A) Financial ratios

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A) Financial ratios

  1. 1. Financial Statement Analysis Every Ratio Tells a Story
  2. 2. Financial Statement Analysis <ul><li>Financial statement analysis can be conducted at the company, segment or divisional level. </li></ul><ul><li>At the company level, the purpose is usually an investment or lending decision. </li></ul><ul><li>At the segment or divisional level, the purpose can be performance evaluation, a funding decision, or an acquisition or divestiture decision. </li></ul>
  3. 3. Types of Financial Statement Analysis Tools <ul><li>Account-by-account trends over time </li></ul><ul><li>Percentage of individual accounts to an aggregate total </li></ul><ul><ul><li>Such as income statement items to revenue or COGS </li></ul></ul><ul><li>Ratio analysis </li></ul>
  4. 4. Account-by-account trends over time Starbucks 2003 2004 2005 2006 2007 Revenues (billions) percentage increase $4.1 24% $5.3 30% $6.4 20% $7.8 22% $9.4 $21%
  5. 5. Comparison of Individual Accounts to an Aggregate Total 2007 Barr Labs Pfizer Revenues COGS Gross Profit R & D S.G.&A. Other Income before taxes 100% 47% 53% 10% 31% 4% 8% 100% 23% 77% 17% 32% 9% 19%
  6. 6. Financial Ratios <ul><li>Liquidity ratios </li></ul><ul><li>Long-term solvency ratios </li></ul><ul><li>Profitability ratios </li></ul><ul><li>Ratios using stock price </li></ul>
  7. 7. Liquidity Ratios <ul><li>Current Ratio </li></ul><ul><li>Quick Ratio </li></ul><ul><li>Days Accounts Receivable </li></ul><ul><li>Days Inventory </li></ul><ul><li>Inventory Turnover </li></ul>
  8. 8. Current Ratio Assets Liabilities & Equity Cash & equivalents Accounts receivable Inventory Other current assets Current Assets P.P.&E. Other assets Total assets Accounts Payable Other current liabilities Current Liabilities Long-term debt Total liabilities Equity Total liabilities & equity
  9. 9. Current Ratio Microsoft 2007 (billions) Current Assets Current Liabilities = $24 $40 = 1.7
  10. 10. Quick Ratio Assets Liabilities & Equity Cash & equivalents Accounts receivable Inventory Other current assets Current Assets P.P.&E. Other assets Total assets Accounts Payable Other current liabilities Current Liabilities Long-term debt Total liabilities Equity Total liabilities & equity
  11. 11. Quick Ratio Enron 1999 (billions) Cash & cash equivalents + accounts receivable Current liabilities = $6.7 $3.8 = 0.57
  12. 12. Days Accounts Receivable Macy’s Inc. 2007 (millions) Average net accounts receivable x 365 Net sales = $26,313 (463 + 517)/2 x 365 = 6.8
  13. 13. Days Accounts Receivable Timberland 2007 (millions) Average net accounts receivable x 365 Net sales = $1,436 (188 + 204)/2 x 365 = 50
  14. 14. Days Inventory Hewlett-Packard 2007 (billions) Average inventory x 365 Cost of goods sold = $63.4 ($8.0 + $7.8)/2 x 365 = 45
  15. 15. Inventory Turnover Hewlett-Packard 2007 (billions) Cost of goods sold Average inventory = ($8.0 + $7.8)/2 63.4 = 8 Note: 8 x 45 = 360 days
  16. 16. Long-term Solvency Ratios <ul><li>Equity-to-Assets </li></ul><ul><li>Equity-to-Debt </li></ul>
  17. 17. Equity to Assets Assets Liabilities & Equity Cash & equivalents Accounts receivable Inventory Other current assets Current Assets P.P.&E. Other assets Total assets Accounts Payable Other current liabilities Current Liabilities Long-term debt Total liabilities Equity Total liabilities & equity
  18. 18. Equity to Assets Apple 2007 (billions) Shareholders’ Equity Total Assets = $25.3 $14.5 = 0.57
  19. 19. Equity to Debt Assets Liabilities & Equity Cash & equivalents Accounts receivable Inventory Other current assets Current Assets P.P.&E. Other assets Total assets Accounts Payable Other current liabilities Current Liabilities Long-term debt Total liabilities Equity Total liabilities & equity
  20. 20. Equity to Debt Apple 2007 (billions) Shareholders’ Equity Total Debt = zero $14.5 = ∞
  21. 21. Profitability Ratios <ul><li>Return on Assets (ROA) </li></ul><ul><li>Return on Sales (ROS) </li></ul><ul><li>Return on Equity (ROE) </li></ul><ul><li>Earnings per Share (EPS) </li></ul>
  22. 22. Profitability Ratios <ul><li>Return on Assets (ROA) </li></ul><ul><ul><li>net income ÷ average total assets </li></ul></ul><ul><li>Return on Sales (ROS) </li></ul><ul><ul><li>net income ÷ net sales </li></ul></ul><ul><li>Return on Equity (ROE) </li></ul><ul><ul><li>net income ÷ average common equity </li></ul></ul><ul><li>Earnings per Share (EPS) </li></ul><ul><ul><li>earnings available to common shareholders ÷ weighted average common shares outstanding </li></ul></ul>
  23. 23. Southwest Airlines <ul><li>Return on Assets (ROA) </li></ul><ul><ul><li>$499 ÷ $13,732 = 3.6% </li></ul></ul><ul><li>Return on Sales (ROS) </li></ul><ul><ul><li>$499 ÷ $9,086 = 5.5% </li></ul></ul><ul><li>Return on Equity (ROE) </li></ul><ul><ul><li>$499 ÷ $6,562 = 7.6% </li></ul></ul><ul><li>Earnings per Share (EPS) </li></ul><ul><ul><li>$0.63 per share (from the income statement) </li></ul></ul>2006
  24. 24. Market Tests <ul><li>Price-Earnings Ratio </li></ul><ul><li>Market to Book </li></ul>
  25. 25. Price Earnings Ratio (earnings multiple) Apple 2007 Share price Earnings per share = $4.04 $111 = 27
  26. 26. Market to Book Apple 2007 (billions) Market value of all shares outstanding* Book value of common equity = $14.5 $74.5 = 5.1 * Most easily obtained from the first page of the 10-K

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