1. An Example: Dell Abbreviated Balance Sheet
Financial Statement Analysis
October 2000
An Example: Dell Abbreviated Balance Sheet
Assets:
Current Assets: $7,681.00
Non-Current Assets: $3,790.00
Total Assets: $11,471.00
Liabilities:
Current Liabilities: $5,192.00
LT Debt & Other LT Liab.: $971.00
Equity: $5,308.00
Total Liab. and Equity: $11,471.00
Dell’s Balance Sheet: Assets the firm owns total more that $11 billion** , more short-term assets than long-term assets like plant and equipment.
Those assets were purchased with money that came mainly from equity and short-term borrowing. Relatively little long-term debt.
C.J. Brown, M.M. Dutton and T.A. Rietz

2. Review: Major Income Statement Items
Financial Statement Analysis
October 2000
Review: Major Income Statement Items
Gross Profit = Sales - Costs of Goods Sold
EBITDA = Gross Profit - Cash Operating Expenses
EBIT = EBDIT - Depreciation - Amortization
EBT = EBIT - Interest
NI or EAT = EBT- Taxes
Net Income is a primary determinant of the firm’s cashflows and, thus, the value of the firm’s shares
Income Statement
1. Summarizes revenues and expenses over an accounting period
2. Information includes
(a) Net income available to common stockholders
  (b) Earnings per Share – “bottom line”
  (c) Usually compared to budget
3. The income statement serves as the basis for determining cashflows.
C.J. Brown, M.M. Dutton and T.A. Rietz

3. An Example: Dell Abbreviated Income Statement
Financial Statement Analysis
October 2000
An Example: Dell Abbreviated Income Statement
Sales $25,265.00
Costs of Goods Sold -$19,891.00
Gross Profit $5,374.00
Cash operating expense -$2,761.00
EBITDA 2,613.00
Depreciation & Amortization -$156.00
Other Income (Net) -$6.00
EBIT $2,451.00
Interest -$0.00
EBT $2,451.00
Income Taxes -$785.00
Special Income/Charges -$194.00
Net Income (EAT) $1,666.00
Dell had more than $25 billion sales during the period.
A large part of revenues went to pay for the raw materials that went into production.
Depreciation reflects expenditure on a long-term asset which firm must expense over several years for tax purposes. It does not reflect an actual expenditure during this particular accounting period.
C.J. Brown, M.M. Dutton and T.A. Rietz

4. Liquidity Ratio Examples: Dell
Financial Statement Analysis
October 2000
Liquidity Ratio Examples: Dell
Current Ratio:
Quick (Acid Test) Ratio:
Used to study ability to cover current obligations
Can firm raise cash to pay its current and upcoming bills on time?
Basic Formulation:
Liquid asset measures include:
Current Assets
Current Assets minus Inventories
If industry average is 3.5, then Dell has fewer current assets per dollar of current liabilities than the norm
If acid test ratio > 1, then Dell can meet all current liabilities even if sales cease
C.J. Brown, M.M. Dutton and T.A. Rietz

5. Ratio Comparison: Current Ratio
Financial Statement Analysis
October 2000
Ratio Comparison: Current Ratio
Comparison of Dell with industry shows both in the 1.5 to 2 range.
If all current assets were liquidated at book value, cash would be 1.5 to 2 times value of current obligations.
Dell appears to be within industry norms for current ratio.
C.J. Brown, M.M. Dutton and T.A. Rietz

6. Leverage Ratio Examples: Dell
Financial Statement Analysis
October 2000
Leverage Ratio Examples: Dell
Debt Ratio:
Measure ability to cover long term debt
How much debt has the firm issued?
Can the firm afford to pay its long term interest and principal obligations?
Basic formulation:
Debt and debt service measures include:
Total liabilities
Long term debt
Annual interest expenses
Asset, profit or cash flow measures include:
Total assets
Total capitalization
EAT, Profit...
1-Debt Ratio is fraction of firm owned by equity holders
If industry average is 2.5 then revenues for Dell relative to interest expenses exceed industry norm
C.J. Brown, M.M. Dutton and T.A. Rietz

7. Ratio Comparison: Debt Ratio
Financial Statement Analysis
October 2000
Ratio Comparison: Debt Ratio
Dell has employed slightly more debt than the industry norm over the last four years.
Nearly 80% debt in January 1997.
This possibly reflects rise and fall in amount of current assets on balance sheet.
Note connection between pattern of current ratio and pattern of debt ratio.
C.J. Brown, M.M. Dutton and T.A. Rietz

8. Profitability Ratio Examples: Dell
Financial Statement Analysis
October 2000
Profitability Ratio Examples: Dell
Return on Assets (ROA):
Return on Equity (ROE):
Used to study operating profitability.
How do profits compare to sales or assets?
Basic Formulation:
Profit measures include:
Sales less costs
Net Income
Income Available to Common Stock Holders
Sales/Asset measures include:
Sales
Total Assets
Common Equity
NOTE: Some books use:
If yours does, use these equations AND adjust the DuPont Method accordingly by adding the the debt burden.
C.J. Brown, M.M. Dutton and T.A. Rietz

9. Profitability Ratio Examples: Dell
Financial Statement Analysis
October 2000
Profitability Ratio Examples: Dell
Net Profit Margin:
Retention Ratio
Used to study operating profitability.
How do profits compare to sales or assets?
Basic Formulation:
Profit measures include:
Sales less costs
Net Income
Income Available to Common Stock Holders
Sales/Asset measures include:
Sales
Total Assets
Common Equity
C.J. Brown, M.M. Dutton and T.A. Rietz

10. Financial Statement Analysis
October 2000
Ratio Comparison: ROE
Compare Dell to industry norm. Both start 1996 with fairly similar ROE but during the next two years Dell’s ROE soars above industry.
What contributed to Dell’s outstanding performance for shareholders relative to the industry?
Recall:
ROE = ROA x Equity Multiplier
Equity Multiplier rises when debt ratio rises. Dell’s debt ratio rose above industry norm during this period. Part of Dell’s superior ROE explained by higher debt ratio.
ROA must also play a role.
C.J. Brown, M.M. Dutton and T.A. Rietz

11. Financial Statement Analysis
October 2000
Ratio Comparison: ROA
Dell’s superior ROE driven by higher than norm ROA.
Note comparison to industry. Dell maintains consistently higher ROA than norm throughout the period.
Also subject to pressures affecting all firms in its industry - rise then decline in ROA.
Able to withstand some of these pressures - ends period better off than at beginning, unlike the average firm in the industry.
How did Dell achieve such an outstanding performance on ROA?
Recall that ROA is affected by two other ratios:
ROA = Profit Margin x Asset Turnover
C.J. Brown, M.M. Dutton and T.A. Rietz

12. Ratio Comparison: Profit Margin
Financial Statement Analysis
October 2000
Ratio Comparison: Profit Margin
Profit Margin measures the firm’s ability to control expenses.
An 8% profit margin for Dell in 1999 says out of each dollar of sales, Dell spent 92 cents on expenses while the industry average was more than 97 cents.
Over the four years Dell consistently did a better job of controlling expenses than the average firm in the industry.
And it got better and better at containing expenses while the average firm in the industry did worse.
Dell’s superior Return on Assets is in part the result of better ability to control expenses.
C.J. Brown, M.M. Dutton and T.A. Rietz

13. Activity (Turnover) Ratio Examples: Dell
Financial Statement Analysis
October 2000
Activity (Turnover) Ratio Examples: Dell
Total Asset Turnover Ratio:
Inventory Turnover Ratio:
Profitability is also affected by the firm’s ability to use its assets efficiently.
Used to study operating efficiency.
How do sales compare to the assets used in production?
Basic Formulation:
Assets include:
All Assets
Inventories
Accounts Receivable
If industry average is 1.25, then Dell gets more sales per dollar invested in assets than typical in the industry
If industry average is 2, then Dell turns its inventory over more times on average than industry (Few assets are tied up in inventories)
C.J. Brown, M.M. Dutton and T.A. Rietz

14. Ratio Comparison: Asset Turnover
Financial Statement Analysis
October 2000
Ratio Comparison: Asset Turnover
A comparison of Dell’s Asset Turnover to that of the industry shows Dell outperformed the industry norm in that area also.
In January 1999 every dollar of assets generated $2.65 in sales for Dell while the average for all firms in the industry was just $2 of sales per dollar invested in assets.
This efficient use of assets also contributed to the superior performance in ROA.
C.J. Brown, M.M. Dutton and T.A. Rietz

15. The DuPont System: Dell
Financial Statement Analysis
October 2000
The DuPont System: Dell
Dells ROE 31.39% is higher than the industry standard (24.1% average over the past 4 years). Where is Dell making these high profits?
Dell’s ROE comes from:
Dell’s profit margin is 6.59%
The industry average over the preceding 4 years is only 3.69%.
So, Dell is nearly twice as efficient as the industry average in generating profits from its sales.
Dell’s sales-to-assets ratio is 2.20.
The industry average over the preceding 4 years is 2.05.
So, Dell is about average is generating sales from its assets.
Dell’s equity multiplier is 2.16.
The industry average over the preceding 4 years is 2.50.
So, Dell is a little below average in its equity multiplier (using a little more equity and a little less debt than an average company in the industry.)
Thus, we can conclude that Dell’s profitability comes from it’s operating efficiency!
C.J. Brown, M.M. Dutton and T.A. Rietz

16. Limitations of Ratio Analysis
Financial Statement Analysis
October 2000
Limitations of Ratio Analysis
A firm’s industry category is often difficult to identify
Published industry averages are only guidelines
Accounting practices differ across firms
Sometimes difficult to interpret deviations in ratios
Industry ratios may not be desirable targets
Seasonality affects ratios
Limitations
1.      Large firms operate different divisions in different industries
a. Difficult to develop meaningful industry averages
b. More useful for small, narrowly focused firms
2.      Firms want to be better than average
a. Attaining average performance not necessarily good
b. Best to focus on industry leaders’ ratios
3.      Inflation may have distorted balance sheets
a. Must consider effects when comparing over time
4.      Seasonal factors distort ratio analysis
a. Use monthly averages for season items such as inventory
5.      Window dressing can make financial statements look better
6.      Different accounting practices can distort comparisons
a. Inventory valuation, depreciation methods
7.      Difficult to generalize whether a ratio is “good” or “bad”
a. High current ratio – strong liquidity or too much cash (nonearning)
8.      Ratios can give “mixed” view of company
a. Analyze net effects of a set of ratios
C.J. Brown, M.M. Dutton and T.A. Rietz