Chapter 18: FINANCIAL STATEMENT Chapter 18: FINANCIAL STATEMENT ANALYSISANALYSIS

Remember summative presentation will be Remember summative presentation will be December 17 and 18. December 17 and 18.

Paper or Report is due December 19Paper or Report is due December 19

CHAPTERCHAPTER

1818

• Ratio Analysis expresses the relationships between selected financial statement items.

•There are 3 types of ratio analysis: 1. Liquidity Ratios : Measure short-term ability of

the enterprise to pay its debts and to meet unexpected needs for cash.

2. Solvency ratios : Measure the ability of the enter prise to survive over a long period of time.

3. Profitability ratios: Measure the income or operating success of an enterprise for a given period of time.

Ratio AnalysisRatio AnalysisRatio AnalysisRatio Analysis

PROFITABILITY RATIOS PROFITABILITY RATIOS

• Profit margin

• Gross profit margin

• Asset turnover

• Return on assets

• Return on common shareholders’ equity

• Earnings per share (EPS)

• Price-earnings (PE) ratio

• Payout ratio

ASSET TURNOVERASSET TURNOVER

• Measures how efficiently assets are used to generate sales (The higher the better)

• It shows how much sales did $1 asset make?

(Discussed in Chapter 10)

Asset turnover =Net sales

Average total assets

Asst TurnoverAsst Turnover

2004: 1837000 / (1M + 1.09M)/2 = 1.8

2005: 1997000 / (1M + 1M)/2 = 2.0

Industry average = 2.4

Canadian Tire = 1.4• In 2005, Home Tire generated $2 of net sales for each

dollar of assets. • Since this ratio increased from 2004, it is a positive sign.• Since 2 is higher than 1.4, but it is lower than industry

average, investors will feel neutral about their ratio.

RETURN ON ASSETSRETURN ON ASSETS

• Measures overall profitability of assets• The higher the better.• It shows how much net income did $1 asset make?

Return on assets =Net income

Average total assets

(Discussed in Chapter 10)

Return on AssetsReturn on Assets

• 2004: 75000 / (1M + 1.09M)/2 = 7.2%• 2005: 82000 / (1M + 1M)/2 = 8.2%• Industry Average: 12.3• Canadian Tire: 5.9%• Higher the better • Since the ratio increased year over year, it is a

positive sign. • But it is lower than industry average – negative• It is higher than Canadian Tire – somewhat positive• Every 1$ asset made 0.082$ in 2005

RETURN ON COMMON SHAREHOLDERS’ RETURN ON COMMON SHAREHOLDERS’ EQUITYEQUITY

• Measures profitability of common shareholders’ investment

• It shows how much net income did one share make?

• ACSE = # of shares X share price

Return on common shareholders’ equity =Net income

Average common shareholders’ equity

(Discussed in Chapter 14)

ExampleExample

Apple’s Net Income = 10 million $

# of shares = 1 million shares

Apple declared 50 cents per share

Each share = $5

EPS=?, ROE=? And Payout ratio=?

• Answer: EPS = NI / # shares = 10 million / 1 million =$10 per share• ROE = NI / Total shares = 10 million / (5 X 1 million) = 2 • Payout ratio = (0.5 X 1 million) / 10 million $ = 0.05 or 5%

PAYOUT RATIOPAYOUT RATIO

• Measures % of earnings distributed in the form of cash dividends

• What is the percentage of cash dividends out of net income?

(Discussed in Chapter 15)

Payout ratio =Cash dividends

Net income

Classwork / HomeworkClasswork / Homework

• P960 E18.9, E18.10, E18.11

• P964 P18.3 – only the ratios we learned so far Optional : It is a good practice, but I do not want to give you too many questions. I will not make it a mandatory question.

(Discussed in Chapter 15)