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Lecture Slides

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  • 1. FINANCIAL RATIOS (using financial statements)
    • Balance sheet
    • - Common-sized balance sheet shows assets,
    • liabilities, and equity as a % of total assets.
    • Income statement
    • - Common-sized income statement shows
    • income and expense items as a % of sales.
    • Statement of cash flows
  • 2. FINANCIAL RATIOS (standardized measures)
    • Used by managers for planning and evaluation
    • Used by credit managers to assess risk
    • Used by investors to assess stocks and bonds
    • Used to compare with industry and over time
  • 3. FINANCIAL RATIOS Types of ratios
    • Liquidity
    • -ability to meet short term debt
    • Asset management
    • -efficiency in using resources
    • Financial leverage management
    • - level of risk due to debt
    • Profitability
    • -effectiveness in generating profits
    • Market-based
    • -market’s view of the firm
  • 4. Liquidity Ratios
    • Current ratio = Current assets Current liabilities
    • CR = $50,190 / $25,523
    • CR = 1.97 vs. 2.4 Ind. Avg.
    • Quick ratio = Current assets – inventories Current liabilities
    • QR = ($50,190 - $27,530) / $25,523
    • QR = .89 vs. .92 Ind. Avg.
  • 5. Asset Management Ratios
    • Avg collection period = Accounts receivable Annual credit sales/365
    • ACP = $18,320 / ($112,760/365)
    • ACP = 59.3 days vs. 47 days Ind. Avg.
    • Inventory turnover = Cost of sales Average inventory
    • Inv. Turn. = $85,300 / ($27,530 + $26,470)/2
    • Inv. Turn. = 3.16 vs. 3.9 Ind. Avg.
  • 6. Asset Management Ratios
    • Fixed-asset turnover = Sales Net fixed assets
    • FAT = $112,760 / $31,700
    • FAT = 3.56 vs. 4.6 Ind. Avg.
    • Total asset turnover = Sales Total assets
    • TAT = $112,760 / $81,890
    • TAT = 1.38 vs. 1.82 Ind. Avg.
  • 7. Financial Leverage Management
    • Debt ratio = Total debt Total assets
    • DR = $47,523 / $81,890
    • DR = 58% vs. 47% Ind. Avg.
    • Debt-to-equity ratio = Total debt Total equity
    • D/E = $47,253 / $34,367
    • D/E = 138.3% vs. 88.7% Ind. Avg.
  • 8. Financial Leverage Management
    • Times interest earned = EBIT Interest charge
    • Coverage Ratio = $11,520 / $3,160
    • Coverage Ratio = 3.65 vs. 6.7 Ind. Avg.
    • Equity multiplier = Total assets Total equity
    • EM = $81,890 / $34,367
    • EM = 2.38 vs. 1.89 Ind. Avg.
  • 9. Profitability Ratios
    • Gross profit margin = Sales - Cost of sales Sales
    • GPM = ($112,760 - $85,300) / $112,760
    • GPM = 24.4% vs. 25.6% Ind. Avg.
    • Net profit margin = EAT Sales
    • NPM = $5,016 / $112,760
    • NPM = 4.45% vs. 5.1% Ind. Avg.
  • 10. Profitability Ratios
    • ROI = EAT Total Assets
    • ROI = $5,016 / $81,890
    • ROI = 6.13% vs. 9.28% Ind. Avg.
    • ROE = EAT Stockholders equity
    • ROE = $5,016 / $34,367
    • ROE = 14.6% vs. 17.54% Ind. Avg.
  • 11. Market-Based Ratios
    • P/E ratio = Market price per share Current earnings per share
    • Market to book ratio= Market price per share Book value per share
  • 12. Dividend Policy Ratios
    • Payout ratio = Dividends per share EPS
    • Dividend yield = Expected dividends per share Stock price
  • 13. Financial Ratio Analysis
    • Trend analysis 2000 01 02
    • XYZ current ratio 1.9 2.2 2.3
    • Cross-sectional analysis 2002
    • XYZ current ratio 2.3
    • Industry averages 2.5
    • Both simultaneously 2000 01 02
    • XYZ current ratio 1.9 2.2 2.3
    • Industry averages 2.5 2.4 2.5
  • 14.  
  • 15. Relationships Among Ratios
    • ROI = EAT  Sales = EAT Sales Total assets Total assets
    • or
    • ROI = Net profit  Total Asset = NPM  TAT margin turnover
    • and
    • ROE = EAT  Total assets = EAT Total assets Equity Equity
    • or
    • ROE = ROI  Equity = ROI  EM multiplier
  • 16. Relationships Among Ratios
    • If
    • ROE = ROI  Equity = ROI  EM multiplier
    • and
    • ROI = Net profit  Total Asset = NPM  TAT margin turnover
    • then
    • ROE = Net profit  Total Assets  Equity margin turnover multiplier
    • or
    • ROE = NPM  TAT  EM
  • 17. Relationships Among Ratios
    • This is the Dupont formula:
    • ROE = Net profit  Total Assets  Equity margin turnover multiplier
    • or
    • ROE = NPM  TAT  EM
  • 18. Dupont Formula
    • Example of the Dupont formula:
    • ROE = NPM  TAT  EM
    • Company:
    • 14.6% = 4.45%  1.38  2.38
    • Industry average:
    • 17.5% = 5.10%  1.82  1.89
  • 19. Sources of Information
    • Dun and Bradstreet
    • Robert Morris Associates
    • Prentice-Hall’s Almanac of Business and Industrial Ratios
    • Moody’s
    • Standard and Poor’s
    • Annual reports
    • 10K’s
    • Trade associations
    • Trade journals
    • Commercial banks
    • Financial Research Associates
    • Computerized data bases

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