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Financial Analysis (Chapter 3)

This document discusses financial ratio analysis and various types of ratios used to analyze a company's liquidity, asset utilization, debt utilization, profitability, and market value. It provides examples of common ratios calculated for each category and explains how to interpret ratios against industry benchmarks. Key relationships between ratios like DuPont analysis are also overviewed along with some analytical problems to consider.

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52 views18 pages

Financial Analysis (Chapter 3)

This document discusses financial ratio analysis and various types of ratios used to analyze a company's liquidity, asset utilization, debt utilization, profitability, and market value. It provides examples of common ratios calculated for each category and explains how to interpret ratios against industry benchmarks. Key relationships between ratios like DuPont analysis are also overviewed along with some analytical problems to consider.

Uploaded by

kazam
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Financial Analysis

(Chapter 3)

 Ratio Analysis
 Liquidity
 Asset Utilization
 Debt Utilization
 Profitability
 Market Value
 DuPont Relationships
 Ratio Analysis and
Wealth Maximization
 Some Analytical
Problems
RATIO ANALYSIS

 Ratio Defined:
 Simply one number divided by another.
 Why Calculate Ratios?
 Make data more meaningful.
 High - Low - Avg: How do you judge?
 Industry Averages:
 Dun & Bradstreet
 Robert Morris Associates
 Trade Associations
Ratio Analysis (Continued)

 Prior Period Ratios:


 Calculated from the firm’s previous financial
statements (e.g., trend analysis)

 Current Goals:
 Often, goals are stated in the form of ratios.

 Benchmarking:
 A group of “selected” companies (e.g., form your
own industry).
Common Size Ratios

 Common Size Balance Sheet


 Each item is stated as a % of total assets.

 Common Size Income Statement


 Each item is stated as a % of sales.
Liquidity Ratios

 Liquidity Ratios:
 Ability to meet short-term obligations

Current Assets
Current Ratio =
Current Liabilities
Current Assets - Inventory
Quick Ratio =
Current Liabilities
Asset Utilization Ratios
Effective use of assets in the process of
generating sales.
 Receivables Ratios
 Note: Ideally, credit sales should be used
for the receivables ratios. However, only
total sales are available at times.

Sales
Accounts Receivable Turnover =
Accounts Receivable
Accounts Receivable
Average Collection Period =
AKA: Days Sales Outstanding
Sales 360
= 360 (Acct. Rec . Turnover)
Asset Utilization Ratios
(Continued)

 Inventory Turnover
Note: COGS is sometimes used in lieu
of sales, and average inventories
may replace ending inventories.

Sales
Inventory Turnover =
Inventories
Asset Utilization Ratios
(Continued)
 Asset Turnover Ratios
 Note: Net fixed assets equals gross fixed
assets minus accumulated depreciation.

Sales
Fixed Assets Turnover =
Net Fixed Assets
Sales
Total Assets Turnover =
Total Assets
Debt Utilization Ratios
(Use of Financial Leverage)

 Leverage Ratios:

Total Liabilities
Debt Ratio =
Total Assets

EBIT
Times Interest Earned =
Interest Expense
Debt Utilization Ratios
(Continued)

 Fixed Charge Coverage Ratio*

EBIT + Lease Payments


Interest + Lease Payments

*Could also be adjusted to include principal


payments on loans.
Profitability Ratios
(Ability to Earn an Adequate Return)

 Profit Margins:

Gross Profit
Gross Profit Margin =
Sales
EBIT
Operating Profit Margin =
Sales
Net Income After Taxes
Net Profit Margin =
Sales
Profitability Ratios
(Continued)
 Return on Investment Ratios:

Net Inc After Taxes


Return on Assets =
AKA: Total Assets
ROI
Net Inc After Taxes
Return on Total Equity =
Stockholders' Equity
EAC
Return on Common Equity =
Common Equity
DuPont Relationships

Return on Assets = (Asset Turnover)(Net Profit Margin)


(ROA)
 Sales  Net Income 
=  
 Total Assets  Sales 
Net Income
=
Total Assets
ROA
Return on Total Equity =
Total Liab
1-
Total Assets
Market Value Ratios
(Investors’ Reactions)
 Notes: (1) Book Value Per Share = (Com Equity)/(# of Shares)
(2) Cash flow per share equals net income plus depreciation or
amortization divided by the number of shares outstanding.

Price Per Share


Price Earnings (P/E) Ratio =
Earnings Per Share
Price Per Share
Price to Book Value =
Book Value Per Share
Price Per Share
Price to Cash Flow 
Cash Flow Per Share
Price Per Share
Price to Sales 
Sales Per Share
Ratio Analysis and
Wealth Maximization

Expenses

Net
Profit Return
Margin on
Assets Return
Sales on Total
Equity
Total Return
Debt to
Asset on
Assets
Turnover Preferred Common
Ratio
Stock Equity
Assets
Financing
Ratio Analysis and Wealth
Maximization (Continued)

Return
Book Value Earnings
on
X Per = Per
Common
Share Share
Equity

Earnings Price
Per X Earnings = Price Per Share
Share Ratio
Some Analytical Problems
Involving Asset Quality

 It is possible to increase ROI by avoiding


the purchase of new plant and equipment
(i.e., keep the asset base low). Of course,
the firm may suffer in the long run.

 A high level of accounts receivable may


improve the current ratio, but what if a
large percentage of accounts are
uncollectible?
Some Additional
Analytical Problems
 Inflation
 Sales and profits may increase simply
because of rising prices, even without an
increase in physical volume.
 Replacement costs of assets may be higher
than historical costs.
 Inventory Accounting
 If firms employ different techniques (e.g.,
LIFO, FIFO), comparability of ratios is
impaired.
 Industry Averages
 Some firms operate in more than one.

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