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Slide 1
Evaluating a Firm’s Financial Performance Goals of evaluating firm performance: Are our decisions maximizing shareholder
wealth? We will want to answer questions about the firm’s
Liquidity Efficient use of Assets Leverage (financing) Profitability
Slide 2
Financial Ratios Tools that help us determine the financial health
of a company We can compare a company’s financial ratios
with its ratios in previous years (trend analysis) We can compare a company’s financial ratios
with those of its industry
Slide 3
Assets: Liabilities & Equity: Cash $2,540 Accounts payable 9,721 Marketable securities 1,800 Notes payable 8,500 Accounts receivable 18,320 Accrued taxes payable 3,200 Inventories 27,530 Other current liabilities 4,102 Total current assets 50,190 Total current liabilities 25,523 Plant and equipment 43,100 Long-term debt (bonds) 22,000 less accum deprec. 11,400 Total liabilities 47,523 Net plant & equip. 31,700 Common stock ($10 par) 13,000 Total assets 81,890 Paid in capital 10,000
Retained earnings 11,367Total stockholders' equity
34,367Total liabilities & equity 81,890
Dragon’s Balance Sheet
Slide 4
Sales (all credit) $112,760 Cost of Goods Sold (85,300) Gross Profit 27,460 Operating Expenses:
Selling (6,540) General & Administrative (9,400) Total Operating Expenses (15,940)
Earnings before interest and taxes (EBIT) 11,520 Interest charges:
Interest on bank notes: (850) Interest on bonds: (2,310) Total Interest charges (3,160)
Earnings before taxes (EBT) 8,360 Taxes (assume 40%) (3,344) Net Income 5,016
Dragon’s Income Statement
Slide 5
Dividends paid on common stock $2,800
Earnings retained in the firm 2,216
Shares outstanding (000) 1,300
Market price per share 20
Book value per share 26.44
Earnings per share 3.86
Dividends per share 2.15
Dragon (Other Information)
Slide 6
What is the firm’s Current Ratio? Do we have enough liquid assets to meet approaching
obligations?
If the average current ratio for the industry is 2.4, is this good or not?
97.1523,25
190,50
sLiabilitie Current
Assets CurrentRatio Current ===
1. Liquidity Ratios
Slide 7
What is the firm’s Acid-Test Ratio (Quick Ratio)?
Suppose the industry average is 0.92. What does this tell us?
89.0523,25
27,530-190,50Ratio (Quick)Test -Acid
sLiabilitieCurrent
sInventorie - AssetsCurrent Ratio (Quick)Test -Acid
1. Liquidity Ratios (Continued)
Slide 8
What is the firm’s Average Collection Period (ACP)?
If the industry average is 47 days, what does this tell us? Alternatively, we can calculate Average Collection Turnover
(Accounts Receivable Turnover (ART)) first as: (Industry average is 8.2 times)
Second, we convert the turnover into a period using 365 day/year:
days 3.59365/760,112
320,18
SalesCredit Daily
Receivable AccountsA CP
times 115.6320,18
760,112
Receivable Accounts
SalesTRA ===
days 3.59155.6
365
Turnover Receivable Accounts
365RPA ===
1. Liquidity Ratios (Continued)
Slide 9
What is the firm’s Accounts Payable Turnover (APT)?
Accounts Payable Period (APP)
times 78.8271,9
300,85
Payable Accounts
SoldGoods of CostPTA ===
days 57.4178.8
365
Turnover Payable Accounts
365PPA ===
1. Liquidity Ratios (Continued)
Slide 10
Measure how efficiently the firm’s assets generate operating profits
What is the firm’s Operating Income Return on Investment (OIROI)?
Slightly below the industry average of 15%. The OIROI reflects product pricing and the firm’s ability to keep costs down
Note: EBIT is Operating Income
%07.14100890,81
520,11
Assets Total
EBITOIROI =×==
2. Operating Efficiency Ratios
Slide 11
What is the firm’s Operating Profit Margin (OPM)?
Below the industry average of 12%
%22.10100760,112
520,11
Sales
(EBIT) Income OperatingOPM =×==
2. Operating Efficiency Ratios (Continued)
Slide 12
What is the firm’s Total Asset Turnover (TAT)?
The industry average is 1.82 times Total Asset Period (TAP):
The firm needs to figure out how to squeeze more sales dollars out of its assets
times 38.1890,81
760,112
Assets Total
SalesTAT ===
days 50.26438.1
365
Turnover Asset Total
365TAP ===
2. Operating Efficiency Ratios (Continued)
Slide 13
What is the firm’s Inventory Turnover?
Dragon turns their inventory over 3.1 times per year. The industry average is 3.9 times. Is this efficient? Inventory Period (IP) for the firm is:
times 10.3530,27
300,85
sInventorie
SoldGoods of CostTI ===
days 74.11710.3
365
TurnoverInventory
365PI ===
2. Operating Efficiency Ratios (Continued)
Slide 14
Low Inventory Turnover The firm may have too much inventory, which is
expensive because:
Inventory takes up costly warehouse space
Some items may become spoiled or obsolete
2. Operating Efficiency Ratios (Continued)
Slide 15
Cash Cycle = (Inventory Period + Receivables Period) – Payables Period
Cash Cycle = (117.74 + 59.30) – 41.57 = 135.47
2. Operating Efficiency Ratios (Continued)
Slide 16
What is the firm’s Fixed Asset Turnover (FAT)?
If the industry average is 4.6 times, what does this tell us about the firm?
Fixed Asset Period (FAP) for the firm is
times 56.3700,31
760,112
Assets Fixed Net
SalesFAT ===
days 53.10256.3
365
Turnover Asset Fixed
365PFA ===
2. Operating Efficiency Ratios (Continued)
Slide 17
Measure the impact of using debt capital to finance assets Firms use debt to lever (increase) returns on common equity How does Leverage work? Suppose we have an all equity-financed firm worth $100,000. Its
earnings this year total $15,000 ROE = 15,000 / 100,000 = 15% Suppose the same $100,000 firm is financed with half equity, and
half 8% debt (bonds). Earnings are still $15,000 ROE = (15,000 – 4,000) / 50,000 = 22%
3. Leverage Ratios (Financing Decisions)
Slide 18
If the industry average is 47%, what does this tell us? Can leverage make the firm more profitable? Can leverage make the firm riskier?
What is Dragon’s Debt Ratio?
%58100890,81
523,47
Assets Total
Debt TotalRatio Debt =×==
3. Leverage Ratios (Financing Decisions) (Continued)
Slide 19
The industry average is 6.7 times. This is further evidence that the firm uses more debt financing than average
What is Dragon’s Times Interest Earned Ratio (TIER)?
times 65.3160,3
520,11
Expense Interest
Income) (Operating EBITTIER ===
3. Leverage Ratios (Financing Decisions) (Continued)
Slide 20
The industry average is 17.54%. Is this what we would expect, given the firm’s leverage?
How well are the firm’s managers maximizing shareholder wealth?
%6.14100367,34
016,5
Equity Total
Income NetROE =×==
4. Return on Equity (ROE)
Slide 21
Even though Dragon has higher leverage than the industry average, they are much less efficient, and therefore, less profitable
Conclusion
Slide 22
Brings together: Profitability – measured by the Net Profit Margin (NPM)
Efficiency – measured by Total Asset Turnover (TAT)
Leverage – measured by Debt Ratio
%45.4100760,112
016,5
Sales
Income NetNPM =×==
times 38.1890,81
760,112
Assets Total
SalesTAT ===
%58100890,81
523,47
Assets Total
Debt TotalRatio Debt =×==
The DuPont Model
Slide 23Assets Total
Income NetAssets on Return
Assets Total
Sales
Sales
Income NetAssets on ReturnTATNPM
58%-1
4Equity on Return
Assets Total
Debt Total-1
Assets Total
Sales
Sales
Income Net
Equity on Return
DR-1
TATNPMEquity on Return
%6.1438.1%45.
The DuPont Model