3. 3
Examples of External Uses
Examples of External Uses
of Statement Analysis
of Statement Analysis
Trade Creditors
Trade Creditors -- Focus on the
liquidity of the firm.
Bondholders
Bondholders -- Focus on the
long-term cash flow of the firm.
Shareholders
Shareholders -- Focus on the
profitability and long-term health of
the firm.
4. 4
Examples of Internal Uses
Examples of Internal Uses
of Statement Analysis
of Statement Analysis
Plan
Plan -- Focus on assessing the current
financial position and evaluating
potential firm opportunities.
Control
Control -- Focus on return on investment
for various assets and asset efficiency.
Understand
Understand -- Focus on understanding
how suppliers of funds analyze the firm.
5. 5
Primary Types of
Primary Types of
Financial Statements
Financial Statements
Income Statement
Income Statement
A summary of a firm’s revenues and
expenses over a specified period, ending
with net income or loss for the period.
Balance Sheet
Balance Sheet
A summary of a firm’s financial position on
a given date that shows total assets = total
liabilities + owners’ equity.
6. 6
Basket Wonders’ Balance
Basket Wonders’ Balance
Sheet (Asset Side)
Sheet (Asset Side)
a. How the firm stands on
a specific date.
b. What BW owned.
c. Amounts owed by
customers.
d. Future expense items
already paid.
e. Cash/likely convertible
to cash within 1 year.
f. Original amount paid.
g. Acc. deductions for
wear and tear.
Cash and C.E. $ 90
Acct. Rec.c
c
394
Inventories 696
Prepaid Expd
d
5
Accum Tax Prepay 10
Current Assets
Current Assetse
e
$1,195
$1,195
Fixed Assets (@Cost)f
f
1030
Less: Acc. Depr. g
g
(329)
Net Fix. Assets
Net Fix. Assets $ 701
$ 701
Investment, LT 50
Other Assets, LT 223
b
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003a
7. 7
Basket Wonders’ Balance
Basket Wonders’ Balance
Sheet (Liability Side)
Sheet (Liability Side)
a. Note, Assets =
Liabilities + Equity.
b. What BW owed and
ownership position.
c. Owed to suppliers for
goods and services.
d. Unpaid wages,
salaries, etc.
e. Debts payable < 1 year.
f. Debts payable > 1 year.
g. Original investment.
h. Earnings reinvested.
Notes Payable $ 290
Acct. Payablec
c
94
Accrued Taxesd
d
16
Other Accrued Liab.d
d
100
Current Liab.
Current Liab.e
e
$
$
500
500 Long-Term Debtf
f
530 Shareholders’
Equity Com. Stock ($1
par)g
g
200 Add Pd in Capitalg
g
729 Retained
Earningsh
h
210 Total
Total
Equity
Equity $
$1,139
1,139
a,b
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003
8. 8
Basket Wonders’
Basket Wonders’
Income Statement
Income Statement
a. Measures profitability
over a time period.
b. Received, or receivable,
from customers.
c. Sales comm., adv.,
officers’ salaries, etc.
d. Operating income.
e. Cost of borrowed funds.
f. Taxable income.
g. Amount earned for
shareholders.
Net Sales $ 2,211
Cost of Goods Soldb
b
1,599
Gross Profit $ 612
SG&A Expensesc
c
402
EBITd
$
210 Interest Expensee
59 EBTf
f
$
151 Income Taxes 60
EATg
$ 91
Cash Dividends 38
Increase in RE
Increase in RE $ 53
$ 53
Basket Wonders Statement of Earnings (in thousands)
Basket Wonders Statement of Earnings (in thousands)
for Year Ending December 31, 2003
for Year Ending December 31, 2003a
9. 9
Framework for
Framework for
Financial Analysis
Financial Analysis
Analytical Tools Used
Analytical Tools Used
Sources and Uses Statement
Statement of Cash Flows
Cash Budgets
1. Analysis of the funds
1. Analysis of the funds
needs of the firm.
needs of the firm.
Trend / Seasonal Component
Trend / Seasonal Component
How much funding will be
required in the future?
Is there a seasonal
component?
10. 10
Framework for
Framework for
Financial Analysis
Financial Analysis
Health of a Firm
Financial Ratios
1. Individually
2. Over time
3. In combination
4. In comparison
1. Analysis of the funds
needs of the firm.
2. Analysis of the financial
2. Analysis of the financial
condition and profitability
condition and profitability
of the firm.
of the firm.
11. 11
Framework for
Framework for
Financial Analysis
Financial Analysis
Examples
Examples:
:
Volatility in sales
Volatility in costs
Proximity to break-even
point
1. Analysis of the funds
needs of the firm.
2. Analysis of the financial
condition and profitability
of the firm.
3. Analysis of the business
3. Analysis of the business
risk of the firm.
risk of the firm.
Business risk
Business risk relates to
the risk inherent in the
operations of the firm.
12. 12
Framework for
Framework for
Financial Analysis
Financial Analysis
A Financial
Manager
must
consider all
three jointly
when
determining
the
financing
needs of the
firm.
Determining
Determining
the
the
financing
financing
needs of
needs of
the firm.
the firm.
1. Analysis of the funds
1. Analysis of the funds
needs of the firm.
needs of the firm.
2. Analysis of the financial
2. Analysis of the financial
condition and profitability
condition and profitability
of the firm.
of the firm.
3. Analysis of the business
3. Analysis of the business
risk of the firm.
risk of the firm.
13. 13
Framework for
Framework for
Financial Analysis
Financial Analysis
Negotiations
Negotiations
with
with
suppliers of
suppliers of
capital.
capital.
Determining
Determining
the
the
financing
financing
needs of
needs of
the firm.
the firm.
1. Analysis of the funds
1. Analysis of the funds
needs of the firm.
needs of the firm.
2. Analysis of the financial
2. Analysis of the financial
condition and profitability
condition and profitability
of the firm.
of the firm.
3. Analysis of the business
3. Analysis of the business
risk of the firm.
risk of the firm.
14. 14
Use of Financial Ratios
Use of Financial Ratios
Types of
Types of
Comparisons
Comparisons
Internal
Internal
Comparisons
Comparisons
External
External
Comparisons
Comparisons
A Financial Ratio is
an index that relates
two accounting
numbers and is
obtained by dividing
one number by the
other.
15. 15
External Comparisons and
External Comparisons and
Sources of Industry Ratios
Sources of Industry Ratios
Examples:
Robert Morris
Robert Morris
Associates
Associates
Dun & Bradstreet
Dun & Bradstreet
Almanac of
Almanac of
Business and
Business and
Industrial
Industrial
Financial Ratios
Financial Ratios
This involves
comparing the ratios
of one firm with those
of similar
similar firms or with
industry averages.
Similarity
Similarity is important
as one should
compare “apples to
apples.”
16. 16
Liquidity Ratios
Liquidity Ratios
Current
Current
Current Assets
Current Assets
Current Liabilities
Current Liabilities
For Basket Wonders
December 31, 2003
Shows a firm’s
ability to cover its
current liabilities
with its current
assets.
Balance Sheet Ratios
Liquidity Ratios
$1,195
$1,195
$500
$500
= 2.39
2.39
18. 18
Liquidity Ratios
Liquidity Ratios
Acid-Test (Quick)
Acid-Test (Quick)
Current Assets - Inv
Current Assets - Inv
Current Liabilities
Current Liabilities
For Basket Wonders
December 31, 2003
Shows a firm’s
ability to meet
current liabilities
with its most liquid
assets.
Balance Sheet Ratios
Liquidity Ratios
$1,195 - $696
$1,195 - $696
$500
$500
= 1.00
1.00
20. 20
Summary of the Liquidity
Summary of the Liquidity
Ratio Comparisons
Ratio Comparisons
Strong current ratio and weak acid-test
ratio indicates a potential problem in
the inventories account.
Note that this industry has a relatively
high level of inventories.
Ratio
Ratio BW
BW Industry
Industry
Current 2.39 2.15
Acid-Test 1.00 1.25
21. 21
Current Ratio -- Trend
Current Ratio -- Trend
Analysis Comparison
Analysis Comparison
Trend Analysis of Current Ratio
1.5
1.7
1.9
2.1
2.3
2.5
2001 2002 2003
Analysis Year
Ratio
Value
BW
Industry
22. 22
Acid-Test Ratio -- Trend
Acid-Test Ratio -- Trend
Analysis Comparison
Analysis Comparison
Trend Analysis of Acid-Test Ratio
0.5
0.8
1.0
1.3
1.5
2001 2002 2003
Analysis Year
Ratio
Value
BW
Industry
23. 23
Summary of the Liquidity
Summary of the Liquidity
Trend Analyses
Trend Analyses
The current ratio for the industry
industry has
been rising slowly at the same time the
acid-test ratio has been relatively
stable.
This indicates that inventories
inventories are a
significant problem for BW
BW.
The current ratio for BW
BW has been rising
at the same time the acid-test ratio has
been declining.
24. 24
Financial Leverage Ratios
Financial Leverage Ratios
Debt-to-Equity
Debt-to-Equity
Total Debt
Total Debt
Shareholders’ Equity
Shareholders’ Equity
For Basket Wonders
December 31, 2003
Shows the extent to
which the firm is
financed by debt.
Balance Sheet Ratios
Financial Leverage
Ratios
$1,030
$1,030
$1,139
$1,139
= .90
.90
25. 25
Financial Leverage
Financial Leverage
Ratio Comparisons
Ratio Comparisons
BW Industry
.90 .90
.88 .90
.81 .89
Year
2003
2002
2001
Debt-to-Equity Ratio
Debt-to-Equity Ratio
BW has average debt utilization
relative to the industry average.
26. 26
Financial Leverage Ratios
Financial Leverage Ratios
Debt-to-Total-Assets
Debt-to-Total-Assets
Total Debt
Total Debt
Total Assets
Total Assets
For Basket Wonders
December 31, 2003
Shows the
percentage of the
firm’s assets that are
supported by debt
financing.
Balance Sheet Ratios
Financial Leverage
Ratios
$1,030
$1,030
$2,169
$2,169
= .47
.47
27. 27
Financial Leverage
Financial Leverage
Ratio Comparisons
Ratio Comparisons
BW Industry
.47 .47
.47 .47
.45 .47
Year
2003
2002
2001
Debt-to-Total-Asset Ratio
Debt-to-Total-Asset Ratio
BW has average debt utilization
relative to the industry average.
28. 28
Financial Leverage Ratios
Financial Leverage Ratios
Total Capitalization
Total Capitalization
Total Debt
Total Debt
Total Capitalization
Total Capitalization
For Basket Wonders
December 31, 2003
Shows the relative
importance of long-term
debt to the long-term
financing of the firm.
Balance Sheet Ratios
Financial Leverage
Ratios
$1,030
$1,030
$1,669
$1,669
= .62
.62
(i.e., LT-Debt + Equity)
29. 29
Financial Leverage
Financial Leverage
Ratio Comparisons
Ratio Comparisons
BW Industry
.62 .60
.62 .61
.67 .62
Year
2003
2002
2001
Total Capitalization Ratio
Total Capitalization Ratio
BW has average long-term debt utilization
relative to the industry average.
30. 30
Coverage Ratios
Coverage Ratios
Interest Coverage
Interest Coverage
EBIT
EBIT
Interest Charges
Interest Charges
For Basket Wonders
December 31, 2003
Indicates a firm’s
ability to cover
interest charges.
Income Statement
Ratios
Coverage Ratios
$210
$210
$59
$59
= 3.56
3.56
31. 31
Coverage
Coverage
Ratio Comparisons
Ratio Comparisons
BW Industry
3.56 5.19
4.35 5.02
10.30 4.66
Year
2003
2002
2001
Interest Coverage Ratio
Interest Coverage Ratio
BW has below average interest coverage
relative to the industry average.
32. 32
Coverage Ratio -- Trend
Coverage Ratio -- Trend
Analysis Comparison
Analysis Comparison
Trend Analysis of Interest Coverage Ratio
3.0
5.0
7.0
9.0
11.0
2001 2002 2003
Analysis Year
Ratio
Value
BW
Industry
33. 33
Summary of the Coverage
Summary of the Coverage
Trend Analysis
Trend Analysis
This indicates that low earnings
low earnings (EBIT)
may be a potential problem for BW
BW.
Note, we know that debt levels
debt levels are in
line with the industry
industry averages.
The interest coverage ratio for BW
BW has
been falling since 2001. It has been
below industry
industry averages for the past
two years.
34. 34
Activity Ratios
Activity Ratios
Receivable Turnover
Receivable Turnover
Annual Net Credit Sales
Annual Net Credit Sales
Receivables
Receivables
For Basket Wonders
December 31, 2003
Indicates quality of
receivables and how
successful the firm is in
its collections.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
$2,211
$2,211
$394
$394
= 5.61
5.61
(Assume all sales are credit sales.)
35. 35
Activity Ratios
Activity Ratios
Avg Collection Period
Avg Collection Period
Days in the Year
Days in the Year
Receivable Turnover
Receivable Turnover
For Basket Wonders
December 31, 2003
Average number of days
that receivables are
outstanding.
(or RT in days)
Income Statement /
Balance Sheet
Ratios
Activity Ratios
365
365
5.61
5.61
= 65 days
65 days
36. 36
Activity
Activity
Ratio Comparisons
Ratio Comparisons
BW Industry
65.0 65.7
71.1 66.3
83.6 69.2
Year
2003
2002
2001
Average Collection Period
Average Collection Period
BW has improved the average collection
period to that of the industry average.
37. 37
Activity Ratios
Activity Ratios
Payable Turnover (PT)
Payable Turnover (PT)
Annual Credit Purchases
Annual Credit Purchases
Accounts Payable
Accounts Payable
For Basket Wonders
December 31, 2003
Indicates the
promptness of payment
to suppliers by the firm.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
$1551
$1551
$94
$94
= 16.5
16.5
(Assume annual credit
purchases = $1,551.)
38. 38
Activity Ratios
Activity Ratios
PT in Days
PT in Days
Days in the Year
Days in the Year
Payable Turnover
Payable Turnover
For Basket Wonders
December 31, 2003
Average number of days
that payables are
outstanding.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
365
365
16.5
16.5
= 22.1 days
22.1 days
40. 40
Activity Ratios
Activity Ratios
Inventory Turnover
Inventory Turnover
Cost of Goods Sold
Cost of Goods Sold
Inventory
Inventory
For Basket Wonders
December 31, 2003
Indicates the
effectiveness of the
inventory management
practices of the firm.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
$1,599
$1,599
$696
$696
= 2.30
2.30
42. 42
Inventory Turnover Ratio
Inventory Turnover Ratio
--Trend Analysis
--Trend Analysis
Comparison
Comparison
Trend Analysis of Inventory Turnover Ratio
2.0
2.5
3.0
3.5
4.0
2001 2002 2003
Analysis Year
Ratio
Value
BW
Industry
43. 43
Activity Ratios
Activity Ratios
Total Asset Turnover
Total Asset Turnover
Net Sales
Net Sales
Total Assets
Total Assets
For Basket Wonders
December 31, 2003
Indicates the overall
effectiveness of the firm
in utilizing its assets to
generate sales.
Income Statement /
Balance Sheet
Ratios
Activity Ratios
$2,211
$2,211
$2,169
$2,169
= 1.02
1.02
44. 44
Activity
Activity
Ratio Comparisons
Ratio Comparisons
BW Industry
1.02 1.17
1.03 1.14
1.01 1.13
Year
2003
2002
2001
Total Asset Turnover Ratio
Total Asset Turnover Ratio
BW has a weak total asset turnover ratio.
Why is this ratio considered weak?
Why is this ratio considered weak?
45. 45
Profitability Ratios
Profitability Ratios
Gross Profit Margin
Gross Profit Margin
Gross Profit
Gross Profit
Net Sales
Net Sales
For Basket Wonders
December 31, 2003
Indicates the efficiency
of operations and firm
pricing policies.
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
$612
$612
$2,211
$2,211
= .277
277
47. 47
Gross Profit Margin --
Gross Profit Margin --
Trend Analysis Comparison
Trend Analysis Comparison
Trend Analysis of Gross Profit Margin
25.0
27.5
30.0
32.5
35.0
2001 2002 2003
Analysis Year
Ratio
Value
(%)
BW
Industry
48. 48
Profitability Ratios
Profitability Ratios
Net Profit Margin
Net Profit Margin
Net Profit after Taxes
Net Profit after Taxes
Net Sales
Net Sales
For Basket Wonders
December 31, 2003
Indicates the firm’s
profitability after taking
account of all expenses
and income taxes.
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
$91
$91
$2,211
$2,211
= .041
.041
50. 50
Net Profit Margin --
Net Profit Margin --
Trend Analysis Comparison
Trend Analysis Comparison
Trend Analysis of Net Profit Margin
4
5
6
7
8
9
10
2001 2002 2003
Analysis Year
Ratio
Value
(%)
BW
Industry
51. 51
Profitability Ratios
Profitability Ratios
Return on Investment
Return on Investment
Net Profit after Taxes
Net Profit after Taxes
Total Assets
Total Assets
For Basket Wonders
December 31, 2003
Indicates the
profitability on the
assets of the firm (after
all expenses and taxes).
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
$91
$91
$2,160
$2,160
= .042
.042
53. 53
Return on Investment –
Return on Investment –
Trend Analysis Comparison
Trend Analysis Comparison
Trend Analysis of Return on Investment
4
6
8
10
12
2001 2002 2003
Analysis Year
Ratio
Value
(%)
BW
Industry
54. 54
Profitability Ratios
Profitability Ratios
Return on Equity
Return on Equity
Net Profit after Taxes
Net Profit after Taxes
Shareholders’ Equity
Shareholders’ Equity
For Basket Wonders
December 31, 2003
Indicates the profitability
to the shareholders of
the firm (after all
expenses and taxes).
Income Statement /
Balance Sheet
Ratios
Profitability Ratios
$91
$91
$1,139
$1,139
= .08
.08
56. 56
Return on Equity --
Return on Equity --
Trend Analysis Comparison
Trend Analysis Comparison
Trend Analysis of Return on Equity
7.0
10.5
14.0
17.5
21.0
2001 2002 2003
Analysis Year
Ratio
Value
(%)
BW
Industry
57. 57
Return on Investment and
Return on Investment and
the Du Pont Approach
the Du Pont Approach
ROI
ROI2003 = .041 x 1.02 = .042
.042 or 4.2%
4.2%
ROI
ROIIndustry = .082 x 1.17 = .098
.098 or 9.8%
9.8%
ROI
ROI = Net profit margin X
Total asset turnover
Earning Power
Earning Power = Sales profitability X
Asset efficiency
58. 58
Return on Equity and
Return on Equity and
the Du Pont Approach
the Du Pont Approach
ROE
ROE2003 = .041 x 1.02 x 1.90 = .080
.080
ROE
ROEIndustry = .082 x 1.17 x 1.88 = .179
179
Return On Equity
Return On Equity = Net profit margin X
Total asset turnover X
Equity Multiplier
Equity Multiplier
Equity Multiplier =
Total Assets
Shareholders’ Equity
59. 59
Summary of the Profitability
Summary of the Profitability
Trend Analyses
Trend Analyses
The profitability ratios for BW
BW have ALL
been falling since 2001. Each has been
below the industry
industry averages for the past
three years.
This indicates that COGS
COGS and
administrative costs
administrative costs may both be too
high and a potential problem for BW
BW.
Note, this result is consistent with the
low interest coverage ratio.
60. 60
Summary of Ratio Analyses
Summary of Ratio Analyses
Inventories are too high.
May be paying off creditors
(accounts payable) too soon.
COGS may be too high.
Selling, general, and
administrative costs may be too
high.
61. 61
Common-size Analysis
Common-size Analysis
An analysis of percentage
financial statements where all
balance sheet items are divided
by total assets and all income
statement items are divided by
net sales or revenues.
62. 62
Basket Wonders’ Common
Basket Wonders’ Common
Size Balance Sheets
Size Balance Sheets
Regular (thousands of $) Common-Size (%)
Assets 2001 2002 2003 2001 2002 2003
Cash 148 100 90 12.10 4.89 4.15
AR 283 410 394 23.14 20.06 18.17
Inv 322 616 696 26.33 30.14 32.09
Other CA 10 14 15 0.82 0.68 0.69
Tot CA 763 1,140 1,195 62.39 55.77 55.09
Net FA 349 631 701 28.54 30.87 32.32
LT Inv 0 50 50 0.00 2.45 2.31
Other LT 111 223 223 9.08 10.91 10.28
Tot Assets 1,223 2,044 2,169 100.0 100.0 100.0
65. 65
Index Analyses
Index Analyses
An analysis of percentage financial
statements where all balance sheet
or income statement figures for a
base year equal 100.0 (percent) and
subsequent financial statement
items are expressed as percentages
of their values in the base year.
66. 66
Basket Wonders’
Basket Wonders’
Indexed Balance Sheets
Indexed Balance Sheets
Regular (thousands of $) Indexed (%)
Assets 2001 2002 2003 2001 2002 2003
Cash 148 100 90 100.0 67.6 60.8
AR 283 410 394 100.0 144.9 139.2
Inv 322 616 696 100.0 191.3 216.1
Other CA 10 14 15 100.0 140.0 150.0
Tot CA 763 1,140 1,195 100.0 149.4 156.6
Net FA 349 631 701 100.0 180.8 200.9
LT Inv 0 50 50 100.0 inf. inf.
Other LT 111 223 223 100.0 200.9 200.9
Tot Assets 1,223 2,044 2,169 100.0 167.1 177.4
