chapter 11 analysis of financial statements

Chapter 11

Analysis of Financial Statements

2

Financial Statements and Reports

The Income Statement

The Balance Sheet

Statement of Cash Flows

Statement of Retained Earnings

3

Unilate Textiles: Comparative IS 2009 2008

Net Sales 1,500.0$ 1,435.0$ Cost of Goods Sold (1,230.0) (1,176.7)

Gross Profit 270.0 258.3 Fixed Operating Expenses (90.0) (85.0) Depreciation (50.0) (40.0)

EBIT 130.0 133.3 Interest (40.0) (35.0)

EBT 90.0 98.3 Taxes (40%) (36.0) (39.3)

Net Income 54.0$ 59.0$ Preferred Dividends - -

EAC 54.0 59.0 Common Dividends (29.0) (27.0)

Additions to Retained Earnings 25.0$ 32.0$

4

Unilate Textiles: Comparative BS2009 2008

AssetsCash & Marketable Securities 15.0$ 40.0$ Accounts Receivable 180.0 160.0 Inventory 270.0 200.0 Total Current Assets 465.0$ 400.0$ Gross Plant & Equipment 680.0$ 600.0$ Less: Accumulated Deprec. (300.0) (250.0) Net Plant & Equipment 380.0$ 350.0$ Total Assets 845.0$ 750.0$

5

Unilate Textiles: Liabilities and Equity

2009 2008Liabilities & EquityAccounts Payable 30.0$ 15.0$ Accruals 60.0 55.0 Notes Payable 40.0 35.0 Total Current Liabilities 130.0$ 105.0$ Long-Term Bonds 300.0 255.0 Total Liabilities 430.0$ 360.0$ Common Stock 130.0 130.0 Retained Earnings 285.0 260.0 Owner's Equity 415.0$ 390.0$

Total Liabilites & Equity 845.0$ 750.0$

6

Ratio Analysis

Analysis of a firm’s ratios is generally the first step in financial analysis.

Ratios are designed to show relationships between financial statement accounts within firms and between firms.

7

What is the Purpose of Ratio Analysis?

Give idea of how well the company is doing

Standardize numbers; facilitate comparisons

Used to highlight weaknesses and strengths

8

What Are the Five Major Categories of Ratios?What Questions Do They Answer?

Liquidity: Can we make required payments in the current period?

Asset mgt.: Right amount of assets vs. sales? Debt mgt.: Right mix of debt and equity? Profitability: Do sales prices exceed unit costs, and

are sales high enough as reflected in PM, ROE, and ROA?

Market values: Do investors like what they see as reflected in P/E and M/B ratios?

9

Industry Average Data

Ratio 2009Current 4.1xQuick 2.1xInventory Turnover 7.4xDays Sales Outstanding (DSO)32.1 daysFixed Asset Turnover 4.0xTotal Asset Turnover 2.1xDebt Ratio 45.0%TIE 6.5xFixed Charge Coverage 5.8xProfit Margin 4.7%ROA 12.6%ROE 17.2%Price/Earnings 13.0xMarket/Book 2.0x

10

What is Unilate’sCurrent Ratio?

Current Ratio = Current AssetsCurrent Liabilities

$465.0$130.0

= = 3.6 times

Industry average = 4.1 times

11

What is Unilate’sQuick, or Acid Test, Ratio?

Industry average = 2.1 times

$465.0 - $270.0$130.0

Quick Ratio = Current Assets- InventoriesCurrent Liabilities

= = = 1.5 times$195.0$130.0

12

Unilate’s Liquidity Position

Ratios is slightly below industry average. Inventories are the least liquid of Unilate’s

assets and they are the assets that suffer losses in the event of a forced sale.

The quick ratio shows that, if receivables are collected in full, Unilate can payoff its current liabilities without having to liquidate its inventory.

13

What is Unilate’s Inventory Turnover Ratio?

=$1,230.0$270.0

= 4.66. times

Inventory turnover =Cost of good sold

Inventories

Industry average = 7.4 times

• Compares poorly with industry• May be holding excess inventories• May be holding old/obsolete inventory.

14

What is Unilate’s Days Sales Outstanding Ratio?

Industry average = 32.1 days

days 43.2$4.167

$180.0

360

$1,500.0

$180.0

360

Sales Annual

sReceivable

SalesDaily

sReceivableDSO

15

What is Unilate’s Fixed Assets Turnover Ratio?

Fixed assets turnover =Sales

Net fixed assets

=$1,500.0$380.0

= 3.9 times

= 4.0 timesIndustry Average

16

What is Unilate’s Total Assets Turnover Ratios?

Total asse ts turnover =Sales

Total asse ts

=$1,500.0$845.0 = 1.8 times

= 2.1 timesIndustry Average

TA turnover is below industry average.Unilate might have excess inventories &

receivables.

17

Calculate the Debt Ratio

Debt Ratio = Total debt Total assets

= +

=

$130.0. $300.0.$845.0

45.0%

= $430.0$845.0

=0.509 = 50.9%

Industry Average

18

Calculate the Times-Interest-Earned Ratio

TIE = EBIT Interest charges

3.3 times$40.0

$130.0==

Industry Average = 6.5 times

19

Calculate theFixed Charge Coverage Ratio

All three previous ratios reflect use of debt, but focus on different aspects.

payments

Lease

charges

Interestpayments LeaseEBIT

FCC

8.250$

0.140$

0.10$0.40$

$10.0$130.0

Industry Average = 5.8x

20

Unilate’s Profitability Ratios--Profit Margin, ROA, and ROE

4.7%Industry Average =

Profit margin = Net income

Sales

$54.0$1,500

0.036 = 3.6%==

21

Unilate’s ROA, and ROE

12.6%Industry Average =

17.2%Industry Average =

$54.0$845.0

= 0.064 = 6.4%

=

ROA = Net income

Total assets

$54.0$415.0

- 0 = 0.130 = 13.0%=

ROENet income

=Common equity

22

Unilate’s Market Value Ratios Price/Earnings Ratio

10.6 times $2.16$23.00

Price / earnings ratio =Price per share

Earnings per share

13.0 timesIndustry Average =

23

Unilate’s Market Value Ratios Market/Book Ratio

Market / Book ratio = Market price per share

Book value per share

$23.00$16.00

1.4 times

2.0 timesIndustry Average =

24

Summary of Ratio Analysis:The DuPont Equation

ROA = Net Profit Margin X Total Assets TurnoverNet Income

Sales

Sales Total Assets

X=

$54.0$1,500.0

X=$1,500.0$845.0

= 3.6% X 1.8 = 6.4%

25

DuPont Equation Provides Overview

Firm’s profitability (measured by ROA)

Firm’s expense control (measured by profit margin)

Firm’s asset utilization (measured by total asset turnover)

26

Limitations of Ratio Analysis? Comparison with industry averages is difficult if

the firm operates many different divisions. “Average” performance not necessarily good. Inflation distorts balance sheets. Seasonal factors can distort ratios. “Window dressing” techniques can make

statements and ratios look better. Different operating and accounting practices

distort comparisons. Sometimes hard to tell if a ratio is “good” or

“bad” Difficult to tell whether company is, on balance,

in strong or weak position