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Chapter 11
Analysis of Financial Statements
© 2005 Thomson/South-Western
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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$
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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$
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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$
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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.
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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
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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?
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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
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What is Unilate’sCurrent Ratio?
Current Ratio = Current AssetsCurrent Liabilities
$465.0$130.0
= = 3.6 times
Industry average = 4.1 times
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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
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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.
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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.
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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
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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
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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.
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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
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Calculate the Times-Interest-Earned Ratio
TIE = EBIT Interest charges
3.3 times$40.0
$130.0==
Industry Average = 6.5 times
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Calculate theFixed Charge Coverage Ratio
All three previous ratios reflect use of debt, but focus on different aspects.
payments
Lease
charges
Interestpayments LeaseEBIT
FCC
8.250$
0.140$
0.10$0.40$
$10.0$130.0
Industry Average = 5.8x
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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%==
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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
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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 =
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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 =
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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%
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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)
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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