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4-1 CHAPTER 4 Analysis of Financial Statements Ratio Analysis Du Pont system <- learn this Effects of improving ratios Limitations of ratio analysis Qualitative.

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Presentation on theme: "4-1 CHAPTER 4 Analysis of Financial Statements Ratio Analysis Du Pont system <- learn this Effects of improving ratios Limitations of ratio analysis Qualitative."— Presentation transcript:

1 4-1 CHAPTER 4 Analysis of Financial Statements Ratio Analysis Du Pont system <- learn this Effects of improving ratios Limitations of ratio analysis Qualitative factors

2 4-2 Why are ratios useful? Ratios Standardize numbers Facilitate comparisons Ratios highlight weaknesses and strengths. Ratio comparisons should be Made through time - Trend analysis Compare competitors - Peer or Industry analysis

3 4-3 What are the five major categories of ratios, and what questions do they answer? Liquidity: Can we make required payments? Asset Management: right amount of assets vs. sales? Debt Management: 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: How do investors value the business as reflected in P/E and Mkt/B ratios?

4 4-4 Balance Sheet: Assets Cash A/R Inventories Total Current Assets Fixed Assets Less: Accum Dep. Net FA Total Assets , , ,000 2,000

5 4-5 Balance sheet: Liabilities and Equity Accts payable Notes payable Accruals Total CL Long-term debt Total Liabilities Common stock Retained earnings Total Equity Total L & E , , ,000

6 4-6 Income statement Sales COGS EBITDA Depr. & Amort. EBIT Interest Exp. EBT Taxes Net income ,850 2, ,000 2,

7 4-7 Income statement Per Share Common Stk Price Earnings / share Dividends / share Book Value / Share Cash Flow /share

8 4-8 Liquidity Ratios

9 4-9 Liquidity Ratios Measure company ability to pay bills Quick Ratio = Current Assets - Inventories Current Liabilities

10 4-10 Management Ratios Measure manager performance

11 4-11 Inventory Turnover Ratio

12 4-12 Days Sales Outstanding

13 4-13 Fixed Assets Turnover

14 4-14 Total Assets Turnover

15 4-15 DEBT MANAGEMENT RATIOS

16 4-16 Total Debt to Total Assets

17 4-17 Time Interest Earned Ratio

18 4-18 EBITDA Coverage Ratio EBITDA Coverage = EBITDA + Lease Payments _ Interest + Principal Pymt + Lease Pymt

19 4-19 PROFITABILITY RATIOS

20 4-20 Profit Margin Profit Margin on Sales = Net Income _ Sales

21 4-21 Return on Assts Return on Total Assets (ROA) = Net Income _ Total Assets

22 4-22 Basic Earning Power B E P= EBIT _ Total Assets

23 4-23 Return on Common Equity Return on Equity R O E = Net Income _ Common Equity

24 4-24 Market Value Ratios

25 4-25 Price / Earnings Ratio PE= Price per Share _ Earnings per Share

26 4-26 Price / Cash Flow Price/Cash Flow = Price per share _ Cash Flow per Share

27 4-27 Market / Book Book Value per share = Common Equity _ Shares Outstanding Market/Book = Market Price per Share _ Book Value per Share

28 4-28 TREND ANALYSIS Compare OVER TIME Are ratios improving Or deteriorating

29 4-29 DuPont Equation Return on Assets Measure of success ROE = Net Income _ Stock Holder Equity

30 4-30 The Du Pont system

31 4-31 The Du Pont system

32 4-32 Potential uses of freed up cash Repurchase stock Expand business Reduce debt All these actions would likely improve the stock price.

33 4-33 Potential problems and limitations of financial ratio analysis Comparison with industry averages is difficult for a conglomerate firm that operates in many different divisions. Example General Electric Businesses Elevators Air-conditioners Jet Engines Lends Money

34 4-34 Potential problems and limitations of financial ratio analysis “Average” performance is not necessarily good, perhaps the firm should aim higher.

35 4-35 Potential problems and limitations of financial ratio analysis Seasonal factors can distort ratios.

36 4-36 Potential problems and limitations of financial ratio analysis “Window dressing” techniques can make statements and ratios look better.

37 4-37 Potential problems and limitations of financial ratio analysis Comparison with industry averages difficult. “Average” is not necessarily good. Seasonal factors can distort ratios. “Window dressing”

38 4-38 More issues regarding ratios Different operating and accounting practices can distort comparisons. Sometimes it is hard to tell if a ratio is “good” or “bad”. Difficult to tell whether a company is in strong or weak position.

39 4-39 Qualitative factors to be considered when evaluating a company’s future financial performance Are the firm’s revenues tied to one key customer, product, or supplier? What percentage of the firm’s business is generated overseas? Competition Future prospects Legal and regulatory environment


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