X100©2008 KEAW L15 X100 Introduction to Business Finance Professor Kenneth EA Wendeln Financial Analysis & Ratios Financial Analysis & Ratios

X100 ©2008 KEAW L15

X100Introduction to Business

X100Introduction to Business

FinanceFinance

Professor Kenneth EA Wendeln Professor Kenneth EA Wendeln

Financial Analysis & Ratios

Financial Analysis & Ratios

X100 Financial Analysis & Ratios L15-2

Financial Management

Types of Financial Management and Planning Tools:

Capital Budgeting

Capital Structure

Financial Ratios

How to manage the financial health of a company – decisions regarding the acquisition & ‘use of money’ to maximize the value of the company while achieving corporate objectives.

Used to gain insight on how a firm operates as well as its RISK and RETURN


Asset Turnover

Liquidity

Financial Leverage

Profitability

Key Financial Ratios

Return on Owners’ Equity%

EPS – Earnings per Share$ DD.00

Return on Sales% Accounts Receivable

TurnoverX (times/year) or # days

Inventory TurnoverX (times/year) or # days

Current Ratio# n.nn

Acid Test or Quick Ratio# n.nn

Total Liabilities to Equity %


Total Liabilities to Owners’ Equity Ratio

This financial leverage ratio indicates the degree to which a firm’s operations are financed through debt & borrowings - and is used to determine a firm’s ‘conservatism’ and ability to borrow money.

The liabilities to owners’ equity ratio typically ranges between 33 and 50%.

The higher this ratio, the riskier the situation for lenders and shareholders.

Total LiabilitiesOwners’ Equity


Zimmer - Total Liabilities to Owners’ Equity

Total Liabilities to Owners Equity = 21.4 %($1051.2)/($4920.5)

12/31/06 12/31/05$ in millions

‘Debt’ = Total Liabilities

‘Equity’ = Stockholders (or Owners) Equity


Return on Owners’ EquityProfitability ratio that provides an overall measure of a business’s performance. Net income earned (after tax) per dollar of owners’ investment.

Typically between 15% and 25% for profitable companies

Net Income (after taxes)Owners’ (Shareholders’) Equity


Zimmer Return on Owners’ Equity

‘Equity’ = ‘Stockholders’ (or ‘Owners’) Equity

Net Income

Return on Owners’ Equity = 17.0%($834.5)/($4920.5)Return on Owners’ Equity = 17.0%($834.5)/($4920.5)

12/31/06 12/31/05


Liabilities & OE – with HIGH DebtShort-Term Liabilities $100,000Long-Term Loan (@12%) 300,000Total Liabilities (Debt) $400,000

Owner’s equity $500,000Total Liabilities + OE $900,000

Year-end EarningsOperating profit $150,000Interest on Debt (@12%) -36,000Taxes @ 40% PBT -45,600Net income after taxes $68,400

Liabilities/Equity 80.0%($400,000/$500,000)Return on Owners Equity 13.7%($68,400/$500,000)

Financial leverage increases RISK as well as the Debt/Equity & Return on Owners’ Equity Ratios.

Capital Structure - LeverageLow & High Liabilities to Equity

Liabilities & OE – with LOW DebtShort-Term Liabilities $100,000Long-Term Loan (@10%) 100,000Total Liabilities (Debt) $200,000

Owner’s equity $700,000Total Liabilities + OE $900,000

Year-end EarningsOperating profit $150,000Interest on Debt (@10%) -10,000Taxes @ 40% PBT -56,000Net income after taxes $ 84,000

Liabilities/Equity 28.6%($200,000/$700,000)Return on Owners Equity 12.0%($84,000/$700,000)

Higher Risk to Lenders & Shareholders

Lower Risk to Lenders & Shareholders

& High

12%

12%


EPSEarnings per Share

This profitability ratio tells the owner of a share of stock how much of the net earnings for the year belongs to him or her.

These earnings may be paid to the stockholders as dividends . . . or reinvested back into the business to fund its growth.

Net Income or Loss (after taxes)Average # Shares of Common

Stock Outstanding


Zimmer Earnings per Share

EPS = $3.43 per share($834.5)/(#243.0 average shares outstanding)

EPS = $3.43 per share($834.5)/(#243.0 average shares outstanding)


Return on Salesor Net Profit Margin

This profitability ratio measures how well the company generated net profit (after tax) per dollar of net sales revenue.

This ratio is best evaluated by analyzing a firm’s year to year trends and by comparing to businesses within appropriate industries.

Net Income (after taxes)Net Sales Revenue


Zimmer Return on Sales

ROS = 23.9%($834.5)/($3495.4)ROS = 23.9%($834.5)/($3495.4)

ROS = 22.3%($732.5)/($3286.1)ROS = 22.3%($732.5)/($3286.1)

2005200520062006


Current RatioMeasures liquidity - the capacity of a firm to meet its current obligations using liquid assets that are in cash or other resources that can be quickly converted to cash.

A high current ratio, typically >1.0, indicates that a firm can pay its current liabilities

using its current assets.

Current AssetsCurrent Liabilities


ZimmerCurrent Ratio

Current Ratio = 2.78($1746.2)/($628.2)Current Ratio = 2.78($1746.2)/($628.2)


Acid-Test or Quick RatioMeasures liquidity - the ability of a firm to pay current liabilities ‘quickly’ – without selling inventory.

For all businesses the desired acid-test ratio is > 1.0

indicating firm can pay its current liabilities from its non-inventory current assets.

Current Assets - InventoryCurrent Liabilities


Zimmer Acid-Test or Quick Ratio

Quick Ratio = 1.76($1746.2 – 638.3)/($628.2)Quick Ratio = 1.76($1746.2 – 638.3)/($628.2)


Accounts Receivable Asset Turnover Ratio

Determines the number of times during the year a company is ‘turning over’ or collecting its accounts receivable. Measured in X times per year. Can be converted to ‘days outstanding’ by dividing turnover ratio into 365 days.

A high A/R turnover is better than a low one, but depends on company & industry terms of

sale.

6X turnover is equivalent to 60 days of outstanding receivables, 9X is 45 days, 12X is 30 days.

Net SalesAverage Accounts Receivable


ZimmerAccounts Receivable

A/R Turnover = 6.1X or 60 days($3495.4)/($574.9) or (365 days/6.1X)A/R Turnover = 6.1X or 60 days($3495.4)/($574.9) or (365 days/6.1X)

Use average $574.9


Inventory Asset Turnover Ratio

Determines the number of times during the year a company is ‘turning over’ its inventory. Measured in X times per year. Can also be converted to ‘days of inventory’ by dividing ratio into 365 days.

The average inventory turnover for all firms is about 9 times per year, or about once every 45 days.

It varies considerable by industry. Supermarkets have turnover rates exceeding 20X (or 18 days) per year.

Cost of Goods SoldAverage Inventory


Use average $611.0

ZimmerInventory Turnover

Inventory Turnover = 1.28X or 286 days($780.1)/($611.0) or (365 days/1.28X)Inventory Turnover = 1.28X or 286 days($780.1)/($611.0) or (365 days/1.28X)


Key Financial Ratios

Net Income (after taxes)Owners’ Equity

Return on Owners’ Equity

Net Income or Loss (after taxes)Average # of Common Stock

Shares Outstanding

EPS – Earnings per Share

Net Income (after taxes)Net Sales Revenue

Return on Sales

Profitability

Net Sales .

Average Accounts Receivable

Accounts Receivable Turnover

Cost of Goods Sold

Average Inventory

Inventory Turnover

Asset Turnover

Current AssetsCurrent Liabilities

Current Ratio

Current Assets - InventoryCurrent Liabilities

Acid Test or Quick Ratio

Liquidity

Total LiabilitiesOwners’ Equity

Total Liability to Equity Ratio

Financial Leverage


Common Financial Ratios

*Return on

Equity

Return on Total Assets (ROA)

Return to

Investors

*EarningsPer

Share

Price to

Earnings Ratio

Dividend Yield

Return to Investors

Derived from: Fraser/Ormiston, Understanding the Corporate Annual Report; Understanding Financial Statements 6e

*A/RTurnover

*InventoryTurnover

FixedAsset

Turnover

TotalAsset

Turnover

Returnon TotalAssets(ROA)

Asset Management

OperatingEfficiency

* ‘Key’ X100

FinancialRatios

OtherCommonRatios

*Return on

Equity

Returns

Return on Total

Assets(ROA)

Cash Return

on Assets

Profitability

*Net Profit Margin(ROS)

Margins

Operating Profit Margin

Gross Profit Margin

ProductContri-butionMargin

Cash Flow

Margin

Amount of

Debt

LEVERAGEAssets/Equity

Debt/Equity

Debt/Assets

*Total Liabilities/

Equity

Coverage of

Debt

TimesInterestEarned

FixedCharge

Coverage

CashFlow

Adequacy

Cash Interest Coverage

Leverage /Debt Management

LT Debt/Total

Capital-ization

ShortRun

Solvency

*CurrentRatio

*Quickor

Acid TestRatio

CashFlow

LiquidityRatio

CurrentAssets

*A/RAverage

CollectionPeriod

*DaysInventory

Held

DaysPayables

Out-standing

Liquidity

Daysof

Working Capital


Key Financial Statements

Current (12mo)

Long-Term

TOTAL ASSETS

● Cash● A/R● Inventories

● PPE● Fixed Assets

Current (12mo)

Long-Term

TOTAL LIABILITIES

● A/P● ST Debt

● LT Debt

● Stock @ par● Paid-in Capital

● Accumulated Net Income● less Dividends

Contributed Capital

Retained Earnings

TOTAL OWNERS’/SHAREHOLDERS’ EQUITY

Asse

ts = Lia

bilitie

s + O

wn

ers’ E

qu

ity

Balance Sheet Period Ending

Net Sales

TOTAL REVENUES

● Units Sold● @ Price● less Returns & Allowances

Change in cash - Sources & (Uses) - between Periods

Other Expenses

● Interest● Taxes● One-time

Operating Profit

TOTAL NET INCOME or (LOSS) CASH provided (used) by

FINANCING Activities

Stock ● Sale (Purchase)

Dividends

Debt/ Borrowing

● (Paid)

● Increase (Decrease)

CASH provided (used) by INVESTING Activities

PPE ● (Additions) Sale

Other Investments

● (Additions) Sale

TOTAL OP EXPENSES

Expenses for Period

● R & D● Marketing● Distribution● Sales● Admin

Cost of Goods Sold

● Units Sold● @ Material● @ Labor● @ Overhead

CASH provided (used) by OPERATING Activities

Net Income ● Income Statement● Accrual Based

● Depreciation● A/R & A/P● Inventory ● Other Accruals

Adjustments for Non-cash Items

Income Statement for Period

Revenues – E

xpense

s = N

et In

com

e

Cash Flow Statement ∆C

ash =

Opera

ting +

Investin

g +

Financin

g


Documents

X100©2008 KEAW L15 X100 Introduction to Business Finance Professor Kenneth EA Wendeln Financial Analysis & Ratios Financial Analysis & Ratios