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Chapter 3 Power Point Slides Chapter 3 Power Point Slides Presentation Transcript

  • Chapter 3 Analysis of Financial Statements: Financial Statements and Reports Ratio Analysis Copyright © 2000 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to the following address: Permissions Department, Harcourt, Inc., 6277 Sea Harbor Drive, Orlando, Florida 32887-6777
  • Financial Statements and Reports
    • The Income Statement
    • The Balance Sheet
    • Statement of Cash Flows
    • Statement of Retained Earnings
  • Computron: Income Statement
  • Computron: Balance Sheet: Assets
  • Computron: Liabilities and Equity
  • Computron: Statement of Cash Flows (2000)
  • Computron: Statement of Cash Flows (continued)
  • What Can You Conclude about Computron’s Financial Condition from its Statement of Cash Flows?
    • Net operating cash flow is ($73,780)
      • Operations are draining cash
    • Had to borrow $126,180 in long- and short-term debt to cover cash outlays, pay for fixed asset additions, and to pay dividends
    • Despite borrowing, cash account still fell $5,600 in 2000
  • Statement of Retained Earnings Balance of retained earnings Dec. 31, 1999 $203,786 2000 Net Income 44,220 2000 dividends to stockholders (22,000) Balance of retained earnings Dec. 31, 2000 $225,988
  • Computron: Additional Data
  • Ratio Analysis
    • An analysis of a firm’s ratios is generally the first step in financial analysis
    • The ratios are designed to show relationships between financial statement accounts within firms and between firms
  • What is the Purpose of Ratio Analysis?
    • Give idea of how well the company is doing
    • Standardize numbers; facilitate comparisons
    • Used to highlight weaknesses and strengths
    • Liquidity: Can we make required payments?
    • Asset mgt.: Right amount of assets vs. sales?
    • Debt mgt.: Right mix of debt and equity?
    • Profitability: Do sales prices exceed unit costs, and are sales high enough as reflected in PM, ROE, and ROA?
    • Market values: Do investors like what they see as reflected in P/E and M/B ratios?
    What Are the Five Major Categories of Ratios? What Questions Do They Answer?
  • Industry Average Data (2000)
  • What are Computron’s Current and Quick ratios?
  • Comment on Computron’s Liquidity Position
    • Ratios held steady but slightly below ind. avg.
    • Inventories are the least liquid of Computron’s assets and they are the assets that suffer losses in the event of a forced sale.
    • The quick ratio shows that even if receivables are collected in full, Computron still needs to raise case from sale of inventories to meet obligations.
  • Note that the $1,290,000 in current assets is made up of... $ 52,000 in cash $402,000 in accts rec $836,000 in inventories $1,290,000 total Cur Lia - Cash - Acc Rec = Inventory needed to be liquidated to meet current liabilities Thus, cur. lia minus cash = $540,200 - $52,000 = $488,200 and $488,200 - accts rec = $488,200 - $402,000 = $86,200 in inventory… That would have to be liquidated in order to meet current liabilities
  • What is Computron’s Inventory Turnover Ratio?
  • Comments on Computron’s Inventory Turnover
    • Compares poorly with industry.
    • Continuing on a downward trend.
    • May be holding excess inventories, or
    • May be holding old/obsolete inventory.
  • What is Computron’s Days Sales Outstanding Ratio?
  • Comments on Computron’s Days Sales Outstanding Ratio
    • Looks bad.
    • Higher than industry average.
    • Getting higher!!
  • What is Computron’s Fixed Assets and Total Assets Turnover Ratios?
  • Comments on Computron’s Fixed Assets Turnover and Total Assets Turnover
    • Fixed assets turnover has improved.
    • However, total asset turnover remains the same and below industry average.
    • As we saw before, Computron may have excess inventories and receivables.
  • Calculate the Debt, TIE, and Fixed Charge Coverage Ratios. Debt Ratio = Total debt Total assets TIE = EBIT Int. expense
  • FCC = EBIT + Lease payments + S.F. Pmts. Interest + Lease + Sinking fund pmt. expense pmt. (1-T) All three ratios reflect use of debt, but focus on different aspects. Fixed Charge Coverage Ratio
  • Comments on Computron’s Debt Management
    • Debt ratio is above industry and going higher.
    • Computron would find it difficult to borrow.
    • TIE and FCC below industry average and falling--indicates Computron has high use of debt.
  • If you are in the 30% tax bracket, you have to earn $1.43 before tax in order to put $1.00 into your pocket $1.43 – 30%($1.43) = $1.00 Or $1.00/(1-Tax Rate) = $1.00/(1-.30) = $1.43 “ Amount/(1-T) “ is frequently used in Finance
  • Calculate Computron’s Profitability Ratios-- Profit Margin, ROA, and ROE Low and Falling!
  • Computron’s ROA, and ROE
  • Comments on Computron’s ROA and ROE
    • Both ROA and ROE substantially below industry average.
    • Company stock probably not doing well.
  • Calculate Computron’s Market Value Ratios - - Price/Earnings Ratio and Market/Book Value Ratio EPS = Net Income / Shares Outstanding
  • Computron’s Market/Book Value Ratio
  • Book Value = Common Equity / shares outstanding
  • Comments on Computron’s Market Value Ratios
    • P/E rose from 1999 to 2000--good?
    • NO! because earnings dropped!
    • M/B well below industry average.
    • Investors view Computron as riskier than other companies in the industry.
  • Summary of Ratio Analysis: The Du Pont Equation
  • DU PONT Equation Provides Overview of:
    • Firm’s profitability (measured by ROA)
    • Firm’s expense control (measured by profit margin)
    • Firm’s asset utilization (measured by total asset turnover)
    • Expense control is poor and trending downward.
    • Asset utilization is below average but not getting worse.
    • Combination = ROA that is very low and falling.
    Computron’s DU PONT Equation
  • Sales per day amount to: $3,850,000/ 360 = $10,694 Accounts Receivable are now $402,000, or 37.6 days sales $10,694 * 37.6 = $402,094.40 or $402,094.40 / $10,694 = 37.6 If DSO can be reduced to 27.6 days without affecting sales… Then accounts receivable would be: $10,694 * 27.6 = $295,154 Compared to the current accounts receivable this would mean a collection (cash inflow) of: $402,000 - $295,154 = $106,846
  • What are Some Potential Problems and Limitations of Financial Ratio Analysis?
    • Comparison with industry averages is difficult if the firm operates many different divisions.
    • “ Average” performance not necessarily good.
    • Inflation distorts balance sheets.
    • Seasonal factors can distort ratios.
    • Window dressing” techniques can make statements and ratios look better.
    • Different operating and accounting practices distort comparisons.
    What are Some Potential Problems and Limitations of Financial Ratio Analysis?
    • Sometimes hard to tell if a ratio is “good” or “bad.”
    • Difficult to tell whether company is, on balance, in strong or weak position.
    What are Some Potential Problems and Limitations of Financial Ratio Analysis?
  • End of Chapter 3 Analysis of Financial Statements