Evaluating a Firm's Financial Performance
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Evaluating a Firm's Financial Performance

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Evaluating a Firm's Financial Performance Presentation Transcript

  • 1. Evaluating a Firm’s Financial Performance
    • Goals of evaluating firm performance:
    • Are our decisions maximizing shareholder wealth?
    • We will want to answer questions about the firm’s
      • Liquidity
      • Efficient use of Assets
      • Leverage (financing)
      • Profitability
  • 2. Financial Ratios
    • Tools that help us determine the financial health of a company
    • We can compare a company’s financial ratios with its ratios in previous years (trend analysis)
    • We can compare a company’s financial ratios with those of its industry
  • 3.
    • Assets: Liabilities & Equity:
    • Cash $2,540 Accounts payable 9,721
    • Marketable securities 1,800 Notes payable 8,500
    • Accounts receivable 18,320 Accrued taxes payable 3,200
    • Inventories 27,530 Other current liabilities 4,102
    • Total current assets 50,190 Total current liabilities 25,523
    • Plant and equipment 43,100 Long-term debt (bonds) 22,000
    • less accum deprec. 11,400 Total liabilities 47,523
    • Net plant & equip. 31,700 Common stock ($10 par) 13,000
    • Total assets 81,890 Paid in capital 10,000
    • Retained earnings 11,367
    • Total stockholders' equity 34,367
    • Total liabilities & equity 81,890
    Dragon’s Balance Sheet
  • 4.
    • Sales (all credit) $112,760
    • Cost of Goods Sold (85,300)
    • Gross Profit 27,460
    • Operating Expenses:
    • Selling (6,540)
    • General & Administrative (9,400)
    • Total Operating Expenses (15,940)
    • Earnings before interest and taxes (EBIT) 11,520
    • Interest charges:
    • Interest on bank notes: (850)
    • Interest on bonds: (2,310)
    • Total Interest charges (3,160)
    • Earnings before taxes (EBT) 8,360
    • Taxes (assume 40%) (3,344)
    • Net Income 5,016
    Dragon’s Income Statement
  • 5.
    • Dividends paid on common stock $2,800
    • Earnings retained in the firm 2,216
    • Shares outstanding (000) 1,300
    • Market price per share 20
    • Book value per share 26.44
    • Earnings per share 3.86
    • Dividends per share 2.15
    Dragon (Other Information)
  • 6. 1. Liquidity Ratios
    • What is the firm’s Current Ratio?
    • Do we have enough liquid assets to meet approaching obligations?
    • If the average current ratio for the industry is 2.4 , is this good or not?
  • 7. 1. Liquidity Ratios (Continued)
    • What is the firm’s Acid-Test Ratio (Quick Ratio)?
    • Suppose the industry average is 0.92 . What does this tell us?
  • 8. 1. Liquidity Ratios (Continued)
    • What is the firm’s Average Collection Period (ACP)?
    • If the industry average is 47 days , what does this tell us?
    • Alternatively, we can calculate Average Collection Turnover (Accounts Receivable Turnover (ART)) first as: (Industry average is 8.2 times)
    • Second, we convert the turnover into a period using 365 day/year:
  • 9.
    • What is the firm’s Accounts Payable Turnover (APT)?
    • Accounts Payable Period (APP)
    1. Liquidity Ratios (Continued)
  • 10.
    • Measure how efficiently the firm’s assets generate operating profits
    • What is the firm’s Operating Income Return on Investment (OIROI)?
    2. Operating Efficiency Ratios
    • Slightly below the industry average of 15% . The OIROI reflects product pricing and the firm’s ability to keep costs down
    • Note: EBIT is Operating Income
  • 11.
    • What is the firm’s Operating Profit Margin (OPM)?
    • Below the industry average of 12%
    2. Operating Efficiency Ratios (Continued)
  • 12.
    • What is the firm’s Total Asset Turnover (TAT)?
    • The industry average is 1.82 times
    • Total Asset Period (TAP):
    • The firm needs to figure out how to squeeze more sales dollars out of its assets
    2. Operating Efficiency Ratios (Continued)
  • 13.
    • What is the firm’s Inventory Turnover?
    • Dragon turns their inventory over 3.1 times per year.
    • The industry average is 3.9 times. Is this efficient?
    • Inventory Period (IP) for the firm is:
    2. Operating Efficiency Ratios (Continued)
  • 14.
    • Low Inventory Turnover
    • The firm may have too much inventory, which is expensive because:
      • Inventory takes up costly warehouse space
      • Some items may become spoiled or obsolete
    2. Operating Efficiency Ratios (Continued)
  • 15.
    • Cash Cycle = (Inventory Period + Receivables Period) – Payables Period
    • Cash Cycle = (117.74 + 59.30) – 41.57 = 135.47
    2. Operating Efficiency Ratios (Continued)
  • 16.
    • What is the firm’s Fixed Asset Turnover (FAT)?
    • If the industry average is 4.6 times, what does this tell us about the firm?
    • Fixed Asset Period (FAP) for the firm is
    2. Operating Efficiency Ratios (Continued)
  • 17.
    • Measure the impact of using debt capital to finance assets
    • Firms use debt to lever (increase) returns on common equity
    • How does Leverage work?
    • Suppose we have an all equity-financed firm worth $100,000. Its earnings this year total $15,000
    • ROE = 15,000 / 100,000 = 15%
    • Suppose the same $100,000 firm is financed with half equity, and half 8% debt (bonds). Earnings are still $15,000
    • ROE = (15,000 – 4,000) / 50,000 = 22%
    3. Leverage Ratios (Financing Decisions)
  • 18.
    • If the industry average is 47%, what does this tell us?
    • Can leverage make the firm more profitable ?
    • Can leverage make the firm riskier ?
    • What is Dragon’s Debt Ratio?
    3. Leverage Ratios (Financing Decisions) (Continued)
  • 19.
    • The industry average is 6.7 times. This is further evidence that the firm uses more debt financing than average
    • What is Dragon’s Times Interest Earned Ratio (TIER)?
    3. Leverage Ratios (Financing Decisions) (Continued)
  • 20.
    • The industry average is 17.54%. Is this what we would expect, given the firm’s leverage?
    • How well are the firm’s managers maximizing shareholder wealth?
    4. Return on Equity (ROE)
  • 21.
    • Even though Dragon has higher leverage than the industry average, they are much less efficient, and therefore, less profitable
    Conclusion
  • 22.
    • Brings together:
    • Profitability – measured by the Net Profit Margin (NPM)
    • Efficiency – measured by Total Asset Turnover (TAT)
    • Leverage – measured by Debt Ratio
    The DuPont Model
  • 23. The DuPont Model