Discussion 3
Financial Statement Analysis
Ratio Analysis Example
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Prufrock Corporation Balance Sheet as of December 31,2008 ($ in millions) |
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Assets |
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Liabilities and Owners' Equity |
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Current assets |
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Current liabilities |
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Cash |
$98 |
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Accounts payable |
$344 |
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Accounts receivable |
$188 |
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Notes payable |
$196 |
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Inventory |
$422 |
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Total |
$540 |
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Total |
$708 |
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Long-term debt |
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$457 |
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Fixed assets |
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Owners' equity |
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Net plant and equipment |
$2,880 |
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Common stock and paid-in surplus |
$550 |
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Total assets |
$3,588 |
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Retained earnings |
$2,041 |
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Total |
$2,591 |
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Total liabilities and owners' equity |
$3,588 |
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Prufrock Corporation 2008 Income Statement ($ in millions) |
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Sales |
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2311 |
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Cost of goods sold |
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1344 |
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Depreciation |
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276 |
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Earnings before interest and taxes |
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691 |
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Interest paid |
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141 |
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Taxable income |
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550 |
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Taxes (34%) |
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187 |
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Net income |
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363 |
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Dividends |
121 |
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Addition to retained earnings |
242 |
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*Create common size balance sheet and common size income statement.
*Calculate ratios for Prufrock Corporation
Short-term solvency or liquidity ratios
Liquidity ratio measures the firm’s ability to pay its bills over the short run without undue stress.
Current ratio=
*Do we have enough short-term liquid assets to cover our short-term debts?
Quick ratio (acid test ratio) =
*Do we have enough really liquid short-term assets to cover our short-term debts?
Long-term solvency, or financial leverage, ratios
Leverage ratio measures the form’s long-run ability to meet its obligations.
Total debt ratio=
What percentage of total assets is financed with either short- or long-term debt?
Debt-equity ratio=
Times interest earned=
* It measures how well a company has its interest obligations covered. Are we generating enough income to make out interest payments?
Asset management or turnover ratios
Turnover ratios measure asset use efficiency.
Inventory turnover=
*On average, how many times per year do we go through our inventory? (Excess inventory is expensive!)
Day’s sales Outstanding=
Fixed Assets Turnover Ratio=
Total Assets Turnover Ratio=
Profitability ratios
Operating margin=
Profit margin=
Return on assets (ROA) =
*What is profit per dollar of asset?
Return on equity (ROE) =
*What is the rate of return for stockholders?
Return on equity (ROE) = Profit margin * Total asset turnover * Equity multiplier
Market value ratios
(We assume that Prufrock has 33 million shares outstanding and stock sold for $88 per share at the end of the year.)
EPS=
Price-earnings ratio=
Market-to-book ratio=
4-1