Financial management and policy chapter 6

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Chapter 6Chapter 6

Financial Statement Financial Statement AnalysisAnalysis

Financial Statement Financial Statement AnalysisAnalysis

© 2001 Prentice-Hall, Inc.Fundamentals of Financial Management, 11/e

Created by: Gregory A. Kuhlemeyer, Ph.D.Carroll College, Waukesha, WI

Published by Lecturesheet.iiuc28a9.com

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Financial Financial Statement AnalysisStatement AnalysisFinancial Financial Statement AnalysisStatement Analysis

Financial Statements

A Possible Framework for Analysis

Ratio Analysis

Trend Analysis

Common-Size and Index Analysis

Financial Statements

A Possible Framework for Analysis

Ratio Analysis

Trend Analysis

Common-Size and Index Analysis

6-3

Examples of External Uses Examples of External Uses of Statement Analysisof Statement AnalysisExamples 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.

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.

6-4

Examples of Internal Uses Examples of Internal Uses of Statement Analysisof Statement AnalysisExamples 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.

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 StatementsPrimary 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.

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.

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)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.

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 AssetsTotal Assetsbb $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)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.

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 Total EquityEquity $ $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 StatementBasket 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.

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

6-9

Framework for Framework for Financial AnalysisFinancial AnalysisFramework for Framework for Financial AnalysisFinancial Analysis

Analytical Tools UsedAnalytical Tools Used

Sources and Uses Statement

Statement of Cash Flows

Cash Budgets

Analytical Tools UsedAnalytical Tools Used

Sources and Uses Statement

Statement of Cash Flows

Cash Budgets

1. Analysis of the funds1. Analysis of the funds needs of the firm.needs of the firm.

Trend / Seasonal ComponentTrend / Seasonal Component

How much funding will be required in the future?

Is there a seasonal component?

Trend / Seasonal ComponentTrend / Seasonal Component

How much funding will be required in the future?

Is there a seasonal component?

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Health of a Firm

Financial Ratios

1. Individually2. Over time3. In combination4. In comparison

Health of a Firm

Financial Ratios

1. Individually2. Over time3. In combination4. In comparison

1. Analysis of the funds needs of the firm.

2. Analysis of the financial2. Analysis of the financial condition and profitabilitycondition and profitability of the firm.of the firm.

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ExamplesExamples::

Volatility in sales

Volatility in costs

Proximity to break-even point

ExamplesExamples::

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 business3. Analysis of the business risk of the firm.risk of the firm.

Business riskBusiness risk relates to the risk inherent in the operations of the firm.

Business riskBusiness risk relates to the risk inherent in the operations of the firm.

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A Financial Manager

must consider all three jointly

when determining

the financing

needs of the firm.

A Financial Manager

must consider all three jointly

when determining

the financing

needs of the firm.

DeterminingDeterminingthe the

financingfinancingneeds of needs of the firm.the firm.




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NegotiationsNegotiationswithwith

suppliers ofsuppliers ofcapital.capital.

DeterminingDeterminingthe the

financingfinancingneeds of needs of the firm.the firm.




6-14

Use of Financial RatiosUse of Financial RatiosUse of Financial RatiosUse of Financial Ratios

Types of Types of ComparisonsComparisons

Internal Internal ComparisonsComparisons

External External ComparisonsComparisons

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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External Comparisons and External Comparisons and Sources of Industry RatiosSources of Industry RatiosExternal Comparisons and External Comparisons and Sources of Industry RatiosSources of Industry Ratios

Examples:

Robert Morris Robert Morris AssociatesAssociates

Dun & BradstreetDun & Bradstreet

Almanac of Almanac of Business and Business and

Industrial Industrial Financial RatiosFinancial Ratios

Examples:

Robert Morris Robert Morris AssociatesAssociates

Dun & BradstreetDun & Bradstreet

Almanac of Almanac of Business and Business and

Industrial Industrial Financial RatiosFinancial Ratios

This involves comparing the ratios of one firm with those of similarsimilar firms or with

industry averages.

SimilaritySimilarity is important as one should

compare “apples to apples.”

6-16

Liquidity RatiosLiquidity RatiosLiquidity RatiosLiquidity Ratios

CurrentCurrent

Current AssetsCurrent AssetsCurrent LiabilitiesCurrent Liabilities

For Basket Wonders December 31, 2003

CurrentCurrent

Current AssetsCurrent AssetsCurrent LiabilitiesCurrent Liabilities


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

6-17

Liquidity Ratio Liquidity Ratio ComparisonsComparisonsLiquidity Ratio Liquidity Ratio ComparisonsComparisons

BW Industry

2.39 2.15

2.26 2.09

1.91 2.01

BW Industry

2.39 2.15

2.26 2.09

1.91 2.01

Year

2003

2002

2001

CurrentCurrent RatioRatio

Ratio is stronger than the industry average.

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Liquidity RatiosLiquidity RatiosLiquidity RatiosLiquidity Ratios

Acid-Test (Quick)Acid-Test (Quick)

Current Assets - InvCurrent Assets - InvCurrent LiabilitiesCurrent Liabilities


Acid-Test (Quick)Acid-Test (Quick)

Current Assets - InvCurrent Assets - InvCurrent LiabilitiesCurrent Liabilities


Shows a firm’s ability to meet

current liabilities with its most liquid

assets.


Liquidity Ratios

$1,195 - $696$1,195 - $696$500$500

= 1.001.00

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Liquidity Ratio Liquidity Ratio ComparisonsComparisonsLiquidity Ratio Liquidity Ratio ComparisonsComparisons

BW Industry

1.00 1.25

1.04 1.23

1.11 1.25

BW Industry

1.00 1.25

1.04 1.23

1.11 1.25

Year

2003

2002

2001

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 ComparisonsSummary 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.

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 IndustryIndustry

Current 2.39 2.15

Acid-Test 1.00 1.25

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Current Ratio -- Trend Current Ratio -- Trend Analysis ComparisonAnalysis ComparisonCurrent Ratio -- Trend Current Ratio -- Trend Analysis ComparisonAnalysis Comparison

Trend Analysis of Current Ratio

1.5

1.7

1.9

2.1

2.3

2.5

2001 2002 2003

Analysis Year

Rat

io V

alu

e

BW

Industry

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Acid-Test Ratio -- Trend Acid-Test Ratio -- Trend Analysis ComparisonAnalysis ComparisonAcid-Test Ratio -- Trend Acid-Test Ratio -- Trend Analysis ComparisonAnalysis Comparison

Trend Analysis of Acid-Test Ratio

0.5

0.8

1.0

1.3

1.5

2001 2002 2003

Analysis Year

Rat

io V

alu

e

BW

Industry

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Summary of the Liquidity Summary of the Liquidity Trend AnalysesTrend AnalysesSummary of the Liquidity Summary of the Liquidity Trend AnalysesTrend Analyses

The current ratio for the industryindustry has been rising slowly at the same time the acid-test ratio has been relatively stable.

This indicates that inventoriesinventories are a significant problem for BWBW.

The current ratio for the industryindustry has been rising slowly at the same time the acid-test ratio has been relatively stable.

This indicates that inventoriesinventories are a significant problem for BWBW.

The current ratio for BWBW has been rising at the same time the acid-test ratio has been declining.

The current ratio for BWBW has been rising at the same time the acid-test ratio has been declining.

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Financial Leverage RatiosFinancial Leverage RatiosFinancial Leverage RatiosFinancial Leverage Ratios

Debt-to-EquityDebt-to-Equity

Total DebtTotal DebtShareholders’ EquityShareholders’ Equity


Debt-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.


Financial LeverageRatios

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

= .90.90

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Financial Leverage Financial Leverage Ratio ComparisonsRatio ComparisonsFinancial Leverage Financial Leverage Ratio ComparisonsRatio Comparisons

BW Industry

.90 .90

.88 .90

.81 .89

BW Industry

.90 .90

.88 .90

.81 .89

Year

2003

2002

2001

Debt-to-Equity RatioDebt-to-Equity Ratio

BW has average debt utilizationrelative to the industry average.

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Debt-to-Total-AssetsDebt-to-Total-Assets

Total DebtTotal DebtTotal AssetsTotal Assets


Debt-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.



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

= .47.47

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BW Industry

.47 .47

.47 .47

.45 .47

BW Industry

.47 .47

.47 .47

.45 .47

Year

2003

2002

2001

Debt-to-Total-Asset RatioDebt-to-Total-Asset Ratio

BW has average debt utilizationrelative to the industry average.

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Total CapitalizationTotal Capitalization

Total DebtTotal DebtTotal CapitalizationTotal Capitalization


Total CapitalizationTotal Capitalization

Total DebtTotal DebtTotal CapitalizationTotal Capitalization


Shows the relative importance of long-term

debt to the long-term financing of the firm.



$1,030$1,030$1,669$1,669

= .62.62

(i.e., LT-Debt + Equity)

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BW Industry

.62 .60

.62 .61

.67 .62

BW Industry

.62 .60

.62 .61

.67 .62

Year

2003

2002

2001

Total Capitalization RatioTotal Capitalization Ratio

BW has average long-term debt utilizationrelative to the industry average.

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Coverage RatiosCoverage RatiosCoverage RatiosCoverage Ratios

Interest CoverageInterest Coverage

EBITEBITInterest ChargesInterest Charges


Interest 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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CoverageCoverageRatio ComparisonsRatio ComparisonsCoverageCoverageRatio ComparisonsRatio Comparisons

BW Industry

3.56 5.19

4.35 5.02

10.30 4.66

BW Industry

3.56 5.19

4.35 5.02

10.30 4.66

Year

2003

2002

2001

Interest Coverage RatioInterest Coverage Ratio

BW has below average interest coveragerelative to the industry average.

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Coverage Ratio -- Trend Coverage Ratio -- Trend Analysis ComparisonAnalysis ComparisonCoverage Ratio -- Trend Coverage Ratio -- Trend Analysis ComparisonAnalysis Comparison

Trend Analysis of Interest Coverage Ratio

3.0

5.0

7.0

9.0

11.0

2001 2002 2003

Analysis Year

Rat

io V

alu

e

BW

Industry

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Summary of the Coverage Summary of the Coverage Trend AnalysisTrend AnalysisSummary 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.

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.

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 RatiosActivity RatiosActivity Ratios

Receivable TurnoverReceivable Turnover

Annual Net Credit SalesAnnual Net Credit SalesReceivablesReceivables


Receivable TurnoverReceivable Turnover

Annual Net Credit SalesAnnual Net Credit SalesReceivablesReceivables

For Basket Wonders December 31, 2003Indicates 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

= 5.615.61

(Assume all sales are credit sales.)

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Avg Collection PeriodAvg Collection Period

Days in the YearDays in the YearReceivable TurnoverReceivable Turnover


Avg Collection PeriodAvg Collection Period

Days in the YearDays in the YearReceivable TurnoverReceivable Turnover


Average number of days that receivables are

outstanding.(or RT in days)


Ratios

Activity Ratios

3653655.615.61

= 65 days65 days

6-36

ActivityActivityRatio ComparisonsRatio ComparisonsActivityActivityRatio ComparisonsRatio Comparisons

BW Industry

65.0 65.7

71.1 66.3

83.6 69.2

BW Industry

65.0 65.7

71.1 66.3

83.6 69.2

Year

2003

2002

2001

Average Collection PeriodAverage Collection Period

BW has improved the average collection period to that of the industry average.

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Payable Turnover (PT)Payable Turnover (PT)

Annual Credit PurchasesAnnual Credit PurchasesAccounts PayableAccounts Payable


Payable Turnover (PT)Payable Turnover (PT)

Annual Credit PurchasesAnnual Credit PurchasesAccounts PayableAccounts Payable


Indicates the promptness of payment to suppliers by the firm.


Ratios

Activity Ratios

$1551$1551$94$94 = 16.516.5

(Assume annual credit purchases = $1,551.)

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PT in DaysPT in Days

Days in the YearDays in the YearPayable TurnoverPayable Turnover


PT in DaysPT in Days

Days in the YearDays in the YearPayable TurnoverPayable Turnover


Average number of days that payables are

outstanding.


Ratios

Activity Ratios

36536516.516.5

= 22.1 days22.1 days

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BW Industry

22.1 46.7

25.4 51.1

43.5 48.5

BW Industry

22.1 46.7

25.4 51.1

43.5 48.5

Year

2003

2002

2001

Payable Turnover in DaysPayable Turnover in Days

BW has improved the PT in Days.Is this good?Is this good?

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Inventory TurnoverInventory Turnover

Cost of Goods SoldCost of Goods SoldInventoryInventory


Inventory TurnoverInventory Turnover

Cost of Goods SoldCost of Goods SoldInventoryInventory


Indicates the effectiveness of the

inventory management practices of the firm.


Ratios

Activity Ratios

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

= 2.302.30

6-41


BW Industry

2.30 3.45

2.44 3.76

2.64 3.69

BW Industry

2.30 3.45

2.44 3.76

2.64 3.69

Year

2003

2002

2001

Inventory Turnover RatioInventory Turnover Ratio

BW has a very poor inventory turnover ratio.

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Inventory Turnover Ratio --Inventory Turnover Ratio --Trend Analysis ComparisonTrend Analysis ComparisonInventory 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

alu

e

BW

Industry

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Total Asset TurnoverTotal Asset Turnover

Net SalesNet SalesTotal AssetsTotal Assets


Total Asset TurnoverTotal Asset Turnover

Net SalesNet SalesTotal AssetsTotal Assets


Indicates the overall effectiveness of the firm in utilizing its assets to

generate sales.


Ratios

Activity Ratios

$2,211$2,211$2,169$2,169

= 1.021.02

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BW Industry

1.02 1.17

1.03 1.14

1.01 1.13

BW Industry

1.02 1.17

1.03 1.14

1.01 1.13

Year

2003

2002

2001

Total Asset Turnover RatioTotal Asset Turnover Ratio

BW has a weak total asset turnover ratio.Why is this ratio considered weak?Why is this ratio considered weak?

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Profitability RatiosProfitability RatiosProfitability RatiosProfitability Ratios

Gross Profit MarginGross Profit Margin

Gross ProfitGross ProfitNet SalesNet Sales



Gross ProfitGross ProfitNet SalesNet Sales


Indicates the efficiency of operations and firm

pricing policies.


Ratios

Profitability Ratios

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

= .277277

6-46

ProfitabilityProfitabilityRatio ComparisonsRatio ComparisonsProfitabilityProfitabilityRatio ComparisonsRatio Comparisons

BW Industry

27.7% 31.1%

28.7 30.8

31.3 27.6

BW Industry

27.7% 31.1%

28.7 30.8

31.3 27.6

Year

2003

2002

2001


BW has a weak Gross Profit Margin.

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Gross Profit Margin --Gross Profit Margin --Trend Analysis ComparisonTrend Analysis ComparisonGross Profit Margin --Gross Profit Margin --Trend Analysis ComparisonTrend Analysis Comparison

Trend Analysis of Gross Profit Margin

25.0

27.5

30.0

32.5

35.0

2001 2002 2003

Analysis Year

Rat

io V

alu

e (%

)

BW

Industry

6-48


Net Profit MarginNet Profit Margin

Net Profit after TaxesNet Profit after TaxesNet SalesNet Sales



Net Profit after TaxesNet Profit after TaxesNet SalesNet Sales


Indicates the firm’s profitability after taking account of all expenses

and income taxes.


Ratios


$91$91$2,211$2,211

= .041.041

6-49

ProfitabilityProfitability Ratio ComparisonsRatio ComparisonsProfitabilityProfitability Ratio ComparisonsRatio Comparisons

BW Industry

4.1% 8.2%

4.9 8.1

9.0 7.6

BW Industry

4.1% 8.2%

4.9 8.1

9.0 7.6

Year

2003

2002

2001


BW has a poor Net Profit Margin.

6-50

Net Profit Margin --Net Profit Margin --Trend Analysis ComparisonTrend Analysis ComparisonNet Profit Margin --Net Profit Margin --Trend Analysis ComparisonTrend Analysis Comparison

Trend Analysis of Net Profit Margin

4

5

6

7

8

9

10

2001 2002 2003

Analysis Year

Rat

io V

alu

e (%

)

BW

Industry

6-51


Return on InvestmentReturn on Investment

Net Profit after TaxesNet Profit after TaxesTotal AssetsTotal Assets



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).


Ratios


$91$91$2,160$2,160

= .042.042

6-52


BW Industry

4.2% 9.8%

5.0 9.1

9.1 10.8

BW Industry

4.2% 9.8%

5.0 9.1

9.1 10.8

Year

2003

2002

2001


BW has a poor Return on Investment.

6-53

Return on Investment –Return on Investment –Trend Analysis ComparisonTrend Analysis ComparisonReturn on Investment –Return on Investment –Trend Analysis ComparisonTrend Analysis Comparison

Trend Analysis of Return on Investment

4

6

8

10

12

2001 2002 2003

Analysis Year

Rat

io V

alu

e (%

)

BW

Industry

6-54


Return on EquityReturn on Equity

Net Profit after TaxesNet Profit after TaxesShareholders’ EquityShareholders’ 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).


Ratios


$91$91$1,139$1,139

= .08.08

6-55


BW Industry

8.0% 17.9%

9.4 17.2

16.6 20.4

BW Industry

8.0% 17.9%

9.4 17.2

16.6 20.4

Year

2003

2002

2001


BW has a poor Return on Equity.

6-56

Return on Equity --Return on Equity --Trend Analysis ComparisonTrend Analysis ComparisonReturn on Equity --Return on Equity --Trend Analysis ComparisonTrend Analysis Comparison

Trend Analysis of Return on Equity

7.0

10.5

14.0

17.5

21.0

2001 2002 2003

Analysis Year

Rat

io V

alu

e (%

)

BW

Industry

6-57

Return on Investment and Return on Investment and the Du Pont Approachthe Du Pont ApproachReturn on Investment and Return on Investment and the Du Pont Approachthe Du Pont Approach

ROIROI2003 = .041 x 1.02 = .042.042 or 4.2%4.2%

ROIROIIndustry = .082 x 1.17 = .098.098 or 9.8%9.8%

ROIROI2003 = .041 x 1.02 = .042.042 or 4.2%4.2%

ROIROIIndustry = .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

6-58

Return on Equity and Return on Equity and the Du Pont Approachthe Du Pont ApproachReturn on Equity and Return on Equity and the Du Pont Approachthe Du Pont Approach

ROEROE2003 = .041 x 1.02 x 1.90 = .080.080

ROEROEIndustry = .082 x 1.17 x 1.88 = .179179

ROEROE2003 = .041 x 1.02 x 1.90 = .080.080

ROEROEIndustry = .082 x 1.17 x 1.88 = .179179

Return On Equity Return On Equity = Net profit margin X Total asset turnover X

Equity Multiplier

Equity Multiplier Equity Multiplier = Total Assets

Shareholders’ Equity

6-59

Summary of the Profitability Summary of the Profitability Trend AnalysesTrend AnalysesSummary of the Profitability Summary of the Profitability Trend AnalysesTrend Analyses

The profitability ratios for BWBW have ALL been falling since 2001. Each has been below the industryindustry averages for the past three years.

This indicates that COGSCOGS and administrative costsadministrative costs may both be too high and a potential problem for BWBW.

Note, this result is consistent with the low interest coverage ratio.

The profitability ratios for BWBW have ALL been falling since 2001. Each has been below the industryindustry averages for the past three years.

This indicates that COGSCOGS and administrative costsadministrative costs may both be too high and a potential problem for BWBW.

Note, this result is consistent with the low interest coverage ratio.

6-60

Summary of Ratio AnalysesSummary of Ratio AnalysesSummary of Ratio AnalysesSummary 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.

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.

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Common-size AnalysisCommon-size AnalysisCommon-size AnalysisCommon-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.

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.

6-62

Basket Wonders’ Common Basket Wonders’ Common Size Balance SheetsSize Balance SheetsBasket Wonders’ Common Basket Wonders’ Common Size Balance SheetsSize 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

6-63

Basket Wonders’ Common Basket Wonders’ Common Size Balance SheetsSize Balance SheetsBasket Wonders’ Common Basket Wonders’ Common Size Balance SheetsSize Balance Sheets


Liab+Equity 2001 2002 2003 2001 2002 2003

Note Pay 290 295 290 23.71 14.43 13.37

Acct Pay 81 94 94 6.62 4.60 4.33

Accr Tax 13 16 16 1.06 0.78 0.74

Other Accr 15 100 100 1.23 4.89 4.61

Tot CL 399 505 500 32.62 24.71 23.05

LT Debt 150 453 530 12.26 22.16 24.44

Equity 674 1,086 1,139 55.11 53.13 52.51

Tot L+E 1,223 2,044 2,169 100.0 100.0 100.0

6-64

Basket Wonders’ Common Basket Wonders’ Common Size Income StatementsSize Income StatementsBasket Wonders’ Common Basket Wonders’ Common Size Income StatementsSize Income Statements


2001 2002 2003 2001 2002 2003

Net Sales 1,235 2,106 2,211 100.0 100.0 100.0

COGS 849 1,501 1,599 68.7 71.3 72.3

Gross Profit 386 605 612 31.3 28.7 27.7

Adm. 180 383 402 14.6 18.2 18.2

EBIT 206 222 210 16.7 10.5 9.5

Int Exp 20 51 59 1.6 2.4 2.7

EBT 186 171 151 15.1 8.1 6.8

EAT 112 103 91 9.1 4.9 4.1

Cash Div 50 50 50 4.0 2.4 2.3

6-65

Index AnalysesIndex AnalysesIndex AnalysesIndex 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.

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.

6-66

Basket Wonders’ Basket Wonders’ Indexed Balance SheetsIndexed Balance SheetsBasket Wonders’ Basket Wonders’ Indexed Balance SheetsIndexed 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

6-67

Basket Wonders’ Basket Wonders’ Indexed Balance SheetsIndexed Balance SheetsBasket Wonders’ Basket Wonders’ Indexed Balance SheetsIndexed Balance Sheets


Liab+Equity 2001 2002 2003 2001 2002 2003

Note Pay 290 295 290 100.0 101.7 100.0

Acct Pay 81 94 94 100.0 116.0 116.0

Accr Tax 13 16 16 100.0 123.1 123.1

Other Accr 15 100 100 100.0 666.7 666.7

Tot CL 399 505 500 100.0 126.6 125.3

LT Debt 150 453 530 100.0 302.0 353.3

Equity 674 1,086 1,139 100.0 161.1 169.0

Tot L+E 1,223 2,044 2,169 100.0 167.1 177.4

6-68

Basket Wonders’ Indexed Basket Wonders’ Indexed Income StatementsIncome StatementsBasket Wonders’ Indexed Basket Wonders’ Indexed Income StatementsIncome Statements


2001 2002 2003 2001 2002 2003

Net Sales 1,235 2,106 2,211 100.0 170.5 179.0

COGS 849 1,501 1,599 100.0 176.8 188.3

Gross Profit 386 605 612 100.0 156.7 158.5

Adm. 180 383 402 100.0 212.8 223.3

EBIT 206 222 210 100.0 107.8 101.9

Int Exp 20 51 59 100.0 255.0 295.0

EBT 186 171 151 100.0 91.9 81.2

EAT 112 103 91 100.0 92.0 81.3

Cash Div 50 50 50 100.0 100.0 100.0

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Financial management and policy chapter 6

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