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Chap002 Chap002 Presentation Transcript

  • Evaluating Financial Performance CHAPTER 2 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
  • Introduction
    • Analogy to flight cockpit.
    • Indicators and levers.
  • Levers of Financial Performance
    • ROE is Net Income divided by Shareholders’ equity.
    • Why is this a sensible definition?
    • 3 determinants of ROE are
      • Profit margin -- Net income / Sales
      • Asset turnover -- Sales / Assets
      • Financial leverage -- Assets / Shareholders’ equity
    • Compare different companies on these.
  • TABLE 2-1 ROEs and Levers of Performance for 10 Diverse Companies, 2007*
  • Comparisons
    • Differences in ROE across firms is less than differences in components.
    • Why?
    • Role of competition?
    • Is there any reason why profit margin and asset returns are negatively related?
  • ROA
    • How defined?
    • Net income / Assets
    • What does this measure?
    • Net income + interest / Assets?
  • Gross Margin
    • Gross Profit / Sales
    • Gross profit = ?
    • Are COGS variable or fixed?
    • Why is it important to distinguish between variable and fixed costs?
  • Asset Turnover
    • Take another look at Table 2-1.
    • Which companies have high asset turnovers?
    • Which is likely to be more sensitive to external events, current assets or fixed assets?
  • TABLE 2-1 ROEs and Levers of Performance for 10 Diverse Companies, 2007
    • What is a self-liquidating loan?
      • What happens to AR and inventory when sales go up?
      • What happens to AR and inventory when sales go down?
    • What does a ratio like AR/Sales tell us?
    • Collection period (DSO)?
  • Inventory Turns
    • COGS / Ending inventory
    • What are the turns?
  • Days’ Sales in Cash
    • Cash + Securities / Sales per day
    • What does this ratio measure?
    • Cash as a substitute?
  • Payables Period
    • AP / Credit purchases per day
    • COGS as a proxy for Credit purchases.
    • Inventory changes do what?
    • Labor costs do what?
  • Fixed Asset Turnover
    • Sales / Net PP&E
    • Capital intensity?
    • What’s the wheel analogy?
  • Financial Leverage
    • What does increased financial leverage do to ROE?
    • Is increased leverage a good thing?
    • Florida Power vs. Netflix and Genentech in Table 2-1?
    • JPMorgan Chase?
    • Have a look, and describe what you see, along with an explanation.
  • TABLE 2-1 ROEs and Levers of Performance for 10 Diverse Companies, 2007
  • Balance Sheet Ratios
    • Debt-to-assets = Total liabilities / Total assets
    • Debt-to-equity = Total liabilities / Shareholders’ equity
    • What do these ratios measure?
  • Coverage Ratios
    • TIE = EBIT / Interest expense
    • Times burden covered = EBIT divided by the sum of interest and principal repayment/1- tax rate.
      • Includes repayment of principal
      • Adjusts for differential impact of what in respect to tax?
    • Which coverage ratio is more important?
    • How much coverage is enough?
    • Cash, borrowing capacity, salable assets, business risk
  • Market Value Leverage Ratios
    • D/E and D/A
    • What do they represent?
    • Coverage ratios?
    • Growth prospects and future coverage potential?
    • Rollover risk?
  • Liquidity Ratios
    • Current ratio = Current Assets / Current Liabilities
    • Acid test removes inventory from current assets to yield the quick ratio.
  • Is ROE a Reliable Yardstick?
    • Timing
      • Forward looking and long-term perspective?
    • Risk
      • Impact of leverage
      • ROIC = EBIT(1-Tax rate) / Interest Bearing Debt + Equity
      • AP excluded
    • Value
      • Book value vs. market value
      • Earnings yield, inverse of P/E
    • Back to ROIC.
  • ROIC Is Not Distorted by Company Financing
  • ROE or Market Price?
    • Which is the better way to measure financial performance?
      • Value creation for investors involves market values.
      • Line of sight?
      • Asymmetric information?
      • External effects, economy, other stocks, etc.?
  • Scatter Plots
    • Price-to-book vs. ROE (weighted average)
    • Figures 2-1 and 2-2 coming up.
    • Slope and dispersion (R-squared)?
  • FIGURE 2-1 Market Value to Book Value of Equity versus Return on Equity for 37 Household Products and Related Companies
  • FIGURE 2-2 Market to Book Value of Equity versus Return on Equity for 87 Large Corporations
  • Using Ratios Effectively
    • Ratio values need to be understood in context.
    • Usually, no “correct” values for ratios.
    • Rely on rule of thumb assessment techniques, such as comps and own time series changes.
  • Figure 2-3 The Levers of Performance Suggest One Road Map for Ratio Analysis
  • Scotts Miracle-Gro
    • Time series of Scotts ROE?
      • Recap in 2007? Quality?
    • ROIC?
    • Profit margin?
      • Puzzle?
    • Gross margin?
      • How strong a brand?
  • Asset Turnover
    • Asset turnover.
      • Low or high?
      • Good or bad?
    • Fixed asset turnover?
    • Inventory turnover?
    • Collection period?
    • Days’ sales in cash?
  • Leverage and Liquidity Ratios?
    • Impact of recap?
    • TIE or TBurdenCovered?
    • Compare Scotts to industry averages: see next slide.
  • TABLE 2-2 Ratio Analysis of Scotts Miracle-Gro Co., 2003-2007, and Industry Averages, 2007
  • Common Size Financial Statements
    • Collection period, inventory turnover vs. ratios of AR and inventory to assets?
      • Sales/assets?
    • Working capital?
      • Fraction of assets that are short-term?
    • COGS
      • Small %s can be large relative to net income.
  • TABLE 2-3 Scotts Miracle-Gro Co., Common-Size Financial Statements, 2003 –2007 and Industry Averages for 2007
  • TABLE 2-3 Scotts Miracle-Gro Co., Common-Size Financial Statements, 2003 –2007 and Industry Averages for 2007 ( continued )
  • Opportunities for Cash?
    • A challenge?
    • Examine statement of cash flows, contrasting cash flows from operations to cash flows from investment.
    • Excess cash?
    • Recap + distribution to shareholders?
  • TABLE 2-4 Selected Ratios for Representative Industries, 2006 (upper-quartile, median and lower-quartile values)
  • TABLE 2-4 Selected Ratios for Representative Industries, 2006 (upper-quartile, median and lower-quartile values) ( continued )
  • TABLE 2-5 Definitions of Principal Ratios Appearing in Chapter
  • TABLE 2-5 Definitions of Principal Ratios Appearing in Chapter ( continued )
  • Appendix International Differences
    • In the upcoming table, look at the UK, Germany and Japan.
    • Asset turns and profit margins in Asia and Latin America?
    • Japanese collection periods, payables periods, and keiretsu .
    • Leverage and liquidity across the globe?
  • Public Companies
    • Indebtedness in Latin America vs. U.S., Europe, and Japan?
    • Indebtedness in Korea, Thailand, Indonesia?
      • Controlling families, state-owned banks, and the state
      • Use of banks to foster top-down directed development
  • TABLE 2A-1 Ratio Analysis of Companies in Various Countries and Regions, 2007, Median Values
  • TABLE 2A-1 ( Continued )
  • Figure 2A.1 Average Interest Coverage Ratio, 1996
  • IFAS
    • International Financial Accounting Standards.
    • 2005, Europe adopts IFAS.
    • Post Enron and WorldCom, U.S. will adopt IFAS.
    • Consolidated balance sheets vs. those of parent, expensing R&D, fair value accounting.
    • Principles vs. rules.