Working with Financial StatementsWorking with Financial Statements

Why Use Financial Statements?Why Use Financial Statements? External UsersExternal Users Internal UsersInternal Users Trend Analysis – Time SeriesTrend Analysis – Time Series Comparing FirmsComparing Firms

The only good number on a stand alone basis The only good number on a stand alone basis is a phone number (old saying)is a phone number (old saying)Different Objectives makes comparisons more Different Objectives makes comparisons more difficultdifficultWhy compare firms…limited investment Why compare firms…limited investment resourcesresources

Working with Financial StatementsWorking with Financial Statements

The Pitfalls of Financial StatementsThe Pitfalls of Financial Statements it is not a cookbook – don’t read to much into a it is not a cookbook – don’t read to much into a

single ratio or comparisonsingle ratio or comparison financial statements are backward lookingfinancial statements are backward looking financial decisions are forward lookingfinancial decisions are forward looking comparing firms…comparing firms…

different industriesdifferent industries

different timing on recording informationdifferent timing on recording information

different goalsdifferent goals

different constraintsdifferent constraints

Working with Financial StatementsWorking with Financial Statements

Ratio AnalysisRatio Analysis Estimating the Health of the FirmEstimating the Health of the Firm

Exxon, McDonalds, Intel, Wal-MartExxon, McDonalds, Intel, Wal-Mart

Which firm is the healthiest?Which firm is the healthiest? Using Ratios as proxies for health of firmUsing Ratios as proxies for health of firm

Most profitableMost profitable

Fastest GrowingFastest Growing

Most stableMost stable

Recession ProofRecession Proof

Long term SurvivalLong term Survival

Working with Financial StatementsWorking with Financial Statements

Examining the FirmExamining the Firm

Working with Financial StatementsWorking with Financial Statements

Four Types of RatiosFour Types of Ratios LiquidityLiquidity

The ability to meet obligations on a timely basisThe ability to meet obligations on a timely basis ActivityActivity

Management of assetsManagement of assets DebtDebt

The borrowing structure of the firmThe borrowing structure of the firm ProfitabilityProfitability

The most abused ratios – measure (potential) returnThe most abused ratios – measure (potential) return

Working with Financial StatementsWorking with Financial Statements

LiquidityLiquidity Net Working CapitalNet Working Capital Current RatioCurrent Ratio Quick RatioQuick Ratio

Chapter 2 – Problem 8Chapter 2 – Problem 8 Analyze Current and Quick RatioAnalyze Current and Quick Ratio Trend AnalysisTrend Analysis EvaluationEvaluation

Working with Financial StatementsWorking with Financial Statements

Activity RatiosActivity Ratios Inventory TurnoverInventory Turnover Average Collection PeriodAverage Collection Period Average Payment PeriodAverage Payment Period Asset TurnoverAsset Turnover

Chapter 2 – Problem 11Chapter 2 – Problem 11

Working with Financial StatementsWorking with Financial Statements

Debt RatiosDebt Ratios Debt RatioDebt Ratio

Total Liabilities / Total AssetsTotal Liabilities / Total AssetsDebt Percent ( 1 – Debt Percent = Equity Debt Percent ( 1 – Debt Percent = Equity Percent)Percent)

Times Interest EarnedTimes Interest EarnedMust make interest payments…failure means Must make interest payments…failure means the firm is in technical bankruptcythe firm is in technical bankruptcyNote before taxes as government is paid after Note before taxes as government is paid after interestinterest

Chapter 2 – Problem 12Chapter 2 – Problem 12

Working with Financial StatementsWorking with Financial Statements

Profitability Ratios (Most Abused)Profitability Ratios (Most Abused) ROA – Return on AssetsROA – Return on Assets ROE – Return on EquityROE – Return on Equity P/E Ratio (not in text but very common)P/E Ratio (not in text but very common) Operating Profit MarginOperating Profit Margin

% profit per sale dollar before interest and taxes% profit per sale dollar before interest and taxes Net Profit MarginNet Profit Margin

% profit per sale dollar% profit per sale dollarWhat is available to shareholdersWhat is available to shareholders

Working with Financial StatementsWorking with Financial Statements

DuPont SystemDuPont System Target is ROETarget is ROE

Breaks down into components of ROEBreaks down into components of ROE ROE = Profit Margin x Total Asset Turnover ROE = Profit Margin x Total Asset Turnover

xxEquity MultiplierEquity Multiplier

Profit Margin is Net Income/SalesProfit Margin is Net Income/Sales Asset Turnover is Sales/AssetsAsset Turnover is Sales/Assets Equity Multiplier is Assets/Total EquityEquity Multiplier is Assets/Total Equity

Chapter 2 – Problem 14Chapter 2 – Problem 14