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3 - 1 Copyright © 2001 by Harcourt, Inc.All rights reserved. Ratio analysis Du Pont system Effects of improving ratios Limitations of ratio analysis Qualitative.

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Presentation on theme: "3 - 1 Copyright © 2001 by Harcourt, Inc.All rights reserved. Ratio analysis Du Pont system Effects of improving ratios Limitations of ratio analysis Qualitative."— Presentation transcript:

1 3 - 1 Copyright © 2001 by Harcourt, Inc.All rights reserved. Ratio analysis Du Pont system Effects of improving ratios Limitations of ratio analysis Qualitative factors CHAPTER 3 Analysis of Financial Statements

2 3 - 2 Copyright © 2001 by Harcourt, Inc.All rights reserved. Balance Sheet: Assets 2001E2000 Cash85,6327,282 AR878,000632,160 Inventories1,716,4801,287,360 Total CA2,680,1121,926,802 Gross FA1,197,1601,202,950 Less: Deprec. 380,120 263,160 Net FA 817,040 939,790 Total assets3,497,1522,866,592

3 3 - 3 Copyright © 2001 by Harcourt, Inc.All rights reserved. Liabilities and Equity 2001E2000 Accounts payable436,800524,160 Notes payable600,000720,000 Accruals 408,000 489,600 Total CL1,444,8001,733,760 Long-term debt500,0001,000,000 Common stock1,680,936460,000 Retained earnings (128,584) (327,168) Total equity1,552,352 132,832 Total L & E3,497,1522,866,592

4 3 - 4 Copyright © 2001 by Harcourt, Inc.All rights reserved. Income Statement Sales7,035,6005,834,400 COGS5,728,000 Other expenses 680,000 EBITDA 627,600 (573,600) Depreciation 116,960 EBIT 510,640 (690,560) Interest exp. 88,000 176,000 EBT 422,640 (866,560) Taxes (40%) 169,056 (346,624) Net income 253,584 (519,936) 2001E2000

5 3 - 5 Copyright © 2001 by Harcourt, Inc.All rights reserved. Other Data 2001E2000 Shares out.250,000100,000 EPS$1.014($5.199) DPS$0.220$0.110 Stock price$12.17$2.25 Lease pmts$40,000

6 3 - 6 Copyright © 2001 by Harcourt, Inc.All rights reserved. Standardize numbers; facilitate comparisons Used to highlight weaknesses and strengths Why are ratios useful?

7 3 - 7 Copyright © 2001 by Harcourt, Inc.All rights reserved. Liquidity: Can we make required payments? Asset management: Right amount of assets vs. sales? What are the five major categories of ratios, and what questions do they answer?

8 3 - 8 Copyright © 2001 by Harcourt, Inc.All rights reserved. Debt management: Right mix of debt and equity? Profitability: Do sales prices exceed unit costs, and are sales high enough as reflected in PM, ROE, and ROA? Market value: Do investors like what they see as reflected in P/E and M/B ratios?

9 3 - 9 Copyright © 2001 by Harcourt, Inc.All rights reserved. Calculate D’Leon’s forecasted current and quick ratios for 2001. CR 01 = = = 1.85x. QR 01 = = = 0.67x. CA CL $2,680 $1,445 $2,680 – $1,716 $1,445 CA - Inv. CL

10 3 - 10 Copyright © 2001 by Harcourt, Inc.All rights reserved. Expected to improve but still below the industry average. Liquidity position is weak. Comments on CR and QR 200120001999Ind. CR1.85x1.1x2.3x2.7x QR0.67x0.4x0.8x1.0x

11 3 - 11 Copyright © 2001 by Harcourt, Inc.All rights reserved. Inv. turnover= = = 4.10x. Sales Inventories $7,036 $1,716 What is the inventory turnover ratio vs. the industry average? 200120001999Ind. Inv. T.4.1x4.5x4.8x6.1x

12 3 - 12 Copyright © 2001 by Harcourt, Inc.All rights reserved. Inventory turnover is below industry average. D’Leon might have old inventory, or its control might be poor. No improvement is currently forecasted. Comments on Inventory Turnover

13 3 - 13 Copyright © 2001 by Harcourt, Inc.All rights reserved. Receivables Average sales per day DSO = = = = 44.9. DSO is the average number of days after making a sale before receiving cash. Receivables Sales/360 $878 $7,036/360

14 3 - 14 Copyright © 2001 by Harcourt, Inc.All rights reserved. Appraisal of DSO nD’Leon collects too slowly, and is getting worse. nD’Leon has a poor credit policy. 200120001999Ind. DSO 44.9 39.0 36.8 32.0

15 3 - 15 Copyright © 2001 by Harcourt, Inc.All rights reserved. F.A. and T.A. turnover vs. industry average Fixed assets turnover Sales Net fixed assets = = = 8.61x. $7,036 $817 Total assets turnover Sales Total assets = = = 2.01x. $7,036 $3,497

16 3 - 16 Copyright © 2001 by Harcourt, Inc.All rights reserved. FA turnover projected to exceed industry average. Good. TA turnover not up to industry average. Caused by excessive current assets (A/R and Inv.) 2001 2000 1999Ind. FA TO 8.6x6.2x10.0x7.0x TA TO 2.0x2.0x2.3x2.6x

17 3 - 17 Copyright © 2001 by Harcourt, Inc.All rights reserved. Calculate the debt ratio, TIE, and EBITDA coverage ratios. Total debt Total assets Debt ratio= = = 55.6%. $1,445 + $500 $3,497 EBIT Int. expense TIE= = = 5.8x. $510.6 $88

18 3 - 18 Copyright © 2001 by Harcourt, Inc.All rights reserved. EBITDA coverage = = = 5.2x. EBITDA + Lease payments (in cash) Interest Lease Loan expense pmt. repayments + $510.6 + $117.0 + $40 $88 + $40 + $0

19 3 - 19 Copyright © 2001 by Harcourt, Inc.All rights reserved. Too much debt, but projected to improve. How do the debt management ratios compare with industry averages? 200120001999 Ind. D/A55.6%95.4%54.8%50.0% TIE 5.8x -3.9x 3.3x 6.2x EBITDA coverage 5.2x -3.3x 3.6x 8.0x

20 3 - 20 Copyright © 2001 by Harcourt, Inc.All rights reserved. Very bad in 2000, but projected to exceed industry average in 2001. Looking good. Profit margin vs. industry average? 200120001999 Ind. P.M.3.6%-8.9%2.6% 3.5% P.M. = = = 3.6%. NI Sales $253.6 $7,036

21 3 - 21 Copyright © 2001 by Harcourt, Inc.All rights reserved. BEP= = = 14.6%. BEP vs. Industry Average? EBIT Total assets $510.6 $3,497

22 3 - 22 Copyright © 2001 by Harcourt, Inc.All rights reserved. BEP removes effect of taxes and financial leverage. Useful for comparison. Projected to be below average. Room for improvement. 200120001999Ind. BEP14.6%-24.1%14.2%19.1%

23 3 - 23 Copyright © 2001 by Harcourt, Inc.All rights reserved. Return on Assets ROA= = = 7.3%. Net income Total assets $253.6 $3,497

24 3 - 24 Copyright © 2001 by Harcourt, Inc.All rights reserved. ROE= = = 16.3%. Net income Common equity $253.6 $1,552 2001 20001999Ind. ROA 7.3% -18.1% 6.0% 9.1% ROE16.3%-391.4%13.3%18.2% Both below average but improving.

25 3 - 25 Copyright © 2001 by Harcourt, Inc.All rights reserved. ROA is lowered by debt--interest lowers NI, which also lowers ROA = NI/Assets. But use of debt lowers equity, hence could raise ROE = NI/Equity. Effects of Debt on ROA and ROE

26 3 - 26 Copyright © 2001 by Harcourt, Inc.All rights reserved. Calculate and appraise the P/E, P/CF, and M/B ratios. Price = $12.17. EPS = = = $1.01. P/E = = = 12x. NI Shares out. $253.6 250 Price per share EPS $12.17 $1.01

27 3 - 27 Copyright © 2001 by Harcourt, Inc.All rights reserved. IndustryP/E ratio Banking 17.15 Computer Software Services 33.01 Drug 41.81 Electric Utilities (Eastern U.S.) 19.40 Internet Services* 290.35 Semiconductors 78.41 Steel 12.71 Tobacco 11.59 Water Utilities 21.84 Typical industry average P/E ratios * Because many internet companies have negative earnings and no P/E, there was only a small sample of internet companies.

28 3 - 28 Copyright © 2001 by Harcourt, Inc.All rights reserved. NI + Depr. Shares out. CF per share= = = $1.48. $253.6 + $117.0 250 Price per share Cash flow per share P/CF = = = 8.21x. $12.17 $1.48

29 3 - 29 Copyright © 2001 by Harcourt, Inc.All rights reserved. Com. equity Shares out. BVPS = = = $6.21. $1,552 250 Mkt. price per share Book value per share M/B= = = 1.96x. $12.17 $6.21

30 3 - 30 Copyright © 2001 by Harcourt, Inc.All rights reserved. P/E: How much investors will pay for $1 of earnings. High is good. P/CF: How much investors will pay for $1 of cash flow. High is good. M/B: How much paid for $1 of BV. Higher is better. P/E and M/B are high if ROE is high, risk is low. 2001 20001999 Ind. P/E12.0x-0.4x 9.7x14.2x P/CF8.21x-0.6x 8.0x11.0x M/B1.96x 1.7x 1.3x 2.4x

31 3 - 31 Copyright © 2001 by Harcourt, Inc.All rights reserved. ( )( )( ) = ROE x x = ROE. Profit margin TA turnover Equity multiplier NI Sales TA CE 19992.6%x2.3x2.2=13.3% 2000-8.9%x2.0x21.6=-391.4% 20013.6%x2.0x2.3=16.3% Ind.3.5%x2.6x2.0=18.2%

32 3 - 32 Copyright © 2001 by Harcourt, Inc.All rights reserved. Dupont Analysis

33 3 - 33 Copyright © 2001 by Harcourt, Inc.All rights reserved. D’Leon Dupont Analysis

34 3 - 34 Copyright © 2001 by Harcourt, Inc.All rights reserved. The Du Pont system focuses on: Expense control (P.M.) Asset utilization (TATO) Debt utilization (Eq. Mult.) It shows how these factors combine to determine the ROE.

35 3 - 35 Copyright © 2001 by Harcourt, Inc.All rights reserved. What are some potential problems and limitations of financial ratio analysis? Comparison with industry averages is difficult if the firm operates many different divisions.

36 3 - 36 Copyright © 2001 by Harcourt, Inc.All rights reserved. “Average” performance not necessarily good. Seasonal factors can distort ratios. “Window dressing” techniques can make statements and ratios look better.

37 3 - 37 Copyright © 2001 by Harcourt, Inc.All rights reserved. Different operating and accounting practices distort comparisons. Sometimes hard to tell if a ratio is “good” or “bad.” Difficult to tell whether company is, on balance, in strong or weak position.

38 3 - 38 Copyright © 2001 by Harcourt, Inc.All rights reserved. What are some qualitative factors analysts should consider when evaluating a company’s likely future financial performance? Are the company’s revenues tied to 1 key customer? To what extent are the company’s revenues tied to 1 key product? To what extent does the company rely on a single supplier? (More…)

39 3 - 39 Copyright © 2001 by Harcourt, Inc.All rights reserved. What percentage of the company’s business is generated overseas? Competition Future prospects Legal and regulatory environment


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