Financial Financial Statement AnalysisStatement Analysis

Financial Statements Balance Sheet Income Statement Flow of Funds Statement

Ratio Analysis

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.

Flow of Funds StatementFlow of Funds Statement

Has been replaced by the cash flow cash flow statementstatement (1989) in U.S. audited annual

reports.

A summary of a firm’s changes in financial position from one period to

another; it is also called a sources and uses of funds statement or a statement

of changes in financial position.

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

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

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

Flow of Funds StatementFlow of Funds Statement

All of the firm’s investments and claims against those investments. Extends beyond just beyond just transactions

involving cashcash.

What are “fundsfunds”?

Sources and Sources and Uses StatementUses Statement

The letters labeling the boxes stand for UUsesses, SSourcesources, AAssetsssets, and LLiabilitiesiabilities (broadly defined). The pluses (minuses) indicate increases (decreases) in assets or liabilities.

AA LL- ++ -

SS

UU

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.

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

Examples:Robert Morris Robert Morris

AssociatesAssociatesDun & 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.”

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

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.

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

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.

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

Current 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

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BWIndustry

Acid-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

alue

BWIndustry

Summary 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 BWBW has been rising at the same time the acid-test ratio has been declining.

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

Financial Leverage Financial Leverage Ratio ComparisonsRatio Comparisons

BW Industry .90 .90 .88 .90 .81 .89

Year200320022001

Debt-to-Equity RatioDebt-to-Equity Ratio

BW has average debt utilizationrelative to the industry average.

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

Financial Leverage Financial Leverage Ratio ComparisonsRatio Comparisons

BW Industry .47 .47 .47 .47 .45 .47

Year200320022001

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

BW has average debt utilizationrelative to the industry average.

Financial Leverage RatiosFinancial Leverage RatiosTotal CapitalizationTotal Capitalization

Total DebtTotal DebtTotal CapitalizationTotal 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 LeverageRatios

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

= .62.62

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

Financial Leverage Financial Leverage Ratio ComparisonsRatio Comparisons

BW Industry .62 .60 .62 .61 .67 .62

Year200320022001

Total Capitalization RatioTotal Capitalization Ratio

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

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

CoverageCoverageRatio ComparisonsRatio Comparisons

BW Industry 3.56 5.19 4.35 5.0210.30 4.66

Year200320022001

Interest Coverage RatioInterest Coverage Ratio

BW has below average interest coveragerelative to the industry average.

Coverage 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

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alue

BWIndustry

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.

Activity RatiosActivity RatiosReceivable 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.)

Activity RatiosActivity RatiosAvg Collection PeriodAvg Collection Period

Days in the YearDays in the YearReceivable TurnoverReceivable 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

3653655.615.61

= 65 days65 days

ActivityActivityRatio ComparisonsRatio Comparisons

BW Industry65.0 65.771.1 66.383.6 69.2

Year200320022001

Average Collection PeriodAverage Collection Period

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

Activity RatiosActivity RatiosPayable Turnover (PT)Payable Turnover (PT)

Annual Credit PurchasesAnnual Credit PurchasesAccounts PayableAccounts Payable

For Basket Wonders December 31, 2003Indicates the

promptness of payment to suppliers by the firm.

Income Statement /Balance Sheet

Ratios

Activity Ratios

$1551$1551$94$94 = 16.516.5

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

Activity RatiosActivity RatiosPT in DaysPT in Days

Days in the YearDays in the YearPayable TurnoverPayable Turnover

For Basket Wonders December 31, 2003Average number of days

that payables are outstanding.

Income Statement /Balance Sheet

Ratios

Activity Ratios

36536516.516.5

= 22.1 days22.1 days

ActivityActivityRatio ComparisonsRatio Comparisons

BW Industry22.1 46.725.4 51.143.5 48.5

Year200320022001

Payable Turnover in DaysPayable Turnover in Days

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

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

ActivityActivityRatio ComparisonsRatio Comparisons

BW Industry2.30 3.452.44 3.762.64 3.69

Year200320022001

Inventory Turnover RatioInventory Turnover Ratio

BW has a very poor inventory turnover ratio.

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

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BWIndustry

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

ActivityActivityRatio ComparisonsRatio Comparisons

BW Industry1.02 1.171.03 1.141.01 1.13

Year200320022001

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?

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

ProfitabilityProfitabilityRatio ComparisonsRatio Comparisons

BW Industry27.7% 31.1%28.7 30.831.3 27.6

Year200320022001

Gross Profit MarginGross Profit Margin

BW has a weak Gross Profit Margin.

Gross 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

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(%)

BWIndustry

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

ProfitabilityProfitability Ratio ComparisonsRatio Comparisons

BW Industry4.1% 8.2%4.9 8.19.0 7.6

Year200320022001

Net Profit MarginNet Profit Margin

BW has a poor Net Profit Margin.

Net 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

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alue

(%)

BWIndustry

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

ProfitabilityProfitability Ratio ComparisonsRatio Comparisons

BW Industry4.2% 9.8%5.0 9.19.1 10.8

Year200320022001

Return on InvestmentReturn on Investment

BW has a poor Return on Investment.

Return 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

alue

(%)

BWIndustry

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

ProfitabilityProfitability Ratio ComparisonsRatio Comparisons

BW Industry 8.0% 17.9% 9.4 17.216.6 20.4

Year200320022001

Return on EquityReturn on Equity

BW has a poor Return on Equity.

Return 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

alue

(%)

BWIndustry