Chapte r3 Working with Financial Statements 3 1 McGraw Hill Irwin Copyright 2013 by The McGraw Hill Companies Inc All rights reserved Chapter Outline Standardized Financial Statements Ratio Analysis The DuPont Identity Using Financial Statement Information 3 2 Standardized Financial Statements Common Size Balance Sheets Compute all accounts as a percent of total assets Common Size Income Statements Compute all line items as a percent of sales 3 3 Financial Statements Analysis Common Size Balance Sheets Compute all accounts as a percent of total assets Common Size Income Statements Compute all line items as a percent of sales The result indicates the growth rate of each account or the trend in each account Standardized financial statements makes it easier to compare financial information particularly as the company grows Also useful for comparing companies of different sizes particularly within the same Sample Balance Sheet XYZ Corporation December 31 201X Figures in millions of dollars 2011 3 5 2010 2011 2010 Cash 696 58 A P 307 303 A R 956 992 N P 26 119 Inventory 301 361 Other CL 1 662 1 353 Other CA 303 264 Total CL 1 995 1 775 Total CA 2 256 1 675 LT Debt 843 1 091 Net FA 3 138 3 358 C S 2 556 2 167 Total Assets 5 394 5 033 Total Liab Equity 5 394 5 033 Common Size Balance Sheets 2011 2010 Change 2011 2010 Change Cash 12 9 1 2 11 8 A P 5 7 6 0 0 3 A R 17 7 19 7 2 0 N P 0 5 2 4 1 9 Inventory 5 6 7 2 1 6 Other CL 30 8 26 9 3 9 Other CA 5 6 5 2 0 4 Total CL 37 0 35 3 1 7 Total CA 41 8 33 3 8 5 LT Debt 15 6 21 7 6 0 Net FA 58 2 66 7 47 4 43 1 4 3 0 0 Total Liab 100 0 100 0 Equity 0 0 Total Assets 3 6 100 0 100 0 8 5 C S Sample Income Statement XYZ Corporation January 1 December 31 201X Figures in millions of dollars Revenues 5 000 Cost of Goods Sold 2 006 Expenses 1 740 Depreciation 116 EBIT 1 138 Interest Expense 3 7 7 Taxable Income 1 131 Taxes 442 Net Income 689 EPS 3 61 Dividends per share 1 08 Common Size Income Statement 2011 Revenues 5 000 100 0 Cost of Goods Sold 2 006 40 1 Expenses 1 740 34 8 116 2 3 1 138 22 8 7 0 1 1 131 22 6 442 8 8 689 13 8 Depreciation EBIT Interest Expense Taxable Income Taxes Net Income 3 8 EPS 3 61 0 1 Dividends per share 1 08 0 0 Ratio Analysis The goal of ratio analysis is to take the numbers from both the income statement and balance sheet and to interpret this information in a meaningful way There is simply too much information to grasp at one time 3 9 Ratio Analysis 3 10 Ratios are simply construction of a numerator and a denominator using data from a balance sheet and or an income the Numerator Denominator Ratio Analysis Ratios allow for better comparison through time or between companies As we look at each ratio ask yourself what the ratio is trying to measure and why that information is important 3 11 Ratio Analysis What is the unit of measurement Percent of a days turnover What does the value indicate How can we improve the company s ratio Categories of Financial Ratios 1 Short term solvency or liquidity ratios 2 Long term solvency or financial leverage ratios 3 Asset management or turnover ratios 3 13 4 Profitability ratios Sample Balance Sheet XYZ Corporation December 31 201X Figures in millions of dollars 2011 Cash A R Inventory Other CA Total CA 3 14 2010 2011 2010 696 58 A P 307 303 956 992 N P 26 119 1 662 1 353 1 995 1 775 843 1 091 301 303 2 256 361 Other CL 264 Total CL 1 675 LT Debt Net FA 3 138 3 358 C S 2 556 2 167 Total Assets 5 394 5 033 Total Liab Equity 5 394 5 033 1 Computing Liquidity Ratios Measure of the firm s ability to meet its short term obligations Primarily of interest to suppliers and other shortterm creditors Current Ratio CA CL 2 256 1 995 1 13 times Quick Ratio CA Inventory CL 2 256 301 1 995 98 times 3 15 Cash Ratio Cash CL Liquidity Ratios Current Ratio CA CL 2 256 1 995 1 13 times 3 16 the firm s ability to cover CL with it s CA XYZ has 1 13 in CA for every 1 in CL has its CL covered 1 1 times over To a creditor such as a supplier the higher the current ratio the better to a firm this may indicate an inefficient use of cash Liquidity Ratios Quick Ratio CA Inventory CL 2 256 301 1 995 98 times Quite a bit lower than the current ratio Relatively large inventories are often sign of short term trouble Cash Ratio Cash CL 3 17 696 1 995 35 times Of interest to very short term creditor Sample Income Statement XYZ Corporation January 1 December 31 201X Figures in millions of dollars Revenues 5 000 2 006 1 740 Cost of Goods Sold Expenses Depreciation 116 EBIT 1 138 Interest Expense 3 18 7 Taxable Income Taxes 1 131 Net Income 689 442 EPS 3 61 Dividends per share 1 08 Liquidity Ratios NWC to Total Assets NWC TA 2 256 1 995 5 394 05 Interval Measure CA average daily operating costs 2 256 2 006 1 740 365 3 19 219 8 days 2 Computing Long term Solvency Ratios Indicate degree of debt financing by a company as well as ability to meet longterm obligations primarily of interest to bondholders Total Debt Ratio TA TE TA 5 394 2 556 5 394 52 61 3 20 The firm finances almost 53 of its assets with debt This is down from about Sample Balance Sheet XYZ Corporation December 31 201X Figures in millions of dollars 2011 3 21 2010 2011 2010 Cash 696 58 A P 307 303 A R 956 992 N P 26 119 Inventory 301 361 Other CL 1 662 1 353 Other CA 303 264 Total CL 1 995 1 775 Total CA 2 256 1 675 LT Debt 843 1 091 Net FA 3 138 3 358 2 556 2 167 5 394 5 033 Total Assets 5 394 C S 5 033 Total Liab Equity Sample Balance Sheet XYZ Corporation December 31 201X Figures in millions of dollars 2011 2011 2010 Cash 696 58 A P 307 303 A R 956 992 N P 26 119 Inventory 301 361 Other CL 1 662 1 353 Other CA 303 264 Total CL 1 995 1 775 843 2 556 1 091 5 394 5 033 Total CA 2 256 1 675 LT Debt Net FA 3 …