X100©2008 KEAW L15 X100 Introduction to Business Finance Professor Kenneth EA Wendeln Financial Analysis & Ratios Financial Analysis & Ratios

X100Financial Analysis & RatiosL15-2 Financial Management Types of Financial Management and Planning Tools:  Capital Budgeting  Capital Structure  Financial Ratios How to manage the financial health of a company – decisions regarding the acquisition & ‘use of money’ to maximize the value of the company while achieving corporate objectives. Used to gain insight on how a firm operates as well as its RISK and RETURN

X100Financial Analysis & RatiosL15-3 Asset Turnover Liquidity Financial Leverage Profitability Key Financial Ratios Return on Owners’ Equity % EPS – Earnings per Share $ DD.00 Return on Sales % Accounts Receivable Turnover X (times/year) or # days Inventory Turnover X (times/year) or # days Current Ratio # n.nn Acid Test or Quick Ratio # n.nn Total Liabilities to Equity %

X100Financial Analysis & RatiosL15-4 Total Liabilities to Owners’ Equity Ratio This financial leverage ratio indicates the degree to which a firm’s operations are financed through debt & borrowings - and is used to determine a firm’s ‘conservatism’ and ability to borrow money. The liabilities to owners’ equity ratio typically ranges between 33 and 50%. The higher this ratio, the riskier the situation for lenders and shareholders. Total Liabilities Owners’ Equity

X100Financial Analysis & RatiosL15-5 Zimmer - Total Liabilities to Owners’ Equity Total Liabilities to Owners Equity = 21.4 % ($1051.2)/($4920.5) 12/31/0612/31/05 $ in millions ‘Debt’ = Total Liabilities ‘Equity’ = Stockholders (or Owners) Equity

X100Financial Analysis & RatiosL15-6 Return on Owners’ Equity Profitability ratio that provides an overall measure of a business’s performance. Net income earned (after tax) per dollar of owners’ investment. Typically between 15% and 25% for profitable companies Net Income (after taxes) Owners’ (Shareholders’) Equity

X100Financial Analysis & RatiosL15-7 Zimmer Return on Owners’ Equity ‘Equity’ = ‘Stockholders’ (or ‘Owners’) Equity Net Income Return on Owners’ Equity = 17.0% ($834.5)/($4920.5) Return on Owners’ Equity = 17.0% ($834.5)/($4920.5) 12/31/0612/31/05

X100Financial Analysis & RatiosL15-8 Liabilities & OE – with HIGH Debt Short-Term Liabilities $100,000 Long-Term Loan 300,000 Total Liabilities (Debt)$400,000 Owner’s equity$500,000 Total Liabilities + OE$900,000 Year-end Earnings Operating profit $150,000 Interest on Debt -36,000 40% PBT -45,600 Net income after taxes $68,400 Liabilities/Equity 80.0% ($400,000/$500,000) Return on Owners Equity 13.7% ($68,400/$500,000) Financial leverage increases RISK as well as the Debt/Equity & Return on Owners’ Equity Ratios. Capital Structure - Leverage Low & High Liabilities to Equity Liabilities & OE – with LOW Debt Short-Term Liabilities $100,000 Long-Term Loan 100,000 Total Liabilities (Debt)$200,000 Owner’s equity$700,000 Total Liabilities + OE$900,000 Year-end Earnings Operating profit $150,000 Interest on Debt -10,000 40% PBT -56,000 Net income after taxes $ 84,000 Liabilities/Equity 28.6% ($200,000/$700,000) Return on Owners Equity 12.0% ($84,000/$700,000) Higher Risk to Lenders & Shareholders Lower Risk to Lenders & Shareholders & High 12%

X100Financial Analysis & RatiosL15-9 EPS Earnings per Share This profitability ratio tells the owner of a share of stock how much of the net earnings for the year belongs to him or her. These earnings may be paid to the stockholders as dividends... or reinvested back into the business to fund its growth. Net Income or Loss (after taxes) Average # Shares of Common Stock Outstanding

X100Financial Analysis & RatiosL15-10 Zimmer Earnings per Share EPS = $3.43 per share ($834.5)/(#243.0 average shares outstanding) EPS = $3.43 per share ($834.5)/(#243.0 average shares outstanding)

X100Financial Analysis & RatiosL15-11 Return on Sales or Net Profit Margin This profitability ratio measures how well the company generated net profit (after tax) per dollar of net sales revenue. This ratio is best evaluated by analyzing a firm’s year to year trends and by comparing to businesses within appropriate industries. Net Income (after taxes) Net Sales Revenue

X100Financial Analysis & RatiosL15-12 Zimmer Return on Sales ROS = 23.9% ($834.5)/($3495.4) ROS = 23.9% ($834.5)/($3495.4) ROS = 22.3% ($732.5)/($ ) ROS = 22.3% ($732.5)/($ )

X100Financial Analysis & RatiosL15-13 Current Ratio Measures liquidity - the capacity of a firm to meet its current obligations using liquid assets that are in cash or other resources that can be quickly converted to cash. A high current ratio, typically >1.0, indicates that a firm can pay its current liabilities using its current assets. Current Assets Current Liabilities

X100Financial Analysis & RatiosL15-14 Zimmer Current Ratio Current Ratio = 2.78 ($1746.2)/($628.2) Current Ratio = 2.78 ($1746.2)/($628.2)

X100Financial Analysis & RatiosL15-15 Acid-Test or Quick Ratio Measures liquidity - the ability of a firm to pay current liabilities ‘quickly’ – without selling inventory. For all businesses the desired acid-test ratio is > 1.0 indicating firm can pay its current liabilities from its non-inventory current assets. Current Assets - Inventory Current Liabilities

X100Financial Analysis & RatiosL15-16 Zimmer Acid-Test or Quick Ratio Quick Ratio = 1.76 ($ – 638.3)/($628.2) Quick Ratio = 1.76 ($ – 638.3)/($628.2)

X100Financial Analysis & RatiosL15-17 Accounts Receivable Asset Turnover Ratio Determines the number of times during the year a company is ‘turning over’ or collecting its accounts receivable. Measured in X times per year. Can be converted to ‘days outstanding’ by dividing turnover ratio into 365 days. A high A/R turnover is better than a low one, but depends on company & industry terms of sale. 6X turnover is equivalent to 60 days of outstanding receivables, 9X is 45 days, 12X is 30 days. Net Sales Average Accounts Receivable

X100Financial Analysis & RatiosL15-18 Zimmer Accounts Receivable A/R Turnover = 6.1X or 60 days ($3495.4)/($574.9) or (365 days/6.1X) A/R Turnover = 6.1X or 60 days ($3495.4)/($574.9) or (365 days/6.1X) Use average $574.9

X100Financial Analysis & RatiosL15-19 Inventory Asset Turnover Ratio Determines the number of times during the year a company is ‘turning over’ its inventory. Measured in X times per year. Can also be converted to ‘days of inventory’ by dividing ratio into 365 days. The average inventory turnover for all firms is about 9 times per year, or about once every 45 days. It varies considerable by industry. Supermarkets have turnover rates exceeding 20X (or 18 days) per year. Cost of Goods Sold Average Inventory

X100Financial Analysis & RatiosL15-20 Use average $611.0 Zimmer Inventory Turnover Inventory Turnover = 1.28X or 286 days ($780.1)/($611.0) or (365 days/1.28X) Inventory Turnover = 1.28X or 286 days ($780.1)/($611.0) or (365 days/1.28X)

X100Financial Analysis & RatiosL15-21 Key Financial Ratios Net Income (after taxes) Owners’ Equity Return on Owners’ Equity Net Income or Loss (after taxes) Average # of Common Stock Shares Outstanding EPS – Earnings per Share Net Income (after taxes) Net Sales Revenue Return on Sales Profitability Net Sales. Average Accounts Receivable Accounts Receivable Turnover Cost of Goods Sold Average Inventory Inventory Turnover Asset Turnover Current Assets Current Liabilities Current Ratio Current Assets - Inventory Current Liabilities Acid Test or Quick Ratio Liquidity Total Liabilities Owners’ Equity Total Liability to Equity Ratio Financial Leverage

X100Financial Analysis & RatiosL15-22 Common Financial Ratios *Return on Equity Return on Total Assets (ROA) Return to Investors *Earnings Per Share Price to Earnings Ratio Dividend Yield Return to Investors Derived from: Fraser/Ormiston, Understanding the Corporate Annual Report; Understanding Financial Statements 6e *A/R Turnover *Inventory Turnover Fixed Asset Turnover Total Asset Turnover Return on Total Assets (ROA) Asset Management Operating Efficiency * ‘Key’ X100 Financial Ratios Other Common Ratios *Return on Equity Returns Return on Total Assets (ROA) Cash Return on Assets Profitability *Net Profit Margin (ROS) Margins Operating Profit Margin Gross Profit Margin Product Contri- bution Margin Cash Flow Margin Amount of Debt LEVERAGE Assets/ Equity Debt/ Equity Debt/ Assets *Total Liabilities/ Equity Coverage of Debt Times Interest Earned Fixed Charge Coverage Cash Flow Adequacy Cash Interest Coverage Leverage /Debt Management LT Debt/ Total Capital- ization Short Run Solvency *Current Ratio *Quick or Acid Test Ratio Cash Flow Liquidity Ratio Current Assets *A/R Average Collection Period *Days Inventory Held Days Payables Out- standing Liquidity Days of Working Capital

X100Financial Analysis & RatiosL15-23 Key Financial Statements Current (12mo) Long-Term TOTAL ASSETS ● Cash ● A/R ● Inventories ● PPE ● Fixed Assets Current (12mo) Long-Term TOTAL LIABILITIES ● A/P ● ST Debt ● LT Debt ● par ● Paid-in Capital ● Accumulated Net Income ● less Dividends Contributed Capital Retained Earnings TOTAL OWNERS’/ SHAREHOLDERS’ EQUITY Assets = Liabilities + Owners’ Equity Balance Sheet Period Ending Net Sales TOTAL REVENUES ● Units Sold Price ● less Returns & Allowances Change in cash - Sources & (Uses) - between Periods Other Expenses ● Interest ● Taxes ● One-time Operating Profit TOTAL NET INCOME or (LOSS) CASH provided (used) by FINANCING Activities Stock ● Sale (Purchase) Dividends Debt/ Borrowing ● (Paid) ● Increase (Decrease) CASH provided (used) by INVESTING Activities PPE ● (Additions) Sale Other Investments ● (Additions) Sale TOTAL OP EXPENSES Expenses for Period ● R & D ● Marketing ● Distribution ● Sales ● Admin Cost of Goods Sold ● Units Sold Material Labor Overhead CASH provided (used) by OPERATING Activities Net Income ● Income Statement ● Accrual Based ● Depreciation ● A/R & A/P ● Inventory ● Other Accruals Adjustments for Non-cash Items Income Statement for Period Revenues – Expenses = Net Income Cash Flow Statement ∆ Cash = Operating + Investing + Financing

X100Financial Analysis & RatiosL15-24