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Financial StatementAnalysis
RATIO ANALYSIS
• Financial statements report both on a firm’s position at a point in time and on its operations over some past period.
• From management’s viewpoint, financial statement analysis is useful both as a way to– anticipate future conditions and – more important, as a starting point for planning actions – that will influence the future course of events or – to show whether a firm’s position has been improving or
deteriorating over time.
• Ratio analysis begins – with the calculation of a set of financial ratios– designed to show the relative strengths and – weaknesses of a company as compared to
• Other firms in the industry• Leadings firms in the industry• The previous year of the same firm
• Ratio analysis helps to show whether the firm’s position has been improving or deteriorating
• Ratio analysis can also help plan for the future
Use of Financial RatiosUse of Financial Ratios
Types of Types of ComparisonsComparisons
Internal Internal ComparisonsComparisons
External External ComparisonsComparisons
Types of Types of ComparisonsComparisons
Internal Internal ComparisonsComparisons
External External ComparisonsComparisons
A Financial Ratio is an index that relates two accounting numbers and is obtained by
dividing one number by the other.
External Comparisons and Sources of Industry RatiosExternal Comparisons and Sources of Industry Ratios
Examples:Risk Management Risk Management
AssociationAssociationDun & BradstreetDun & Bradstreet
Almanac of Business and Industrial
Financial Ratios
Examples:Risk Management Risk Management
AssociationAssociationDun & BradstreetDun & Bradstreet
Almanac of Business and Industrial
Financial Ratios
This involves comparing the ratios of one firm with those of similarsimilar firms or with industry averages.
Similarity is important as one should compare “apples to apples.”
f
Liquidity RatiosLiquidity Ratios
CurrentCurrent
Current AssetsCurrent Liabilities
For Basket Wonders December 31, 2007
CurrentCurrent
Current AssetsCurrent Liabilities
For Basket Wonders December 31, 2007
Shows a firm’s ability to cover its current liabilities with its current assets.
Balance Sheet Ratios
Liquidity Ratios
$1,195$1,195$500$500
= 2.392.39
Liquidity Ratio ComparisonsLiquidity Ratio Comparisons
BW Industry2.39 2.152.26 2.091.91 2.01
BW Industry2.39 2.152.26 2.091.91 2.01
Year200720062005
CurrentCurrent RatioRatio
Ratio is stronger than the industry average.
Liquidity RatiosLiquidity Ratios
Acid-Test (Quick)Acid-Test (Quick)
Current Assets - InvCurrent Liabilities
For Basket Wonders December 31, 2007
Acid-Test (Quick)Acid-Test (Quick)
Current Assets - InvCurrent Liabilities
For Basket Wonders December 31, 2007
Shows a firm’s ability to meet current liabilities
with its most liquid assets.
Balance Sheet Ratios
Liquidity Ratios
$1,195 - $696$1,195 - $696$500$500
= 1.001.00
Liquidity Ratio ComparisonsLiquidity Ratio Comparisons
BW Industry1.00 1.251.04 1.231.11 1.25
BW Industry1.00 1.251.04 1.231.11 1.25
Year200720062005
Acid-Test RatioAcid-Test Ratio
Ratio is weaker than the industry average.
Summary of the Liquidity Ratio Comparisons
Summary of the Liquidity Ratio Comparisons
• Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account.
• Note that this industry has a relatively high level of inventories.
• Strong current ratio and weak acid-test ratio indicates a potential problem in the inventories account.
• Note that this industry has a relatively high level of inventories.
RatioRatio BWBW IndustryIndustryCurrent 2.39 2.15Acid-Test 1.00 1.25
Financial Leverage RatiosFinancial Leverage Ratios
Debt-to-EquityDebt-to-Equity
Total DebtShareholders’ Equity
For Basket Wonders December 31, 2007
Debt-to-EquityDebt-to-Equity
Total DebtShareholders’ Equity
For Basket Wonders December 31, 2007Shows the extent to
which the firm is financed by debt.
Balance Sheet Ratios
Financial LeverageRatios
$1,030$1,030$1,139$1,139
= .90.90
Financial Leverage Ratio Comparisons
Financial Leverage Ratio Comparisons
BW Industry .90 .90 .88 .90 .81 .89
BW Industry .90 .90 .88 .90 .81 .89
Year200720062005
Debt-to-Equity RatioDebt-to-Equity Ratio
BW has average debt utilizationrelative to the industry average.
Financial Leverage RatiosFinancial Leverage Ratios
Debt-to-Total-AssetsDebt-to-Total-Assets
Total DebtTotal DebtTotal AssetsTotal Assets
For Basket Wonders December 31, 2007
Debt-to-Total-AssetsDebt-to-Total-Assets
Total DebtTotal DebtTotal AssetsTotal Assets
For Basket Wonders December 31, 2007Shows the percentage of
the firm’s assets that are supported by debt
financing.
Balance Sheet Ratios
Financial LeverageRatios
$1,030$1,030$2,169$2,169
= .47.47
Financial Leverage Ratio Comparisons
Financial Leverage Ratio Comparisons
BW Industry .47 .47 .47 .47 .45 .47
BW Industry .47 .47 .47 .47 .45 .47
Year200720062005
Debt-to-Total-Asset RatioDebt-to-Total-Asset Ratio
BW has average debt utilizationrelative to the industry average.
Financial Leverage RatiosFinancial Leverage Ratios
Total CapitalizationTotal Capitalization
Long-term DebtTotal Capitalization
For Basket Wonders December 31, 2007
Total CapitalizationTotal Capitalization
Long-term DebtTotal Capitalization
For Basket Wonders December 31, 2007
Shows the relative importance of long-term debt to the long-term financing of
the firm.
Balance Sheet Ratios
Financial LeverageRatios
$530$530$1,669$1,669
= .32.32
(i.e., LT-Debt + Equity)
Financial Leverage Ratio Comparisons
Financial Leverage Ratio Comparisons
BW Industry .32 .30 .32 .31 .37 .32
BW Industry .32 .30 .32 .31 .37 .32
Year200720062005
Total Capitalization RatioTotal Capitalization Ratio
BW has average long-term debt utilizationrelative to the industry average.
Activity RatiosActivity Ratios
Receivable TurnoverReceivable Turnover
Annual Net Credit SalesReceivables
For Basket Wonders December 31, 2007
Receivable TurnoverReceivable Turnover
Annual Net Credit SalesReceivables
For Basket Wonders December 31, 2007Indicates quality of
receivables and how successful the firm is in its
collections.
Income Statement /Balance Sheet
Ratios
Activity Ratios
$2,211$2,211$394$394
= 5.615.61
(Assume all sales are credit sales.)
Activity RatiosActivity Ratios
Avg Collection PeriodAvg Collection Period
Days in the YearReceivable Turnover
For Basket Wonders December 31, 2007
Avg Collection PeriodAvg Collection Period
Days in the YearReceivable Turnover
For Basket Wonders December 31, 2007
Average number of days that receivables are
outstanding.(or RT in days)
Income Statement /Balance Sheet
Ratios
Activity Ratios
3653655.615.61
= 65 days65 days
ActivityRatio Comparisons
ActivityRatio Comparisons
BW Industry65.0 65.771.1 66.383.6 69.2
BW Industry65.0 65.771.1 66.383.6 69.2
Year200720062005
Average Collection PeriodAverage Collection Period
BW has improved the average collection period to that of the industry average.
Activity RatiosActivity Ratios
Payable Turnover (PT)Payable Turnover (PT)
Annual Credit PurchasesAccounts Payable
For Basket Wonders December 31, 2007
Payable Turnover (PT)Payable Turnover (PT)
Annual Credit PurchasesAccounts Payable
For Basket Wonders December 31, 2007Indicates the promptness of
payment to suppliers by the firm.
Income Statement /Balance Sheet
Ratios
Activity Ratios
$1551$1551$94$94 = 16.516.5
(Assume annual credit purchases = $1,551.)
Activity RatiosActivity Ratios
PT in DaysPT in Days
Days in the YearDays in the YearPayable TurnoverPayable Turnover
For Basket Wonders December 31, 2007
PT in DaysPT in Days
Days in the YearDays in the YearPayable TurnoverPayable Turnover
For Basket Wonders December 31, 2007
Average number of days that payables are
outstanding.
Income Statement /Balance Sheet
Ratios
Activity Ratios
36536516.516.5
= 22.1 days22.1 days
ActivityRatio Comparisons
ActivityRatio Comparisons
BW Industry22.1 46.725.4 51.143.5 48.5
BW Industry22.1 46.725.4 51.143.5 48.5
Year200720062005
Payable Turnover in DaysPayable Turnover in Days
BW has improved the PT in Days.Is this good?Is this good?
Activity RatiosActivity Ratios
Inventory TurnoverInventory Turnover
Cost of Goods SoldInventory
For Basket Wonders December 31, 2007
Inventory TurnoverInventory Turnover
Cost of Goods SoldInventory
For Basket Wonders December 31, 2007
Indicates the effectiveness of the inventory
management practices of the firm.
Income Statement /Balance Sheet
Ratios
Activity Ratios
$1,599$1,599$696$696
= 2.302.30
ActivityRatio Comparisons
ActivityRatio Comparisons
BW Industry2.30 3.452.44 3.762.64 3.69
BW Industry2.30 3.452.44 3.762.64 3.69
Year200720062005
Inventory Turnover RatioInventory Turnover Ratio
BW has a very poor inventory turnover ratio.
Activity RatiosActivity Ratios
Total Asset TurnoverTotal Asset Turnover
Net SalesNet SalesTotal AssetsTotal Assets
For Basket Wonders December 31, 2007
Total Asset TurnoverTotal Asset Turnover
Net SalesNet SalesTotal AssetsTotal Assets
For Basket Wonders December 31, 2007
Indicates the overall effectiveness of the firm in
utilizing its assets to generate sales.
Income Statement /Balance Sheet
Ratios
Activity Ratios
$2,211$2,211$2,169$2,169
= 1.021.02
ActivityRatio Comparisons
ActivityRatio Comparisons
BW Industry1.02 1.171.03 1.141.01 1.13
BW Industry1.02 1.171.03 1.141.01 1.13
Year200720062005
Total Asset Turnover RatioTotal Asset Turnover Ratio
BW has a weak total asset turnover ratio.
Profitability RatiosProfitability Ratios
Gross Profit MarginGross Profit Margin
Gross ProfitGross ProfitNet SalesNet Sales
For Basket Wonders December 31, 2007
Gross Profit MarginGross Profit Margin
Gross ProfitGross ProfitNet SalesNet Sales
For Basket Wonders December 31, 2007
Indicates the efficiency of operations and firm pricing
policies.
Income Statement /Balance Sheet
Ratios
Profitability Ratios
$612$612$2,211$2,211
= .277277
ProfitabilityRatio Comparisons
ProfitabilityRatio Comparisons
BW Industry27.7% 31.1%28.7 30.831.3 27.6
BW Industry27.7% 31.1%28.7 30.831.3 27.6
Year200720062005
Gross Profit MarginGross Profit Margin
BW has a weak Gross Profit Margin.
Profitability RatiosProfitability Ratios
Return on InvestmentReturn on Investment
Net Profit after TaxesNet Profit after TaxesTotal AssetsTotal Assets
For Basket Wonders December 31, 2007
Return on InvestmentReturn on Investment
Net Profit after TaxesNet Profit after TaxesTotal AssetsTotal Assets
For Basket Wonders December 31, 2007Indicates the profitability on
the assets of the firm (after all expenses and taxes).
Income Statement /Balance Sheet
Ratios
Profitability Ratios
$91$91$2,160$2,160
= .042.042
Profitability Ratio Comparisons
Profitability Ratio Comparisons
BW Industry4.2% 9.8%5.0 9.19.1 10.8
BW Industry4.2% 9.8%5.0 9.19.1 10.8
Year200720062005
Return on InvestmentReturn on Investment
BW has a poor Return on Investment.
Profitability RatiosProfitability Ratios
Return on EquityReturn on Equity
Net Profit after TaxesNet Profit after TaxesShareholders’ EquityShareholders’ Equity
For Basket Wonders December 31, 2007
Return on EquityReturn on Equity
Net Profit after TaxesNet Profit after TaxesShareholders’ EquityShareholders’ Equity
For Basket Wonders December 31, 2007Indicates the profitability to
the shareholders of the firm (after all expenses and
taxes).
Income Statement /Balance Sheet
Ratios
Profitability Ratios
$91$91$1,139$1,139
= .08.08
Profitability Ratio Comparisons
Profitability Ratio Comparisons
BW Industry 8.0% 17.9% 9.4 17.216.6 20.4
BW Industry 8.0% 17.9% 9.4 17.216.6 20.4
Year200720062005
Return on EquityReturn on Equity
BW has a poor Return on Equity.