Financial Ratios Analysis PDF

Financial Ratio Analysis FINA 320 Dr. Lei Zhou  Learning Objectives Create, understand, and interpret common-size financial statements. Calculate and interpret financial ratios. Compare different company performances using financial ratios. NIU...

Financial Ratio Analysis FINA 320 Dr. Lei Zhou  Learning Objectives Create, understand, and interpret common-size financial statements. Calculate and interpret financial ratios. Compare different company performances using financial ratios. NIU FINA 320 - Dr. Lei Zhou 2  Common Size Financial Statements It is difficult to compare financial statements of firms of different size. One useful way to deal with the issue of size is to create common size financial statement. Express each income statement item as a percent of sales Express each balance sheet item as a percent of total assets. NIU FINA 320 - Dr. Lei Zhou 3 NIU FINA 320 - Dr. Lei Zhou 4 Note: Cogswell has 1,790,000 shares outstanding and Spacely has 587,000 shares outstanding. NIU FINA 320 - Dr. Lei Zhou 5  Trend Analysis In addition to peer comparison, it is also important and informative to performance time-series analysis, or trend analysis Compare oneself against its past compare a firm’s current performance against that of its own performance over a 3-5 year period Examine the growth rate in various key items such as sales, costs, and profits. NIU FINA 320 - Dr. Lei Zhou 6 Cogswell Cola’s Abbreviated Income Statements ($ in thousands) NIU FINA 320 - Dr. Lei Zhou 7  Financial Ratio Analysis Common size financial statement and trend analysis are good starting points to detect trends (if any) in a firm’s performance and to make quick comparisons of key financial statement values with competitors on a relative basis. More in-depth diagnosis requires individual item analyses and comparisons which are best done by conducting ratio analysis. NIU FINA 320 - Dr. Lei Zhou 8  Financial Ratios Financial ratios are relationships between different accounts from financial statements—usually the income statement and the balance sheet—that serve as performance indicators Being relative values, financial ratios allow for meaningful comparisons across time, between competitors, and with industry averages. NIU FINA 320 - Dr. Lei Zhou 9  Financial Ratios There are five key sets of financial ratios Liquidity ratios: Can the company meet its obligations over the short term? Solvency ratios: (also known as financial leverage ratios): Can the company meet its obligations over the long term? Asset management ratios: How efficiently is the company managing its assets to generate sales? Profitability ratios: How well has the company performed overall? Market value ratios: How does the market (investors) view the company’s financial prospects? NIU FINA 320 - Dr. Lei Zhou 10  Short-Term Solvency: Liquidity Ratios Measure a company’s ability to cover its short-term debt obligations in a timely manner 3 key liquidity ratios include: NIU FINA 320 - Dr. Lei Zhou 11  Liquidity Ratios for Cogswell Cola and Spacely Spritzers Cogswell has better liquidity and short-term solvency than Spacely, but higher investment in current assets is costly. NIU FINA 320 - Dr. Lei Zhou 12 Assets 2009 2008 Current as s ets : Cas h and cas h equivalents $ 632 245 Short-term inves tm ents 425 416 Merchandis e inventory - net 8,249 8,209 Deferred incom e taxes - net 208 105 Other current as s ets 218 215 Total current assets 9,732 9,190 Property les s acc. depreciation 22,499 22,722 Long-term inves tm ents 277 253 Other as s ets 497 460 Total assets $ 33,005 32,625 Liabilities and Shareholders' Equity 2009 2008 Current liabilities: Short-term borrowings $ - 987 Current m aturities of long-term debt 552 34 Accounts payable 4,287 4,109 Accrued com p./em ployee benefits 577 434 Deferred revenue 683 674 Other current liabilities 1,256 1,322 Total current liabilities 7,355 7,560 Long-term debt, excl. current m aturities 4,528 5,039 Deferred incom e taxes - net 598 599 Other liabilities 1,455 1,372 Total liabilities 13,936 14,570 Shareholders' equity: - - Com m on s tock - $.50 par value 729 735 Capital in exces s of par value 6 277 Retained earnings 18,307 17,049 Acc. other com prehens ive incom e 27 (6) Total shareholders' equity 19,069 18,055 Total liabilities and shareholders' equity $ 33,005 32,625 NIU FINA 320 - Dr. Lei Zhou 13 Lowe's Income Statement 2009 Net sales 47,220 Cost of sales 30,757 Gross margin 16,463 Expenses: Selling, general and administrative 11,688 Store opening costs 49 Depreciation 1,614 Interest - net 287 Total expenses 13,638 Pre-tax earnings 2,825 Income tax provision 1,042 Net earnings 1,783 NIU FINA 320 - Dr. Lei Zhou 14 What was Lowe's current ratio in 2009? A) 1.32 B) 0.76 C) 2.37 D) 0.42 NIU FINA 320 - Dr. Lei Zhou 15 What was Lowe's quick ratio in 2009? A) 0.20 B) 4.96 C) 1.12 D) 0.89 NIU FINA 320 - Dr. Lei Zhou 16 What was Lowe's cash ratio in 2009? A) 0.086 B) 11.64 C) 0.065 D) 15.40 NIU FINA 320 - Dr. Lei Zhou 17  Long-Term Solvency Ratio Measure a company’s ability to meet its long-term debt obligations based on its overall debt level and earnings capacity. Failure to meet its interest obligation could put a firm into bankruptcy. Two sets of long term solvency ratios: Leverage ratios measure the degree of liability Debt service ratios measure the firm’s ability to meet its interest payment obligations NIU FINA 320 - Dr. Lei Zhou 18 Long-Term Solvency Ratios NIU FINA 320 - Dr. Lei Zhou 19 Long Term Solvency Ratios for Cogswell Cola and Spacely Spritzers Cogswell Cola has relatively less debt and a significantly greater ability to cover its interest obligations by using either its EBIT (times interest earned ratio) or its net cash flow (cash coverage ratio) than Spacely Spritzers. Leverage must be analyzed as a combination of debt level and coverage. If a firm is heavily leveraged but has good interest coverage, it is using the interest deductibility feature of taxes to its benefit. Having a high leverage with low coverage could put the firm into a risk of bankruptcy. NIU FINA 320 - Dr. Lei Zhou 20 What was Lowe's debt ratio in 2009? A) 0.42 B) 2.37 C) 0.73 D) 1.37 NIU FINA 320 - Dr. Lei Zhou 21 What was Lowe's time-interest- earned ratio in 2009? A) 10.84 B) 57.36 C) 9.84 D) 6.21 NIU FINA 320 - Dr. Lei Zhou 22 What was Lowe's cash coverage ratio in 2009? A) 16.47 B) 15.48 C) 11.84 D) 2.20 NIU FINA 320 - Dr. Lei Zhou 23  Asset Management Ratios Measure how efficiently a firm is using its assets to generate revenues or how much cash is being tied up in other assets such as receivables and inventory. They are also called turnover ratios NIU FINA 320 - Dr. Lei Zhou 24 Asset Management Ratios for Cogswell Cola and Spacely Spritzers While Cogswell is more efficient at managing its inventory, Spacely seems to be doing a better job of collecting its receivables and utilizing its total assets in generating revenues NIU FINA 320 - Dr. Lei Zhou 25  What was Lowe's inventory turnover ratio in 2009? A) 3.73 B) 5.72 C) 0.27 D) 0.17 NIU FINA 320 - Dr. Lei Zhou 26 What was Lowe's days' sales in inventory? A) 97.89 B) 63.76 C) 3.73 D) 1,361 NIU FINA 320 - Dr. Lei Zhou 27 Suppose that Lowes reported $1000 in account receivable by the end of 2009. What was Lowes account receivable turnover ratio? A) 47.22 B) 30.76 C) 7.73 D) 11.87 NIU FINA 320 - Dr. Lei Zhou 28 Suppose that Lowes reported $1000 in account receivable by the end of 2009. What was Lowes days sales in account receivable? A) 47.22 B) 30.76 C) 7.73 D) 11.87 NIU FINA 320 - Dr. Lei Zhou 29 What was Lowes' asset turnover ratio for 2009? A) 1.43 B) 0.70 C) 0.93 D) 1.07 NIU FINA 320 - Dr. Lei Zhou 30  Profitability Ratios Profitability ratios such as net profit margin, returns on assets, and return on equity, measure a firm’s effectiveness in turning sales or assets into profits. NIU FINA 320 - Dr. Lei Zhou 31  Profitability Ratios for Cogswell Cola and Spacely Spritzers As far as profitability is concerned, Cogswell is outperforming Spacely significantly. NIU FINA 320 - Dr. Lei Zhou 32 What was Lowes' profit margin in 2009? A) 3.78% B) 5.40% C) 9.35% D) 244.58% NIU FINA 320 - Dr. Lei Zhou 33 What was Lowes' return on assets (ROA) in 2009? A) 3.78% B) 5.40% C) 9.35% D) 244.58% NIU FINA 320 - Dr. Lei Zhou 34 What was Lowes' return on equity (ROE) in 2009? A) 3.78% B) 5.40% C) 9.35% D) 244.58% NIU FINA 320 - Dr. Lei Zhou 35  Market Value Ratios Used to gauge how attractive or reasonable a firm’s current price is relative to its earnings, growth rate, and book value. NIU FINA 320 - Dr. Lei Zhou 36  Market Value Ratios Potential investors and analysts often use these ratios as part of their valuation analysis. Typically, if a firm has a high price to earnings and a high market to book value ratio, it is an indication that investors have a good perception about the firm’s performance. However, if these ratios are very high it could also mean that a firm is over-valued. With the price/earnings to growth ratio (PEG ratio), the lower it is, the more of a bargain it seems to be trading at, vis-à-vis its growth expectation. NIU FINA 320 - Dr. Lei Zhou 37  Market Value Ratios Cogswell stock is trading at $28.51 and Spacely has a current price of $19.00. Cogswell has 1,790,000 shares outstanding and Spacely has 587,000 shares outstanding. Total shareholders’ equities of Cogswell and Spacely are $9.291 million and $2.677 million respectively. The net incomes of Cogswell Spacely are $3.313 million and $857,000 respectively. Analysts project that the earning growth rates for Cogswell and Spacely are 12% and 15% respectively. NIU FINA 320 - Dr. Lei Zhou 38  Market Value Ratios Ratio Cogswell Cola Spacely Spritzers P/E 15.41 13.01 PEG 1.28 0.86 P/B 5.49 4.17 The ratios seem to indicate that investors in both firms seem to have good expectations about their performance and are therefore paying fairly high prices relative to their earnings book values. NIU FINA 320 - Dr. Lei Zhou 39  DuPont analysis DuPont analysis breaks down ROE into three components: 1) operating profit, as measured by the profit margin (net income/sales); 2) asset management efficiency, as measured by asset turnover (sales/total assets); and 3) financial leverage, as measured by the equity multiplier (total assets/total equity). NIU FINA 320 - Dr. Lei Zhou 40 DuPont analysis NIU FINA 320 - Dr. Lei Zhou 41