sld03 fin analysis

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Financial Analysis

McGraw-Hill Ryerson McGraw-Hill Ryerson Limited 2000

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McGraw-Hill Ryerson Limited 2000

Foundations of FinancialManagement CANADIAN

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PPT 3-1

The classification system for ratiosWe will separate 13 significant ratios into four primary categories.A. Profitability Ratios.

1. Profit margin.

2. Return on assets (investment).

3. Return on equity (common shareholders).

B. Asset utilization ratios.

4. Receivable turnover.

5. Average collection period.

6. Inventory turnover.

7. Capital asset turnover.

8. Total asset turnover.

C. Liquidity ratios.

9. Current ratio.

10. Quick ratio.

D. Debt utilization ratios.

11. Debt to total assets.

12. Times interest earned.

13. Fixed charge coverage.

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SAXTON COMPANY

Income StatementFor the Year 1999

Sales (all on credit) . . . . . . . . . . . . . . . . . . $ 4,000,000Cost of goods sold . . . . . . . . . . . . . . . . . . . 3,000,000Gross profit . . . . . . . . . . . . . . . . . . . . . 1,000,000Selling and administrative expense* . . . . . . . . . . . 450,000Operating profit . . . . . . . . . . . . . . . . . . . 550,000Interest expense . . . . . . . . . . . . . . . . . . . 50,000Extraordinary loss . . . . . . . . . . . . . . . . . . 100,000Net income before taxes . . . . . . . . . . . . . . . . 400,000Taxes (50%) . . . . . . . . . . . . . . . . . . . . . 200,000Net income . . . . . . . . . . . . . . . . . . . . . . $ 200,000

* Includes $50,000 in lease payments.

PPT 3-2

Table 3-1aFinancial statements for ratio analysis

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Balance SheetAs of December 31, 1999

AssetsCash $ 30,000Marketable securities 50,000Accounts receivable 350,000Inventory 370,000 Total current assets 800,000Net plant and equipment 800,000Total assets $1,600,000

Liabilities and Shareholders' EquityAccounts payable $ 50,000Notes payable 250,000

Total current liabilities 300,000Long-term liabilities 300,000

Total liabilities 600,000Common stock 400,000Retained earnings 600,000Total liabilities and shareholders' equity $1,600,000

PPT 3-2

Table 3-1bFinancial statements for ratio analysis

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Saxton Company Industry Average

3-1. Profit margin = = 5% 6.5%

3-2. Return on assets (investment) =

a. = 12.5% 10%

b. 5% 2.5 = 12.5% 6.5% 1.5 = 10%

3-3. Return on equity =

a. = 20% 15%

b. = 20% = 15%

Net incomesales

$200,000$4,000,000

Net incomeTotal assets

Net incomeSales

SalesTotal assets

$200,000$1,600,000

Net incomeShareholders equity

$200,000$1,000,000

Return on assets (investment)(1 Debt/Assets)

0.1251 0.375

0.101 0.33

PPT 3-3

Profitability ratios

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Figure 3-1Du Pont analysis

Net Income

Sales

Total Assets

Profit Margin

Asset Turnover

Total Debt

Total Assets

Return onAssets

FinancingPlan

Return onEquityReturn on Assets

(1 - Debt/Assets)=

PPT 3-4

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Profit Asset Return on ReturnCompany Margin Turnover Assets (1 Debt/Assets) on Equity

Womens

Wear 6.47% x 5.43 = 35.13%

Tip Top 3.10 x 2.54 = 7.87

Biway 2.81 x 4.40 = 12.36

Thriftys 14.80 x 4.42 = 65.42

Overall (before

corporate

charges) 5.10 x 4.17 = 21.27

Overall (with

corporate

charges) 1.85 x 3.38 = 6.25 (1-.419) = 10.76%

PPT 3-5

Applying Du Pont analysis at Dylex, January 1, 1999

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3-4. Receivables turnover =

= 11.4 10 times

3-5. Average collection period =

= 32 36 days

3-6. Inventory turnover =

Cost of Goods Sold = 8.1 7 times

Inventory

Sales (credit)Receivables

$4,000,000$350,000

Accounts receivableAverage daily credit sales

$350,000$10,959

$3,000,000$370,000

PPT 3-6

Asset utilization ratios

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Asset utilization ratios


3-7. Capital asset turnover =

= 5 5.4 times

3-8. Total asset turnover =

= 2.5 1.5 times

SalesCapital assets

$4,000,000$800,000

SalesTotal assets

$4,000,000$1,600,000

PPT 3-6

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Liquidity ratios


3-9. Current ratio =

= 2.67 2.1

3-10. Quick ratio =

= 1.43 1.0

Current assetsCurrent liabilities

$800,000$300,000

Current assets InventoryCurrent liabilities

$430,000$300,000

PPT 3-7

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Debt utilization ratios


3-11. Debt to total assets =

= 37.5% 33%

3-12. Times interest earned =

= 11 7 times

3-13. Fixed charge coverage =

= 6 5.5 times

Total debtTotal assets

$600,000$1,600,000

Income before interest and taxes

Interest$550,000$50,000

Income before fixed charges and taxes

Fixed charges$600,000$100,000

PPT 3-8

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Saxton IndustryCompany Average Conclusion

A. Profitability1. Profit margin 5% 6.5% Below average2. Return on assets... 12.5% 10% Above average due

to high turnover3. Return on equity. 20% 15% Good due to ratios 2 and 11

B. Asset Utilization4. Receivables turnover ... 11.4 10.0 Good5. Average collection period. 32.0 36.0 Good6. Inventory turnover ... 8.1 7.0 Good7. Capital asset turnover . 5.0 5.4 Below average8. Total asset turnover . 2.5 1.5 Good

C. Liquidity9. Current ratio 2.67 2.1 Good

10. Quick ratio .. 1.43 1.0 GoodD. Debt Utilization

11. Debt to total assets .. 37.5% 33% Slightly more debt12. Times interest earned . 11 7Good13. Fixed charge coverage . 6 5.5 Good

PPT 3-9

Table 3-2Ratio analysis

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Figure 3-2aTrend analysis

A. Profit Margin Percent

7

5

3

1

1986 1988 1990 1992 1994 1996 1999

Industry

Saxton

PPT 3-10

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B. Total asset turnover

3.5X

3.0X

2.5X

2.0X

1.5X

1.0X

.5X

1986 1988 1990 1992 1994 1996 1999

Industry

Saxton

PPT 3-10

Figure 3-2Trend Analysis

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Table 3-3Trend analysis for banking industry

19811983198519871989199019911992199319941995199619971998

4.2%4.04.35.80.5

4.9 6.0 7.2 7.4 8.3 8.2

9.0 9.0 7.8

ProfitMargin

19.9%11.89.8

*1.4

14.5 14.9 14.1 14.0 14.4 15.4 17.0 17.1 15.2

Return onEquity

Toronto-Dominion BankRoyal Bank Bank of Montreal

4.2%3.54.96.0

4.5 6.6 7.0 0.9 2.6 8.7 8.2 8.7 9.5 9.2

ProfitMargin

17.0%9.5

10.9 *

9.1 17.5 15.4 0.3 2.4 16.8 16.6 17.6 19.3 18.4

Return onEquity

4.5%5.27.42.5

10.2 7.7 6.3 6.2 3.9 9.2 9.1 9.710.1 8.2

20.5%14.415.618.318.2

13.6 10.7 8.4 5.4 13.3 15.9 14.4 15.6 14.0

ProfitMargin

Return onEquity

PPT 3-11

*Large loan loss provisions on Third World loans.Source: Annual reports

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10 Chemical 8 Drug Companies Companies

Replacement Historical Replacement HistoricalCost Cost Cost Cost

Increase in assets. . . . . . . . 28.4% 15.4%

Decrease in net incomebefore taxes . . . . . . . . . 45.8% 19.3%

Return on assets . . . . . . . . 2.8% 6.2% 8.3% 11.4%

Return on equity. . . . . . . . 4.9% 13.5% 12.8% 19.6%

Debt-to-assets ratio. . . . . . 34.3% 43.8% 30.3% 35.2%

Interest coverage ratio(times interest earned) 7.1 8.4 15.4 16.7

PPT 3-12

Table 3-7Comparison of replacement cost accounting and historical costaccounting

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Income Statement For the Year 1999 High Reported

Conservative Income A B

Sales . . . . . . . . . . . . $4,000,000 $4,200,000

Cost of goods sold . . . . . . . . 3,000,000 2,400,000Gross profit . . . . . . . . . . 1,000,000 1,800,000

Selling and administrative expense . . . 450,000 450,000

Operating profit . . . . . . . . 550,000 1,350,000

Interest expense . . . . . . . . 50,000 50,000

Net income before taxes . . . . . . 500,000 1,300,000

Taxes (40%) . . . . . . . . . 200,000 520,000

Net income . . . . . . . . . . 300,000 780,000

Extraordinary loss (net of tax) . . . . 60,000 Net income transferred to retained earnings . $ 240,000 $ 780,000

PPT 3-13

Table 3-8Illustration of conservative versus high reported income firms

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Chapter 3 - Outline LT 3-1

Financial Analysis

4 Categories of Financial Ratios

Importance of Ratios

Inflation and its Impact on Profits

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Financial Analysis and Ratios LT 3-2

What is financial analysis?

Evaluating a firms financial performance

Analyzing ratios or numerical calculations

Comparing a company to its industry and to its pastperformance

A long-run trend analysis over a 5-10 year period isusually performed by an analyst.

Ratio analysis may not answer questions, but leads tofurther inquiry

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4 Categories of Ratios LT 3-3

Profitability Ratios

Asset Utilization Ratios

Liquidity Ratios

Debt Utilization Ratios

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Profitability Ratios LT 3-4

Show how profitable a company is.

The ratios express:

Profit Margin or Return on Sales (%)

Return on Assets or Return on Investment (%)

Return on Equity (%)

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Asset Utilization Ratios LT 3-5

Show how effectively a company uses its assets.

The ratios express:

Receivables Turnover (times)

Average Collection Period (days)

Inventory Turnover (times)

Capital Asset Turnover (times)

Total Asset Turnover (times)

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Liquidity Ratios LT 3-6

Show how liquid a company is or how much $ it hasto meet S/T needs.

The ratios express:

Current Ratio (times)

Quick Ratio or Acid-Test Ratio (times)

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Debt Utilization Ratios LT 3-7

Show how well a company is managing or usingdebt.

The ratios express:

Debt-to-Total Assets (%)

Times Interest Earned (times)

Fixed Charge Coverage (times)

(Fixed Charges = lease payments, interestexpense)

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Importance of Ratios LT 3-8

Which ratios are most important?

It depends on your perspective.

Suppliers and banks (lenders) are most interested inliquidity ratios.

Shareholders are most interested in profitability ratios

Bondholders concentrate on debt utilization ratios

The effective utilization of assets is managementsresponsibility

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Inflations Impact on Profits LT 3-9

FIFO (First-In, First-Out) Inventory:

Lowers COGS

Raises Profits

LIFO (Last-In, First-Out) Inventory:

Raises COGS

Lowers Profits

sld03 fin analysis

Documents

total current assets

total liabilities

total asset turnover

total current liabilities

net incomeshareholders

assets investment1 debtassets0

asset utilization ratios

net plant