI0.0969.6% ROI Industry = 0.082 × 1.17 = 0.096 or 9.6% (Note: values are rounded) ROI0.0424.2% ROI 2007 = 0.041 × 1.02 = 0.042 or 4.2% ROI0.0969.6% ROI Industry = 0.082 × 1.17 = 0.096 or 9.6% (Note: values are rounded) ROI ROI = Net profit margin × Total asset turnover Earning Power Earning Power = Sales profitability × Asset efficiency Return on Investment and the Du Pont Approach

60. 6.60 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. ROE0.080 ROE 2007 = 0.041 × 1.02 × 1.90 = 0.080 ROE0.180 ROE Industry = 0.082 × 1.17 × 1.88 = 0.180 (Note: values are rounded) ROE0.080 ROE 2007 = 0.041 × 1.02 × 1.90 = 0.080 ROE0.180 ROE Industry = 0.082 × 1.17 × 1.88 = 0.180 (Note: values are rounded) Return On Equity Return On Equity = Net profit margin X Total asset turnover X Equity Multiplier Equity Multiplier Equity Multiplier = Total Assets Shareholders’ Equity Return on Equity and the Du Pont Approach

61. 6.61 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BW industry The profitability ratios for BW have ALL been falling since 2005. Each has been below the industry averages for the past three years. COGS administrative costs BW This indicates that COGS and administrative costs may both be too high and a potential problem for BW. Note, this result is consistent with the low interest coverage ratio. BW industry The profitability ratios for BW have ALL been falling since 2005. Each has been below the industry averages for the past three years. COGS administrative costs BW This indicates that COGS and administrative costs may both be too high and a potential problem for BW. Note, this result is consistent with the low interest coverage ratio. Summary of the Profitability Trend Analyses

62. 6.62 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Inventories are too high. May be paying off creditors (accounts payable) too soon. COGS may be too high. Selling, general, and administrative costs may be too high. Inventories are too high. May be paying off creditors (accounts payable) too soon. COGS may be too high. Selling, general, and administrative costs may be too high. Summary of Ratio Analyses

63. 6.63 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. An analysis of percentage financial statements where all balance sheet items are divided by total assets and all income statement items are divided by net sales or revenues. Common-Size Analysis

64. 6.64 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Basket Wonders’ Common Size Balance Sheets

65. 6.65 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Basket Wonders’ Common- Size Balance Sheets

66. 6.66 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Basket Wonders’ Common- Size Income Statements

67. 6.67 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. An analysis of percentage financial statements where all balance sheet or income statement figures for a base year equal 100.0 (percent) and subsequent financial statement items are expressed as percentages of their values in the base year. Index Analyses

68. 6.68 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Basket Wonders’ Indexed Balance Sheets

69. 6.69 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Basket Wonders’ Indexed Balance Sheets

70. 6.70 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Regular (thousands of $) Indexed (%) 2005 6 7 5 6 7 Net Sales 1,235 2,106 2,211 100.0 170.5 179.0 COGS 849 1,501 1,599 100.0 176.8 188.3 Gross Profit 386 605 612 100.0 156.7 158.5 Adm. 180 383 402 100.0 212.8 223.3 EBIT 206 222 210 100.0 107.8 101.9 Int Exp 20 51 59 100.0 255.0 295.0 EBT 186 171 151 100.0 91.9 81.2 EAT 112 103 91 100.0 92.0 81.3 Cash Div 50 100.0 Basket Wonders’ Indexed Income Statements