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    clem.mscd.edu clem.mscd.edu Presentation Transcript

    • Analysis of Financial Statements Timothy R. Mayes, Ph.D. FIN 3300: Chapter 3
    • Common-size Income Statements
      • A common-size income statement restates all expenses as a percentage of sales
      • This allows the analyst to quickly and easily see which expenses have increased or decreased relative to sales
    • Common-size Balance Sheets
      • A common-size balance sheet restates all assets and liabilities as a percentage of total assets
      • This allows the analyst to quickly and easily see which accounts have increased or decreased relative to total assets
    • Financial Ratios
      • Financial ratios are the analyst’s microscope; they allow us to get a better view of the firm’s financial health than just looking at the raw financial statements
      • Ratios are used by both internal and external analysts
        • Internal uses
          • planning
          • evaluation of management
        • External uses
          • credit granting
          • performance monitoring
          • investment decisions
    • Categories of Financial Ratios
      • Financial ratios are often divided into categories based on the information that they provide:
        • Liquidity
        • Efficiency
        • Leverage
        • Coverage
        • Profitability
        • Market valuation
    • Liquidity Ratios
      • ‘Liquidity’ refers to the speed with which an asset can be converted to cash
      • Liquidity ratios describe the ability of a firm to meet its current obligations
      • There are three common liquidity ratios:
        • The Current Ratio
        • The Quick Ratio
        • The Cash Ratio
    • The Current Ratio For EPI the current ratio in 1997 is:
    • The Quick Ratio For EPI the quick ratio in 1997 is:
    • The Cash Ratio For EPI the cash ratio in 1997 is:
    • Efficiency Ratios
      • The efficiency ratios (A.K.A. assets utilization ratios) describe how well a firm is using its investment in various asset classes:
        • Inventory Turnover Ratio
        • Accounts Receivable Turnover Ratio
        • Average Collection Period
        • Fixed Asset Turnover Ratio
        • Total Asset Turnover Ratio
    • The Inventory Turnover Ratio For EPI the inventory turnover ratio in 1997 is:
    • The A/R Turnover Ratio For EPI the accounts receivable turnover ratio in 1997 is:
    • The Average Collection Period For EPI the average collection period in 1997 is:
    • The Fixed Asset Turnover Ratio For EPI the fixed asset turnover ratio in 1997 is:
    • The Total Asset Turnover Ratio For EPI the total asset turnover ratio in 1997 is:
    • Leverage Ratios
      • Leverage ratios describe the amount of debt that the firm has used to finance its investments in assets:
        • Total Debt Ratio
        • Long-term Debt Ratio
        • Debt to Equity
        • Long-term Debt to Equity
    • The Total Debt Ratio For EPI the total debt ratio in 1997 is:
    • The Long-term Debt Ratio For EPI the long-term debt ratio in 1997 is:
    • The Debt to Equity Ratio For EPI the debt to equity ratio in 1997 is:
    • The Long-term Debt to Equity Ratio For EPI the long-term debt to equity ratio in 1997 is:
    • Coverage Ratios
      • Coverage ratios indicate the firm’s ability to pay certain expenses:
        • Times Interest Earned Ratio
        • Cash Coverage Ratio
    • The Times Interest Earned Ratio For EPI the times interest earned ratio in 1997 is:
    • The Cash Coverage Ratio For EPI the cash coverage ratio in 1997 is:
    • The Fixed Charge Coverage Ratio
      • Note: SF Payments are Sinking Fund payments which are not tax deductible. Therefore, we must divide them by (1-t) to find out how much we need before taxes to meet this after-tax expense. Also, you must include preferred dividends in this number.
    • Profitability Ratios
      • Profitability ratios provide a measure of the returns that a firm is generating:
        • Gross Profit Margin
        • Operating Profit Margin
        • Net Profit Margin
        • Return on Total Assets
        • Return on Equity
        • Return on Common Equity
    • The Gross Profit Margin For EPI the gross profit margin in 1997 is:
    • The Operating Profit Margin For EPI the operating profit margin in 1997 is:
    • The Net Profit Margin For EPI the net profit margin in 1997 is:
    • The Return on Total Assets For EPI the return on total assets in 1997 is:
    • The Return on Equity For EPI the return on equity in 1997 is:
    • The Return on Common Equity For EPI the return on common equity in 1997 is:
    • Market Valuation Ratios
      • The market valuation ratios provide an indication of the relative under- or over-pricing of a firm’s stock:
        • Price/Earnings Ratio
        • Price/Book Ratio
    • The Price/Earnings Ratio
    • The Price/Book Ratio
    • Rules for Memorizing Ratios
      • There can be an infinite number of financial ratios, but knowing a few basic rules will help you to memorize the formulas: The basic rule is that the name tells you how to calculate the ratio.
        • Any ‘ margin ’ ratio is something divided by sales
        • Any ‘ turnover ’ ratio is sales (or a variation of sales) divided by something
        • Any ‘ return on ’ ratio is net income (or a variation of net income) divided by something
    • Using Financial Ratios
      • Calculating ratios is pointless unless you know how to use them
      • The most basic rule is: a single ratio provides very little information and may be misleading
      • With that in mind, there are at least 4 uses of ratios:
        • Trend analysis (internal and external)
        • Comparison to industry averages (internal and external)
        • Setting and evaluating company goals (internal)
        • Restrictive debt covenants (external)
    • Trend Analysis of Ratios
      • Trend analysis involves the examination of ratios over time
      • The analyst tries to determine if the ratio is changing in a favorable, or unfavorable, direction
      • The chart shows EPI’s current ratio for two years (we really need more data)
    • Comparing to Industry Averages
      • Industry average ratios provide a benchmark for comparison
      • We assume that if a ratio is too far from the average something is wrong
      • Industry ratios are available from Robert Morris Associates and Standard & Poor’s
    • Company Goals and Debt Covenants
      • Company goals are often stated in terms of financial ratios
        • For example, it is common for management to set goals regarding the firm’s ROE
      • Debt covenants often contain restrictions on certain ratios
        • For example, a borrower might be required to maintain a debt to equity ratio of less than 1.0 and a current ratio greater than 2.0