1. FOUNDATION OF RATIO AND FINANCIAL ANALYSIS

2. PURPOSE & USE OF RATIO ANALYSIS Primary advantage of ratio: –They can be used to compare the risk and return relationships of firms of different size –Provide profile of a firm Caution: –Ignores differences among industry –Ignores effect of varying capital structure –Ignores differences in accounting and reporting methods

3. PURPOSE & USE OF RATIO ANALYSIS Four broad categories: –Activity analysis –Liquidity analysis –Long-term debt and solvency analysis –Profitability analysis

4. RATIO ANALYSIS: CAUTIONARY NOTES ECONOMIC ASSUMPTION –The economics relationship between numerator and denominator does not depend on size –Ignore the existence of fixed cost –The relationship between numerator and denominator is not always linear

5. RATIO ANALYSIS: CAUTIONARY NOTES BENCHMARK –Lack of appropriate benchmark –Industry norms as benchmark Industry classification Ratio of individual firms tend to converge toward the industrywide average

6. RATIO ANALYSIS: CAUTIONARY NOTES TIMING AND WINDOW DRESSING –Data used to compote ratio are available only at specific points in time when financial statement are issued –Transaction at year end (window dressing) to manipulate the ratio

7. RATIO ANALYSIS: CAUTIONARY NOTES NEGATIVE NUMBER –Ratio analysis without reference to the underlying data can lead to wrong conclusion ACCOUNTING METHOD –The ratios are not comparable between firms (with differing accounting methods) or for the same firm over time (when it change accounting methods).

8. COMMON-SIZE STATEMENTS Common size statement are used to standardize financial statement components by expressing them as a percentage of a relevant base. First step in developing insight into the economic characteristics of different industries and of different firms in the same industry –Cross-sectional comparison –Industry comparison –Comparison over time

9. DISCUSSION OF RATIO BY CATEGORY ACTIVITY ANALYSIS LIQUIDITY ANALYSIS LONG TERM DEBT AND SOLVENCY ANALYSIS PROFITABILITY ANALYSIS OPERATING AND FINANCIAL LEVERAGE

10. RATIO: AN INTEGRATED ANALYSIS Comprehensive financial analysis requires a review of relationships among variable: –Economic relationship –Overlap component –Ratio as composites of other ratio

11. ECONOMIC CHARACTERISTICS AND STRATEGIES Competing strategies Product life cycle –Startup –Growth –Maturity –Dicline (Harvest) Interindustry economic factors Classification and selection of ratio

12. EPS AND OTHER RATIOS USED IN VALUATION EPS –Simple capital structure –Complex capital structure –Limitation of EPS calculation The assumption behind treasury stock method are unrealistic EPS growth rate can be distorted by a firm’s dividend and financing policy

13. EPS AND OTHER RATIOS USED IN VALUATION CASH FLOW PER SHARE EBITDA PER SHARE BOOK VALUE PER SHARE PRICE TO EARNINGS AND PRICE TO BOOK VALUE RATIO DIVIDEND PAY OUT RATIO