Chapter 18: FINANCIAL STATEMENT ANALYSIS Due date for summative is the last day, December 19

Ratio Analysis expresses the relationships between selected financial statement items. There are 3 types of ratio analysis: 1.Liquidity Ratios : Measure short-term ability of the enterprise to pay its debts and to meet unexpected needs for cash. 2.Solvency ratios : Measure the ability of the enter prise to survive over a long period of time. 3.Profitability ratios : Measure the income or operating success of an enterprise for a given period of time. Ratio Analysis

RETURN ON COMMON SHAREHOLDERS’ EQUITY Measures profitability of common shareholders’ investment It shows how much net income is generated by one dollar of equity (which is invested by shareholders) in the company. = The higher the better Return on common shareholders’ equity = Net income Average common shareholders’ equity (Discussed in Chapter 14)

Return on CSE Hometown 2004 = / ( )/2 = 39.7% 2005 = / ( ) /2 = 34.6% Industry Average = 23.9% Canadian Tire = 13.9% Although this ratio decreased from 2004 to 2005, Hometown’s number is better than industry average and Canadian Tire’s number. It seems like a good number.

SOLVENCY RATIOS SOLVENCY RATIOS Debt to total assets Interest coverage Cash total debt coverage

DEBT TO TOTAL ASSETS Measures % of total assets provided by creditors Debt to total assets = Total liabilities Total assets (Discussed in Chapter 16)

Debt to Total Assets This ratio indicates the company’s degree of leverage. (=indebtness) Leverage = how much debt the company carries. The higher number indicates that greater risk that the company might not be able to pay their debts. Generally speaking, the lower the better for this number. The number should be less than 1 (or 100%) to be a good number.

Debt to Total Assets 2004: 78.9% 2005: 73.8% Industry Average: 61.9% Canadian Tire: 57.8% 73.8% means that lenders provided 73.8% of the total assets. Only 26.2% of the total assets was provided by shareholders. Year over year trend is going down, so it seems OK. But when you compare it to industry average or Canadian Tire, the debt portion is bigger  not so good

INTEREST COVERAGE Measures ability to meet interest payments as they come due EBIT = Earnings before interest and tax Interest coverage = Income before interest expense and income tax expense (EBIT) Interest expense (Discussed in Chapter 16)

Interest Coverage The higher the better 2004: 4.2 times 2005: 4.7 times Industry Average: 13.6 times Canadian Tire : 7.3 times. Year to year trend shows positive, but comparing it to industry average, (or competitor) 4.7 is not a great number. Their EBIT is only 4.7 times of their interest expense, when other companies in this industry has 13.6 times of their interest expense.

CASH TOTAL DEBT COVERAGE Measures long-term debt-paying ability (cash basis) Cash total debt coverage ratio = Net cash provided by operating activities Average total liabilities (Discussed in Chapter 18)

Estimates Historical cost Alternative accounting methods Atypical data Diversification LIMITATIONS OF FINANCIAL ANALYSIS

Cash Total Debt Coverage Will not show up in final exam Classwork / Homework P959 E18.8, E18.9, E18.10 (ones you did not do yet), E18.11 (ones you did not do yet) P963 P18.3 (ones you did not do yet) P966 P18.6