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Chapter 18: FINANCIAL Chapter 18: FINANCIAL STATEMENT ANALYSISSTATEMENT ANALYSIS
Due date for summative is the last day, Due date for summative is the last day, December 19December 19
• 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
RETURN ON COMMON RETURN ON COMMON SHAREHOLDERS’ EQUITYSHAREHOLDERS’ EQUITY
• Measures profitability of common shareholders’ investment
• It shows how much net income is generated by one dollar of equity (which is invested by shareholders) in the company. = The higher the better
Return on common shareholders’ equity =Net income
Average common shareholders’ equity
(Discussed in Chapter 14)
Return on CSEReturn on CSE
• Hometown 2004 = 75000 / (211500 + 166500)/2 = 39.7%• 2005 = 82000 / (262300 + 211500) /2 = 34.6%• Industry Average = 23.9%• Canadian Tire = 13.9%• Although this ratio decreased from 2004 to 2005,
Hometown’s number is better than industry average and Canadian Tire’s number.
• It seems like a good number.
SOLVENCY RATIOSSOLVENCY RATIOS
• Debt to total assets
• Interest coverage
• Cash total debt coverage
DEBT TO TOTAL ASSETSDEBT TO TOTAL ASSETS
• Measures % of total assets provided by creditors
Debt to total assets =
Total liabilities Total assets
(Discussed in Chapter 16)
Debt to Total AssetsDebt to Total Assets
• This ratio indicates the company’s degree of leverage. (=indebtness)
• Leverage = how much debt the company carries.• The higher number indicates that greater risk that the
company might not be able to pay their debts. • Generally speaking, the lower the better for this number. • The number should be less than 1 (or 100%) to be a good
number.
Debt to Total AssetsDebt to Total Assets
• 2004: 78.9%• 2005: 73.8%• Industry Average: 61.9%• Canadian Tire: 57.8%• 73.8% means that lenders provided 73.8% of the total assets.
Only 26.2% of the total assets was provided by shareholders.• Year over year trend is going down, so it seems OK. • But when you compare it to industry average or Canadian
Tire, the debt portion is bigger not so good
INTEREST COVERAGEINTEREST COVERAGE
• Measures ability to meet interest payments as they come due
• EBIT = Earnings before interest and tax
Interest coverage = Income before interest expenseand income tax expense (EBIT)
Interest expense
(Discussed in Chapter 16)
Interest CoverageInterest Coverage
• The higher the better• 2004: 4.2 times• 2005: 4.7 times• Industry Average: 13.6 times • Canadian Tire : 7.3 times.• Year to year trend shows positive, but comparing it to
industry average, (or competitor) 4.7 is not a great number. • Their EBIT is only 4.7 times of their interest expense, when
other companies in this industry has 13.6 times of their interest expense.
CASH TOTAL DEBT COVERAGECASH TOTAL DEBT COVERAGE
• Measures long-term debt-paying ability (cash basis)
Cash total debt coverage ratio =Net cash provided by operating
activitiesAverage total liabilities
(Discussed in Chapter 18)
• Estimates
• Historical cost
• Alternative accounting methods
• Atypical data
• Diversification
LIMITATIONS OF FINANCIAL LIMITATIONS OF FINANCIAL ANALYSISANALYSIS
Cash Total Debt CoverageCash Total Debt Coverage
• Will not show up in final exam
Classwork / HomeworkP959 E18.8, E18.9, E18.10 (ones you did not do yet),
E18.11 (ones you did not do yet)P963 P18.3 (ones you did not do yet)
P966 P18.6