Post on 27-Dec-2015
X100 ©2008 KEAW L15
X100Introduction to Business
X100Introduction to Business
FinanceFinance
Professor Kenneth EA Wendeln Professor Kenneth EA Wendeln
Financial Analysis & Ratios
Financial Analysis & Ratios
X100 Financial Analysis & Ratios L15-2
Financial Management
Types of Financial Management and Planning Tools:
Capital Budgeting
Capital Structure
Financial Ratios
How to manage the financial health of a company – decisions regarding the acquisition & ‘use of money’ to maximize the value of the company while achieving corporate objectives.
Used to gain insight on how a firm operates as well as its RISK and RETURN
X100 Financial Analysis & Ratios L15-3
Asset Turnover
Liquidity
Financial Leverage
Profitability
Key Financial Ratios
Return on Owners’ Equity%
EPS – Earnings per Share$ DD.00
Return on Sales% Accounts Receivable
TurnoverX (times/year) or # days
Inventory TurnoverX (times/year) or # days
Current Ratio# n.nn
Acid Test or Quick Ratio# n.nn
Total Liabilities to Equity %
X100 Financial Analysis & Ratios L15-4
Total Liabilities to Owners’ Equity Ratio
This financial leverage ratio indicates the degree to which a firm’s operations are financed through debt & borrowings - and is used to determine a firm’s ‘conservatism’ and ability to borrow money.
The liabilities to owners’ equity ratio typically ranges between 33 and 50%.
The higher this ratio, the riskier the situation for lenders and shareholders.
Total LiabilitiesOwners’ Equity
X100 Financial Analysis & Ratios L15-5
Zimmer - Total Liabilities to Owners’ Equity
Total Liabilities to Owners Equity = 21.4 %($1051.2)/($4920.5)
12/31/06 12/31/05$ in millions
‘Debt’ = Total Liabilities
‘Equity’ = Stockholders (or Owners) Equity
X100 Financial Analysis & Ratios L15-6
Return on Owners’ EquityProfitability ratio that provides an overall measure of a business’s performance. Net income earned (after tax) per dollar of owners’ investment.
Typically between 15% and 25% for profitable companies
Net Income (after taxes)Owners’ (Shareholders’) Equity
X100 Financial Analysis & Ratios L15-7
Zimmer Return on Owners’ Equity
‘Equity’ = ‘Stockholders’ (or ‘Owners’) Equity
Net Income
Return on Owners’ Equity = 17.0%($834.5)/($4920.5)Return on Owners’ Equity = 17.0%($834.5)/($4920.5)
12/31/06 12/31/05
X100 Financial Analysis & Ratios L15-8
Liabilities & OE – with HIGH DebtShort-Term Liabilities $100,000Long-Term Loan (@12%) 300,000Total Liabilities (Debt) $400,000
Owner’s equity $500,000Total Liabilities + OE $900,000
Year-end EarningsOperating profit $150,000Interest on Debt (@12%) -36,000Taxes @ 40% PBT -45,600Net income after taxes $68,400
Liabilities/Equity 80.0%($400,000/$500,000)Return on Owners Equity 13.7%($68,400/$500,000)
Financial leverage increases RISK as well as the Debt/Equity & Return on Owners’ Equity Ratios.
Capital Structure - LeverageLow & High Liabilities to Equity
Liabilities & OE – with LOW DebtShort-Term Liabilities $100,000Long-Term Loan (@10%) 100,000Total Liabilities (Debt) $200,000
Owner’s equity $700,000Total Liabilities + OE $900,000
Year-end EarningsOperating profit $150,000Interest on Debt (@10%) -10,000Taxes @ 40% PBT -56,000Net income after taxes $ 84,000
Liabilities/Equity 28.6%($200,000/$700,000)Return on Owners Equity 12.0%($84,000/$700,000)
Higher Risk to Lenders & Shareholders
Lower Risk to Lenders & Shareholders
& High
12%
12%
X100 Financial Analysis & Ratios L15-9
EPSEarnings per Share
This profitability ratio tells the owner of a share of stock how much of the net earnings for the year belongs to him or her.
These earnings may be paid to the stockholders as dividends . . . or reinvested back into the business to fund its growth.
Net Income or Loss (after taxes)Average # Shares of Common
Stock Outstanding
X100 Financial Analysis & Ratios L15-10
Zimmer Earnings per Share
EPS = $3.43 per share($834.5)/(#243.0 average shares outstanding)
EPS = $3.43 per share($834.5)/(#243.0 average shares outstanding)
X100 Financial Analysis & Ratios L15-11
Return on Salesor Net Profit Margin
This profitability ratio measures how well the company generated net profit (after tax) per dollar of net sales revenue.
This ratio is best evaluated by analyzing a firm’s year to year trends and by comparing to businesses within appropriate industries.
Net Income (after taxes)Net Sales Revenue
X100 Financial Analysis & Ratios L15-12
Zimmer Return on Sales
ROS = 23.9%($834.5)/($3495.4)ROS = 23.9%($834.5)/($3495.4)
ROS = 22.3%($732.5)/($3286.1)ROS = 22.3%($732.5)/($3286.1)
2005200520062006
X100 Financial Analysis & Ratios L15-13
Current RatioMeasures liquidity - the capacity of a firm to meet its current obligations using liquid assets that are in cash or other resources that can be quickly converted to cash.
A high current ratio, typically >1.0, indicates that a firm can pay its current liabilities
using its current assets.
Current AssetsCurrent Liabilities
X100 Financial Analysis & Ratios L15-14
ZimmerCurrent Ratio
Current Ratio = 2.78($1746.2)/($628.2)Current Ratio = 2.78($1746.2)/($628.2)
X100 Financial Analysis & Ratios L15-15
Acid-Test or Quick RatioMeasures liquidity - the ability of a firm to pay current liabilities ‘quickly’ – without selling inventory.
For all businesses the desired acid-test ratio is > 1.0
indicating firm can pay its current liabilities from its non-inventory current assets.
Current Assets - InventoryCurrent Liabilities
X100 Financial Analysis & Ratios L15-16
Zimmer Acid-Test or Quick Ratio
Quick Ratio = 1.76($1746.2 – 638.3)/($628.2)Quick Ratio = 1.76($1746.2 – 638.3)/($628.2)
X100 Financial Analysis & Ratios L15-17
Accounts Receivable Asset Turnover Ratio
Determines the number of times during the year a company is ‘turning over’ or collecting its accounts receivable. Measured in X times per year. Can be converted to ‘days outstanding’ by dividing turnover ratio into 365 days.
A high A/R turnover is better than a low one, but depends on company & industry terms of
sale.
6X turnover is equivalent to 60 days of outstanding receivables, 9X is 45 days, 12X is 30 days.
Net SalesAverage Accounts Receivable
X100 Financial Analysis & Ratios L15-18
ZimmerAccounts Receivable
A/R Turnover = 6.1X or 60 days($3495.4)/($574.9) or (365 days/6.1X)A/R Turnover = 6.1X or 60 days($3495.4)/($574.9) or (365 days/6.1X)
Use average $574.9
X100 Financial Analysis & Ratios L15-19
Inventory Asset Turnover Ratio
Determines the number of times during the year a company is ‘turning over’ its inventory. Measured in X times per year. Can also be converted to ‘days of inventory’ by dividing ratio into 365 days.
The average inventory turnover for all firms is about 9 times per year, or about once every 45 days.
It varies considerable by industry. Supermarkets have turnover rates exceeding 20X (or 18 days) per year.
Cost of Goods SoldAverage Inventory
X100 Financial Analysis & Ratios L15-20
Use average $611.0
ZimmerInventory Turnover
Inventory Turnover = 1.28X or 286 days($780.1)/($611.0) or (365 days/1.28X)Inventory Turnover = 1.28X or 286 days($780.1)/($611.0) or (365 days/1.28X)
X100 Financial Analysis & Ratios L15-21
Key Financial Ratios
Net Income (after taxes)Owners’ Equity
Return on Owners’ Equity
Net Income or Loss (after taxes)Average # of Common Stock
Shares Outstanding
EPS – Earnings per Share
Net Income (after taxes)Net Sales Revenue
Return on Sales
Profitability
Net Sales .
Average Accounts Receivable
Accounts Receivable Turnover
Cost of Goods Sold
Average Inventory
Inventory Turnover
Asset Turnover
Current AssetsCurrent Liabilities
Current Ratio
Current Assets - InventoryCurrent Liabilities
Acid Test or Quick Ratio
Liquidity
Total LiabilitiesOwners’ Equity
Total Liability to Equity Ratio
Financial Leverage
X100 Financial Analysis & Ratios L15-22
Common Financial Ratios
*Return on
Equity
Return on Total Assets (ROA)
Return to
Investors
*EarningsPer
Share
Price to
Earnings Ratio
Dividend Yield
Return to Investors
Derived from: Fraser/Ormiston, Understanding the Corporate Annual Report; Understanding Financial Statements 6e
*A/RTurnover
*InventoryTurnover
FixedAsset
Turnover
TotalAsset
Turnover
Returnon TotalAssets(ROA)
Asset Management
OperatingEfficiency
* ‘Key’ X100
FinancialRatios
OtherCommonRatios
*Return on
Equity
Returns
Return on Total
Assets(ROA)
Cash Return
on Assets
Profitability
*Net Profit Margin(ROS)
Margins
Operating Profit Margin
Gross Profit Margin
ProductContri-butionMargin
Cash Flow
Margin
Amount of
Debt
LEVERAGEAssets/Equity
Debt/Equity
Debt/Assets
*Total Liabilities/
Equity
Coverage of
Debt
TimesInterestEarned
FixedCharge
Coverage
CashFlow
Adequacy
Cash Interest Coverage
Leverage /Debt Management
LT Debt/Total
Capital-ization
ShortRun
Solvency
*CurrentRatio
*Quickor
Acid TestRatio
CashFlow
LiquidityRatio
CurrentAssets
*A/RAverage
CollectionPeriod
*DaysInventory
Held
DaysPayables
Out-standing
Liquidity
Daysof
Working Capital
X100 Financial Analysis & Ratios L15-23
Key Financial Statements
Current (12mo)
Long-Term
TOTAL ASSETS
● Cash● A/R● Inventories
● PPE● Fixed Assets
Current (12mo)
Long-Term
TOTAL LIABILITIES
● A/P● ST Debt
● LT Debt
● Stock @ par● Paid-in Capital
● Accumulated Net Income● less Dividends
Contributed Capital
Retained Earnings
TOTAL OWNERS’/SHAREHOLDERS’ EQUITY
Asse
ts = Lia
bilitie
s + O
wn
ers’ E
qu
ity
Balance Sheet Period Ending
Net Sales
TOTAL REVENUES
● Units Sold● @ Price● less Returns & Allowances
Change in cash - Sources & (Uses) - between Periods
Other Expenses
● Interest● Taxes● One-time
Operating Profit
TOTAL NET INCOME or (LOSS) CASH provided (used) by
FINANCING Activities
Stock ● Sale (Purchase)
Dividends
Debt/ Borrowing
● (Paid)
● Increase (Decrease)
CASH provided (used) by INVESTING Activities
PPE ● (Additions) Sale
Other Investments
● (Additions) Sale
TOTAL OP EXPENSES
Expenses for Period
● R & D● Marketing● Distribution● Sales● Admin
Cost of Goods Sold
● Units Sold● @ Material● @ Labor● @ Overhead
CASH provided (used) by OPERATING Activities
Net Income ● Income Statement● Accrual Based
● Depreciation● A/R & A/P● Inventory ● Other Accruals
Adjustments for Non-cash Items
Income Statement for Period
Revenues – E
xpense
s = N
et In
com
e
Cash Flow Statement ∆C
ash =
Opera
ting +
Investin
g +
Financin
g
X100 Financial Analysis & Ratios L15-24