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Financial Analysis

future financial conditions

• Done to find firm’s financial strengths and

weaknesses

• Primary Tools:

– Financial Statements

– Comparison of financial ratios to past,

industry, sector and all firms

Objectives of Ratio Analysis

• Standardize financial information for

comparisons

• Evaluate current operations

• Compare performance with past

performance

• Compare performance against other

firms or industry standards

• Study the efficiency of operations

• Study the risk of operations

Uses for Ratio Analysis

• Evaluate Customers’ Creditworthiness

• Assess Potential Merger Candidates

• Analyze Internal Management Control

• Analyze and Compare Investment

Opportunities

Types of Ratios

• Financial Ratios:

– Liquidity Ratios

• Assess ability to cover current obligations

– Leverage Ratios

• Assess ability to cover long term debt obligations

• Operational Ratios:

– Activity (Turnover) Ratios

• Assess amount of activity relative to amount of

resources used

– Profitability Ratios

• Assess profits relative to amount of resources

used

• Valuation Ratios:

• Assess market price relative to assets or earnings

Liquidity Ratios

• Current Ratio

– Current Assets / Current Liabilities

• Current Assets include Cash, Marketable Securities, Accounts

Receivable and Inventory

• Current Liabilities include Accounts Payable, Debt Due within one

year, and Other Current Liabilities

Current Ratio = = = 1.2 : 1

Current Liabilities 1555.75

Liquidity Ratios

– Current Assets minus Inventory / Current Liabilities

– A more precise measure of liquidity, especially if

inventory is not easily converted into cash.

Quik Ratio = = = 0.46 : 1

Current Liabilitie s 1555.75

Liquidity Ratios

• Cash Ratio

Cash + Marketable Securities 26.08

Cash Ratio = = = 0.17

Current Liabilities 1555.75

by the bank

Liquidity Ratios

Interval Measure

regular cash outgoings

Interval Measure =

Average Daily operating expenses

1,870.92 − 1,150.39

= = 77 Days

3,369.94 / 360

Leverage Ratios

– Leverage ratios measure the extent to which a firm has

been financed by debt.

– Debt Ratio

– Debt--Equity Ratio

will perceive its exposure in your business. Thus, high

leverage ratios make it more difficult to obtain credit

(loans).

Leverage Ratios Cont.

Leverage ratios also include the Interest-

coverage Ratio, Fixed coverage Ratio etc,.

previous slide, the higher the Interest

Coverage Ratio (Times-Interest-Earned Ratio),

the more credit worthy the firm is, and the

easier it will be to obtain credit (loans).

Total Debt Ratio

structure.

– In general, the lower the number, the better.

Debt Ratio = = = 0.646

Net Assets 1901.87

Debt-Equity Ratio

– The Debt-Equity Ratio indicates the percentage of total

funds provided by creditors versus by owners.

on debt financing (creditor money versus owner’s equity).

Debt − Equity Ratio = = = 1.83

Net Worth 972.81

• Treatment of

– Preference Capital

– Lease Payments

Interest Coverage Ratio

– interest coverage ratio indicates the extent to which

earnings can decline without the firm becoming unable

to meet its annual interest costs.

– Also called the Times-Interest-Earned Ratio, this

calculation shows how many times the firm could pay

back (or cover) its annual interest expenses out of

earnings before interest and taxes (EBIT).

EBIT 342.61

Interest Coverage Ratio = = = 2.4

Interest 143.46

Interest Coverage Ratio

Interest Coverage Ratio = = = 2.7

Interest 143.46

Fixed Coverage Ratio

– Principal repayments are added to interest payments

• EBITDA

Fixed Coverage Ratio =

Interest + Loan repayment

1-Tax Rate

Fixed Coverage Ratio = + Pref. Dividend

Interest + Lease rentals + Loan repayment

1-Tax Rate

Activity Ratios

– Activity ratios measure how effectively a firm is using its

resources, or how efficient a company is in its operations

and use of assets.

– In general, the higher the ratio, the better.

– Activity ratios include:

Inventory turnover

Accounts receivable turnover

Average collection period.

Total assets turnover

Fixed assets turnover

Inventory Turnover Ratio

– The inventory turnover ratio indicates how fast a firm is

selling its inventories

– This ratio indicates how well inventory is being managed,

which is important because the more times inventory can

be turned (i.e., the higher the turnover rate) in a given

operating cycle, the greater the profit.

Inventory Turnover Ratio = = = 8.6

Avg Inventory (244.26 + 7461.81) / 2

360

Days of Inventory Holding = = 42 days

Inventory Turnover

Inventory Turnover Ratio Cont.

– In the absence of information. Instead of CGS

we can use Sales

– In the case of CGS and Inventory both are

valued at cost. While the sales are valued at

market prices

– Therefore better to use CGS

Accounts Receivable Turnover

– The accounts receivable turnover ratio, indicates the

average length of time it takes a firm to collect credit sales

(in percentage terms), i.e., how well accounts receivable

are being collected.

– If receivables are excessively slow in being converted to

cash, liquidity could be severely impaired.

Credit Sales

A R Turnover =

Avg AR

Sales 3,717.23

= = = 7.7

Avg AR 483.18

Average Collection Period

– The average collection period is the average length of

time (in days) it takes a firm to collect on credit sales.

360

ACP = = 47 days

AR Turnover

Net Assets Turnover

– The total assets turnover ratio, indicates how efficiently

a firm is using all its assets to generate revenues.

– This ratio helps to signal whether a firm is generating a

sufficient volume of business for the size of its asset

investment

Sales 3,717.23

Net Assets Turnover = = = 1.95 times

Net Assets 1901.87

Profitability Ratios

– Profitability ratios measure management’s overall

effectiveness as shown by returns generated on sales

and investment.

– Gross profit margin

– Operating profit margin

– Net profit margin

– Return on total assets (ROA)

– Return on stockholders’ equity (ROE)

– Earnings per share (EPS)

– Price-earnings ratio (P/E).

Gross Profit Margin

operating expenses and yield a profit. This ratio indicates

how efficiently a business is using its labor and materials in

the production process, and shows the percentage of net

sales remaining after subtracting cost of goods sold.

– The higher the ratio, the better. A high gross profit margin

indicates that a firm can make a reasonable profit on sales,

as long as it keeps overhead costs under control.

Gross Profit 663.57

GP Margin = = = 0.179 or 17.9%

Sales 3,717.23

The DuPont System

• Method to breakdown ROE into:

– ROA and Equity Multiplier

• ROA is further broken down as:

– Profit Margin and Asset Turnover

• Helps to identify sources of strength and

weakness in current performance

• Helps to focus attention on value drivers

The DuPont System

ROE

P ro fit M a rg in T o ta l A s s e t T u rn o v e r

The DuPont System

ROE

P ro fit M a rg in T o ta l A s s e t T u rn o v e r

Net Income Total Assets

= ×

Total Assets Common Equity

The DuPont System

ROE

P ro fit M a rg in T o ta l A s s e t T u rn o v e r

Net Income Sales

= ×

Sales Total Assets

The DuPont System

ROE

P ro fit M a rg in T o ta l A s s e t T u rn o v e r

Net Income Sales Total Assets

= × ×

Sales Total Assets Common Equity

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