PowerPoint PresentationKey Concepts and SkillsChapter Outline3.1 Financial Statements AnalysisCommon-Size Financial StatementsPrufrock Corporation Comparison: Financial & Common Size Balance SheetSlide 73.2 Ratio AnalysisCategories of Financial RatiosComputing Liquidity RatiosComputing Leverage RatiosComputing Coverage RatiosComputing Inventory RatiosComputing Receivables RatiosComputing Total Asset TurnoverComputing Profitability MeasuresComputing Market Value MeasuresSummary of Ratio FormulaeUsing Financial Ratios3.3 The DuPont IdentityDerivation of The Du Pont IdentityUsing the Du Pont IdentityCalculating the Du Pont IdentityPotential Problems in Financial Analysis3.4 Financial ModelsFinancial Planning IngredientsPercent of Sales ApproachSlide 28Percent of Sales Approach – Income StatementSlide 30Percent of Sales and EFN3.5 External Financing and GrowthThe Internal Growth RateThe Sustainable Growth RateDeterminants of Growth3.6 Some CaveatsQuick QuizSlide 383-1FINANCIAL STATEMENTS ANALYSIS AND FINANCIAL MODELSChapter 3Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.3-2KEY CONCEPTS AND SKILLS•Standardize financial statements for comparison purposes•Compute and interpret important financial ratios including the famous DuPont Identity•Develop a financial plan using the percentage of sales approach•Discern how capital structure and dividend policies affect a firm’s ability to grow3-3CHAPTER OUTLINE3.1 Financial Statements Analysis3.2 Ratio Analysis3.3 The Du Pont Identity3.4 Financial Models3.5 External Financing and Growth3.6 Some Caveats Regarding Financial Planning Models3-43.1 FINANCIAL STATEMENTS ANALYSIS•Must develop a good working knowledge of financial statements•Making financial statements useful for users is one finance role•In order to make meaningful comparisons of companies of different size financial professionals use two key techniques:•Common-Size Statements•Financial Ratios3-5COMMON-SIZE 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•Standardized statements make it easier to compare financial information, particularly as the company grows.•They are also useful for comparing companies of different sizes, particularly within the same industry.•Practice Hint: You may have round percentages in Common-Size Statements3-63-6PRUFROCK CORPORATIONCOMPARISON: FINANCIAL & COMMON SIZE BALANCE SHEETBalance SheetCommon Size Balance Sheet3-7Prufrock CorporationComparison: Financial & Common Size Income StatementIncome StatementCommon Size Income Statement3-73-83.2 RATIO ANALYSIS•Ratios compliment common size analysis and allow for deeper comparison through time or between dissimilar companies•Not always computed precisely the same; document your approach•As we look at each ratio, ask yourself:•How is the ratio computed?•What is the ratio trying to measure and why?•What is the unit of measurement?•What does the value indicate?•How can we improve the company’s ratio?3-9CATEGORIES OF FINANCIAL RATIOS•Short-term solvency or liquidity ratios•Long-term solvency or financial leverage ratios•Asset management or turnover ratios•Profitability ratios•Market value ratios•Following examples all based on Tables 3.1 & 3.43-10COMPUTING LIQUIDITY RATIOS•Current Ratio = CA / CL•708 / 540 = 1.31 times•Quick Ratio = (CA – Inventory) / CL•(708 - 422) / 540 = .53 times•Cash Ratio = Cash / CL•98 / 540 = .18 times3-11COMPUTING LEVERAGE RATIOS•Total Debt Ratio = (TA – TE) / TA•(3588 - 2591) / 3588 = 28%•Debt/Equity = TD / TE•(3588 – 2591) / 2591 = 38.5%•Equity Multiplier = TA / TE = 1 + D/E•1 + .385 = 1.3853-12COMPUTING COVERAGE RATIOS•Times Interest Earned = EBIT / Interest•691 / 141 = 4.9 times•Cash Coverage = (EBIT + Depreciation + Amortization) / Interest•(691 + 276) / 141 = 6.9 times3-13COMPUTING INVENTORY RATIOS•Inventory Turnover = Cost of Goods Sold / Inventory•1344 / 422 = 3.2 times•Days’ Sales in Inventory = 365 / Inventory Turnover•365 / 3.2 = 114 days3-14COMPUTING RECEIVABLES RATIOS•Receivables Turnover = Sales / Accounts Receivable•2311 / 188 = 12.3 times•Days’ Sales in Receivables = 365 / Receivables Turnover•365 / 12.3 = 30 days3-15COMPUTING TOTAL ASSET TURNOVER•Total Asset Turnover = Sales / Total Assets•2311 / 3588 = .64 times•It is not unusual for TAT < 1, especially if a firm has a large amount of fixed assets.3-16COMPUTING PROFITABILITY MEASURES•Profit Margin = Net Income / Sales•363 / 2311 = 15.7%•Return on Assets (ROA) = Net Income / Total Assets•363 / 3588 = 10.12%•Return on Equity (ROE) = Net Income / Total Equity•363 / 2591 = 14.01%•EBITDA Margin = EBITDA / Sales•967 / 2311 = 41.8%3-17COMPUTING MARKET VALUE MEASURES•Market Capitalization = $88 per share x 33 million shares = 2904 million•PE Ratio = Price per share / Earnings per share•88 / 11 = 8 times•Market-to-book ratio = Market value per share / Book value per share•88 / (2591 / 33) = 1.12 times•Enterprise Value (EV) = Market capitalization + Market value of interest bearing debt – Cash•2904 + (196 + 457) – 98 = 3459 million•EV Multiple = EV / EBITDA•3459 / 967 = 3.6 times3-183-18SUMMARY OF RATIO FORMULAE3-19USING FINANCIAL RATIOS•Ratios are not very helpful by themselves: they need to be compared to something•Time-Trend Analysis•Used to see how the firm’s performance is changing through time•Peer Group Analysis•Compare to similar companies or within industries•Go to www.reuters.com/finance/stocks •Use the Financials link to get comparative ratios for many companies3-203.3 THE DUPONT IDENTITY•Popularized by the DuPont Corporation•A more sophisticated method of evaluating return•Illustrates the interaction between profit, assets and leverage•Holds that ROE is actually a function of 3 measures:•Operating Efficiency (Profit Margin)•Asset Use Efficiency (Total Asset Turnover)•Financial Leverage (Equity Multiplier)3-21DERIVATION OF THE DU PONT IDENTITY•ROE = NI / TE•Multiply by 1 and then rearrange:•ROE = (NI / TE) (TA / TA)•ROE = (NI / TA) (TA / TE) = ROA * EM•Multiply by 1 again and then rearrange:•ROE = (NI / TA) (TA / TE) (Sales / Sales)•ROE = (NI / Sales) (Sales / TA) (TA /