FIN437 Vicentiu Covrig 1 Financial Statements Analysis (chapter 14)
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Transcript of FIN437 Vicentiu Covrig 1 Financial Statements Analysis (chapter 14)
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Financial Statements Financial Statements AnalysisAnalysis(chapter 14)(chapter 14)
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Ratio analysis: Why are ratios Ratio analysis: Why are ratios useful?useful?
Ratios standardize numbers and facilitate comparisons
Ratios are used to highlight weaknesses and strengths.
Ratio comparisons should be made through time and with competitors.- Trend analysis.
- Peer (or industry) analysis.
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What are the five major categories of ratios, What are the five major categories of ratios, and what questions do they answer?and what questions do they answer?
Liquidity: Can we make required payments? Asset management: right amount of assets vs.
sales? Debt management: 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 value: Do investors like what they see as reflected in P/E and M/B ratios?
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D’Leon’s Balance Sheet: AssetsD’Leon’s Balance Sheet: Assets
CashA/RInventories
Total CAGross FALess: Dep.
Net FATotal Assets
20087,282
632,1601,287,3601,926,8021,202,950 263,160 939,7902,866,592
2009E85,632
878,0001,716,4802,680,1121,197,160 380,120 817,0403,497,152
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D’Leon’s Balance sheet: D’Leon’s Balance sheet: Liabilities and EquityLiabilities and Equity
Accts payableNotes payableAccruals
Total CLLong-term debtCommon stockRetained earnings
Total EquityTotal L & E
2008524,160
636,808 489,6001,650,568
723,432460,000
32,592 492,5922,866,592
2009E436,800
300,000 408,0001,144,800
400,0001,721,176 231,1761,952,3523,497,152
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D’Leon’s Income statementD’Leon’s Income statement
SalesCOGSOther expenses
EBITDADepr. & Amort.
EBITInterest Exp.EBTTaxesNet income
20086,034,000
5,528,000 519,988
(13,988) 116,960(130,948) 136,012(266,960) (106,784)(160,176)
2009E7,035,600
5,875,992 550,000
609,608 116,960
492,648 70,008
422,640 169,056 253,584
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Other dataOther data
No. of sharesEPSDPSStock price
2009E250,000
$1.014$0.220$12.17
2008100,000-$1.602$0.110
$2.25
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Calculate D’Leon’s forecasted current ratio Calculate D’Leon’s forecasted current ratio for 2009.for 2009.
Current ratio = Current assets / Current liabilities
=
2009 2008 2007 Ind.
Current
ratio2.34x 1.20x 2.30x 2.70x
Expected to improve but still below the industry average. Liquidity position is weak.
See also the Quick ratio in text
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What is the fixed asset turnover vs. What is the fixed asset turnover vs. the industry average?the industry average?
2009 2008 2007 Ind.
FA
Turnover8.61x 6.42x 6.8x 9x
FA turnover = Cost of Sales / Fixed assets
=
FA turnover is below industry average.
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Calculate the debt ratio and EBIT coverage Calculate the debt ratio and EBIT coverage ratios.ratios.
Debt to equity = long-term debt/ equity
=
Debt to total capital = Long term debt debt / (equity +long term debt)
=
Interest coverage = EBIT / Debt Interest charge
=
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How do the debt management ratios How do the debt management ratios compare with industry averages?compare with industry averages?
2009 2008 2007 Ind.
D/TC 17% 60% 54.8% 50.0%
Int. cov. 7.0x -1.0x 4.3x 6.2x
D/E 20% 140% 120% 170%
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Profitability ratios: Profitability ratios: Profit marginProfit margin
Profit margin = Net income / Sales
=
2009 2008 2007 Ind.
PM 3.6% -2.7% 2.6% 3.5%
Profit margin was very bad in 2008, but is projected to exceed the industry average in 2009. .
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Profitability ratios: Profitability ratios: Return on assets and Return on equityReturn on assets and Return on equity
ROA = Net income / Total assets
=
ROE = Net income / Total common equity
=
2009 2008 2007 Ind.
ROA 7.3% -5.6% 6.0% 9.1%
ROE 13.0% -32.5% 13.3% 18.2%
Both ratios rebounded from the previous year, but are still below the industry average. More improvement is needed.
Wide variations in ROE illustrate the effect that leverage can have on profitability.
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Calculate the Price/Earnings and Calculate the Price/Earnings and Market/Book ratiosMarket/Book ratios
P/E = Price / Earnings per share=
M/B = Mkt price per share / Book value per share
=(Book value is Total Assets minus Total Liabilities)
2009 2008 2007 Ind.
P/E 12.0x -1.4x 9.7x 14.2x
M/B 1.56x 0.5x 1.3x 2.4x
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Analyzing the market value ratiosAnalyzing the market value ratios
P/E: How much investors are willing to pay for $1 of earnings. M/B: How much investors are willing to pay for $1 of book value
equity. For each ratio, the higher the number, the better. P/E and M/B are high if ROE is high and risk is low.
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Extended DuPont equation: Extended DuPont equation: Breaking down Return on equityBreaking down Return on equity
ROE = (Profit margin) x (TA turnover) x (Equity multiplier)
= 3.6% x 2 x 1.8
= 13.0%
PM TA TO EM ROE
2007 2.6% 2.3 2.2 13.3%
2008 -2.7% 2.1 5.8 -32.5%
2009E 3.6% 2.0 1.8 13.0%
Ind. 3.5% 2.6 2.0 18.2%
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The Du Pont systemThe Du Pont system
Also can be expressed as:
ROE = (NI/Sales) x (Sales/TA) x (TA/Equity) Focuses on:
- Expense control (PM)
- Asset utilization (TATO)
- Debt utilization (Eq. Mult.) Shows how these factors combine to determine ROE.
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Potential problems and limitations of Potential problems and limitations of financial ratio analysisfinancial ratio analysis
Comparison with industry averages is difficult for a conglomerate firm that operates in many different divisions.
“Average” performance is not necessarily good, perhaps the firm should aim higher.
Seasonal factors can distort ratios. “Window dressing” techniques can make statements and ratios
look better. Different operating and accounting practices can distort
comparisons. Sometimes it is hard to tell if a ratio is “good” or “bad”. Difficult to tell whether a company is, on balance, in strong or
weak position.