Chapter 18: FINANCIAL STATEMENT ANALYSIS Remember summative presentation will be December 17 and 18. Paper or Report is due December 19 CHAPTER 18

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

PROFITABILITY RATIOS Profit margin Gross profit margin Asset turnover Return on assets Return on common shareholders’ equity Earnings per share (EPS) Price-earnings (PE) ratio Payout ratio

ASSET TURNOVER Measures how efficiently assets are used to generate sales (The higher the better) It shows how much sales did $1 asset make? (Discussed in Chapter 10) Asset turnover = Net sales Average total assets

Asst Turnover Asst Turnover 2004: / (1M M)/2 = : / (1M + 1M)/2 = 2.0 Industry average = 2.4 Canadian Tire = 1.4 In 2005, Home Tire generated $2 of net sales for each dollar of assets. Since this ratio increased from 2004, it is a positive sign. Since 2 is higher than 1.4, but it is lower than industry average, investors will feel neutral about their ratio.

RETURN ON ASSETS Measures overall profitability of assets The higher the better. It shows how much net income did $1 asset make? Return on assets = Net income Average total assets (Discussed in Chapter 10)

Return on Assets Return on Assets 2004: / (1M M)/2 = 7.2% 2005: / (1M + 1M)/2 = 8.2% Industry Average: 12.3 Canadian Tire: 5.9% Higher the better Since the ratio increased year over year, it is a positive sign. But it is lower than industry average – negative It is higher than Canadian Tire – somewhat positive Every 1$ asset made 0.082$ in 2005

RETURN ON COMMON SHAREHOLDERS’ EQUITY Measures profitability of common shareholders’ investment It shows how much net income did one share make? ACSE = # of shares X share price Return on common shareholders’ equity = Net income Average common shareholders’ equity (Discussed in Chapter 14)

Example Apple’s Net Income = 10 million $ # of shares = 1 million shares Apple declared 50 cents per share Each share = $5 EPS=?, ROE=? And Payout ratio=? Answer: EPS = NI / # shares = 10 million / 1 million =$10 per share ROE = NI / Total shares = 10 million / (5 X 1 million) = 2 Payout ratio = (0.5 X 1 million) / 10 million $ = 0.05 or 5%

PAYOUT RATIO Measures % of earnings distributed in the form of cash dividends What is the percentage of cash dividends out of net income? (Discussed in Chapter 15) Payout ratio = Cash dividends Net income

Classwork / Homework P960 E18.9, E18.10, E18.11 P964 P18.3 – only the ratios we learned so far  Optional : It is a good practice, but I do not want to give you too many questions. I will not make it a mandatory question. (Discussed in Chapter 15)