2. Financial Analysis (Chapter 3) zRatio Analysis yLiquidity yAsset Utilization yDebt Utilization yProfitability yMarket Value zDuPont Relationships zRatio Analysis and Wealth Maximization zSome Analytical Problems

3. RATIO ANALYSIS zRatio Defined: ySimply one number divided by another. zWhy Calculate Ratios? yMake data more meaningful. zHigh - Low - Avg: How do you judge? yIndustry Averages: xDun & Bradstreet xRobert Morris Associates xTrade Associations

4. Ratio Analysis (Continued) yPrior Period Ratios: xCalculated from the firm’s previous financial statements (e.g., trend analysis) yCurrent Goals: xOften, goals are stated in the form of ratios. yBenchmarking: xA group of “selected” companies (e.g., form your own industry).

5. Common Size Ratios zCommon Size Balance Sheet yEach item is stated as a % of total assets. zCommon Size Income Statement yEach item is stated as a % of sales.

6. Liquidity Ratios zLiquidity Ratios: yAbility to meet short-term obligations

7. Asset Utilization Ratios Effective use of assets in the process of generating sales. zReceivables Ratios yNote: Ideally, credit sales should be used for the receivables ratios. However, only total sales are available at times. AKA: Days Sales Outstanding

8. Asset Utilization Ratios (Continued) zInventory Turnover Note: COGS is sometimes used in lieu of sales, and average inventories may replace ending inventories.

9. Asset Utilization Ratios (Continued) zAsset Turnover Ratios yNote: Net fixed assets equals gross fixed assets minus accumulated depreciation.

10. Debt Utilization Ratios ( Use of Financial Leverage) zLeverage Ratios:

11. Debt Utilization Ratios (Continued) zFixed Charge Coverage Ratio* * Could also be adjusted to include principal payments on loans.

12. Profitability Ratios (Ability to Earn an Adequate Return) zProfit Margins:

13. Profitability Ratios (Continued) zReturn on Investment Ratios: AKA: ROI

14. DuPont Relationships (ROA)

15. Market Value Ratios (Investors’ Reactions) zNotes: (1) Book Value Per Share = (Com Equity)/(# of Shares) (2) Cash flow per share equals net income plus depreciation or amortization divided by the number of shares outstanding.

16. Ratio Analysis and Wealth Maximization Expenses Sales Assets Net Profit Margin Total Asset Turnover Return on Assets Return on Total Equity Debt to Assets Ratio Preferred Stock Financing Return on Common Equity

17. Ratio Analysis and Wealth Maximization (Continued) Return on Common Equity X Book Value Per Share = Earnings Per Share Earnings Per Share X Price Earnings Ratio = Price Per Share

18. Some Analytical Problems Involving Asset Quality zIt is possible to increase ROI by avoiding the purchase of new plant and equipment (i.e., keep the asset base low). Of course, the firm may suffer in the long run. zA high level of accounts receivable may improve the current ratio, but what if a large percentage of accounts are uncollectible?

19. Some Additional Analytical Problems zInflation ySales and profits may increase simply because of rising prices, even without an increase in physical volume. yReplacement costs of assets may be higher than historical costs. zInventory Accounting yIf firms employ different techniques (e.g., LIFO, FIFO), comparability of ratios is impaired. zIndustry Averages ySome firms operate in more than one.