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Copyright ©2003 South-Western/Thomson Learning

  1. 1. 3 Evaluation of Financial Performance
  2. 2. Introduction <ul><li>This chapter introduces financial statement analysis techniques that are used to accurately evaluate a company’s performance. </li></ul><ul><li>Ratios give additional meaning to absolute values. </li></ul><ul><li>Ratios are compared to industry average, to the history data of some company (trend analysis) </li></ul>
  3. 3. Ratio Classifications <ul><li>Liquidity </li></ul><ul><li>Asset management </li></ul><ul><li>Financial leverage management </li></ul><ul><li>Profitability </li></ul><ul><li>Market-based </li></ul><ul><li>Dividend policy </li></ul>
  4. 4. Financial Ratios Are Used By <ul><li>Management for planning and evaluating </li></ul><ul><li>Credit managers to estimate the riskiness of potential borrowers </li></ul><ul><li>Investors to evaluate corporate securities </li></ul><ul><li>Managers to identify and assess potential merger candidates </li></ul>
  5. 5. Major Financial Statements <ul><li>Balance sheet (page 67 Table 3.1) </li></ul><ul><ul><li>Common-sized balance sheet shows assets, liabilities, and equity as a percent of total assets. (page 68 Table 3.3) </li></ul></ul><ul><li>Income statement (page 68 Table 3.2) </li></ul><ul><ul><li>Common-sized income statement shows income and expense items as a percent of net sales (page 69 Table 3.4). </li></ul></ul><ul><li>Statement of cash flows </li></ul>
  6. 6. Liquidity Ratios <ul><li>Current ratio = </li></ul><ul><li>Quick ratio = </li></ul><ul><li>Calculations are shown in Table 3.5 page 80, using the data in Table 3.1 , 3.2 </li></ul>Current assets Current liabilities Current assets – Inventories Current liabilities
  7. 7. Asset Management Ratios <ul><li>Avg. collection period = </li></ul><ul><ul><li>Annual credit sales= net sales </li></ul></ul><ul><li>Inventory turnover = </li></ul><ul><li>Fixed-asset turnover = </li></ul><ul><ul><li>Fixed asset = net plant and equipment </li></ul></ul><ul><li>Total asset turnover = </li></ul>Cost of sales Average inventory Sales Net fixed assets Sales Total assets Accounts receivable Annual credit sales/365
  8. 8. Financial Leverage Management <ul><li>Debt ratio = </li></ul><ul><li>Debt-to-equity ratio = </li></ul><ul><li>Times interest earned = </li></ul><ul><li>Fixed charge coverage = </li></ul>Total debt Total assets Total debt Total equity EBIT Interest charges EBIT + Lease pmts Interest + Lease pmt + P/S div before tax + Before tax sinking fund
  9. 9. Profitability Ratios <ul><li>Gross profit margin = </li></ul><ul><li>Net profit margin = </li></ul><ul><li>ROI = </li></ul><ul><li>ROE = </li></ul>Sales – Cost of sales Sales EAT Sales EAT Total assets EAT Stockholders’ equity
  10. 10. Market-Based Ratios <ul><li>P/E ratio = </li></ul><ul><ul><li>The lower the firm’s risk, the higher its P/E ratio </li></ul></ul><ul><ul><li>The better the growth prospects of its earning, the higher its P/E ratio </li></ul></ul><ul><li>Market to book ratio = </li></ul>Marketing price per share Current earnings per share Market price per share Book value per share
  11. 11. Dividend Policy Ratios <ul><li>Payout ratio = </li></ul><ul><li>Dividend yield = </li></ul>Dividends per share EPS (Expected) dividends per share Stock price
  12. 12. Financial Ratio Analysis <ul><li>Trend analysis 20X0 X1 X2 </li></ul><ul><li>XYZ current ratio 1.9 2.2 2.3 </li></ul><ul><li>Cross-sectional analysis 20X2 </li></ul><ul><li>XYZ current ratio 2.3 </li></ul><ul><li>Industry norms 2.5 </li></ul><ul><li>Both simultaneously 20X0 X1 X2 </li></ul><ul><li>XYZ current ratio 1.9 2.2 2.3 </li></ul><ul><li>Industry norms 2.5 2.4 2.5 </li></ul>
  13. 13. Relationships Among Ratios <ul><li>ROI = </li></ul><ul><ul><li>=Net Profit Margin x Total asset turn </li></ul></ul><ul><li>ROE = </li></ul><ul><li>ROE = </li></ul>EAT Total assets EAT Sales Sales Total assets =  EAT Sales Sales Total assets Total assets Equity   Net profit margin Total assets turnover Equity multiplier  
  14. 14. Dupont Analysis <ul><li>An excellent way to present ratio analysis for an assignment or for an on-the-job presentation </li></ul>
  15. 15. Sources of Information <ul><li>Dun and Bradstreet </li></ul><ul><li>Robert Morris Associates </li></ul><ul><li>Prentice-Hall’s Almanac of Business and Industrial Ratios </li></ul><ul><li>Moody’s </li></ul><ul><li>Standard and Poor’s </li></ul><ul><li>Annual reports </li></ul><ul><li>10Ks </li></ul><ul><li>Trade associations </li></ul><ul><li>Trade journals </li></ul><ul><li>Commercial banks </li></ul><ul><li>Financial Research Associates </li></ul><ul><li>Computerized databases </li></ul>
  16. 16. Sources of Information on the Web <ul><li> </li></ul><ul><li> </li></ul><ul><li> </li></ul><ul><li> </li></ul><ul><li> </li></ul><ul><li> </li></ul><ul><li> </li></ul><ul><li> </li></ul>
  17. 17. Complex International Aspects of Financial Statement Analysis <ul><li>Influenced by fluctuating exchange rates </li></ul><ul><li>Statement of Accounting Standards No. 52 deals with foreign currency translation. </li></ul>
  18. 18. Accuracy of Financial Statements <ul><li>External auditor </li></ul><ul><li>Generally accepted accounting principles </li></ul><ul><li>Corporations pose for a financial statement like people pose for a picture. </li></ul>