Presentation on theme: "CHAPTER 4 Analysis of Financial Statements"— Presentation transcript:
1 CHAPTER 4 Analysis of Financial Statements Ratio AnalysisDu Pont system <- learn thisEffects of improving ratiosLimitations of ratio analysisQualitative factors
2 Why are ratios useful? Ratios Standardize numbersFacilitate comparisonsRatios highlight weaknesses and strengths.Ratio comparisons should beMade through time - Trend analysisCompare competitors - Peer or Industry analysis
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 Balance Sheet: Assets Cash A/R Inventories Total Current Assets Fixed AssetsLess: Accum Dep.Net FATotal Assets2004803154158108701,6802005103756151,0002,000
5 Balance sheet: Liabilities and Equity Accts payableNotes payableAccrualsTotal CLLong-term debtTotal LiabilitiesCommon stockRetained earningsTotal EquityTotal L & E2005601101403107501,0601308109402,000200430601302205808007508801,680
32 Potential uses of freed up cash Repurchase stockExpand businessReduce debtAll these actions would likely improve the stock price.
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.ExampleGeneral Electric BusinessesElevatorsAir-conditionersJet EnginesLends Money
34 Potential problems and limitations of financial ratio analysis “Average” performance is not necessarily good, perhaps the firm should aim higher.
35 Potential problems and limitations of financial ratio analysis Seasonal factors can distort ratios.
36 Potential problems and limitations of financial ratio analysis “Window dressing” techniques can make statements and ratios look better.
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 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 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?CompetitionFuture prospectsLegal and regulatory environment