3. Objective Provide Tools to Assess the Global Financial Health of a Company Part 1:Common Size and Comparative Financial Statements Part 2: Financial Statement Ratio Analysis 3
4. Part I Common Size and Comparative Financial Statements 4
10. What is the Current Ratio? An organization’s current ratio consists of the relationship between its current assets and liabilities. Current Assets Current Liabilities Current Ratio = 10
12. Calculating the Current Ratio The current ratio is the ratio between Current Assets and Liabilities 708 540 Current Ratio Current Assets 708 1.31 = = = Current Liabilities 540 12
13. Current Ratio Why Is It Important? Current Assets Current Liabilities Current Ratio = Current Ratio = 1.00 What does this tell me? 3-13
14. Current Ratio Current Assets Current Liabilities Current Ratio = Which company is in the best and worst financial shape? 14
16. Inventory Turnover andDays’ Sales in Inventory Inventory Turnover = 3.2 365 365 Days’ Sales in Inventory = = = 114 days Inventory Turnover 3.2 365 365* Inventory = = 114 days Inventory * COGS COGS 3-16
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18. In the previous example, 114 days. If the company does not add to inventory, it will run out of inventory to sell after 114 days.17
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21. Every time the inventory is low, they order $100,000 of bicycles from their manufacturer.
22. Then Prufrock will buy and sell their $100,000 blocks of inventory 3.2 times during the year.18
23. Days’ Sales in Inventory (Inventory on Hand) What is this Ratio Important? Why Calculate it? 1. Would a Sales Manager want a low or high Days Sales in Inventory Ratio? 2. Would a Chief Financial Officer want a low or high Days’ Sales in Inventory ratio? 19
25. Receivables Turnover and Days’ Sales in Receivables Sales 2,311 Receivables Turnover = = = Accounts Receivable 12.3 188 365 Day’s Sale in Receivables 365 = = = 30 days Receivables Turnover 12.3 21
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27. The HIGHER the number, the better.Why? Higher ratio more sales are made by cash. It is better to have cash from a sale, than a receivable which will may or may not be collected. What if the ratio = 1? Sales = Accounts Receivable 22
28. Days’ Sales in Receivables Whyis this Important? Why Calculate it? 365 Day’s Sale in Receivables 365 = = = 30 days Receivables Turnover 12.3 The LOWER the number, the better. Why? Higher ratio more sales are made by cash. It is better to have cash from a sale, than a receivable which will hopefully be collected. If 30 days, roughly 1 month of sales has not been collected. If 60 days, roughly 2 months of sales has not been collected. 23
29. Profit Margin 2,311 Sales 363 Net Income Profit Margin Net Income 363 = = = 15.7% Sales 2,311 24
30. Profitability Measures Why are they Important? Why Calculate them? Profit Margin 363 Net Income = = = 15.7% Sales 2,311 Profit Margin of 15.7% For every $100 in Sales, the company keeps $15.70 after expenses. Profit Margin of 25% For every $100 in Sales, the company keeps $25.00 after expenses. Profit Margin of 50% For every $100 in Sales, the company keeps $50.00 after expenses. 25
31. Why Analyze Financial Statements? Internal Uses Performance evaluation Planning for the future – estimating future cash flows. Profit Margin of 15% vs. 50% makes could drastically change company’s plans. 3. Compare with companies in same industry. What if Nike Profit Margin = 20% AND Rebook’s Profit Margin = 5%? 26
32. Why Analyze Financial Statements? ExternalUses Creditors – owed money by our company. 2. Suppliers – owed money and rely on sales to our company. 3. Customers – regularly buy our products. 4. Stockholders – own company stock. 27
Hello Everyone, David Stubing. I will introduce myself just briefly.I have spent a lot of my career in corporate accounting.I have been the senior finance officer of small to mid-size companies.I am also a licensed CPA.I am also a Director in a couple of professional associations.
This chapter is all about reviewing a company’s statements to ascertain its health.First we will look at Financial Statements.And then we will see what key financial ratios tell us about the company.
Part 1, Common Size and Comparative Financial Statements.What are they?
Here is your standard income statementIf have had an accounting class this should look familryIt starts with you Sales and subtracts costsShows the dollar amounts
Here is a common size income statementEach line item is listed as a % of SalesAs a former Controller and CFO, I find this one particularly useful.Why is this use do you ask?This tells me For every $100 of Merchandise I see, wepay $58.20 for goods to sellpay $6.10 for interest on loansget to keep 15.7% or $15.70
This is not in the book, but I am going to add it as additional material.I want show you some financial reports I find particulalry useful from working as a CFO for a number of small companies. 08 – 09 -10 When most Accounting textbooks show an Income statement, as we saw before, is often one column with one time period of results.But any organization is certainly not limited to that.Here is a simplified example of a Income Statement I like.It is a combination of a common size income statement and a comparative one.It has three year of data, so as the CFO, I can see a trend.I want you to look at the bottom.Questions for the class?What is the pattern of my Net Income over these three years?What is my pattern of sales?Why is that? The answerSo, if I am the CFO of this, it would behoove me to find out what this isMaybe our supplier has raised its prices.Maybe it is time to find a new supplier.Are the people buying our goods aware of what is going on and the cumulative effect of these price increases.Common Size and Comparative Income Statements can be very useful in analyzing what is happening in your company. Month by MonthHere is a real internal income statementI am a member of the Finance Committee of a nonprofit.What does this show us?Question for the class:Where does most of the organization’s revenue come from?It is on the far right column.What is the organization’s biggest expense?Overall, what is the organization’s financial health? Not good. Over these three months, the organization is spending more money than it has.Thankfully, this organization has large endowment. An endowment is basically a savings account from donations over the years.Most non-profits as well private universities have an endowment.
The next part is using financial statement ratios to analyze the company’s financial health.
A very common financial ratio is the Current RatioHow to calculate it, is to take the Current Assets, here, divided by the Current Liabilities, here.You divide one by the other, and here is our Current ratio.
Question for the class, if the Current Ratio = 1, what does this tell me about the company’s ability to pay its bills?Hint – Current Liabilities are unpaid bills.Hint - Current Assets are either cash, or something that can turned into cash fairly.For an ratio to be 1, it mean the numerator and the denominator are the same.In this case, it has as much current assets as it has current liabilities.The answer is this, if my current ratio is 1, then for every $1 of unpaid bills, I have $1 of cash or cash equivalents.Not bad.
Questions for the Class?I have 3 companies here.Which company is in the best and worst financial shape, in terms of paying its bills.Generally speaking the higher the ratio, the better.So, ABC is in the best shape. They have $1.50 for every $1 in unpaid bills.At the bottom, Stubing’s Bike Store is in trouble. We have 25 cents for every $1 in unpaid bills.
Questions for the Class?I have 3 companies here.Which company is in the best and worst financial shape, in terms of paying its bills.Generally speaking the higher the ratio, the better.So, ABC is in the best shape. They have $1.50 for every $1 in unpaid bills.At the bottom, Stubing’s Bike Store is in trouble. We have 25 cents for every $1 in unpaid bills.
Let’s talk about another useful set of ratios, ReceiveablesPOINTMechanically, Here are the formulas.For turnover, you divie your Sales of the Income Statement by Reciables on the Balance Sheet.For the Day’s Sales, you divide 365 by your turnover figure.Next, how do we use this?Why is this important?
Ratio = 1All Sales are made by credit not cash, and the business has to wait to get paid.You have to wait to get paidNot all customers will pay you.And you will have to hound some before they will pay up.
Why is Day’s Sales in Receibables important?
Internally, the main reason is to gauge how well are doing.Question for the class why would those outsideWhy would a someone outside of the company evaluate our financial statements. For example why would a creditor be interested in the companies financial statements?How are you doing compared to your competitors?If your Profit Margin is 5%, and industry average is 20%, then there is something wrong.
