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Summary Of Previous Lecture  basic financial statements and their contents.  financial statement analysis and its importance to the firm and to outside.

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Presentation on theme: "Summary Of Previous Lecture  basic financial statements and their contents.  financial statement analysis and its importance to the firm and to outside."— Presentation transcript:

1 Summary Of Previous Lecture  basic financial statements and their contents.  financial statement analysis and its importance to the firm and to outside suppliers of capital  Liquidity Ratios  Current = Current Assets/Current Liabilities  Acid Test (Quick) = (Current assets – Inventory)/Current Liabilities  Leverage Ratios  Debt to to Equity = Total Debt/Shareholder’s equity  Debt to Total Assets = Total Debt / Total Assets  Coverage Ratio  Interest Coverage Ratio = EBIT / Interest Expense

2 Chapter 6 (II) Financial Statement Analysis

3 After studying Chapter 6, you should be able to: 1. Understand the purpose of basic financial statements and their contents. 2. Explain why financial statement analysis is important to the firm and to outside suppliers of capital. 3. Define, calculate, and categorize (according to liquidity, financial leverage, coverage, activity, and profitability) the major financial ratios and understand what they can tell us about the firm. 4. Define, calculate, and discuss a firm’s operating cycle and cash cycle.

4 After studying Chapter 6, you should be able to: 5. Use ratios to analyze a firm's health and then recommend reasonable alternative courses of action to improve the health of the firm. 6. Analyze a firm’s return on investment (i.e., “earning power”) and return on equity using a DuPont approach. 7. Understand the limitations of financial ratio analysis. 8. Use trend analysis, common-size analysis, and index analysis to gain additional insights into a firm's performance.

5 Activity Ratios Receivable Turnover Annual Net Credit Sales Receivables For Basket Wonders December 31, 2007 Indicates quality of receivables and how successful the firm is in its collections. Income Statement / Balance Sheet Ratios Activity Ratios $2,211 $394 = 5.61 (Assume all sales are credit sales.)

6 Activity Ratios Avg Collection Period Days in the Year Receivable Turnover For Basket Wonders December 31, 2007 Average number of days that receivables are outstanding. (or RT in days) Income Statement / Balance Sheet Ratios Activity Ratios 365 5.61 = 65 days

7 Activity Ratio Comparisons BW Industry 65.065.7 71.166.3 83.669.2 Year 2007 2006 2005 Average Collection Period BW has improved the average collection period to that of the industry average.

8 Activity Ratios Payable Turnover (PT) Annual Credit Purchases Accounts Payable For Basket Wonders December 31, 2007 Indicates the promptness of payment to suppliers by the firm. Income Statement / Balance Sheet Ratios Activity Ratios $1551 $94 = 16.5 (Assume annual credit purchases = $1,551.)

9 Activity Ratios PT in Days Days in the Year Payable Turnover For Basket Wonders December 31, 2007 Average number of days that payables are outstanding. Income Statement / Balance Sheet Ratios Activity Ratios 365 16.5 = 22.1 days

10 Activity Ratio Comparisons BW Industry 22.146.7 25.451.1 43.548.5 Year 2007 2006 2005 Payable Turnover in Days BW has improved the PT in Days. Is this good?

11 Activity Ratios Inventory Turnover Cost of Goods Sold Inventory For Basket Wonders December 31, 2007 Indicates the effectiveness of the inventory management practices of the firm. Income Statement / Balance Sheet Ratios Activity Ratios $1,599 $696 = 2.30

12 Activity Ratio Comparisons BW Industry 2.303.45 2.443.76 2.643.69 Year 2007 2006 2005 Inventory Turnover Ratio BW has a very poor inventory turnover ratio.

13 Inventory Turnover Ratio – Trend Analysis Comparison Trend Analysis of Inventory Turnover Ratio

14 Activity Ratios Total Asset Turnover Net Sales Total Assets For Basket Wonders December 31, 2007 Indicates the overall effectiveness of the firm in utilizing its assets to generate sales. Income Statement / Balance Sheet Ratios Activity Ratios $2,211 $2,169 = 1.02

15 Activity Ratio Comparisons BW Industry 1.021.17 1.031.14 1.011.13 Year 2007 2006 2005 Total Asset Turnover Ratio BW has a weak total asset turnover ratio. Why is this ratio considered weak?

16 Profitability Ratios Gross Profit Margin Gross Profit Net Sales For Basket Wonders December 31, 2007 Indicates the efficiency of operations and firm pricing policies. Income Statement / Balance Sheet Ratios Profitability Ratios $612 $2,211 =.277

17 Profitability Ratio Comparisons BW Industry 27.7%31.1% 28.730.8 31.327.6 Year 2007 2006 2005 Gross Profit Margin BW has a weak Gross Profit Margin.

18 Gross Profit Margin – Trend Analysis Comparison Trend Analysis of Gross Profit Margin

19 Profitability Ratios Net Profit Margin Net Profit after Taxes Net Sales For Basket Wonders December 31, 2007 Indicates the firm’s profitability after taking account of all expenses and income taxes. Income Statement / Balance Sheet Ratios Profitability Ratios $91 $2,211 =.041

20 Profitability Ratio Comparisons BW Industry 4.1%8.2% 4.98.1 9.07.6 Year 2007 2006 2005 Net Profit Margin BW has a poor Net Profit Margin.

21 Net Profit Margin – Trend Analysis Comparison Trend Analysis of Net Profit Margin

22 Profitability Ratios Return on Investment Net Profit after Taxes Total Assets For Basket Wonders December 31, 2007 Indicates the profitability on the assets of the firm (after all expenses and taxes). Income Statement / Balance Sheet Ratios Profitability Ratios $91 $2,160 =.042

23 Profitability Ratio Comparisons BW Industry 4.2% 9.8% 5.0 9.1 9.110.8 Year 2007 2006 2005 Return on Investment BW has a poor Return on Investment.

24 Return on Investment – Trend Analysis Comparison Trend Analysis of Return on Investment

25 Profitability Ratios Return on Equity Net Profit after Taxes Shareholders’ Equity For Basket Wonders December 31, 2007 Indicates the profitability to the shareholders of the firm (after all expenses and taxes). Income Statement / Balance Sheet Ratios Profitability Ratios $91 $1,139 =.08

26 Profitability Ratio Comparisons BW Industry 8.0%17.9% 9.417.2 16.620.4 Year 2007 2006 2005 Return on Equity BW has a poor Return on Equity.

27 Return on Equity – Trend Analysis Comparison Trend Analysis of Return on Equity

28  ROI = Net Profit Margin x Total Assets Turnover = (Net profit after Tax/ Net Sales) x (Net Sales / Total Assets)  Return on Equity (ROE) = Net Profit after Tax / Shareholder’s Equity  ROE = Net Profit Margin x Total Assets Turnover x Equity Multiplier  ROE =( Net Profit After Tax/Net Sales) x (Net Sales/Total Assets) x (Total Assets / Shareholder’s Equity) Return on Investment and the Du Pont Approach

29 ROI 2007 =.041 x 1.02 =.042 or 4.2% ROI Industry =.082 x 1.17 =.098 or 9.8% ROI = Net profit margin X Total asset turnover Earning Power = Sales profitability X Asset efficiency

30 Return on Equity and the Du Pont Approach ROE 2007 =.041 x 1.02 x 1.90 =.080 ROE Industry =.082 x 1.17 x 1.88 =.179 Return On Equity = Net profit margin X Total asset turnover X Equity Multiplier Equity Multiplier = Total Assets Shareholders’ Equity

31 Summary of the Profitability Trend Analyses  The profitability ratios for BW have ALL been falling since 2005. Each has been below the industry averages for the past three years.  This indicates that COGS and administrative costs may both be too high and a potential problem for BW.  Note, this result is consistent with the low interest coverage ratio.

32 Summary of Ratio Analyses  Inventories are too high.  May be paying off creditors (accounts payable) too soon.  COGS may be too high.  Selling, general, and administrative costs may be too high.

33 Common-size Analysis An analysis of percentage financial statements where all balance sheet items are divided by total assets and all income statement items are divided by net sales or revenues.

34 Basket Wonders’ Common Size Balance Sheets

35

36 Basket Wonders’ Common Size Income Statements

37 Index Analyses An analysis of percentage financial statements where all balance sheet or income statement figures for a base year equal 100.0 (percent) and subsequent financial statement items are expressed as percentages of their values in the base year.

38 Basket Wonders’ Indexed Balance Sheets

39

40 Basket Wonders’ Indexed Income Statements

41 Summary Activity Ratios  Receivable Turnover (RT) = Annual Net Credit Sales / Receivables  Receivables Turnover in Days (RTD) = 365/ RT (Average Collection Period)  Inventory Turnover (IT) = Cost of Goods sold / Inventory  Inventory Turnover in Days (ITD) = 365 / IT  Total Assets Turnover (Capital Turnover) = Net Sales / Total Assets

42 Profitability  Net Profit Margin = Net Profit after Taxes / Net Sales  Return on Investment (ROI) = Net Profit After Tax / Total Assets (Return on Assets)  ROI = Net Profit Margin x Total Assets Turnover = (Net profit after Tax/ Net Sales) x (Net Sales / Total Assets)  Return on Equity (ROE) = Net Profit after Tax / Shareholder’s Equity  ROE = Net Profit Margin x Total Assets Turnover x Equity Multiplier  ROE =( Net Profit After Tax/Net Sales) x (Net Sales/Total Assets) x (Total Assets / Shareholder’s Equity) Summary


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