1. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin FINANCIAL STATEMENT ANALYSIS – part 2

2. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Ratios

3. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Uses and Limitations of Financial Ratios

4. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Ratio Categories Liquidity Ratio  assess the ability of a company to meet its short term liabilities Solvency Ratio  Measure the ability of a company to meet its long-term liabilities Profitability Ratio  Assess management’s effectiveness in achieving profitability Activity Ratio  Reflects management’s ability in using the assets Operating Ratio  To analyze the operations of a company

5. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Liquidity Ratio RatiosFormulaUsersComparing StandardsBasic Analysis Current Ratio Current Assets Current Liabilities Creditors Owners Management - Normally 2 : 1 - Hotel 1.5 : 1 and Motel 1 : 1 (less inventory) Creditors prefer higher ratio for safety Owners prefer lower ratio for productivity Management try to satisfy both Acid-Test Ratio (Quick Ratio) (Cash + Receivables + Marketable Securities) Current Liabilities Creditors Owners management Lower than current ratio and most quick ratios are less than 1 : 1 Only consider the assets that can be readily convert to cash. Users’ opinion the same as Current Ratio Receivable Turnover Ratio Revenues Average Receivable Creditors Management Indicate how fast the receivable can be converted into cash Receivable Collection Period 365 Receivable Turnover Ratio Creditors Management Credit Cards less than 10 days Account Receivable from 1 month – 3 months How many days it takes to collect receivables

6. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Solvency Ratio RatiosFormulaUsersComparing StandardsBasic Analysis Total assets to total liabilities (Solvency Ratio) Total Assets Total Liabilities Creditors2:1 Creditors prefer to see the ratio as high as possible Total liabilities to total assets (Debt Ratio) Total Liabilities Total Assets Creditors Normally <50% Hospitality Industry usually 60% - 90% Creditors prefer lower % for less risk Investors prefer higher % for more profit Total liabilities to total equity (Debt Equity Ratio) Total Liabilities Total Owner’s Equity Creditors Creditors prefer lower one for less risk Investors prefer higher one for more profit Number of interest earned EBIT Interest Expense Creditors Management Owners Greater than 4 All like to see this ratio as high as possible

7. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Profitability Ratio RatiosFormulaUsersBasic Analysis Profit Margin Net Income / Gross Profit Sales Revenues Creditors Management Owners Indicate management’s ability to generate Sales and control expenses Return on Assets (ROA) Net Income Average Total Assets Mostly Creditors Management Owners Measures the effectiveness of management’s use of the company’s assets Higher is better (>15%) Return on Owner’s Equity (ROE) Net Income Average Owner’s Equity Creditors Management Mostly Owners Measures the effectiveness of management’s use of equity funds Higher is better, usually higher than interest rate Earning per Share (EPS) Net Income Average Common Shares Outstanding Creditors Management Owners Higher is better Price/Earning Ratio (P/E Ratio) Market Price per Share Earning per Share Creditors Management Owners The higher the ratio, the better the investors’ expectation about the company

8. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Activity Ratio RatiosFormulaUsersComparing StandardsBasic Analysis Inventory Turnover Ratio Cost of Sales Average Inventory Management Food: Turnover from 2 – 4 times a month Beverages: Turnover from 1 – 4 times a month Shows how quickly the inventory is being used. Although high turnover is good, it can be an indication of stockout problems Inventory Holding Period Operating days for the period Inventory turnover for the period Management Food: should be 15 days at most and at least 1 week Beverages: 1 month at most and 1 week at least Fixed Assets Turnover Ratio Sales Revenue Average Fixed Assets Management For hotel, this ratio vary from one half to two or more per year. For food service, usually has a turnover of 4 – 5 times a year if the building is being rented Higher ratio means an effective use of assets

9. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Operating Ratio RatiosFormulaUsers Comparing Standards Basic Analysis Food (Beverage) cost % Food (Beverage) Cost Food (Beverage) Revenue Management - A standard or a predetermined % The difference should be investigated Average Food (Beverage) Check Food (Beverage) Revenue Number of food covers Management This ratio sometimes are calculated by each menu items. Help to find out the most attractive dishes to guests & decide the menu items Seat Turnover Guest Served Seats Available Management Analyze the trend for further improvement

10. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Operating Ratio RatiosFormulaUsersBasic Analysis Average Room Rate (Average Daily Rate) ADR Rooms Revenue Rooms Occupied Management Calculate the ratio by each market segment or by each room type. Higher result is better when the occupancy % stay the same Occupancy % Rooms Occupied Total Rooms Management High result is better when the ADR stay the same Revenue per Available Room (REVPAR) Rooms Revenue Total Rooms Management Look at the combined effect of ADR and Occupancy % on the total revenue, an improvement on ADR and Occupancy %

11. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Restaurant ARestaurant BA%B% Sales Revenue Cost of sales Gross margin Direct Expenses Wages expense Supplies expense Other direct costs Contributory Income Indirect Expenses Rent Expense Insurance expense Other indirect expense Operating Income $ 154,300 60,200 94,100 45,600 12,700 4,500 31,300 6,500 2,000 3,200 $ 19,600 $ 206,100 78,900 127,200 70,400 16,800 6,100 33,900 9,000 3,000 3,600 $ 18,300 A company owns two restaurants with 100 seats in the same town. Operating results for the first three months of the current year for restaurant A and B are as follows: The owners of the two restaurants are concerned that Restaurant B reports higher sales revenue yet produces a lower operating income than Restaurant Analyze this information by using appropriate tool and comment on the results (what appears to require the attention of the owners?)

12. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin ANSWER: Restaurant ARestaurant BA%B% Sales Revenue Cost of sales Gross margin Direct Expenses Wages expense Supplies expense Other direct costs Contributory Income Indirect Expenses Rent Expense Insurance expense Other indirect expense Operating Income $ 154,300 60,200 94,100 45,600 12,700 4,500 31,300 6,500 2,000 3,200 $ 19,600 $ 206,100 78,900 127,200 70,400 16,800 6,100 33,900 9,000 3,000 3,600 $ 18,300 100 39 61 29.6 8.2 2.9 20.3 4.2 1.3 2.1 12.7 100 38.3 61.7 29.6 12.71 3 16.4 4.4 1.5 1.7 8.9 The difference in Operating Income seems to be the supplies expense. B has 4.51% higher than A. Since both restaurants A&B are in the same town and have the same size, the difference in supplies expense should be evaluated further. The variance might be due to the difference in menu, service style, or supplies.