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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.