due june 6/27/19 in 1 hour
jackson
WorkingwithFinancialStatements_L3.pptx
Working with Financial Statements
Ch. 3
Review
A(n) ______________ asset is one which can be quickly converted into cash without significant loss in value.
A) current
B) fixed
C) intangible
D) liquid
E) long-term
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Review
The financial statement summarizing a firm's performance over a period of time is the:
A) Income statement.
B) Balance sheet.
C) Statement of cash flows.
D) Tax reconciliation statement.
E) Shareholders' equity sheet.
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Focus on ..
Know how to standardize financial statements for comparison purposes
Know how to compute and interpret important financial ratios
Know the determinants of a firm’s profitability and growth
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Standardized Financial Statements
Common-Size Balance Sheets
Compute all accounts as a percent of total assets
Common-Size Income Statements
Compute all line items as a percent of sales
Standardized statements make it easier to compare financial information, particularly as the company grows
They are also useful for comparing companies of different sizes, particularly within the same industry
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Why use ratios?
Ratios are not very helpful by themselves; they need to be compared to something
Time-Trend Analysis
Used to see how the firm’s performance is changing through time
Internal and external uses
Peer Group Analysis
Compare to similar companies or within industries
SIC and NAICS codes
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5 Categories of Financial Ratios
Short-term solvency or liquidity ratios
Long-term solvency or financial leverage ratios
Asset management or turnover ratios
Profitability ratios
Market value ratios
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Sample Balance Sheet
| Cash | 6,489 | A/P | 340,220 |
| A/R | 1,052,606 | N/P | 86,631 |
| Inventory | 295,255 | Other CL | 1,098,602 |
| Other CA | 199,375 | Total CL | 1,525,453 |
| Total CA | 1,553,725 | LT Debt | 871,851 |
| Net FA | 2,535,072 | S/E | 1,691,493 |
| Total Assets | 4,088,797 | Total Liab. & Equity | 4,088,797 |
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Numbers in thousands
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Sample Income Statement
| Revenues | 3,991,997 |
| Cost of Goods Sold | -1,738,125 |
| Expenses | -1,205,530 |
| Depreciation | -308,355 |
| EBIT | 739,987 |
| Interest Expense | -42,013 |
| Taxable Income | 697,974 |
| Taxes | -272,210 |
| Net Income | 425,764 |
| EPS | 2.17 |
| Dividends per share | 0.86 |
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Numbers in thousands, except EPS & DPS
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Ratio Analysis
3 Things to do
How to calculate? Calculate each ratio.
What is measuring? Understand its meaning.
Comparing the ratio to the industry average. Conclude whether it is better or worse than the industry average.
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Computing Liquidity Ratios
Current Ratio = CA / CL
1,553,725 / 1,525,453 = 1.02 times
Measuring: how much of current assets for every $1 in current liabilities
Higher is better
Quick Ratio = (CA – Inventory) / CL
(1,553,725 – 295,225) / 1,525,453 = .825 times
Measuring: similar to current ratio, except inventory is omitted.
Higher is better
Cash Ratio = Cash / CL
6,489 / 1,525,453 = .004 times
Measuring: how much of cash for every $1 in current liabilities
Higher is better
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Computing Leverage Ratios
Total Debt Ratio = (TA – TE) / TA
(4,088,797 – 1,691,493) / 4,088,797 = .5863 times or 58.63%
Measuring: The firm finances almost 59% of their assets with debt.
Lower is better
Debt/Equity = TD / TE
(4,088,797 – 1,691,493) / 1, 691,493 = 1.417 times
Measuring: how much of debt for every $1 in equity
Lower is better
Equity Multiplier = TA / TE = 1 + D/E
1 + 1.417 = 2.417
Used in Du Pont Identity
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Computing Coverage Ratios
Times Interest Earned = EBIT / Interest
739,987 / 42,013 = 17.6 times
Measuring: how well a company has its interest obligations covered
Higher is better
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Computing Inventory Ratios
Inventory Turnover = Cost of Goods Sold / Inventory
1,738,125 / 295,255 = 5.89 times
Measuring: how many times inventory is turned over per year
Higher is better
Days’ Sales in Inventory = 365 / Inventory Turnover
365 / 5.89 = 62 days
Measuring: how many days inventory sits on average before it is sold
Lower is better
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Computing Receivables Ratios
Receivables Turnover = Sales / Accounts Receivable
3,991,997 / 1,052,606 = 3.79 times
Measuring: how many times a business turns it accounts receivable into cash over per year
Higher is better
Days’ Sales in Receivables = 365 / Receivables Turnover
365 / 3.79 = 96 days
Measuring: how many days, on average, to collect the cash from credit sales
Lower is better
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Computing Total Asset Turnover
Total Asset Turnover = Sales / Total Assets
3,991,997 / 4,088,797 = .98 times
Measure of asset use efficiency
Not unusual for TAT < 1, especially if a firm has a large amount of fixed assets
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Computing Profitability Measures
Profit Margin = Net Income / Sales
425,764 / 3,991,997 = .1067 times or 10.67%
Measuring: A measure of profit per dollar of sales
Higher is better
Return on Assets (ROA) = Net Income / Total Assets
425,764 / 4,088,797 = .1041 times or 10.41%
Measuring: A measure of profit per dollar of assets
Higher is better
Return on Equity (ROE) = Net Income / Total Equity
425,764 / 1,691,493 = .2517 times or 25.17%
Measuring: A measure of profit per dollar of equity
Higher is better
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Computing Market Value Measures
Market Price = $61.625 per share
Shares outstanding = 205,838,594
PE Ratio = Price per share / Earnings per share
61.625 / 2.17 = 28.4 times
Measuring: how much investors are willing to pay per dollar of current earnings future growth measures
Higher is better
Market-to-book ratio = market value per share / book value per share
61.625 / (1,691,493,000 / 205,838,594) = 7.5 times
Measuring: the value of a company by comparing its current market price to book value (accounting value)
Higher is better
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Summary: Table 3.5
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Deriving the Du Pont Identity
ROE = NI / TE
Multiply by 1 and then rearrange
ROE = (NI / TE) (TA / TA)
ROE = (NI / TA) (TA / TE) = ROA * EM
Multiply by 1 again and then rearrange
ROE = (NI / TA) (TA / TE) (Sales / Sales)
ROE = (NI / Sales) (Sales / TA) (TA / TE)
ROE = PM * TAT * EM
So, Du Pont identity is a breakdown of ROE into three components.
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Using the Du Pont Identity
ROE = PM * TAT * EM
Profit margin is a measure of the firm’s operating efficiency – how well does it control costs
Total asset turnover is a measure of the firm’s asset use efficiency – how well does it manage its assets
Equity multiplier is a measure of the firm’s financial leverage
Back to previous example
ROE = PM * TAT * EM = 0.1067 x 0.9763 x 2.417 = 0.2518
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Determinants of Growth
Profit margin – operating efficiency
Total asset turnover – asset use efficiency
Financial leverage – choice of optimal debt ratio
Dividend policy – choice of how much to pay to shareholders versus reinvesting in the firm
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Example
You are given:
Current Liabilities 300
Long Term Liabilities 700
Shareholder Equity 1,400
Total Assets 2,400
EBIT 400
Depreciation 100
Interest 50
Taxes 60
Debt/Equity, Total Debt ratio, Equity Multiplier?
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Example..
If you are given further:
Sales 2500
Costs of Goods Sold 1200
Inventory 500
Accounts Receivable 1000
Inventory Turnover, Day’s Sales in Inventory?
Receivable Turnover, Day’s Sales in Receivables?
Total Assets Turnover?
Times Interest Earned?
PM?
ROA?
Du Pont Identity? Show all three parts.
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Daily Assignment
How do you standardize balance sheets and income statements and why is standardization useful?
What are the major determinants of a firm’s growth potential?
Answer slides #2 & #3
Answer slides # 23 & #24
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