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

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

3. 3 Unilate Textiles: Comparative IS

4. 4 Unilate Textiles: Comparative BS

5. 5 Unilate Textiles: Liabilities and Equity

6. 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. 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. 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. 9 Industry Average Data

10. 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. 11 What is Unilate’s Quick, or Acid Test, Ratio? Industry average =2.1 times $465.0 - $270.0 $130.0 Quick Ratio = Current Assets- Inventories Current Liabilities == = 1.5 times $195.0 $130.0

12. 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. 13 What is Unilate’s Inventory Turnover Ratio? = $1,230.0 $270.0 = 4.66. times Industry average =7.4 times Compares poorly with industry May be holding excess inventories May be holding old/obsolete inventory.

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

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

16. 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. 17 Calculate the Debt Ratio Debt Ratio = Total debt Total assets = + = $130.0.$300.0. $845.0 45.0% = $430.0 $845.0 = 0.509 = 50.9% Industry Average

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

19. 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. 20 Unilate’s Profitability Ratios-- Profit Margin, ROA, and ROE 4.7% Industry Average = $54.0 $1,500 0.036 = 3.6% ==

21. 21 Unilate’s ROA, and ROE 12.6% Industry Average = 17.2% Industry Average = $54.0 $845.0 = 0.064 = 6.4% = $54.0 $415.0 - 0 = 0.130 = 13.0% =

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

23. 23 Unilate’s Market Value Ratios Market/Book Ratio  $23.00 $16.00 1.4 times  2.0 times Industry Average =

24. 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. 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. 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