Chapter 11 Analysis of Financial Statements © 2005 Thomson/South-Western

2 Financial Statements and Reports  The Income Statement  The Balance Sheet  Statement of Cash Flows  Statement of Retained Earnings

3 Unilate Textiles: Comparative IS

4 Unilate Textiles: Comparative BS

5 Unilate Textiles: Liabilities and Equity

6 Ratio Analysis  Analysis of a firm’s ratios is generally the first step in financial analysis.  Ratios are designed to show relationships between financial statement accounts within firms and between firms.

7 What is the Purpose of Ratio Analysis?  Give idea of how well the company is doing  Standardize numbers; facilitate comparisons  Used to highlight weaknesses and strengths

8 What Are the Five Major Categories of Ratios? What Questions Do They Answer?  Liquidity: Can we make required payments in the current period?  Asset mgt.: Right amount of assets vs. sales?  Debt mgt.: Right 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 values: Do investors like what they see as reflected in P/E and M/B ratios?

9 Industry Average Data

10 What is Unilate’s Current Ratio? Current Ratio = Current Assets Current Liabilities $465.0 $130.0 == 3.6 times Industry average =4.1 times

11 What is Unilate’s Quick, or Acid Test, Ratio? Industry average =2.1 times $ $270.0 $130.0 Quick Ratio = Current Assets- Inventories Current Liabilities == = 1.5 times $195.0 $130.0

12 Unilate’s Liquidity Position  Ratios is slightly below industry average.  Inventories are the least liquid of Unilate’s assets and they are the assets that suffer losses in the event of a forced sale.  The quick ratio shows that, if receivables are collected in full, Unilate can payoff its current liabilities without having to liquidate its inventory.

13 What is Unilate’s Inventory Turnover Ratio? = $1,230.0 $270.0 = times Industry average =7.4 times Compares poorly with industry May be holding excess inventories May be holding old/obsolete inventory.

14 What is Unilate’s Days Sales Outstanding Ratio? Industry average =32.1 days

15 What is Unilate’s Fixed Assets Turnover Ratio? = $1,500.0 $380.0 = 3.9 times = 4.0 times Industry Average

16 What is Unilate’s Total Assets Turnover Ratios? = $1,500.0 $845.0 = 1.8 times = 2.1 times Industry Average  TA turnover is below industry average.  Unilate might have excess inventories & receivables.

17 Calculate the Debt Ratio Debt Ratio = Total debt Total assets = + = $130.0.$ $ % = $430.0 $845.0 = = 50.9% Industry Average

18 Calculate the Times-Interest-Earned Ratio TIE = EBIT Interest charges 3.3 times $40.0 $130.0 = = Industry Average =6.5 times

19 Calculate the Fixed Charge Coverage Ratio All three previous ratios reflect use of debt, but focus on different aspects. Industry Average = 5.8x

20 Unilate’s Profitability Ratios-- Profit Margin, ROA, and ROE 4.7% Industry Average = $54.0 $1, = 3.6% ==

21 Unilate’s ROA, and ROE 12.6% Industry Average = 17.2% Industry Average = $54.0 $845.0 = = 6.4% = $54.0 $ = = 13.0% =

22 Unilate’s Market Value Ratios Price/Earnings Ratio 10.6 times $2.16 $23.00  13.0 times Industry Average =

23 Unilate’s Market Value Ratios Market/Book Ratio  $23.00 $ times  2.0 times Industry Average =

24 Summary of Ratio Analysis: The DuPont Equation ROA = Net Profit Margin X Total Assets Turnover Net Income Sales Total Assets X = $54.0 $1,500.0 X = $845.0 = 3.6% X 1.8 = 6.4%

25 DuPont Equation Provides Overview  Firm’s profitability (measured by ROA)  Firm’s expense control (measured by profit margin)  Firm’s asset utilization (measured by total asset turnover)

26 Limitations of Ratio Analysis?  Comparison with industry averages is difficult if the firm operates many different divisions.  “Average” performance not necessarily good.  Inflation distorts balance sheets.  Seasonal factors can distort ratios.  “Window dressing” techniques can make statements and ratios look better.  Different operating and accounting practices distort comparisons.  Sometimes hard to tell if a ratio is “good” or “bad”  Difficult to tell whether company is, on balance, in strong or weak position