1. ©2012 McGraw-Hill Ryerson Limited 1 of 34 Learning Objectives 1.Calculate 13 financial ratios that measure profitability, asset utilization, liquidity and debt utilization. (LO1) 2.Assess a company’s source of profitability using the DuPont system of analysis. (LO2) 3.Examine the ratios in comparison to industry averages. (LO3) 4.Examine the ratios and company performance by means of trend analysis. (LO4)

2. ©2012 McGraw-Hill Ryerson Limited 2 of 34 What is Financial Analysis? Evaluating a firm’s financial performance Calculating ratios to reveal relationships between different accounts of financial statements Linking ratios to reveal the factors determining a firm’s profitability and value Financial analysis may not answer questions, but leads to further inquiry LO1

3. ©2012 McGraw-Hill Ryerson Limited 3 of 34 Classification System of Financial Ratios A. Profitability Ratios B. Asset Utilization Ratios C. Liquidity Ratios D. Debt Utilization Ratios LO1

4. ©2012 McGraw-Hill Ryerson Limited 4 of 34 A. Profitability Ratios Show how profitable a company is The ratios are: 1.Profit margin 2.Return on assets (ROA) (investment) 3.Return on equity (ROE) (common shareholders) LO1

5. ©2012 McGraw-Hill Ryerson Limited 5 of 34 B. Asset Utilization Ratios Show how effectively a company uses its assets The ratios are: 4a. Receivables turnover 4b. Average collection period (days sales outstanding) 5a. Inventory turnover 5b. Inventory holding period 6a. Accounts payable turnover 6b. Accounts payable period 7. Capital asset turnover 8. Total asset turnover LO1

6. ©2012 McGraw-Hill Ryerson Limited 6 of 34 C. Liquidity Ratios Show how liquid a company is or how much cash it has to meet short-term needs. The ratios are: 9. Current Ratio 10. Quick Ratio LO1

7. ©2012 McGraw-Hill Ryerson Limited 7 of 34 D. Debt Utilization Ratios Show how well a company is managing or using debt The ratios are 11. Debt to total assets 12. Times interest earned 13. Fixed charge coverage LO1

8. ©2012 McGraw-Hill Ryerson Limited 8 of 34 Table 3-1a Financial statements for ratio analysis LO1 SAXTON COMPANY Income Statement For the year 2012 Sales (all on credit)...........$4,000,000 Cost of good old.............3,000,000 Gross profits...............1,000,000 Selling and administrative expense *.....450,000 Operating profit..............550,000 Interest expense..............50,000 Extraordinary loss..............100,000 Net Income before taxes..........400,000 Taxes(50%)............... 200,000 Net Income..............$ 200,000 * Includes $50,000 in lease payments.

9. ©2012 McGraw-Hill Ryerson Limited 9 of 34 Balance Sheet As of December 31, 2012 Assets Cash$ 30,000 Marketable securities50,000 Accounts receivable350,000 Inventory370,000 Total current assets800,000 Net plant and equipment800,000 Total assets$1,600,000 Liabilities and Shareholders' Equity Accounts payable$ 50,000 Notes payable250,000 Total current liabilities300,000 Long-term liabilities300,000 Total liabilities600,000 Common stock400,000 Retained earnings600,000 Total liabilities and shareholders' equity$1,600,000 Table 3-1b Financial statements for ratio analysis LO1

10. ©2012 McGraw-Hill Ryerson Limited 10 of 34 Saxton Company Industry Average 3-1. Profit margin = = 5% 6.5% 3-2. Return on assets (ROA) (investment) = a. = 12.5% 10% b. 5% x 2.5 = 12.5% 6.5% x 1.5 = 10% Net income Sales $200,000 $4,000,000 Net income Total assets Net income Sales Total assets  $200,000 $1,600,000 Profitability ratios(a) LO1

11. ©2012 McGraw-Hill Ryerson Limited 11 of 34 Saxton Company Industry Average 3-3. Return on equity (ROE) = a. = 20% 15% b. Equity multiplier = = 1.6 = 1.5 c. ROA × Equity multiplier = 0.125 × 1.60 = 20% 0.10 × 1.50 = 15% Total assets Equity $1,600,000 $1,000,000 Net income Shareholders’ equity $200,000 $1,000,000 Profitability ratios(b) 1 0.6667 LO1 and LO2

12. ©2012 McGraw-Hill Ryerson Limited 12 of 34 Saxton Company Industry Average 3-4a. Receivables turnover = = 11.410 times 3-4b. Average collection period = = 32 36 days 3-5a. Inventory turnover = Cost of Goods Sold = 8.17 times Inventory Sales (credit) Receivables $4,000,000 $350,000 Accounts receivable Average daily credit sales $350,000 $10,959 $3,000,000 $370,000 Asset utilization ratios(a) LO1 and LO3

13. ©2012 McGraw-Hill Ryerson Limited 13 of 34 Saxton Company Industry Average 3-5b. Inventory holding period = = 4552 days 3-6a. Accounts payable turnover = = 60.0 12 times 3-6b. Accounts payable period = Accounts payable = 630 days Average daily purchases (COGS) Inventory Average daily COGS $370,000 $8,219 Cost of goods sold Accounts payable $3,000,000 $50,000 $8,219 Asset utilization ratios(b) LO1 and LO3

14. ©2012 McGraw-Hill Ryerson Limited 14 of 34 Asset utilization ratios(c) Saxton Company Industry Average 3-7. Capital asset turnover = = 5.05.4 times 3-8. Total asset turnover = = 2.5 1.5 times Sales Capital assets $4,000,000 $800,000 Sales Total assets $4,000,000 $1,600,000 LO1 and LO3

15. ©2012 McGraw-Hill Ryerson Limited 15 of 34 Liquidity ratios Saxton Company Industry Average 3-9. Current ratio = = 2.672.1 3-10. Quick ratio = = 1.43 1.0 Current assets Current liabilities $800,000 $300,000 Current assets – Inventory Current liabilities $430,000 $300,000 LO1/LO3

16. ©2012 McGraw-Hill Ryerson Limited 16 of 34 Debt utilization ratios Saxton Company Industry Average 3-11. Debt to total assets = = 37.5%33% 3-12. Times interest earned = = 11 7 times 3-13. Fixed charge coverage = = 65.5 times Total debt Total assets $600,000 $1,600,000 Income before interest and taxes Interest $550,000 $50,000 Income before fixed charges and taxes Fixed charges $600,000 $100,000 LO1/LO3

17. ©2012 McGraw-Hill Ryerson Limited 17 of 34 Techniques of Ratio Analysis 1.DuPont Analysis 2.Comparative Analysis 3.Trend Analysis 4.Common-Size Statements LO1/LO2/LO3/LO4