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Transcript

  • 1. TOPIC 4
    • EVALUATING FINANCIAL
    • PERFORMANCE
  • 2.
    • How easy is it for us to
    • pay our bills?
    • How easy is it for us to
    • pay our bills if our inventory
    • is not very liquid?
    • Are we carrying the right
    • amount of inventory?
    • Are we collecting our accounts
    • receivable as fast as we should?
    • Do we have the right amount of debt?
    • Are we earning enough profit?
    • How is our stock price?
  • 3. What are the five major categories of ratios, and what questions do they answer?
    • Liquidity: Can we make required payments?
    • Asset management: right amount of assets vs. sales?
    • Debt management: 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 value: Do investors like what they see as reflected in P/E and M/B ratios?
  • 4. FOR EACH RATIO YOU SHOULD KNOW:
    • THE “PROBLEM”
    • DEFINITION OF THE RATIO
    • RATIONALE FOR THE RATIO
    • HOW TO EVALUATE
  • 5. LIQUIDITY RATIOS
    • CURRENT RATIO
    • Current assets / current liabilities
    • QUICK RATIO
    • Current assets – inventory / current liabilities
    When would this ratio be used?
  • 6. Comments on current ratio
    • Expected to improve but still below the industry average.
    • Liquidity position is weak.
    2004 2003 2002 Ind. Current ratio 2.34x 1.20x 2.30x 2.70x
  • 7. ASSET MANAGEMENT RATIOS
    • INVENTORY TURNOVER
    • Sales / Inventory
    • Do we want this ratio to be as high as
    • possible?
    • AR TURNOVER (DAYS SALES
    • OUTSTANDING)
    • Accounts receivable / sales per day
    • Do we want this ratio to be as low as
    • possible?
  • 8. Fixed asset and total asset turnover
    • FA turnover = Sales / Net fixed assets
    • TA turnover = Sales / Total assets
  • 9. What is the inventory turnover vs. the industry average? Inv. turnover = Sales / Inventories = $7,036 / $1,716 = 4.10x 2004 2003 2002 Ind. Inventory Turnover 4.1x 4.70x 4.8x 6.1x
  • 10. Appraisal of DSO
    • The company collects on sales too slowly, and is getting worse.
    • The company has a poor credit policy.
    2004 2003 2002 Ind. DSO 45.6 38.2 37.4 32.0
  • 11. DEBT RATIOS
    • THE DEBT RATIO (amount of debt)
    • Total debt / Total assets
    • TIMES INTEREST EARNED (ability to
    • service the debt)
    • EBIT / Annual Interest
  • 12. PROFITABILITY RATIOS
    • PROFIT MARGIN
    • Net Income / Sales
    • 2. RETURN ON ASSETS
    • Net Income / assets
    • 3. RETURN ON EQUITY
    • Net Income / equity
  • 13. MARKET VALUE RATIOS
    • P/E RATIO
    • MARKET/BOOK RATIO
    • Market value of the stock per share
    • divided by
    • book value of the stock per share
    • Book value is total equity on the balance
    • sheet divided by the number of shares
    • outstanding
  • 14. DUPONT ANALYSIS RETURN PROFIT ASSET ON ASSETS = MARGIN X TURNOVER ROA = NI/S X S/A
  • 15. The Du Pont system
    • Also can be expressed as:
    • ROE = (NI/Sales) x (Sales/TA) x (TA/Equity)
    • Focuses on:
      • Expense control (PM)
      • Asset utilization (TATO)
      • Debt utilization (Eq. Mult.)
    • Shows how these factors combine to determine ROE.
  • 16. EXTENDED DUPONT EQUATION RETURN RETURN EQUITY ON EQUITY = ON ASSETS X MULTIPLIER NI/E = NI/S X S/A X A/E
  • 17. Extended DuPont equation: Breaking down Return on equity
    • ROE = (Profit margin) x (TA turnover) x (Equity multiplier)
    • = 3.6% x 2 x 1.8
    • = 13.0%
    PM TA TO EM ROE 2001 2.6% 2.3 2.2 13.3% 2002 -2.7% 2.1 5.8 -32.5% 2003E 3.6% 2.0 1.8 13.0% Ind. 3.5% 2.6 2.0 18.2%
  • 18. Appraising profitability with the return on assets and return on equity
    • Both ratios rebounded from the previous year, but are still below the industry average. More improvement is needed.
    • Wide variations in ROE illustrate the effect that leverage can have on profitability.
    2004 2003 2002 Ind. ROA 7.3% -5.6% 6.0% 9.1% ROE 13.0% -32.5% 13.3% 18.2%
  • 19. Why are ratios useful?
    • Ratios standardize numbers and facilitate comparisons.
    • Ratios are used to highlight weaknesses and strengths.
  • 20. NON-FINANCIAL ASPECTS OF COMPANY EVALUATION
    • Number of customers, suppliers, products
    • Amount of oversees business
    • Competition
    • Laws and regulations
    • Management
    (Possible problem of “double counting.”
  • 21. PROBLEMS OR LIMITATIONS OF RATIO ANALYSIS
    • Determining the industry.
    • Accounting practices differ.
    • Industry average may not be appropriate.
    • Ratios may be misleading (for example, high current ratio)
    • Seasonal changes