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Lecture Slides

  1. 1. FINANCIAL RATIOS (using financial statements) <ul><li>Balance sheet </li></ul><ul><li>- Common-sized balance sheet shows assets, </li></ul><ul><li>liabilities, and equity as a % of total assets. </li></ul><ul><li>Income statement </li></ul><ul><li>- Common-sized income statement shows </li></ul><ul><li>income and expense items as a % of sales. </li></ul><ul><li>Statement of cash flows </li></ul>
  2. 2. FINANCIAL RATIOS (standardized measures) <ul><li>Used by managers for planning and evaluation </li></ul><ul><li>Used by credit managers to assess risk </li></ul><ul><li>Used by investors to assess stocks and bonds </li></ul><ul><li>Used to compare with industry and over time </li></ul>
  3. 3. FINANCIAL RATIOS Types of ratios <ul><li>Liquidity </li></ul><ul><li>-ability to meet short term debt </li></ul><ul><li>Asset management </li></ul><ul><li>-efficiency in using resources </li></ul><ul><li>Financial leverage management </li></ul><ul><li>- level of risk due to debt </li></ul><ul><li>Profitability </li></ul><ul><li>-effectiveness in generating profits </li></ul><ul><li>Market-based </li></ul><ul><li>-market’s view of the firm </li></ul>
  4. 4. Liquidity Ratios <ul><li>Current ratio = Current assets Current liabilities </li></ul><ul><li>CR = $50,190 / $25,523 </li></ul><ul><li>CR = 1.97 vs. 2.4 Ind. Avg. </li></ul><ul><li>Quick ratio = Current assets – inventories Current liabilities </li></ul><ul><li>QR = ($50,190 - $27,530) / $25,523 </li></ul><ul><li>QR = .89 vs. .92 Ind. Avg. </li></ul>
  5. 5. Asset Management Ratios <ul><li>Avg collection period = Accounts receivable Annual credit sales/365 </li></ul><ul><li>ACP = $18,320 / ($112,760/365) </li></ul><ul><li>ACP = 59.3 days vs. 47 days Ind. Avg. </li></ul><ul><li>Inventory turnover = Cost of sales Average inventory </li></ul><ul><li>Inv. Turn. = $85,300 / ($27,530 + $26,470)/2 </li></ul><ul><li>Inv. Turn. = 3.16 vs. 3.9 Ind. Avg. </li></ul>
  6. 6. Asset Management Ratios <ul><li>Fixed-asset turnover = Sales Net fixed assets </li></ul><ul><li>FAT = $112,760 / $31,700 </li></ul><ul><li>FAT = 3.56 vs. 4.6 Ind. Avg. </li></ul><ul><li>Total asset turnover = Sales Total assets </li></ul><ul><li>TAT = $112,760 / $81,890 </li></ul><ul><li>TAT = 1.38 vs. 1.82 Ind. Avg. </li></ul>
  7. 7. Financial Leverage Management <ul><li>Debt ratio = Total debt Total assets </li></ul><ul><li>DR = $47,523 / $81,890 </li></ul><ul><li>DR = 58% vs. 47% Ind. Avg. </li></ul><ul><li>Debt-to-equity ratio = Total debt Total equity </li></ul><ul><li>D/E = $47,253 / $34,367 </li></ul><ul><li>D/E = 138.3% vs. 88.7% Ind. Avg. </li></ul>
  8. 8. Financial Leverage Management <ul><li>Times interest earned = EBIT Interest charge </li></ul><ul><li>Coverage Ratio = $11,520 / $3,160 </li></ul><ul><li>Coverage Ratio = 3.65 vs. 6.7 Ind. Avg. </li></ul><ul><li>Equity multiplier = Total assets Total equity </li></ul><ul><li>EM = $81,890 / $34,367 </li></ul><ul><li>EM = 2.38 vs. 1.89 Ind. Avg. </li></ul>
  9. 9. Profitability Ratios <ul><li>Gross profit margin = Sales - Cost of sales Sales </li></ul><ul><li>GPM = ($112,760 - $85,300) / $112,760 </li></ul><ul><li>GPM = 24.4% vs. 25.6% Ind. Avg. </li></ul><ul><li>Net profit margin = EAT Sales </li></ul><ul><li>NPM = $5,016 / $112,760 </li></ul><ul><li>NPM = 4.45% vs. 5.1% Ind. Avg. </li></ul>
  10. 10. Profitability Ratios <ul><li>ROI = EAT Total Assets </li></ul><ul><li>ROI = $5,016 / $81,890 </li></ul><ul><li>ROI = 6.13% vs. 9.28% Ind. Avg. </li></ul><ul><li>ROE = EAT Stockholders equity </li></ul><ul><li>ROE = $5,016 / $34,367 </li></ul><ul><li>ROE = 14.6% vs. 17.54% Ind. Avg. </li></ul>
  11. 11. Market-Based Ratios <ul><li>P/E ratio = Market price per share Current earnings per share </li></ul><ul><li>Market to book ratio= Market price per share Book value per share </li></ul>
  12. 12. Dividend Policy Ratios <ul><li>Payout ratio = Dividends per share EPS </li></ul><ul><li>Dividend yield = Expected dividends per share Stock price </li></ul>
  13. 13. Financial Ratio Analysis <ul><li>Trend analysis 2000 01 02 </li></ul><ul><li>XYZ current ratio 1.9 2.2 2.3 </li></ul><ul><li>Cross-sectional analysis 2002 </li></ul><ul><li>XYZ current ratio 2.3 </li></ul><ul><li>Industry averages 2.5 </li></ul><ul><li>Both simultaneously 2000 01 02 </li></ul><ul><li>XYZ current ratio 1.9 2.2 2.3 </li></ul><ul><li>Industry averages 2.5 2.4 2.5 </li></ul>
  14. 15. Relationships Among Ratios <ul><li>ROI = EAT  Sales = EAT Sales Total assets Total assets </li></ul><ul><li>or </li></ul><ul><li>ROI = Net profit  Total Asset = NPM  TAT margin turnover </li></ul><ul><li>and </li></ul><ul><li>ROE = EAT  Total assets = EAT Total assets Equity Equity </li></ul><ul><li>or </li></ul><ul><li>ROE = ROI  Equity = ROI  EM multiplier </li></ul>
  15. 16. Relationships Among Ratios <ul><li>If </li></ul><ul><li>ROE = ROI  Equity = ROI  EM multiplier </li></ul><ul><li>and </li></ul><ul><li>ROI = Net profit  Total Asset = NPM  TAT margin turnover </li></ul><ul><li>then </li></ul><ul><li>ROE = Net profit  Total Assets  Equity margin turnover multiplier </li></ul><ul><li>or </li></ul><ul><li>ROE = NPM  TAT  EM </li></ul>
  16. 17. Relationships Among Ratios <ul><li>This is the Dupont formula: </li></ul><ul><li>ROE = Net profit  Total Assets  Equity margin turnover multiplier </li></ul><ul><li>or </li></ul><ul><li>ROE = NPM  TAT  EM </li></ul>
  17. 18. Dupont Formula <ul><li>Example of the Dupont formula: </li></ul><ul><li>ROE = NPM  TAT  EM </li></ul><ul><li>Company: </li></ul><ul><li>14.6% = 4.45%  1.38  2.38 </li></ul><ul><li>Industry average: </li></ul><ul><li>17.5% = 5.10%  1.82  1.89 </li></ul>
  18. 19. 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>10K’s </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 data bases </li></ul>

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