Finance Short Response
jandreg
ch03_show.pptx1
CHAPTER 3
Analysis of Financial Statements
2
Topics in Chapter
Ratio analysis
Du Pont system
Effects of improving ratios
Limitations of ratio analysis
Qualitative factors
3
Value = + + +
FCF1
FCF2
FCF∞
(1 + WACC)1
(1 + WACC)∞
(1 + WACC)2
Free cash flow
(FCF)
Market interest rates
Firm’s business risk
Market risk aversion
Firm’s debt/equity mix
Cost of debt
Cost of equity
Weighted average
cost of capital
(WACC)
Net operating
profit after taxes
Required investments
in operating capital
−
=
Determinants of Intrinsic Value:
Using Ratio Analysis
...
For value box in Ch 3 ratios FM13.
4
Overview
Ratios facilitate comparison of:
One company over time
One company versus other companies
Ratios are used by:
Lenders to determine creditworthiness
Stockholders to estimate future cash flows and risk
Managers to identify areas of weakness and strength
5
Income Statement
| 2010 | 2011E | |
| Sales | $5,834,400 | $7,035,600 |
| COGS | 4,980,000 | 5,800,000 |
| Other expenses | 720,000 | 612,960 |
| Deprec. | 116,960 | 120,000 |
| Tot. op. costs | 5,816,960 | 6,532,960 |
| EBIT | 17,440 | 502,640 |
| Int. expense | 176,000 | 80,000 |
| EBT | (158,560) | 422,640 |
| Taxes (40%) | (63,424) | 169,056 |
| Net income | ($ 95,136) | $ 253,584 |
6
Balance Sheets: Assets
| 2010 | 2011E | |
| Cash | $ 7,282 | $ 14,000 |
| S-T invest. | 20,000 | 71,632 |
| AR | 632,160 | 878,000 |
| Inventories | 1,287,360 | 1,716,480 |
| Total CA | 1,946,802 | 2,680,112 |
| Net FA | 939,790 | 836,840 |
| Total assets | $2,886,592 | $3,516,952 |
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Balance Sheets: Liabilities & Equity
| 2010 | 2011E | |
| Accts. payable | $ 324,000 | $ 359,800 |
| Notes payable | 720,000 | 300,000 |
| Accruals | 284,960 | 380,000 |
| Total CL | 1,328,960 | 1,039,800 |
| Long-term debt | 1,000,000 | 500,000 |
| Common stock | 460,000 | 1,680,936 |
| Ret. earnings | 97,632 | 296,216 |
| Total equity | 557,632 | 1,977,152 |
| Total L&E | $2,886,592 | $3,516,952 |
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Other Data
| 2010 | 2011E | |
| Stock price | $6.00 | $12.17 |
| # of shares | 100,000 | 250,000 |
| EPS | -$0.95 | $1.01 |
| DPS | $0.11 | $0.22 |
| Book val. per sh. | $5.58 | $7.91 |
| Lease payments | $40,000 | $40,000 |
| Tax rate | 0.4 | 0.4 |
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Liquidity Ratios
Can the company meet its short-term obligations using the resources it currently has on hand?
10
Forecasted Current and Quick Ratios for 2011.
CR10 = = = 2.58.
QR10 =
= = 0.93.
CA
CL
$2,680
$1,040
$2,680 - $1,716
$1,040
CA - Inv.
CL
11
Comments on CR and QR
| 2011E | 2010 | 2009 | Ind. | |
| CR | 2.58 | 1.46 | 2.3 | 2.7 |
| QR | 0.93 | 0.5 | 0.8 | 1.0 |
Expected to improve but still below the industry average.
Liquidity position is weak.
12
Asset Management Ratios
How efficiently does the firm use its assets?
How much does the firm have tied up in assets for each dollar of sales?
13
Inventory Turnover Ratio vs. Industry Average
Inv. turnover =
= = 4.10.
Sales
Inventories
$7,036
$1,716
2011E 2010 2009 Ind.
Inv. T. 4.1 4.5 4.8 6.1
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Comments on Inventory Turnover
Inventory turnover is below industry average.
Firm might have old inventory, or its control might be poor.
No improvement is currently forecasted.
15
DSO =
= =
= 45.5 days.
Receivables
Average sales per day
$878
$7,036/365
Receivables
Sales/365
DSO: average number of days from sale until cash received.
16
Appraisal of DSO
Firm collects too slowly, and situation is getting worse.
Poor credit policy.
2011 2010 2009 Ind.
DSO 45.5 39.5 37.4 32.0
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Total assets
turnover
=
= = 2.00.
Sales
Total assets
$7,036
$3,517
Fixed assets
turnover
Sales
Net fixed assets
=
= = 8.41.
$7,036
$837
(More…)
Fixed Assets and Total Assets Turnover Ratios
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Fixed Assets and Total Assets Turnover Ratios
FA turnover is expected to exceed industry average. Good.
TA turnover not up to industry average. Caused by excessive current assets (A/R and inventory).
| 2011E | 2010 | 2009 | Ind. | |
| FA TO | 8.4 | 6.2 | 10.0 | 7.0 |
| TA TO | 2.0 | 2.0 | 2.3 | 2.5 |
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Debt Management Ratios
Does the company have too much debt?
Can the company’s earnings meet its debt servicing requirements?
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Total liabilities
Total assets
Debt ratio =
= = 43.8%.
$1,040 + $500
$3,517
EBIT
Int. expense
TIE =
= = 6.3.
$502.6
$80
(More…)
Calculate the debt, TIE, and EBITDA coverage ratios.
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= = 5.5.
EBIT + Depr. & Amort. + Lease payments
Interest Lease
expense pmt.
+ + Loan pmt.
$502.6 + $120 + $40
$80 + $40 + $0
EBITDA Coverage (EC)
22
Recapitalization improved situation, but lease payments drag down EC.
2011E 2010 2009 Ind.
D/A 43.8% 80.7% 54.8% 50.0%
TIE 6.3 0.1 3.3 6.2
EC 5.5 0.8 2.6 8.0
Debt Management Ratios vs. Industry Averages
23
Profitability Ratios
What is the company’s rate of return on:
Sales?
Assets?
24
Profit Margins
PM = = = 3.6%.
NI
Sales
$253.6
$7,036
OM = = = 7.1%.
EBIT
Sales
$503
$7,036
Net profit margin (PM):
Operating profit margin (OM):
(More…)
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Sales − COGS
Sales
Profit Margins (Continued)
GPM = =
GPM = = 17.6%.
$1,236
$7,036
Gross profit margin (GPM):
$7,036 − $5,800
$7,036
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Very bad in 2010, but projected to
meet or exceed industry average in 2011.
2011E 2010 2009 Ind.
PM 3.6% -1.6% 2.6% 3.6%
OPM 7.1 0.3 6.1 7.1
GPM 17.6 14.6 16.6 15.5
Profit Margins vs. Industry Averages
27
BEP =
= = 14.3%.
EBIT
Total assets
$502.6
$3,517
(More…)
Basic Earning Power (BEP)
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Basic Earning Power vs. Industry Average
BEP removes effect of taxes and financial leverage. Useful for comparison.
Projected to be below average.
Room for improvement.
2011E 2010 2009 Ind.
BEP 14.3% 0.6% 14.2% 17.8%
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ROA =
= = 7.2%.
NI
Total assets
$253.6
$3,517
(More…)
Return on Assets (ROA) and Return on Equity (ROE)
30
ROE =
= = 12.8%.
NI
Common Equity
$253.6
$1,977
(More…)
Return on Assets (ROA) and Return on Equity (ROE)
31
2011E 2010 2009 Ind.
ROA 7.2% -3.3% 6.0% 9.0%
ROE 12.8% -17.1% 13.3% 18.0%
Both below average but improving.
ROA and ROE vs. Industry Averages
32
Effects of Debt on ROA and ROE
ROA is lowered by debt--interest expense lowers net income, which also lowers ROA.
However, the use of debt lowers equity, and if equity is lowered more than net income, ROE would increase.
33
Market Value Ratios
Market value ratios incorporate the:
High current levels of earnings and cash flow increase market value ratios
High expected growth in earnings and cash flow increases market value ratios
High risk of expected growth in earnings and cash flow decreases market value ratios
34
Price = $12.17.
EPS = = = $1.01.
P/E = = = 12.
NI
Shares out.
$253.6
250
Price per share
EPS
$12.17
$1.01
Calculate and appraise the P/E, P/CF, and M/B ratios.
35
Industry P/E Ratios:
| Industry | Ticker* | P/E |
| Banking | STI | 1.32 |
| Software | MSFT | 6.14 |
| Drug | PFE | 5.87 |
| Electric Utilities | DUK | 10.14 |
| Semiconductors | INTC | 4.01 |
| Steel | NUE | 0.33 |
| Tobacco | MO | 1.30 |
| S&P 500 | 14.22 | |
| *Ticker is for typical firm in industry, but P/E ratio is for the industry, not the individual firm; www.investor.reuters.com, January 2009. |
36
NI + Depr.
Shares out.
CF per share =
= = $1.49.
$253.6 + $120.0
250
Price per share
Cash flow per share
P/CF =
= = 8.2.
$12.17
$1.49
Market Based Ratios
37
Com. equity
Shares out.
BVPS =
= = $7.91.
$1,977
250
Mkt. price per share
Book value per share
M/B =
= = 1.54.
$12.17
$7.91
Market Based Ratios (Continued)
38
Interpreting Market Based Ratios
P/E: How much investors will pay for $1 of earnings. Higher is better.
M/B: How much paid for $1 of book value. Higher is better.
P/E and M/B are high if ROE is high, risk is low.
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2011E 2010 2009 Ind.
P/E 12.0 -6.3 9.7 14.2
P/CF 8.2 27.5 8.0 7.6
M/B 1.5 1.1 1.3 2.9
Comparison with Industry Averages
40
Common Size Balance Sheets: Divide all items by Total Assets
| Assets | 2009 | 2010 | 2011E | Ind. |
| Cash | 0.6% | 0.3% | 0.4% | 0.3% |
| ST Inv. | 3.3% | 0.7% | 2.0% | 0.3% |
| AR | 23.9% | 21.9% | 25.0% | 22.4% |
| Invent. | 48.7% | 44.6% | 48.8% | 41.2% |
| Total CA | 76.5% | 67.4% | 76.2% | 64.1% |
| Net FA | 23.5% | 32.6% | 23.8% | 35.9% |
| TA | 100.0% | 100.0% | 100.0% | 100.0% |
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Divide all items by Total Liabilities & Equity
| Assets | 2009 | 2010 | 2011E | Ind. |
| AP | 9.9% | 11.2% | 10.2% | 11.9% |
| Notes pay. | 13.6% | 24.9% | 8.5% | 2.4% |
| Accruals | 9.3% | 9.9% | 10.8% | 9.5% |
| Total CL | 32.8% | 46.0% | 29.6% | 23.7% |
| LT Debt | 22.0% | 34.6% | 14.2% | 26.3% |
| Total eq. | 45.2% | 19.3% | 56.2% | 50.0% |
| Total L&E | 100.0% | 100.0% | 100.0% | 100.0% |
42
Analysis of Common Size Balance Sheets
Computron has higher proportion of inventory and current assets than Industry.
Computron now has more equity (which means LESS debt) than Industry.
Computron has more short-term debt than industry, but less long-term debt than industry.
43
Common Size Income Statement: Divide all items by Sales
| 2009 | 2010 | 2011E | Ind. | |
| Sales | 100.0% | 100.0% | 100.0% | 100.0% |
| COGS | 83.4% | 85.4% | 82.4% | 84.5% |
| Other exp. | 9.9% | 12.3% | 8.7% | 4.4% |
| Depr. | 0.6% | 2.0% | 1.7% | 4.0% |
| EBIT | 6.1% | 0.3% | 7.1% | 7.1% |
| Int. Exp. | 1.8% | 3.0% | 1.1% | 1.1% |
| EBT | 4.3% | -2.7% | 6.0% | 5.9% |
| Taxes | 1.7% | -1.1% | 2.4% | 2.4% |
| NI | 2.6% | -1.6% | 3.6% | 3.6% |
44
Analysis of Common Size Income Statements
Computron has lower COGS (86.7) than industry (84.5), but higher other expenses. Result is that Computron has similar EBIT (7.1) as industry.
45
Percentage Change Analysis: % Change from First Year (2009)
| Income St. | 2009 | 2010 | 2011E |
| Sales | 0.0% | 70.0% | 105.0% |
| COGS | 0.0% | 73.9% | 102.5% |
| Other exp. | 0.0% | 111.8% | 80.3% |
| Depr. | 0.0% | 518.8% | 534.9% |
| EBIT | 0.0% | -91.7% | 140.4% |
| Int. Exp. | 0.0% | 181.6% | 28.0% |
| EBT | 0.0% | -208.2% | 188.3% |
| Taxes | 0.0% | -208.2% | 188.3% |
| NI | 0.0% | -208.2% | 188.3% |
46
Analysis of Percent Change Income Statement
We see that 2011 sales grew 105% from 2009, and that NI grew 188% from 2009.
So Computron has become more profitable.
47
Percentage Change Balance Sheets: Assets
| Assets | 2009 | 2010 | 2011E |
| Cash | 0.0% | -19.1% | 55.6% |
| ST Invest. | 0.0% | -58.8% | 47.4% |
| AR | 0.0% | 80.0% | 150.0% |
| Invent. | 0.0% | 80.0% | 140.0% |
| Total CA | 0.0% | 73.2% | 138.4% |
| Net FA | 0.0% | 172.6% | 142.7% |
| TA | 0.0% | 96.5% | 139.4% |
48
Percentage Change Balance Sheets: Liabilities & Equity
| Liab. & Eq. | 2009 | 2010 | 2011E |
| AP | 0.0% | 122.5% | 147.1% |
| Notes pay. | 0.0% | 260.0% | 50.0% |
| Accruals | 0.0% | 109.5% | 179.4% |
| Total CL | 0.0% | 175.9% | 115.9% |
| LT Debt | 0.0% | 209.2% | 54.6% |
| Total eq. | 0.0% | -16.0% | 197.9% |
| Total L&E | 0.0% | 96.5% | 139.4% |
49
Analysis of Percent Change Balance Sheets
We see that total assets grew at a rate of 139%, while sales grew at a rate of only 105%. So asset utilization remains a problem.
50
Explain the Du Pont System
The Du Pont system focuses on:
Expense control (PM)
Asset utilization (TATO)
Debt utilization (EM)
It shows how these factors combine to determine the ROE.
51
( )( )( ) = ROE
Profit
margin
TA
turnover
Equity
multiplier
NI
Sales
Sales
TA
TA
CE
x
x
= ROE
The Du Pont System
52
2008: 2.6% x 2.3 x 2.2 = 13.2%
2009: -1.6% x 2.0 x 5.2 = -16.6%
2010: 3.6% x 2.0 x 1.8 = 13.0%
Ind.: 3.6% x 2.5 x 2.0 = 18.0%
NI
Sales
Sales
TA
TA
CE
x
x
= ROE
The Du Pont System
53
Potential Problems and Limitations of Ratio Analysis
Comparison with industry averages is difficult if the firm operates many different divisions.
Seasonal factors can distort ratios.
Window dressing techniques can make statements and ratios look better.
Different accounting and operating practices can distort comparisons.
54
Qualitative Factors
There is greater risk if:
revenues tied to a single customer
revenues tied to a single product
reliance on a single supplier?
High percentage of business is generated overseas?
What is the competitive situation?
What products are in the pipeline?
What are the legal and regulatory issues?
