Slide 1Today’s OutlineSlide 3My PrinciplesClassificationSlide 6Short-Term Solvency: AnalysisShort-Term Solvency: The RatiosLiquidity Ratio AnalysisA Custom Ratio ExampleSlide 11Long-Term SolvencyLong-Term Solvency: Degree of Leverage AnalysisLong-Term Solvency: Degree of Leverage RatiosLong-Term Solvency: Coverage AnalysisLong-Term Solvency: Coverage RatiosSlide 17Efficiency: AnalysisTurnover AnalysisEfficiency: The Inventory RatiosEfficiency: The Receivables RatiosEfficiency: The Asset RatiosCustomized Efficiency RatiosSlide 24Profitability: AnalysisProfitability: The RatiosSlide 27Market Value: AnalysisMarket Value: AnalysisSlide 30DuPont Equations: AnalysisThe DuPont EquationExtending the DuPont EquationUsing RatiosMy Principles–RevisitedSome Cautions1 of 3611:03 PMTopic 4: Analysis of Financial StatementsLarry Schrenk, InstructorFIN 614 Financial Management2 of 3611:03 PM•The Ratios•DuPont Equation•Uses of Ratios•Website: D&B Key Business RatiosToday’s Outline3 of 3611:03 PMThe Ratios4 of 3611:03 PM1. Consider the Perspective2. Toolbox Approach3. Annualization4. Anomalies/Accounting Numbers5. Red Flags6. Customized Ratios7. No RulesMy Principles5 of 3611:03 PM1. Short-Term Solvency (Liquidity)2. Long-Term Solvency (Leverage)3. Efficiency4. Profitability5. Market ValueClassification6 of 3611:03 PM1. Short-Term Solvency7 of 3611:03 PM•Form•Purpose–Short-Term Liquidity–Can the Firm Meet Current Obligations?Short-Term Solvency: AnalysisMeasure of Short-Term Cash InflowMeasure of Short-Term Cash Outflow8 of 3611:03 PMShort-Term Solvency: The Ratios•Cash Ratio•Quick Ratio•Current RatioCurrent AssetsCurrent LiabilitiesCashCurrent LiabilitiesCurrent Assets - InventoryCurrent Liabilities9 of 3611:03 PM•Liquidity–Ability to Convert Assets to Cash with Significant Loss of Value•Differing Time Horizons for Liquidity–Cash Ratio???–Quick Ratio???–Current Ratio???Liquidity Ratio Analysis10 of 3611:03 PM•A New Coverage Ratio•Application?A Custom Ratio ExampleCashInterest11 of 3611:03 PM2. Long-Term Solvency12 of 3611:03 PM•Measures of the Long-Term Viability of the Firm•Two Metrics–Degree of Leverage–CoverageLong-Term Solvency13 of 3611:03 PM•Form•Purpose–Long-Term Liquidity–Is the Total Amount of Debt Reasonable?–Can the Firm Remain Solvent?Long-Term Solvency: Degree of Leverage AnalysisMeasure of DebtMeasure Asset Base14 of 3611:03 PM•Total Debt Ratio •Debt/Equity Ratio•Equity MultiplierLong-Term Solvency:Degree of Leverage RatiosTotal Assets - Total EquityTotal AssetsTotal DebtTotal EquityTotal Assets Debt = 1 + Total Equity Equity15 of 3611:03 PM•Form•Purpose–Short-Term Liquidity–Can the Firm Service its Long-Term Obligations?–Is Bankruptcy a Concern?Long-Term Solvency: Coverage AnalysisMeasure of Short-Term Cash InflowInterest Payment16 of 3611:03 PM•Times Interest Earned (TIE)•Cash CoverageLong-Term Solvency: Coverage RatiosEBIT + DepreciationInterestEBITInterest17 of 3611:03 PM3. Efficiency18 of 3611:03 PM•Form•Purpose–How Efficiently does the Firm Use the Value Invested in each Asset? •Balance Sheet Assets as Portfolio•Liquidity-Return Trade-Off–Turnover versus ‘Days Sales’Efficiency: AnalysisSales (or other Benchmark)Balance Sheet Asset19 of 3611:03 PM•Sales as Goal–Total Asset Turnover Ratio–Sales versus a Dollar Spend on Total Assets•Example–Total Asset Turnover Ratio = 5x–$1.00 in Assets Generates $5.00 in Sales on Average.Turnover Analysis20 of 3611:03 PM•Inventory Turnover•Days’ Sales in InventoryEfficiency: The Inventory RatiosCOGSInventory365Inventory Turnover21 of 3611:03 PM•Receivables Turnover•Days’ Sales in Receivables Efficiency: The Receivables RatiosSalesAccounts Receivable365Receivables Turnover22 of 3611:03 PM•Total Asset Turnover•Fixed Asset TurnoverEfficiency: The Asset RatiosSalesTotal AssetsSalesFixed Assets23 of 3611:03 PM•Denominator–Any Balance Sheet Asset•Numerator–Any Firm GoalCustomized Efficiency Ratios24 of 3611:03 PM4. Profitability25 of 3611:03 PM•Form•Purpose–Is the Firm Generating Reasonable Earnings Relative to•Total Assets•Equity–NOTE: Accounting MeasuresProfitability: AnalysisEarnings Cash FlowAsset Benchmark26 of 3611:03 PM•Profit Margin•Return on Assets (ROA)•Return on Equity (ROE)Profitability: The RatiosNet IncomeSalesNet IncomeTotal AssetsNet IncomeTotal Equity27 of 3611:03 PM5. Market Values28 of 3611:03 PM•No Common Form•No Common Purpose•Market DataMarket Value: Analysis29 of 3611:03 PM•PE Ratio•Market-to-Book RatioMarket Value: AnalysisMarket Value per ShareBook Value per SharePrice per ShareEarnings per Share30 of 3611:03 PMDuPont Equations31 of 3611:03 PM•Decomposition•Analysis, Not CalculationDuPont Equations: Analysis32 of 3611:03 PMThe DuPont Equation� �� �� � �Net IncomeROE = Total EquityNet Income Sales Total Assets= Sales Total Assets Total EquityProfit Total Assets Equity= Margin Turnover Multiplier Profitability Effeciency Leverage33 of 3611:03 PMExtending the DuPont Equation34 of 3611:03 PM•Comparisons–Time-Trend Analysis•Firm’s Performance over Time–Peer Group Analysis•Similar Companies or Industry AnalysisUsing Ratios35 of 3611:03 PM1. Consider the Perspective2. Toolbox Approach3. Annualize Data4. Anomalies/Accounting Numbers5. Red Flags6. Customized Ratios7. No RulesMy Principles–Revisited36 of 3611:03 PM•No Underlying Theory•Diversified Firms•Globalization•Varying Accounting Procedures•Different Fiscal YearsSome