04/12/23 Ratios 1

Financial Ratios

04/12/23 Ratios 2

Ratio Analysis

1. Measure firm performance

2. Compare over time

3. Compare with other firms or industries

4. Analyze ROE

5. Project financial statements into future

04/12/23 Ratios 3

Ratios

1. Profitability

2. Activity or Utilization

3. Liquidity

4. Leverage

5. Growth

6. Valuation

04/12/23 Ratios 4

1. Profit Margin (PM) =

2. Operating Profit Margin

(not in the book) =

3. Return on Assets

(ROA) =

4. Return on Equity

(ROE) =

05.SalesIncomeNet

10.SalesEBIT

15.Assets Total

IncomeNet

19.Equity rsStockholde

IncomeNet

Profitability Ratios

04/12/23 Ratios 5

Liquidity Ratios

Current Ratio =

Quick Ratio =

Cash Ratio =

2sLiabilitieCurrent

AssetsCurrent

1sLiabilitieCurrent

Inventory - AssetsCurrent

75.sLiabilitieCurrent

Cash

04/12/23 Ratios 6

Activity or Utilization Ratios

Receivables Turnover =

Average Collection Period =

Inventory Turnover* =

Fixed Asset Turnover =

Total Asset Turnover =

12sReceivable

(credit) Sales

30SalesCredit Daily Average

Receivable Accounts

4Inventory

COGS

2Assets Fixed

Sales

1Assets Total

Sales

InventorySales

* Sometimes =

04/12/23 Ratios 7

Leverage RatiosDebt Ratio (DR) =

Long-term Debt Ratio* =

Time Interest Earned (XIE) =

Cash Coverage =

Fixed Charge Coverage (not in the book) =

Debt to Equity =

Equity Multiplier (EM) =

*Also called Debt to Capital Ratio

50.Assets TotalDebt Total

25. Equity Debt termLong

Debt termLong

5InterestEBIT

7Interest

onDepreciati EBIT

3Charges Fixed

Taxes and Charges Fixed Before Income

0.1Equity

Debt Total

0.2Equity

Assets Total

04/12/23 Ratios 8

Growth Rates

1. Percentage growth of Sales, Net Income, etc.

Example:

2. Sustainable Growth = ROBE(1-PO)

where PO is the payout ratio = Div/NI

03

0304

Sales

SalesSalesgrowth Sales

PO)-ROE(1

04/12/23 Ratios 9

Sustainable Growth

Growth financed through:a) Internal equity fundsb) Supportable debt

Such that:a) Firm’s debt ratio is held constant

SG

(Grant’s approx.)

(Book’s formula)

Where b is the “plowback” or retention ratio

)NI

DIV-ROE(1

PO)-ROE(1

b*ROE-1b*ROE

04/12/23 Ratios 10

Valuation Ratios

Price Earnings (PE) =

Market to Book =

15shareper Earnings

shareper priceMarket

2shareper Book valueshareper priceMarket

04/12/23 Ratios 11

P/E RatioA B

EPS $5 $5

Growth High Low

Price $50 $25

P/E 10x 5x

04/12/23 Ratios 12

Price-earnings Ratios for Selected U.S. Companies

Coca-Cola . . . . . Beverages 13 17 20 25 34 53

27Disney . . . . . . Entertainment 25 20 19 26 23 38

23Liz Claiborne . . . Clothing 13 19 11 19 17 29 13McDonald’s . . . . Restaurants 10 16 18 20 24 28

22NationsBank . . . Banking 7 10 9 10 10 21

Phelps Dodge . . . Copper 6 8 4 17 7 23 35Southwest Air . . . Airlines 20 14 15 38 21 21 27Texas Utilities . . . Public Utilities 6 7 8 15 14 14

Wal-Mart . . . . . Retail 26 28 24 39 18 38 25Standard & Poor’s . . . (500 Stock Index) 11 14 15 22 17 25

20

Jan. Jan. Jan. Jan. Jan. June July Corporation Industry 1983 1986 1990 1993 1996 1998 2004

04/12/23 Ratios 13

Comparison of Market Value to Book Value per Share

CorporationJuly 2004 Market Value per Share

Ratio of Market Value to Book Value

Microsoft $ 27.95 4.64

Pfizer 32.11 3.77

Colgate-Palmolive 56.13 57.98

Oracle Corp 10.33 7.01

Monsanto 36.58 1.78

Steelcase, Inc. 13.57 1.71

Amazon, Inc. 46.02 -

Yahoo, Inc. 28.11 8.33

Wolverine Tube 11.01 .74

04/12/23 Ratios 14

Du Pont Analysis

1. ROE =

2. ROE =

=

3. ROE =

EQNI

EQAssets Total

*Assets Total

Sales*

SalesNI

Profit Margin * Total Asset Turnover * Equity Multiplier (PM) (TAT) (EQ)

DR-1TAT*PM

04/12/23 Ratios 15

Sustainable Growth and Du Pont

D eb t

N ew

R etu rn ed E arn in g s D ivid en d s

O ld (R E )

E q u ity

A sse t G row th

S a les G row thSalesAsset

Asset Equity

PATSales

1 - PO

PO) - PM(1DR - 11

TAT SG

PO) - ROE(1

04/12/23 Ratios 16

Microsoft Income Statements(in millions)

04/12/23 Ratios 17

Microsoft Balance Sheet(in millions)

1994

AssetsCurrent assets:

Cash and short-term investmentsAccounts receivable— net of allowancesInventoriesOther

Total current assetsProperty, plant, and equipment— netOther assets

Total assets

$3,614475102

1214,312

930 121

$5,363

Liabilities and stockholders’ equityCurrent liabilities:

Accounts payableAccounts compensationIncome taxes payableOther

Total current liabilitiesCommitments and contingenciesStockholders’ equity:

Common stock and paid-in capitalRetained earnings

Total stockholders’ equityTotal liabilities and stockholders’ equity

$ 32496

305 188

913

1,500 2,950 4,450

$5,363

04/12/23 Ratios 18

Wal-Mart Stores Income Statement(in thousands)

1994

Revenues:Net salesRentals from licensed departmentsOther income—net

Costs and Expenses:Cost of salesOperating, selling and general

and administrative expenses

Interest Costs:DebtCapital leases

Income Before Income TaxesProvision for Income Taxes:

CurrentDeferred

Net Income

$67,344,57447,422

593,54867,985,544

53,443,743

10,333,218

331,308 185,697 64,293,966

3,691,578

1,324,777 33,524 1,358,277

$ 2,333,277

04/12/23 Ratios 19

Wal-Mart Stores Balance Sheet (in thousands)

AssetsCurrent Assets:

Cash and cash equivalentsReceivablesRecoverable costs from sale/leasebackInventoryPrepaid expenses and other

Total Current AssetsProperty, Plant and Equipment:

LandBuildings and improvementsFixtures and equipmentTransportation equipment

Less accumulated depreciationNet property, plant, and equipmentNet property under capital leases

Other Assets and Deferred ChargesTotal Assets

1994

$ 20,115689,987208,236

11,013,706 182,558

12,114,602

2,740,8836,818,4793,980,674

259,53713,799,573

2,172,80811,626,7651,548,601

1,150,796 $26,440,764

04/12/23 Ratios 20

Wal-Mart Stores Balance Sheet (cont.)(in thousands)

1994

Liabilities and Shareholders’ EquityCurrent Liabilities:

Commercial paperAccounts payableAccrued liabilitiesAccrued federal and state income taxesLong-term debt due within one yearObligations under capital leases due within one year

Total Current LiabilitiesLong-Term DebtLong-Term Obligations Under Capital LeasesDeferred Income TaxesShareholders’ Equity:

Common stockCapital in excess of par valueRetained earnings

Total Shareholders’ EquityTotal Liabilities and Shareholders’ Equity

$ 1,575,0294,103,8781,473,198

183,03119,658

51,4297,406,2236,155,8941,804,300

321,909

229,877535,639

9,986,922 10,752,438 $26,440,764

04/12/23 Ratios 21

Du Pont Examples

Microsoft ROE = 24.6% * 0.867 * 1.21 = 25.7%

Wal-Mart ROE = 3.5% * 2.547 * 2.46 = 21.8%

04/12/23 Ratios 22

How Are They Doing Now?

Microsoft Wal-Mart

04/12/23 Ratios 23

Things to Consider Concerning Financial Ratios

• What aspect of the firm or its operations are we attempting to analyze?

Generally, the aspects are “fuzzy”, e.g., utilization

• What goes into a particular ratio?Historical cost? Market values? What accounting conventions?

• What is the unit of measurement?Dollars? Days? Turns?

• What would a desirable ratio value be?Always?

04/12/23 Ratios 24

Income Statement for the Year 2004Conservative High Reported Income

SalesCost of goods soldGross profitSelling and administrativeOperating profitInterest expenseExtraordinary lossIncome before taxesTaxes (30%)Net IncomeExtraordinary loss (net of tax)Net income transferred to RE

$4,000,000 3,000,000 1,000,000 450,000 550,000 50,000 100,000 400,000 120,000 280,000 --- $ 280,000

$4,200,000 2,700,000 1,500,000 450,000 1,050,000 50,000 --- 1,000,000 300,000 700,000 70,000 $630,000

Discrepancies1. Revenue recognition (i.e., installment sales and leases)2. Cost of goods sold (i.e., may use LIFO during inflation)3. Extraordinary losses

04/12/23 Ratios 25

Trends in Annual Reports Interactive On-line Reports http://

www.intel.com/intel/finance Plain Speaking

http://www.berkshirehathaway.com/2003ar/2003ar.pdf

Filings, i.e. 10k annual reports http://www.edgar-online.com/bin/esearch/fullsearch.asp