ch03 ppt brighamfm1ce

8/3/2019 Ch03 Ppt Brighamfm1ce

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PowerPoint Presentationprepared by

Traven ReedCanadore College


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chapter3Analysis of Financial

Statements


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Copyright 2011 by Nelson Education Ltd. All rights reserved. 3-3

Corporation Valuation andAnalysis of Financial Statements


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Topics in Chapter

Ratio analysis

Trend, common-size andpercentage change analysis

Du Pont system

Uses and limitations of ratioanalysis


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Income Statement

2009 2008

Net sales 3,000.0 2,850.0

Op. costs excluding

depre. & amort.

2,616.2 2,497.0

EBITDA $383.8 $353.0

Depre. & amort. 100.0 90.0

EBIT $283.8 $263.0

Int. expense 88.0 60.0EBT $195.8 $203.0

Taxes (40%) 78.3 81.2

Net income $117.5 $121.8


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Balance Sheets: Assets

2009 2008

Cash 10 15

S-T invest. 0 65

AR 375 3

Inventories 615 415

Total CA $1,000 $810Net FA 1,000 870

Total assets $2,000 $1,680


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Balance Sheets:Liabilities & Equity

2009 2008

Accts. payable 60 30

Notes payable 110 60

Acc

ruals 140 130Total CL $310 $220

Long-term bonds 754 580

Total liabilities $1,064 $800

Pref. stock (400,000 shares) 40 40Com. Stock (50,000,000 shares) 130 130

Ret. earnings 766 710

Total common equity $896 $840

Total L&E $2,000 $1,680


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Other Data

2009 2008

Stock price $23.00 $26.00

# of shares 50,000,000 50,000,000EPS $2.27 $2.36

DPS $1.15 $1.06

CFPS $4.27 $4.16BVPS $17.92 $16.80

Lease payments $28 $28

Tax rate 0.4 0.4


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Why are ratios useful?

Standardize numbers; facilitatecomparisons

Used to highlight weaknesses andstrengths


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Five Major Categories of Ratios

Liquidity: Can we make required payments asthey fall due?

Asset management: Do we have the rightamount of assets for the level of sales?

Debt management: Do we have the right mix ofdebt and equity?

Profitability: Do sales pric

es exc

eed unitc

osts,and are sales high enough as reflected in PM,ROE, and ROA?

Mar ket value: Do investors like what they seeas reflected in P/E and M/B ratios?


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Forecasted Current andQuick Ratios for 2009

CR09

= = = 3.2x

QR09 =

= = 1.2x

CA

CL

$1,000

$310

$1,000 - $615$310

CA - Inv.

CL


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Comments on CR and QR

2009 2008 Industry

CR 3.2x 3.7x 4.2x

QR 1.2x 1.8x 2.1x

Expected to worsen and still below the

industry average.

Liquidity position is weak.

Shareholders may not want a high CR


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Inventory Turnover Ratio vs.Industry Average

Inv. turnover =

= = 4.90x

Sales

Inventories$3,000$615

2009 2008 Ind.

Inv. T. 4.9 x 6.9x 9.0x


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Comments on InventoryTurnover

Inventory turnover is below industryaverage.

Firm might have old inventory, or itscontrol might be poor.

True turnover will be overstated

when sales are stated at marketprices, but inventories are recordedat historical cost


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Receivables

Average sales per dayDSO =

= =

= 45.6 days 46 days

Receivables

Sales/365

$375$3,000/365

DSO: average number of daysfrom sale until cash received


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Appraisal of DSO

Firm collects too slowly, andsituation is getting worse.

Poor credit policy.

2009 2008 Ind.

DSO 46 40 36


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Average Payables Period


365/

.

atingCostAnnualOper

PayablesostPerDayOperatingCAvg

PayablesAPP

!

!

daysdaysAPP 84.81677.7$

60$

3652.616,2$

60$}!!!


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APP: Interpretation

With an industry average of 9 days, thefirm is doing fine with sufficient cash flow

to pay bills on time. If APP is significantly longer than thecredit term provided, firm will be at risk oflosing those credit terms.

If APP is lower than the credit termsoffered, firm has not taken advantage of

the free financing from suppliers.



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Fixed assetsturnover

SalesNet fixed assets

=

= = 3.0x$3,000$1,000

Total assetsturnover

SalesTotal assets=

= = 1.5x$3,000$2,000

Fixed Assets and Total AssetsTurnover Ratios


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Fixed Assets and Total AssetsTurnover Ratios

FA turnover is equal to the industry averagesuggesting that the firm has about the rightamount of fixed assets in relation to other firms.

TA turnover not up to industry average caused byexcessive current assets (A/R and inventory).

2009 2008 Ind.

FA TO 3.0x 3.3x 3.0x

TA TO 1.5x 1.7x 1.8x


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Total liabilities

Total assets

Debt ratio =

= = 53.2%$310 + $754

$2,000

EBITInt. expenseTIE =

= = 3.2x$283.8$88

Calculate the debtand TIE ratios


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= = 3.0x

EBITDA + Lease payments

Interest Leaseexpense pmt.+ + Loan pmt.

($283.8 + $100) + $28$88 + $28 + $20

EBITDA Coverage Ratio


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Recapitalization improved situation,but lease payments drag down EC.

2009 2008 Ind.

D/A 53.2% 47.6% 40.0%

TIE 3.2x 4.4x 6.0x

EC 3.0x 0.8x 4.3x

Debt Management Ratios vs.Industry Averages


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Very bad in 2009, because of highcosts. It is resulted from inefficientoperations or heavy use of debt.

Profit Margin (PM)

2009 2008 Ind.

PM 3.8% 4.1% 5.0%

PM = = = 3.8%NI

Sales$113.5$3,000


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BEP =

= = 14.2%

EBITTotal assets

$283.8$2,000

Basic Earning Power (BEP)


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Basic Earning Power vs.Industry Average

BEP removes effect of taxes and financialleverage. Useful forcomparison.

BEP is below average probably due to the lowturnover ratios and low profit margin on sales.

Room for improvement.

2009 2008 Ind.BEP 14.2% 15.7% 17.2 %


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ROA =

= = 5.7%

NITotal assets

$113.5$2,000

Return on Assets (ROA)and Return on Equity (ROE)


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ROE =

= = 12.7%

NI

Common Equity

$113.5$896

(More)

Return on Assets (ROA)and Return on Equity (ROE)


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2009 2008 Ind.

ROA 5.7% 7.0% 9.0%

ROE 12.7% 14.0% 15.0%

Both below average but worsening.

ROA and ROE vs. IndustryAverages


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Effects of Debt on ROA and ROE

ROA is lowered by debt--interestexpense lowers net income, which

also lowers ROA.

However, the use of debt lowersequity, and if equity is lowered more

than net income, ROE wouldincrease.


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Price = $23.00

EPS = = = $2.27

P/E = = = 10.1X

NIShares out.

$113.5m50m

Price per shareEPS

$23.00$2.27

Calculate and appraise theP/E, P/CF, and M/B ratios


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NI + Depr.Shares out.CF per share =

= = $4.27$113.5 + $100.050

Price per share

Cash flow per shareP/CF =

= = 5.4x$23.00$4.27

Market Value Ratios


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Com. equity

Shares out.BVPS =

= = $17.92$896m

50m

Mkt. price per shareBook value per shareM/B =

= = 1.3x$23.00$17.92

Market Based Ratios (contd)


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Interpreting Market BasedRatios

P/E: How much investors will payfor $1 of earnings. Higher is better.

M/B: How much paid for $1 of bookvalue. Higher is better.

P/E and M/B are high if ROE is

high, risk is low.


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2009 2008 Ind.P/E 10.1x 11.0x 12.5x

P/CF 5.4x 6.3x 6.8x

M/B 1.3x 1.1x 1.7x

Comparison with IndustryAverages


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Common Size Balance Sheets:Divide all items by Total Assets

Assets 2009 2008 Ind.

Cash 0.5% 0.9% 1.0%

ST Inv. 0.0% 3.9% 2.2%AR 18.8% 18.8% 17.8%

Invent. 30.8% 24.7% 19.8%

Total CA 50.0% 48.2% 40.8%Net FA 50.0% 51.8% 59.2%

TA 100.0% 100.0% 100.0%


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Divide all items by TotalLiabilities & Equity

Assets 2009 2008 Ind.

AP 3.0% 1.8% 1.8%

Notes pay. 5.5% 3.6% 4.4%

Accruals 7.0% 7.7% 3.6%

Total CL 15.5% 13.1% 9.8%

LT Bonds 37.7% 34.5% 30.2%

Total Liabilities 53.2% 47.6% 40.0%Pref. stock 2.0% 2.4% 0.0%

Total com. eq. 44.8% 50.0% 60.0%

Total L&E 100.0% 100.0% 100.0%


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Analysis of Common SizeBalance Sheets

The company has higher proportionof inventory and current assets than

Industry. The company has less equity

(which means more debt) thanIndustry.

The company now has zero short-term debt, but more long-term debtthan industry.


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Common Size Income Statement:Divide all items by Sales

2009 2008 Ind.

Net sales 100.0% 100.0% 100.0%

Op.costs 87.2% 87.6% 87.6%

EBITDA 12.8% 12.4% 12.4%Depr. 3.3% 3.2% 2.8%

EBIT 9.5% 9.2% 9.6%

Int. Exp. 2.9% 2.1% 1.3%

EBT 6.5% 7.1% 8.3%

Taxes 2.6% 2.8% 3.3%

NI before pref. div. 3.9% 4.3% 5.0%

Pref. dividends 0.1% 0.1% 0.0%


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Analysis of Common SizeIncome Statements

The company has similar operatingcost (87.2) as industry (87.6), but

slightly higher depreciation andamortization. Result is that thecompany has similar EBIT.

However, the high interest expenselowers the EBT (6.5) compared toindustry (8.3).


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Income Statement Percentage ChangeAnalysis: % Change from Base Year

Base year (2008) % in 2009

Net sales 5.3%

Operating costs 4.8%

EBITDA 8.7%Depr. & Amortization 11.1%

EBIT 7.9%

Int. Exp. 46.7%

EBT (3.5%)

Taxes @40% (3.5%)

NI before pref. dividends (3.5%)

Preferred dividends 0.0%


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Analysis of Percent ChangeIncome Statement

We see that 2009 sales grew 5.3%from 2008, and that NI fell 3.7% from

2008. So the company has becomeless profitable.

The analysis reveals whether thefirms condition has been improving ordeteriorating over time.

Similar analysis can be performed onthe balance sheet.


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Explain the Du Pont System

The Du Pont system focuses on:

Expense control (PM)

Asset utilization (TATO)

Debt utilization (EM)

It shows how these factors combine

to determine the ROE.


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( )( )( ) = ROEProfitmarginTA

turnoverEquity

multiplier

NI

SalesSales

TATACEx x = ROE.

The Du Pont System


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2009: 3.8% x 1.5 x 2.23= 12.7%

Alternatively,ROE = ROA equity multiplier= 5.7% x ($2,000/$896) = 12.7%

NISales

SalesTA

TACEx x

= ROE

The Du Pont System


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Potential Problems andLimitations of Ratio Analysis?

Comparison with industry averages isdifficult if the firm operates many

different divisions.

Average performance is notnecessarily good.

Seasonal factors can distort ratios.


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Problems and Limitations(contd)

Window dressing techniques canmake statements and ratios look

better. Different accounting and operating

practices can distort comparisons.


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Copyright 2011 by Nelson Education Ltd All rights reserved 3 48

Problems and Limitations(contd)

Sometimes it is difficult to tell if aratio value is good or bad.

Often, different ratios give differentsignals, so it is difficult to tell, onbalance, whether a company is in a

strong or weak financial condition.

ch03 ppt brighamfm1ce

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