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Chapter 6Chapter 6Financial Statement Financial Statement

AnalysisAnalysis© 2001 Prentice-Hall, Inc.

Fundamentals of Financial Management, 11/eCreated by: Gregory A. Kuhlemeyer, Ph.D.

Carroll College, Waukesha, WI

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Examples of External Uses Examples of External Uses of Statement Analysisof Statement Analysis

Trade CreditorsTrade Creditors -- Focus on the liquidity of the firm.

BondholdersBondholders -- Focus on the long-term cash flow of the firm.

ShareholdersShareholders -- Focus on the profitability and long-term health of the firm.

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Examples of Internal Uses Examples of Internal Uses of Statement Analysisof Statement Analysis

PlanPlan -- Focus on assessing the current financial position and evaluating potential firm opportunities.

ControlControl -- Focus on return on investment for various assets and asset efficiency.

UnderstandUnderstand -- Focus on understanding how suppliers of funds analyze the firm.

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Primary Types of Primary Types of Financial StatementsFinancial Statements

Income StatementIncome Statement A summary of a firm’s revenues and

expenses over a specified period, ending with net income or loss for the period.

Balance SheetBalance Sheet A summary of a firm’s financial position on

a given date that shows total assets = total liabilities + owners’ equity.

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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.cc 394 Inventories 696 Prepaid Exp dd 5 Accum Tax Prepay 10 Current AssetsCurrent Assetsee $1,195 $1,195 Fixed Assets (@Cost)ff 1030 Less: Acc. Depr. gg (329) Net Fix. AssetsNet Fix. Assets $ 701 $ 701 Investment, LT 50 Other Assets, LT 223 Total Total AssetsAssets bb $2,169 $2,169

Basket Wonders Balance Sheet (thousands) Dec. 31, 2003Basket Wonders Balance Sheet (thousands) Dec. 31, 2003a

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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. Payablecc 94 Accrued Taxes dd 16 Other Accrued Liab. dd 100 Current Liab.Current Liab. ee $ 500 $ 500 Long-Term Debt ff 530 Shareholders’ Equity Com. Stock ($1 par) gg 200 Add Pd in Capital gg 729 Retained Earnings hh 210

Total EquityTotal Equity $ $1,1391,139 Total Liab/EquityTotal Liab/Equitya,ba,b $2,169 $2,169

Basket Wonders Balance Sheet (thousands) Dec. 31, 2003Basket Wonders Balance Sheet (thousands) Dec. 31, 2003

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Basket Wonders’ Basket Wonders’ Income StatementIncome 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 Sold bb 1,599

Gross Profit $ 612 SG&A Expenses c c 402 EBITd $ 210 Interest Expensee 59 EBT f f $ 151 Income Taxes 60 EATg $ 91 Cash Dividends 38 Increase in REIncrease in RE $ 53 $ 53

Basket Wonders Statement of Earnings (in thousands) Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31, 2003for Year Ending December 31, 2003a

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Use of Financial RatiosUse of Financial Ratios

Types of Types of ComparisonsComparisons

Internal Internal ComparisonsComparisons

External External ComparisonsComparisons

A Financial Ratio is an index that relates

two accounting numbers and is

obtained by dividing one number by the

other.

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Liquidity RatiosLiquidity RatiosCurrentCurrent

Current AssetsCurrent AssetsCurrent LiabilitiesCurrent 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

= 2.392.39

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Liquidity Ratio Liquidity Ratio ComparisonsComparisons

BW Industry2.39 2.152.26 2.091.91 2.01

Year200320022001

CurrentCurrent RatioRatio

Ratio is stronger than the industry average.

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Liquidity RatiosLiquidity RatiosAcid-Test (Quick)Acid-Test (Quick)

Current Assets - InvCurrent Assets - InvCurrent LiabilitiesCurrent 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

= 1.001.00

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Liquidity Ratio Liquidity Ratio ComparisonsComparisons

BW Industry1.00 1.251.04 1.231.11 1.25

Year200320022001

Acid-Test RatioAcid-Test Ratio

Ratio is weaker than the industry average.

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Summary of the Liquidity Summary of the Liquidity Ratio ComparisonsRatio 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.

RatioRatio BWBW IndustryIndustryCurrent 2.39 2.15Acid-Test 1.00 1.25

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Financial Leverage RatiosFinancial Leverage RatiosDebt-to-EquityDebt-to-Equity

Total DebtTotal DebtShareholders’ EquityShareholders’ Equity

For Basket Wonders December 31, 2003Shows the extent to

which the firm is financed by debt.

Balance Sheet Ratios

Financial LeverageRatios

$1,030$1,030$1,139$1,139

= .90.90

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Financial Leverage RatiosFinancial Leverage RatiosDebt-to-Total-AssetsDebt-to-Total-Assets

Total DebtTotal DebtTotal AssetsTotal Assets

For Basket Wonders December 31, 2003Shows the percentage

of the firm’s assets that are supported by

debt financing.

Balance Sheet Ratios

Financial LeverageRatios

$1,030$1,030$2,169$2,169

= .47.47

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Coverage RatiosCoverage RatiosInterest CoverageInterest Coverage

EBITEBITInterest ChargesInterest Charges

For Basket Wonders December 31, 2003Indicates a firm’s

ability to cover interest charges.

Income StatementRatios

Coverage Ratios

$210$210$59$59

= 3.563.56

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Summary of the Coverage Summary of the Coverage Trend AnalysisTrend Analysis

This indicates that low earnings low earnings (EBIT) may be a potential problem for BWBW.

Note, we know that debt levels debt levels are in line with the industryindustry averages.

The interest coverage ratio for BWBW has been falling since 2001. It has been below industryindustry averages for the past two years.

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Activity RatiosActivity RatiosInventory TurnoverInventory Turnover

Cost of Goods SoldCost of Goods SoldInventoryInventory

For Basket Wonders December 31, 2003Indicates the

effectiveness of the inventory management practices of the firm.

Income Statement /Balance Sheet

Ratios

Activity Ratios

$1,599$1,599$696$696

= 2.302.30

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Inventory Turnover Ratio --Inventory Turnover Ratio --Trend Analysis ComparisonTrend Analysis Comparison

Trend Analysis of Inventory Turnover Ratio

2.0

2.5

3.0

3.5

4.0

2001 2002 2003

Analysis Year

Rat

io V

alue

BWIndustry

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Activity RatiosActivity RatiosTotal Asset TurnoverTotal Asset Turnover

Net SalesNet SalesTotal AssetsTotal Assets

For Basket Wonders December 31, 2003Indicates 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

= 1.021.02

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Profitability RatiosProfitability RatiosGross Profit MarginGross Profit Margin

Gross ProfitGross ProfitNet SalesNet Sales

For Basket Wonders December 31, 2003Indicates the efficiency

of operations and firm pricing policies.

Income Statement /Balance Sheet

Ratios

Profitability Ratios

$612$612$2,211$2,211

= .277277

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Profitability RatiosProfitability RatiosNet Profit MarginNet Profit Margin

Net Profit after TaxesNet Profit after TaxesNet SalesNet Sales

For Basket Wonders December 31, 2003Indicates 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

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Profitability RatiosProfitability RatiosReturn on InvestmentReturn on Investment

Net Profit after TaxesNet Profit after TaxesTotal AssetsTotal Assets

For Basket Wonders December 31, 2003Indicates 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

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Profitability RatiosProfitability RatiosReturn on EquityReturn on Equity

Net Profit after TaxesNet Profit after TaxesShareholders’ EquityShareholders’ Equity

For Basket Wonders December 31, 2003Indicates 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