Lecture 2: Ratio Analysis

Lecture 2: Ratio Analysis

• Ratio analysis translates accounting figures into relative values.
• Ratios demonstrate relationships between financial statement accounts within and between firms.
• The purpose of ratio analysis is to give insights into a company's performance, standardize numbers for easier comparisons, and highlight weaknesses and strengths.
• Key categories of ratios include: liquidity (ability to meet current obligations), asset management (efficiency of asset use), debt management (mix of debt and equity), profitability (combined effects of liquidity, assets, and debt management), and market values (relationship between stock price, earnings, and book value).

Learning Objectives

• Identifying major financial statements
• Understanding major methods for analysing financial information
• Describing ratio analysis and its significance for managers and investors

The Annual Report

• Consists of a verbal section (typically a letter from the chairman), and financial statements.
• Financial statements include the income statement, balance sheet, and statement of cash flows.

Financial Statements

• Income Statement: Shows profitability (revenues minus expenses) over a specific period, but does not demonstrate cash flow.
• Balance Sheet: Reflects the financial position of a firm at a particular point in time, showing assets, liabilities, and shareholders' equity (assets = liabilities + equity).
• Statement of Cash Flows: Shows changes in cash flow resulting from operating, investing, and financing activities.

Carrefour Income Statement (201X)

• Revenues or sales: €87,379 million
• Expenses: €86,942 million
• Profit (or loss): €437 million

Carrefour Balance Sheet (Dec 31, 201X)

• Assets: €51,553 million
• Liabilities: €40,438 million
• Shareholders' equity: €11,115 million

Balance Sheet Components

• Assets: Fixed assets (used for more than a year; property, plant, equipment, cars), Current assets (liquidated within a year; cash, inventory, receivables)
• Liabilities & Equity: Liabilities (what the firm owes), Shareholders' equity (investors' stake in the company)

Methods for Analyzing Financial Information

• Common Size Analysis: Balance sheet data are expressed as a percentage of total assets; income statement elements are reported as a percentage of sales. Useful for comparing firms of different sizes or across time periods.
• Trend Analysis: Tracks how financial data changes over time to observe trends.
• Ratio Analysis: Uses mathematical relationships between financial data to evaluate performance.
• Benchmarking: Compares a firm's performance to that of competitors or industry averages.

Liquidity Ratios

• Current Ratio: Current assets divided by current liabilities. Measures a firm's ability to cover short-term obligations.
• Acid-Test (Quick) Ratio: (Current assets - inventory) divided by current liabilities. More stringent measure of short-term liquidity than the current ratio, as inventory is less liquid.

Unilate's Current Ratio (20XX)

• Current Ratio: 3.6 times
• Industry average: 4.1 times

Unilate's Acid-Test (Quick) Ratio (20XX)

• Quick Ratio: 1.5 times
• Industry Average: 2.1 times

Asset Management Ratios

• Inventory Turnover Ratio: Cost of goods sold divided by inventory. Measures how efficiently a company manages its inventory.
• Days Sales Outstanding (DSO): (Receivables/ Annual Sales)*365. Measures how many days on average it takes to collect from customers.
• Total Assets Turnover Ratio: Sales divided by total assets. Measures how efficiently a firm uses its assets to generate sales.

Unilate's Inventory Turnover Ratio (20XX)

• 4.6 times
• Industry average: 7.4 times

Unilate's Days Sales Outstanding Ratio (20XX)

• 43.8 days
• Industry average: 32.1 days

Unilate's Total Asset Turnover Ratio (20XX)

• 1.8 times
• Industry Average: 2.1 times

Debt Management Ratios

• Debt Ratio: Total Liabilities / Total Assets. Percentage of assets financed with debt.
• Times-Interest-Earned Ratio (TIE): EBIT / Interest charges. Measures a firm's ability to cover interest expenses.

Unilate's Debt Ratio (20XX)

• 50.9%
• Industry average: 42.0%

Unilate's Times-Interest-Earned Ratio (20XX)

• 3.3 times
• Industry average: 6.5 times

Profitability Ratios

• Net Profit Margin: Net Income divided by Sales. Reflects the percentage of sales that remains as profit after all expenses and taxes.
• Return on Total Assets (ROA): Net Income / Total Assets. Measures overall profitability relative to total assets.
• Return on Common Equity (ROE): Net Income / Common Equity. Represents the return generated on common shareholders' investments.

Unilate's Profit Margin Ratio (20XX)

• 3.6%
• Industry average: 4.9%

Unilate's ROA (20XX)

• 6.4%
• Industry Average: 10.3%

Unilate's ROE (20XX)

• 13.0%
• Industry Average: 17.7%

Market Value Ratios

• Price/Earnings Ratio (P/E): Price per share / Earnings per share. Measures how much investors are willing to pay for each dollar of current earnings.

Unilate's Price/Earnings Ratio (20XX)

• 10.6 times
• Industry average: 15.0 times

Common-Size Financial Analysis

• A method to evaluate a company by comparing line-items of the balance sheet or income statement as a percentage.

Trend Analysis

• Used to compare performance against past periods to identify trends. Often visualised on graphs.

DuPont Analysis

• A method for decomposing the return on equity (ROE) into components. It is a way to examine the underlying drivers of a company's profitability.

This quiz covers key concepts from Lecture 2 on Ratio Analysis. Participants will explore the significance of ratio analysis in evaluating financial statements, including liquidity, asset management, debt management, profitability, and market values. Understanding these ratios is crucial for managers and investors alike.