of 70
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Chap ter 6
Financial StatementAnalysis
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After Studying Chapter 6,
you should be able to:
1. Understand the purpose of basic financial statements and their contents.
2. Understand what is meant by convergence in accounting standards.
3. Explain why financial statement analysis is important to the firm and tooutside suppliers of capital.
4. Define, calculate, and categorize (according to liquidity, financial leverage,coverage, activity, and profitability) the major financial ratios andunderstand what they can tell us about the firm.
5. Define, calculate, and discuss a firms operating cycle and cash cycle.
6. Use ratios to analyze a firm's health and then recommend reasonablealternative courses of action to improve the health of the firm.
7. Analyze a firms return on investment (i.e., earning power) and return onequity using a DuPont approach.
8. Understand the limitations of financial ratio analysis.
9. Use trend analysis, common-size analysis, and index analysis to gainadditional insights into a firm's performance.
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Financial Statements
A Possible Framework for Analysis
Balance Sheet Ratios
Income Statement and Income/Balance
Sheet Ratios Trend Analysis
Common-Size and Index Analysis
Financial
Statemen t Analys is
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Trade Credito rsFocus on theliquidity of the firm.
BondholdersFocus on thelong-term cash flow of the firm.
ShareholdersFocus on theprofitability and long-term health ofthe firm.
Examples o f External Uses
o f Statemen t Analys is
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PlanFocus on assessing the currentfinancial position and evaluatingpotential firm opportunities.
Contro lFocus on return on investmentfor various assets and asset efficiency.
UnderstandFocus on understandinghow suppliers of funds analyze the firm.
Examp les o f In ternal Uses
o f Statemen t Analys is
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6/706.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Convergence of Account ing Standards: Aims tonarrow or remove differences so that investors canbetter understand financial statements prepared under
different accounting frameworks IASBInternational Accounting Standards Board has the
responsibility of IFRS
IFRSInternational Financial Reporting Standards (EU
countries adopted) US GAAPUS Generally Accepted Accounting Principles
determined by FASB
FASBFinancial Accounting Standards Board determinesaccounting standards for financial statements
Global Accoun t ing Standards
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7/706.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Income Statemen t
A summary of a firms revenues and
expenses over a specified period, endingwith net income or loss for the period.
Balance Sheet
A summary of a firms financial position ona given date that shows total assets = totalliabilities + owners equity.
Primary Types o f
Financ ial Statements
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a. How the f i rm stands on
a specif ic date.
b. What BW owned.
c . Amounts owed by
customers.
d. Future expense items
already paid .
e. Cash/l ikely convertible
to cash w ithin 1 year.
f . Original amoun t paid.
g. Acc. deduc t ions for
wear and tear.
Cash $ 90Acct. Rec.c 394Inventories 696Prepaid Expd 5Accum Tax Prepay 10
Current Assetse$1,195Fixed Assets (@Cost)f 1030
Less: Acc. Depr. g (329)Net Fix. Assets $ 701
Investment, LT 50Other Assets, LT 223
Total Assetsb
$2,169
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007a
Basket Wonders Balance
Sheet (Asset Side)
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a. Note, Assets =
Liabi l i t ies + Equ ity.
b. What BW owed and
ownersh ip posi t ion.
c. Owed to suppl iers for
goods and services.
d. Unpaid wages,
salaries , etc.
e. Debts payab le < 1 year.
f. Debts payab le > 1 year.
g. Original investment.
h. Earnings reinvested.
Notes Payable $ 290Acct. Payablec 94Accrued Taxesd 16
Other Accrued Liab.d 100Current Liab.e $ 500
Long-Term Debtf 530Shareholders Equity
Com. Stock ($1 par)g 200Add Pd in Capitalg 729Retained Earningsh 210
Total Equity $1,139
Total Liab/Equity
a,b
$2,169
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007
Basket Wonders Balance
Sheet (L iab i l i ty Side)
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a. Measures pro f i tabi l i ty
over a time period .
b. Received, or receivable,
f rom customers.
c. Sales comm., adv .,
officers salaries, etc.
d. Operat ing income.e. Cost of bo rrowed funds.
f. Taxab le inc om e.
g. Amount earned for
shareholders.
Net Sales $ 2,211Cost of Goods Soldb 1,599
Gross Profit $ 612SG&A Expensesc 402
EBITd $ 210Interest Expensee 59
EBTf
$ 151Income Taxes 60
EATg $ 91Cash Dividends 38Increase in RE $ 53
Basket Wonders Statement of Earnings (in thousands)for Year Ending December 31, 2007a
Basket Wonders
Income Statement
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6.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Analyt ical Tools Used
Sources and Uses Statement
Statement of Cash Flows
Cash Budgets
1. Analysis of the fundsneeds of the firm.
Trend/Seasonal Component
How much funding will berequired in the future?
Is there a seasonalcomponent?
Framework for
Financial Analys is
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6.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Health o f a Firm
Financial Ratios
1. Individually
2. Over time3. In combination
4. In comparison
1. Analysis of the fundsneeds of the firm.
2. Analysis of the financialcondition and profitabilityof the firm.
Framework for
Financial Analys is
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6.13 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Examples:
Volatility in sales
Volatility in costs
Proximity to break-evenpoint
1. Analysis of the funds
needs of the firm.
2. Analysis of the financialcondition and profitabilityof the firm.
3. Analysis of the businessrisk of the firm.
Business r isk relates tothe risk inherent in theoperations of the firm.
Framework for
Financial Analys is
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6.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
A FinancialManager
must
consider allthreejointly
whendetermining
thefinancing
needs of thefirm.
Determiningthe
financingneeds ofthe firm.
1. Analysis of the funds
needs of the firm.
2. Analysis of the financialcondition and profitabilityof the firm.
3. Analysis of the businessrisk of the firm.
Framework for
Financial Analys is
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6.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Negotiationswith
suppliers ofcapital.
Determiningthe
financingneeds ofthe firm.
1. Analysis of the fundsneeds of the firm.
2. Analysis of the financialcondition and profitabilityof the firm.
3. Analysis of the businessrisk of the firm.
Framework for
Financial Analys is
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6.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Types of
Compar isons
InternalComparisons
ExternalComparisons
AFinancial Ratiois
an index that relatestwo account ingnumbersand is
obtained by dividingone number by the
other.
Use of Financ ial Ratios
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6.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Examples:
Risk Management
AssociationDun & Bradstreet
Almanac ofBusiness and
IndustrialFinancial Ratios
This involvescomparing the ratiosof one firm with thoseof simi larfirms or with
industry averages.
Similar i tyis importantas one should
compare apples to
apples.
External Compar isons and
Sources o f Industry Rat ios
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6.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Current
Current AssetsCurrent Liabilities
For Basket Wonders
December 31, 2007
Shows a firms
ability to cover itscurrent liabilitieswith its current
assets.
Balance Sheet Ratios
Liquidity Ratios
$1,195$500
= 2.39
L iqu id i ty Rat ios
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6.19 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
2.39 2.15
2.26 2.09
1.91 2.01
Year
2007
2006
2005
CurrentRatio
Ratio is stronger than the industry average.
L iqu id i ty Rat io
Compar isons
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6.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Acid -Test (Quick)
Current Assets - InvCurrent Liabilities
For Basket Wonders
December 31, 2007
Shows a firms
ability to meetcurrent liabilitieswith its most liquid
assets.
Balance Sheet Ratios
Liquidity Ratios
$1,195$696$500
= 1.00
L iqu id i ty Rat ios
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6.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
1.00 1.25
1.04 1.23
1.11 1.25
Year
2007
2006
2005
Acid-Test Ratio
Ratio is weakerthan the industry average.
L iqu id i ty Rat io
Compar isons
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6.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Strong current ratio and weak acid-testratio indicates a potential problem in theinventories account.
Note that this industry has a relativelyhigh level of inventories.
Ratio BW Indus try
Current 2.39 2.15
Acid-Test 1.00 1.25
Summary of the Liqu id i ty
Rat io Compar isons
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6.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Trend Analysis of Current Rat io
1.5
1.7
1.9
2.1
2.3
2.5
2005 2006 2007
Analysis Year
R
atioValue
BW
Industry
Curren t Ratio Trend
Analys is Compar ison
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6.24 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Trend Analys is o f Acid -Test Rat io
0.5
0.8
1.0
1.3
1.5
2005 2006 2007
Analysis Year
R
atioValue
BW
Industry
Ac id-Tes t Ratio Trend
Analys is Compar ison
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6.25 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
The current ratio for the industryhasbeen rising slowly at the same time the
acid-test ratio has been relatively stable. This indicates that inventor iesare a
significant problem for BW.
The current ratio for BWhas been risingat the same time the acid-test ratio has
been declining.
Summary of the Liqu id i ty
Trend Analyses
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6.26 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Debt-to-Equity
Total Debt
Shareholders Equity
For Basket Wonders
December 31, 2007Shows the extent towhich the firm isfinanced by debt.
Balance Sheet Ratios
Financial LeverageRatios
$1,030$1,139
= 0.90
Financ ial Leverage Ratios
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6.27 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
0.90 0.90
0.88 0.90
0.81 0.89
Year
2007
2006
2005
Debt-to-Equity Ratio
BW has average debt utilization
relative to the industry average.
Financ ial Leverage
Rat io Compar isons
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6.28 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Debt-to-Total-Assets
Total Debt
Total Assets
For Basket Wonders
December 31, 2007Shows the percentageof the firms assetsthat are supported by
debt financing.
Balance Sheet Ratios
Financial LeverageRatios
$1,030$2,169
= 0.47
Financ ial Leverage Ratios
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6.29 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
0.47 0.47
0.47 0.47
0.45 0.47
Year
2007
2006
2005
Debt-to-Total-Asset Ratio
BW has average debt utilization
relative to the industry average.
Financ ial Leverage
Rat io Compar isons
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6.30 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Total Capital izat ion
Total DebtTotal Capitalization
For Basket WondersDecember 31, 2007
Shows the relativeimportance of long-term
debt to the long-termfinancing of the firm.
Balance Sheet Ratios
Financial LeverageRatios
$1,030$1,669
= 0.62
(i.e., LT-Debt + Equity)
Financ ial Leverage Ratios
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6.31 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
0.62 0.60
0.62 0.61
0.67 0.62
Year
2007
2006
2005
Total Capitalization Ratio
BW has average long-term debt utilization
relative to the industry average.
Financ ial Leverage
Rat io Compar isons
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6.32 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
In teres t Coverage
EBIT
Interest Charges
For Basket Wonders
December 31, 2007Indicates a firmsability to coverinterest charges.
Income StatementRatios
Coverage Ratios
$210$59
= 3.56
Coverage Ratios
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6.33 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
3.56 5.19
4.35 5.02
10.30 4.66
Year
2007
2006
2005
Interest Coverage Ratio
BW has below average interest coverage
relative to the industry average.
Coverage
Rat io Compar isons
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6.34 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Trend Analysis of Interest Coverage Ratio
3.0
5.0
7.0
9.0
11.0
2005 2006 2007
Analysis Year
RatioValue
BW
Industry
Coverage Ratio Trend
Analys is Compar ison
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6.35 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
This indicates that low earnings (EBIT)
may be a potential problem for BW. Note, we know that debt levels are in
line with the industryaverages.
The interest coverage ratio for BWhasbeen falling since 2005. It has been
below industryaverages for the pasttwo years.
Summary of the Coverage
Trend Analys is
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6.36 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Receivable Turnover
Annual Net Credit Sales
Receivables
For Basket Wonders
December 31, 2007Indicates quality ofreceivables and how
successful the firm is inits collections.
Income Statement/Balance Sheet
Ratios
Activity Ratios
$2,211$394
= 5.61
(Assume all sales are credit sales.)
Act iv i ty Rat ios
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6.37 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Avg Col lect ion Period
Days in the Year
Receivable Turnover
For Basket WondersDecember 31, 2007
Average number of daysthat receivables are
outstanding.
(or RT in days)
Income Statement/Balance Sheet
Ratios
Activity Ratios
3655.61
= 65 days
Act iv i ty Rat ios
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6.38 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
65.0 65.7
71.1 66.3
83.6 69.2
Year
2007
2006
2005
Average Collection Period
BW has improved the average collectionperiod to that of the industry average.
Act iv i ty
Rat io Compar isons
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6.39 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Payab le Turnover (PT)
Annual Credit Purchases
Accounts Payable
For Basket WondersDecember 31, 2007
Indicates thepromptness of paymentto suppliers by the firm.
Income Statement/Balance Sheet
Ratios
Activity Ratios
$1551$94
= 16.5
(Assume annual creditpurchases = $1,551.)
Act iv i ty Rat ios
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6.40 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
PT in Days
Days in the Year
Payable Turnover
For Basket Wonders
December 31, 2007Average number of daysthat payables are
outstanding.
Income Statement/Balance Sheet
Ratios
Activity Ratios
36516.5
= 22.1 days
Act iv i ty Rat ios
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6.41 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
22.1 46.7
25.4 51.1
43.5 48.5
Year
2007
2006
2005
Payable Turnover in Days
BW has improved the PT in Days.
Is this good?
Act iv i ty
Rat io Compar isons
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6.42 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Invento ry Turnover
Cost of Goods Sold
Inventory
For Basket Wonders
December 31, 2007Indicates theeffectiveness of the
inventory managementpractices of the firm.
Income Statement/Balance Sheet
Ratios
Activity Ratios
$1,599$696
= 2.30
Act iv i ty Rat ios
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6.43 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
2.30 3.45
2.44 3.76
2.64 3.69
Year
2007
2006
2005
Inventory Turnover Ratio
BW has a very poor inventory turnover ratio.
Act iv i ty
Rat io Compar isons
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6.44 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Trend Analysis of Inventory Turnover Rat io
2.0
2.5
3.0
3.5
4.0
2005 2006 2007
Analysis Year
RatioValue
BW
Industry
Invento ry Turnover Ratio
Trend Analys is Compar ison
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6.45 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Total Asset Turnover
Net Sales
Total Assets
For Basket Wonders
December 31, 2007Indicates the overalleffectiveness of the firmin utilizing its assets to
generate sales.
Income Statement/Balance Sheet
Ratios
Activity Ratios
$2,211$2,169
= 1.02
Act iv i ty Rat ios
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6.46 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
1.02 1.17
1.03 1.14
1.01 1.13
Year
2007
2006
2005
Total Asset Turnover Ratio
BW has a weak total asset turnover ratio.
Why is this ratio considered weak?
Act iv i ty
Rat io Compar isons
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6.47 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Gross Prof i t Margin
Gross Profit
Net Sales
For Basket Wonders
December 31, 2007Indicates the efficiencyof operations and firm
pricing policies.
Income Statement/Balance Sheet
Ratios
Profitability Ratios
$612$2,211
= 0.277
Prof i tab i l ity Ratios
f
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6.48 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
27.7% 31.1%
28.7 30.8
31.3 27.6
Year
2007
2006
2005
Gross Profit Margin
BW has a weak Gross Profit Margin.
Prof i tabi l i ty
Rat io Compar isons
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6.49 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Trend Analysis of Gros s Prof i t Margin
25.0
27.5
30.0
32.5
35.0
2005 2006 2007
Analysis Year
RatioValue(%
)
BW
Industry
Gross Prof i t Margin
Trend Analys is Compar ison
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6.50 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Net Pro f i t Margin
Net Profit after Taxes
Net Sales
For Basket Wonders
December 31, 2007Indicates the firmsprofitability after takingaccount of all expenses
and income taxes.
Income Statement/Balance Sheet
Ratios
Profitability Ratios
$91$2,211
= 0.041
Prof i tab i l ity Ratios
P fi t bi l i t
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6.51 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
4.1% 8.2%
4.9 8.1
9.0 7.6
Year
2007
2006
2005
Net Profit Margin
BW has a poor Net Profit Margin.
Prof i tabi l i ty
Rat io Compar isons
N t P fi t M i
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6.52 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Trend Analysis of Net Prof i t Margin
4
5
6
7
8
9
10
2005 2006 2007
Analysis Year
R
atioValue(%)
BW
Industry
Net Pro fi t Marg in
Trend Analys is Compar ison
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6.53 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Return on Investment
Net Profit after Taxes
Total Assets
For Basket Wonders
December 31, 2007Indicates theprofitability on the
assets of the firm (afterall expenses and taxes).
Income Statement/Balance Sheet
Ratios
Profitability Ratios
$91$2,160
= 0.042
Prof i tab i l ity Ratios
P fi t bi l i t
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6.54 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
4.2% 9.6%
5.0 9.1
9.1 10.8
Year
2007
2006
2005
Return on Investment
BW has a poor Return on Investment.
Prof i tabi l i ty
Rat io Compar isons
R t I t t
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6.55 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Trend Analysis o f Return on Investment
4
6
8
10
12
2005 2006 2007
Analysis Year
RatioValue(%
)
BW
Industry
Return on Investment
Trend Analys is Compar ison
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6.56 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Return on Equi ty
Net Pro fi t after Taxes
Shareholders Equity
For Basket Wonders
December 31, 2007Indicates the profitabilityto the shareholders of
the firm (after allexpenses and taxes).
Income Statement/Balance Sheet
Ratios
Profitability Ratios
$91$1,139
= 0.08
Prof i tab i l ity Ratios
P fi t bi l i t
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6.57 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BW Industry
8.0% 18.0%
9.4 17.2
16.6 20.4
Year
2007
2006
2005
Return on Equity
BW has a poor Return on Equity.
Prof i tabi l i ty
Rat io Compar isons
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6.58 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Trend Analys is of Return on Equi ty
7.0
10.5
14.0
17.5
21.0
2005 2006 2007
Analysis Year
RatioValue(%
)
BW
Industry
Return on Equ i ty
Trend Analys is Compar ison
R t I t t d
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6.59 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
ROI2007
= 0.041 1.02=0.042 or 4.2%
ROIIndustry = 0.082 1.17=0.096 or 9.6%(Note: values are rounded)
ROI = Net profit margin Total asset turnover
Earning Power = Sales profitability Asset efficiency
Return on Investment and
the Du Pont App roach
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6.60 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
ROE2007 = 0.041 1.02 1.90=0.080
ROEIndustry = 0.082 1.17 1.88= 0.180(Note: values are rounded)
Return On Equity = Net profit margin XTotal asset turnoverX
Equity Multiplier
Equity Multiplier =Total Assets
Shareholders Equity
Return on Equ i ty and
the Du Pont App roach
S f th P f i t b i l i t
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6.61 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
The profitability ratios for BWhave ALL been falling since 2005. Each has beenbelow the industryaverages for the past
three years.
This indicates that COGSandadministrative costs may both be too
high and a potential problem for BW. Note, this result is consistent with the low
interest coverage ratio.
Summary of the Prof i tabi l i ty
Trend Analyses
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6.62 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Inventories are too high.
May be paying off creditors
(accounts payable) too soon.
COGS may be too high.
Selling, general, andadministrative costs may be toohigh.
Summary of Rat io Analyses
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6.63 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
An analysis of percentagefinancial statements where all
balance sheet items are dividedby to tal assetsand all incomestatement items are divided by
net salesor revenues.
Common-Size Analys is
Basket Wonders Common
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6.64 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Regular (thousands of $) Common-Size (%)
Assets 2005 2006 2007 2005 2006 2007
Cash 148 100 90 12.10 4.89 4.15
AR 283 410 394 23.14 20.06 18.17Inv 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 32.32LT 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
Basket Wonders Common
Size Balance Sheets
Basket Wonders Common
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6.65 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Regular (thousands of $) Common-Size (%)
Liab+Equity 2005 2006 2007 2005 2006 2007
Note Pay 290 295 290 23.71 14.43 13.37
Acct Pay 81 94 94 6.62 4.60 4.33Accr 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 24.44Equity 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
Basket Wonders Common-
Size Balance Sheets
Basket Wonders Common
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6.66 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Regular (thousands of $) Common-Size (%)
2005 2006 2007 2005 2006 2007
Net Sales 1,235 2,106 2,211 100.0 100.0 100.0
COGS 849 1,501 1,599 68.7 71.3 72.3Gross 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 2.7EBT 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
Basket Wonders Common-
Size Income Statements
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6.67 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
An analysis of percentagefinancialstatements where all balance sheetor income statement figures for a
base year equal 100.0 (percent) andsubsequent financial statement
items are expressed as percentagesof their values in the base year.
Index Analyses
Basket Wonders
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6.68 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Regular (thousands of $) Indexed (%)
Assets 2005 2006 2007 2005 2006 2007
Cash 148 100 90 100.0 67.6 60.8
AR 283 410 394 100.0 144.9 139.2Inv 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 349 631 701 100.0 180.8 200.9LT 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
Basket Wonders
Indexed Balance Sheets
Basket Wonders
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6.69 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Regular (thousands of $) Indexed (%)
Liab+Equity 2005 2006 2007 2005 2006 2007
Note Pay 290 295 290 100.0 101.7 100.0
Acct Pay 81 94 94 100.0 116.0 116.0Accr 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 150 453 530 100.0 302.0 353.3Equity 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
Basket Wonders
Indexed Balance Sheets
Basket Wonders Indexed
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Regular (thousands of $) Indexed (%)
2005 2006 2007 2005 2006 2007
Net Sales 1,235 2,106 2,211 100.0 170.5 179.0
COGS 849 1,501 1,599 100.0 176.8 188.3Gross 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 59 100.0 255.0 295.0EBT 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
Basket Wonders Indexed
Income Statements