Financial Analysis & Ratios

Comparative Analysis

There are three types of comparisons to provide decision usefulness of financial information:

•  Intra-company basis •  Inter-company basis •  Industry averages

Comparative Analysis

•  Intra-company basis – comparisons within the company.

•  Inter-company basis – comparisons with other companies.

•  Industry averages – comparisons with other companies in the same industry.

Financial Statement Analysis Three basic tools are used in financial statement analysis :

1. Horizontal analysis 2. Vertical analysis 3. Ratio analysis

Horizontal Analysis •  Is a technique for evaluating a series of financial

statement data over a period of time.

•  Did an increase or decrease take place?

Vertical Analysis •  Expresses each item in a financial statement as a

percent of a base amount.

•  Total Assets is the base amount on a Balance Sheet. • Common-size balance sheet

•  Net Sales is the base amount on an Income Statement.

• Common-size income statement

Ratio Analysis ➨ Five types:

➨ Liquidity ratios ➨ Solvency ratios ➨ Turnover ratios ➨ Profitability ratios ➨ Market value ratios

Liquidity Ratios Measure the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash.

WHO CARES? Short-term creditors such as bankers and suppliers

Current Ratio

Indicates short-term debt-paying ability

Current Assets Current Liabilities

Acid-Test Ratio

Indicates immediate short-term debt-paying ability

Current Assets - Inventory Current Liabilities

Cash Ratio

Indicates short-term debt-paying ability (cash basis)

_ Cash _

Current Liabilities

Solvency Ratios Measure the ability of the enterprise to survive over a long period of time

WHO CARES? Long-term creditors and stockholders

Debt to Assets Ratio

Indicates % of total assets provided by creditors

Total Liabilities Total Assets

Times Interest Earned Ratio

Indicates company’s ability to meet interest payments as they come due

_ EBIT _ Interest Expense

Cash Debt Coverage Ratio Indicates long-term debt-paying ability (cash basis)

Cash provided by operations Average total liabilities

Turnover Ratios Measure how efficiently, or intensively, a firm uses its assets to generate sales

.

WHO CARES?

Short-term creditors such as bankers and suppliers

Inventory Turnover Ratio

Indicates liquidity of inventory

Cost of Goods Sold Inventory

Average Days in Inventory

Indicates liquidity of inventory and inventory management

365 days

Inventory Turnover Ratio

Receivables Turnover Ratio Indicates liquidity of receivables

Net Sales

Accounts Receivable

Average Collection Period Indicates liquidity of receivables and

collection success

365 days Receivables Turnover

Asset Turnover Ratio

Indicates how efficiently assets are used to generate sales

Net Sales Total Assets

Profitability Ratios Measure the income or operating success of an enterprise for a given period of time

WHO CARES? Everybody

WHY? A company’s income affects: ➩ its ability to obtain debt and equity financing ➩ its liquidity position ➩ its ability to grow

Profit Margin Ratio Indicates net income generated by each dollar of sales

Net Income Net Sales

Return On Assets

Reveals the amount of net income generated by each dollar invested

Net Income Average Total Assets

Return on Equity Indicates profitability of common

stockholders’ investment

Net Income Average Total Equity

Market Value Ratios Deals with market value of stock.

.

WHO CARES? Stockholder’s

Earnings Per Share (EPS) Indicates net income earned on each

share of common stock sales

Net Income Shares Outstanding

Price Earnings Ratio Indicates relationship between market

price per share and earnings per share

Stock Price Earnings Per Share

Payout Ratio

Indicates % of earnings distributed in the form of cash dividends

Dividends Net Income

Retention Ratio

Indicates % of earnings plowed back into the corporation.

Addition to Retained Earnings Net Income

Limitations Of Financial Analysis

•  Horizontal, vertical, and ratio analysis are frequently used in making significant business decisions.

•  One should be aware of the limitations of these tools and the financial statements.