1Working with FinancialStatements2Evaluating Financial PerformanceEvaluate the success of an ongoing businessDetermine weaknesses of an ongoing businessCompare current performance with past performanceCompare current performance with industry standards. Why?4Ratio AnalysisFinancial Ratios represent an attempt to standardize financial information in order to facilitate meaningful comparisons over time and between firms.The business is a storehouse of resources (i.e. assets on the balance sheet) which it converts to profit through production and then sales (reported on the income statement)RESOURCES PRODUCTION SALES5Ratio AnalysisLiquidity RatiosLong Term Solvency ratiosAsset Activity RatiosProfitability RatiosMarket Value RatiosFive Categories of Ratios7Ratio AnalysisLiquidity RatiosCurrent Ratio =Current Assets Current LiabilitiesMeasure the ability of the firm to meet its short-term financial obligations.Is there a sufficient amount of current assets to pay off current liabilities? What is the cushion of safety?8Ratio AnalysisBalance SheetSimsboro Computer CompanyCash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories 625 Current Liabilities $230Current Assets $1,230 Bonds $600Plant & Equipment $2,500 Owner’s EquityLess:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300Paid-in Capital 600Total Assets $2,530 Retained Earnings 800Total Owners’ Equity $1,700Total Liabilities andOwners Equity $2,530Assets Liabilities Income StatementSimsboro Computer CompanySales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200EBIT $330Interest Expense 60Net Income Before Taxes $270Taxes (40%) 108Net Income $162Dividends Paid 100Addition to Retained Earnings $62$1,230 $230Current Ratio == 5.35xCurrent Ratio =Current Assets Current Liabilities9Ratio AnalysisLiquidity RatiosAcid-Test Ratio =Current Assets - Inventory Current LiabilitiesMeasure the ability of the firm to meet its short-term financial obligations.What happens to the firm’s ability to repay current liabilities after the least liquid of the current assets is subtracted? aka Quick Ratio10Ratio AnalysisBalance SheetSimsboro Computer CompanyCash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories 625 Current Liabilities $230Current Assets $1,230 Bonds $600Plant & Equipment $2,500 Owner’s EquityLess:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300Paid-in Capital 600Total Assets $2,530 Retained Earnings 800Total Owners’ Equity $1,700Total Liabilities andOwners Equity $2,530Assets Liabilities Income StatementSimsboro Computer CompanySales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200EBIT $330Interest Expense 60Net Income Before Taxes $270Taxes (40%) 108Net Income $162Dividends Paid 100Addition to Retained Earnings $62$1,230 -$625$230Acid-Test Ratio ==2.63xAcid-Test Ratio =Current Assets - Inventory Current Liabilities11Ratio AnalysisSummary of Simsboro Computer & IndustryRatio Industry SimsboroLiquidityCurrent Ratio 5.00x 5.35xAcid-Test Ratio 3.00x 2.63xLooking at the current ratio it appears that Simsboro is more liquid than the industry.... however when looking at Acid Test (a better measure) they are not as liquid, this could be an indication that inventory levels may be too high relative to the sales. 12Ratio AnalysisLong Term Solvency RatiosUsed to measure the extent to which non-owner supplied funds have been used to finance the firm’s assetsTwo TypesBalance Sheet Debt Management RatiosCoverage Ratios13Ratio AnalysisBalance Sheet Debt Management Ratios measure the proportionof the firm’s assets financed with non-owner funds.Debt Ratio =Total Debt Total AssetsWhat proportion of the firm’s assets are financed with debt?Long Term Solvency Ratios14Ratio AnalysisBalance SheetSimsboro Computer CompanyCash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories 625 Current Liabilities $230Current Assets $1,230 Bonds $600Plant & Equipment $2,500 Owner’s EquityLess:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300Paid-in Capital 600Total Assets $2,530 Retained Earnings 800Total Owners’ Equity $1,700Total Liabilities andOwners Equity $2,530Assets Liabilities Income StatementSimsboro Computer CompanySales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200EBIT $330Interest Expense 60Net Income Before Taxes $270Taxes (40%) 108Net Income $162Dividends Paid 100Addition to Retained Earnings $62$230 + $600 $2,530Debt Ratio == 33%Debt Ratio =Total Debt Total Assets15Ratio AnalysisBalance Sheet Debt Management Ratios measure the proportionof the firm’s assets financed with non-owner funds.Debt/Equity Ratio =Total Debt Common EquityWhat is the relationship of the firm’s debt and equity levels?Long Term Solvency Ratios16Ratio AnalysisBalance SheetSimsboro Computer CompanyCash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories 625 Current Liabilities $230Current Assets $1,230 Bonds $600Plant & Equipment $2,500 Owner’s EquityLess:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300Paid-in Capital 600Total Assets $2,530 Retained Earnings 800Total Owners’ Equity $1,700Total Liabilities andOwners Equity $2,530Assets Liabilities Income StatementSimsboro Computer CompanySales $1,450Cost of Goods Sold 875Gross Profit $575Operating Expenses 45Depreciation 200EBIT $330Interest Expense 60Net Income Before Taxes $270Taxes (40%) 108Net Income $162Dividends Paid 100Addition to Retained Earnings $62$230 + $600 $1,700Debt/Equity Ratio == 49%Debt/Equity Ratio =Total Debt Common Equity17Ratio AnalysisBalance Sheet Debt Management Ratios measure the proportionof the firm’s assets financed with non-owner funds.What is the effect on the stockholders earnings as a result of the current debt level?Long Term Solvency RatiosEquity Multiplier =Total Assets Common Equity11 – Debt Ratio oror 1 + Debt/Equity Ratio18Ratio AnalysisBalance SheetSimsboro Computer CompanyCash $175 Accounts Payable $115Accounts Receivable 430 S-T Notes Payable 115Inventories 625 Current Liabilities $230Current Assets $1,230 Bonds $600Plant & Equipment $2,500 Owner’s EquityLess:Acc. Depr. (1,200) Common Stock $300Net Fixed Assets $1,300Paid-in Capital 600Total Assets $2,530 Retained Earnings 800Total Owners’ Equity $1,700Total Liabilities andOwners Equity $2,530Assets Liabilities
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