1. Chapter 17 Financial Statement Analysis

2. Topics Covered  Financial Ratios  DuPont System  Using Financial ratios  Measuring Company Performance  The Role of Financial Ratios

3. Ratio Analysis  Examines firm’s management of various facets of the company’s business through its financial statements.  Scales balance sheet and income statement information for easy comparison across time or to other companies.

4. Two common approaches  Trend Analysis - looks at changes in one company’s ratios over time.  Comparison or Industry Analysis - compares company’s ratios against a similar company or against industry- wide ratios.  We will look at both with Coca-Cola and Pepsi.

5. Areas Examined by Ratio Analysis  Leverage - measures the use of financial leverage (debt) and its impact  Liquidity - measures the ability to meet short-term obligations  Efficiency - measures the ability to contain the growth of assets, and the ability to effectly utilize assets  Profitability - measures the profitability of various segments of a company

6. Leverage Ratios

8. Leverage Ratios calculation notes for Target & Wal-Mart  Given our Financial Statement (B/S and I/S) formatting from OneSource/Multitex: Long-term debt = Total long-term debt from the B/S, which includes long-term borrowing and capital lease obligations. Equity = Total Equity from B/S EBIT = Operating income + Interest Expense from I/S Depreciation expense was listed on Target’s I/S, but had to find Wal-Mart’s depreciation by the annual change in accumulated depreciation from B/S.

9. Target & Walmart’s Leverage Ratios Target2002200120001999 Long-term debt ratio0.5190.5070.4640.435 Debt-equity ratio1.0791.0290.8640.771 Total debt ratio0.6700.6750.6660.658 Times interest Earned5.5515.6665.8195.926 Cash coverage ratio7.6127.9478.0268.099 Walmart2002200120001999 Long-term debt ratio0.3330.3480.3330.392 Debt-equity ratio0.4980.5340.4990.645 Total debt ratio0.5850.5800.5990.633 Times interest Earned14.75010.0659.4659.887 Cash coverage ratio17.21411.21911.23910.756

10. Best Leverage Management?

11. Liquidity Ratios

13. Liquidity Ratios calculation notes for Target & Wal-Mart  Given our Financial Statement (B/S and I/S) formatting from OneSource/Multitex: Net working capital = total current assets – total current liabilities Cash and marketable securities are in one account (cash and short-term investments)

14. Target & Walmart’s Liquidity Ratios Target2002200120001999 NWC to assets0.1540.1070.0510.037 Current ratio1.5861.3681.1591.108 Quick ratio0.8400.6140.3650.352 Cash ratio0.1010.0710.0560.038 Walmart2002200120001999 NWC to assets-0.0230.007-0.031-0.021 Current ratio0.9351.0220.9170.944 Quick ratio0.1490.1530.1320.124 Cash ratio0.0850.0790.0710.072

15. Best Liquidity Management?

16. Efficiency Ratios

18. Efficiency Ratios calculation notes for Target & Wal-Mart  Given our Financial Statement (B/S and I/S) formatting from OneSource/Multitex: Sales = Total Revenue from I/S Cost of Goods Sold = Cost of Revenue, Total from I/S Average “whatever asset” = (beginning+ ending amounts from B/S)/2 Average Daily Sales or Cost of Goods Sold = Amount form I/S divided by 365

19. Target & Walmart’s Efficiency Ratios Target2002200120001999 Total asset turnover1.6651.8252.0122.054 Average collection period39.04626.45018.71018.915 Inventory turnover6.5216.3486.3406.404 Days' sales in inventories55.97557.49557.57556.996 Walmart2002200120001999 Total asset turnover2.7672.7182.6012.772 Average collection period3.0413.1302.9382.690 Inventory turnover8.0777.7887.2887.034 Days' sales in inventories45.19346.86550.08451.893

20. Best Efficiency Management?

21. Profitability Ratios

23. Profitability Ratios calculation notes for Target & Wal-Mart  Given our Financial Statement (B/S and I/S) formatting from OneSource/Multitex: Dividend information listed below the I/S: Gross dividends = total annual dividends. Also can find EPS and Dividends per share here. Earnings = Net Income from I/S

24. Target & Walmart’s Profitability Ratios Target2002200120001999 Net profit margin3.8%3.4% Operating profit margin5.1%4.6% Return on assets8.5%8.4%9.2%9.4% Return on equity19.1%19.0%20.4% Payout ratio13.2%14.8%15.3%16.7% Plowback ratio86.8%85.2%84.7%83.3% Growth in equity from plowback16.6%16.2%17.3%17.0% Walmart2002200120001999 Net profit margin3.3%3.0%3.3%3.2% Operating profit margin3.6% 3.9%3.8% Return on assets10.1%9.7%10.1%10.6% Return on equity21.6%20.1%22.0%22.9% Payout ratio16.5%18.7%17.0%16.6% Plowback ratio83.5%81.3%83.0%83.4% Growth in equity from plowback18.0%16.3%18.3%19.1%

25. Best Profitability Management?

26. The DuPont System  A breakdown of ROE and ROA into component ratios

27. The DuPont System asset turnover Operating profit margin

28. The DuPont System leverage ratio asset turnover Operating profit margin debt burden

29. The DuPont System: Simplification of ROE  The last two terms of the 4-part DuPont equation for ROE, operating profit margin and debt burden, can be simplified to one term, net profit margin.  Net profit margin = Net Income/Sales  Also assets/equity can be written in terms of the total debt ratio.

30. Target vs. Walmart Du Pont System Target2002200120001999 Asset turnover1.6651.8252.0122.054 Operating profit margin5.1%4.6% ROA8.5%8.4%9.2%9.4% Leverage ratio3.0493.0352.9592.930 Asset turnover1.6651.8252.0122.054 Operating profit margin5.1%4.6% Debt burden0.7380.7430.7480.744 ROE19.1%19.0%20.4% Walmart2002200120001999 Asset turnover2.7672.7182.6012.772 Operating profit margin3.6% 3.9%3.8% ROA10.1%9.7%10.1%10.6% Leverage ratio2.3942.4332.5972.563 Asset turnover2.7672.7182.6012.772 Operating profit margin3.6% 3.9%3.8% Debt burden0.8970.8490.840 ROE21.6%20.1%22.0%22.9%

31. Final Du Pont System comments  When a firm uses no debt financing, the leverage term = 1 and ROE = ROA.  Using more financial leverage will increase ROE when the return on new assets (investment) exceeds the interest rate on the new debt.

32. MVA & Economic Profit A gauge of how much value management added for the year. Depends upon managerial decisions and stock market forces. Market Value Added = The difference between the market value of common stock and its book value

33. MVA for Target and Wal-Mart Target200220012000Wal- Mart 200220011999 Stock Price 28.0542.8336.31Stock Price 47.5659.3755.90 # of Shares 909.8905.2897.8# of Shares 439544534470 MV of Equity 255203877032599 MV of Equity 209,026264,375249,873 Total BV Eq 944378606519 Total BV Eq 393373510231343 MVA 16,07730,91026,080 MVA 169,689229,273218,530 MV/BV2.703.935.00MV/BV5.317.537.97

34. Residual Income & EVA Economic Profit = capital invested multiplied by the spread between return on investment and the cost of capital. Residual Income or EVA = Net Dollar return after deducting the cost of capital © EVA is copyrighted by Stern-Stewart Consulting Firm and used with permission.

35. EVA for Target and Wal-Mart  From Stern-Stewart (www.sternstewart.com) EVA/MVA ranking in millions of dollars.www.sternstewart.com  Target 2002 EVA: 3412002 MVA rank: 44 1999 EVA: 7101999 MVA rank: 92  Wal-Mart 2002 EVA: 2,9282002 MVA rank: 3 1999 EVA: 2,2331999 MVA rank: 6