ANALYSIS

OF
FINANCIAL
STATEMEN
TS
Accounting and Finance
Yogyakarta, 14 Maret 2020

Ex. 35 – Group 1
CITRA MUSTIKA PUTRI
DYAH PUSPITASARI
MUH CHAIRULLAH ARGA WICAKSONO
Contents
4-1 Ratio Analysis Market Value Ratio 4-6
4-2 Liquidity Ratios Price / Earning Ratio 4-6a
Market / Book Ratio 4-6b
4-2a. Current Ratio
4-2b. Quick, or Acid Test, Ratio Tying the Ratios Together: The 4-7
4-3 Asset Management Ratios DuPont Equation
4-3a. Inventory Turnover Ratio
4-3b. Days Sales Outstanding
4-3c. Fixed Assets Turnover Ratio
Potential Misuses of ROE 4-8
4-3d. Total Assets Turnover Ratio
Using Financial Ratios to Assess
4-4 Debt Management Ratios Performance
4-9
4-4a. Total Debt to Total Capital Comparison to Industry Average 4-9a
4-4b. Times-Interest-Earned Ratio Benchmarking 4-9b
Trend Analysis 4-9c
4-5 Profitability Ratios
4-5a. Operating Margin Uses and Limitations of Ratios 4-10
4-5b. Profit Margin
4-5c. Return on Total Assets
4.5d. Return on Common Equity
4-5e. Return on Invested Capital
Looking Beyond the Numbers 4-11
4-5f. Basic Earning Power (BEP)
4 -1
Ratio Analysis
We divide the ratios into five categories:
 Liquidity ratios, which give an idea of the firm’s ability to pay off debts that
are maturing within a year.
 Asset management ratios, which give an idea of how efficiently the firms is
using its assets.
 Debt management ratios, which give an idea of how the firm has financed its
assets as well as the firm’s ability to repay its long-term debt.
 Profitability ratios, which give an idea of how profitably the firm is operating
and utilizing its assets.
 Market value ratios, which give an idea of what investors think about the firm
and its future prospects.
4-2
Liquidity Ratios

Liquidity Ratios
Liquid Asset
Ratios that show the relationship
An asset that can be
of a firm’s cash and other current
converted to cash quickly
assets to its current liabilities.
without having to reduce the
Current Ratio
asset’s price very much. Quick (Acid Test) Ratio
4-2.a. Current Ratio

This ratio is calculated by dividing current assets by current

liabilities. It indicates the extent to which current liabilities are
covered by those assets expected to be converted to cash in the
near future.
Current ratio is less than the industry average (< 4.2 x)
indicates that the Current liabilities is too high.
If Current ratio << 4.2 x then the Liquidity is not good.
 4-2.b. Quick, or Acid Test, Ratio

This ratio is calculated by deducting inventories from current

assets and then dividing the remainder by current liabilities.

Quick ratio is less than the industry average (< 2.2 x) indicates that
the Current liabilities is too high.
If Quick ratio << 2.2 x then the Liquidity is in dangerous.
 4-3
Asset Management
Ratios

A set of ratios that measure how Inventory Turnover Ratio

effectively a firm is managing its
assets.
Days Sale Outstanding
Fixed Assets Turnover Ratio
Total Assets Turnover Ratio
 4-3.a. Inventory Turnover Ratio

Inventory Turnover Ratio

This ratio is calculated by dividing sales by inventories.
Inventory turnover ratio is less than the industry average (< 10.9 x) indicates
that the Inventories are too high.
If Inventory turnover ratio << 10.9 x then the Liquidity is not good.
 4-3.b. Days Sales Outstanding

Days Sales Outstanding (DSO) Ratio

This ratio is calculated by dividing accounts receivable by
average sales per day. It indicates the average length of time
firm must wait after making a sale before it receives cash.
 4-3.c. Fixed Assets Turnover Ratio

Fixed Assets Turnover Ratio

The ratio of sales to net fixed assets.
Fixed assets turnover ratio is less than the industry average (< 2.8 x) indicates
that the Sales are too low.
If Fixed assets turnover ratio << 2.8 x then the Liquidity is not good.
 4-3.d. Total Assets Turnover Ratio

Total Assets Turnover Ratio

This ratio is calculated by dividing sales by total assets.
Total assets turnover ratio is less than the industry average (< 1.8 x) indicates
that the Sales are too low.
If Total assets turnover ratio << 1.8 x then the Liquidity is not good.
 4-4
Debt Management
Ratios

A set of ratios that measure how

effectively a firm manages its debt
Total Debt to Total Capital
Time-Interest-Earned Ratio
 4-4.a. Total Debt to Total Capital

Total Debt to Total Capital

The ratio of total debt to total capital.
Total debt to total capital is less than the industry average (36.4%) indicates that the total debt
is too high.
If Total debt to total capital << 36.4% then the Liquidity is not good.
 4-4.b. Times-Interest-Earned Ratio

Times-Interest-Earned (TIE) Ratio

The ratio of earning before interest and taxes (EBIT) to interest charges; a measure of the
firm’s ability to meet its annual interest payments.
Times-interest-earned ratio is less than the industry average (6.0 x) indicates that the interest
charges are too high.
If Times-interest-earned ratio << 6.0 x then the Liquidity is not good.
 4-5
PROFITABILITY - The liquidity, assets management, and debt ratios tell

RATIOS about the firm’s policies and operations,

- The Profitability Ratio reflect the net result of all of

A group of ratio that show the the firm’s financing policies and operating decisions.
- Types of the profitability ratios:
combined effects of liquidity, asset
a. Operating Margin
management, and debt on operating
b. Profit Margin
results.
c. Return on Total Assets
d. Return on Common Equity
e. Return on Invested Capital
 4-5.a. Operating Margin
Operating margin :
𝐸𝐵𝐼𝑇 ( 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 )
 ¿ 𝑆𝑎𝑙𝑒𝑠

Industry average = 10%

= This ratio measures operating income or EBIT, per dollar / IDR sales;
- It’s calculated by dividing operating income (EBIT) by sales.
- The ratio shows the efficiency of the firm’s in controlling operating
cost.
- Higher operating margin indicates more efficiency the firms
 Operating margin is below the industry average (< 10%) indicates
that Operating Cost are too high.
 4-5.b. Profit Margin
= This ratio measured net income per dollar of sales and is
calculated by dividing net income by sales. Profit Margin :
- Also called Net Profit Margin (NPM) 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
- Is calculated by dividing net income by sales.  ¿ 𝑆𝑎𝑙𝑒𝑠

- The ratio shows the efficiency of the firm’s in controlling all

expenses for generating net income/profit and capital Industry average = 5%
increasement.
 Profit margin is below the industry average (<5%) indicates that :
1) High operating cost
2) Heavy use of debt
Operating margin was below the industry average

High interest charges

 4-5.c. Return on Total Assets (ROA)
Return on Assets (ROA):
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
 ¿ 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

Industry average = 9%

Return on Assets
= The ratio of net income to total assets
- Higher ROA is better than lower ROA
- The ratio shows the efficiency of the firm’s in used the assets for generating profit.
 Low ROA can result from a conscious decision to use a great deal of debt

High interest expenses will cause net income to be relatively low

 4-5.d. Return on Common Equity (ROE)
Return on Common Equity (ROE):
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
¿
  𝐶𝑜𝑚𝑚𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦

Industry average = 15%

Return on Assets
= The ratio of net income to common equity; measures the rate of return on common
stockholders’ investment
- The ratio shows the efficiency of the firm’s in managing capital for generating net
income/profit.
- Higher ROE is better than lower ROE
- Higher ROE indicates more efficiency the firms
 Better ROE result from a conscious decision to use a great deal of debt
 4-5.e. Return on Incested Capital (ROIC)
Return on Invested Capital (ROIC):
 ¿ 𝑬𝑩𝑰𝑻 (𝟏 − 𝑻 )
𝑻𝒐𝒕𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒆𝒅 𝒄𝒂𝒑𝒊𝒕𝒂𝒍

Industry average = 10.8%

Return on Invested Capital (ROIC)

= The ratio of after-tax operating income to total invested capital
- ROIC measures the total return that the company has provided for its investors.
- Differences between ROIC vs ROA?
 ROIC, The returns is based on total invested capital rather than total assets.
 In the numerators it uses after-tax operating income (NOPAT) rather than net
income.
 4-5.f. Basic Earning Power (BEP) Ratio
Basic Earning Power (BEP):
𝐸𝐵𝐼𝑇
 ¿ 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

Industry average = 18%

Basic Earning Power (BEP)

= This ratio indicates the ability of the firm’s assets to generate operating income.
- It’s calculated by dividing EBIT by total assets.
- The ratio shows the raw earning power of the firm’s assets before the influence of
tax and debt.
- It’s useful when comparing the firm’s with different debt and tax situations.
 4-6
MARKET VALUE
RATIOS - The market value ratios are used in three
primary ways:
By investor when they are deciding to buy or
Ratios that relate the firm’s stock price sell a stock
to its earnings and book value per By investment bankers when they are setting
share. the share price for a new stock issue (an IPO)
By firm’s when they are deciding how much to
offer for another firm in a potential merger.

- Types of the market value ratios :

a.Price/Earning Ratio
b.Market/Book Ratio
 4-6.a. Price/Earnings Ratio
Price/Earning (P/E) Ratio:
 ¿ 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠h𝑎𝑟𝑒
𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑝𝑒𝑟 𝑠h𝑎𝑟𝑒

Industry average = 11.3x

Price/Earning (P/E) Ratio

= The ratio of price per share to earnings per share; shows the dollar or IDR amount
investors will pay for $1 of current earnings.
- The ratio shows how much investors are willing to pay per dollar of reported profit.
 P/E ratio are relatively high for firm's with strong growth prospects and little risk but
low for slowly growing and risky firm’s.
 P/E ratio is below the industry average indicates that the company is regarded as
being relatively risky, as having poor growth prospects, or both.
 4-6.b. Market/Book Ratio
Market/Book (M/B) Ratio :
Book value per sharing
  𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠h𝑎𝑟𝑒
¿
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠h𝑎𝑟𝑒  ¿ 𝐶𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦
𝑆h𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑑𝑖𝑛𝑔
Industry average = 1.7x

Market/Book Ratio
= The ratio of a stock’s market price to its book value
- Companies that are well regarded by investor – which means low risk high growth –
have high M/B ratios.
 4-7
Tying the Ratio Together :
The DuPont Equation

A formula that show the rate of return on equity can be found as

the product from profit margin, total asset turnover, and the
equity multiplier.
It show the relationship among asset management, debt
management, and profitability ratios.
DuPont Equation DuPont Equation:

 
EXAMPLE
DuPont Equation for Allied and the food processing industry:

 𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦=5.00 %  × 1.8 𝑡𝑖𝑚𝑒𝑠 × 1.67 𝑡𝑖𝑚𝑒𝑠 =15.0 %

 EXAMPLE
The Total Assets Turnover
The Profit Margin
- Tell us how much the firm’s earn on its sales. - It’s a Multiplier that tell us how any times the
- This ratio depends on cost and sales prices. profit margin is earned each years.
- If the firm’s can command a premium price - Allied earned 3.92% on each dollar of sales,
and its assets were turnover 1.5 times each
and hold down its cost, its profit margin will be
high, which will help its ROE 1 2 year; so its return on assets was 3.92% x 1.5 =
5.9%.

The Equity Multiplier The DuPont Equation

- Allied’s assets are 2.13 times its equity, so we

must multiply the 5.9% ROA by the 2.13 x 3 4 - The DuPont Equation helps us see why Allied’s
ROE is only 12.5% vs 15.0% for the industry.
equity multiplier to arrive at its ROE of
12.5%.
- The equity multiplier relates to the firm’s use
of the debt.
Why Allied’s ROE (only 12.5%) is below the average of industry (15%)?

- Its profit margin is below the average, which indicates that its cost are not being controlled and that it
cannot charge premium prices. In addition, it uses more debt, its high interest charge also reduce its
profit margin.
- Its total assets turnover is below the industry average, which indicates that it has more assets than it
needs.
- Its equity multiplier is relatively high, its heavy use of debt offsets to some extent its low profit margin
and turnover.
- The high debt ratio → above average bankruptcy risk → cut back its financial leverage → if reduced its
debt to the same level as the average industry without any other changes → ROE decline significantly, to
3.92% x 1.5 x 1.67 = 9.8%

SOLUTIONS:
1. Focusing on profit margin by increasing revenues (raising sales price or launching new product with
higher margin).
2. Speed up collection which would reduce Account Receivable → improve quality of total assets turnover
ratio.
3. Analyze about debt policies → how changes in leverage would affect both ROE and the risk of
bankruptcy
4-8 Potential Misuses of ROE
ROE must be combined with its size and risk to
- ROE is an important measure of performance.
determine its effect on shareholder value
ROE increased → the shareholder wealth will
also increased?
- Answer : NO. why? Capital Invested
ROE
- First, ROE does not consider risk. Shareholder
care about ROE and risk. RISK
- Financial leverage can increase expected ROE,
but more leverage means higher risk; so raising
ROE through the use leverage may not be good.
- Second, ROE does not consider the amount of
invested capital.
- Third, a focus on ROE can cause manager to turn
down profitable projects. SHAREHOLDER
VALUE
4 - 9 Using Financial Ratios to Assess Performance

 Although financial ratios help us evaluate financial statements, it is

often hard to evaluate a company by just looking at the ratios.
 If we see that a company has a current ratio of 1.2, it is hard to know
if that is good or bad, unless we put the ratio in its proper
perspective.
 Allied’s management could look at industry averages. It could
compare itself to specific companies or “benchmarks”; and it can
analyze the trends in each ratio.
 We look at all three approaches in this section.
4-9.a. Comparison to Industrial Average
4-9.a. Comparison to Industrial Average
 4-9.b. Benchmarking
The process of comparing a particular company with a subset
of top competitors in its industry.
 4-9.c. Trend Analysis

An analysis of a firm’s financial ratios over time;

used to estimate the likelihood of improvement
or deterioration in its financial condition.
4 - 10 Uses and Limitations of Ratios
4 - 11 Looking Beyond the Numbers
THANK YOU 