Chapter 17
Financial Statement Analysis
Topics Covered
Financial Ratios DuPont System Using Financial ratios Measuring Company Performance The Role of Financial Ratios
Ratio Analysis
Examines firm’s management of various facets of the company’s business through its financial statements.
Scales balance sheet and income statement information for easy comparison across time or to other companies.
Two common approaches
Trend Analysis - looks at changes in one company’s ratios over time.
Comparison or Industry Analysis - compares company’s ratios against a similar company or against industry-wide ratios.
We will look at both with Coca-Cola and Pepsi.
Areas Examined by Ratio Analysis
Leverage - measures the use of financial leverage (debt) and its impact
Liquidity - measures the ability to meet short-term obligations
Efficiency - measures the ability to contain the growth of assets, and the ability to effectly utilize assets
Profitability - measures the profitability of various segments of a company
Leverage Ratios
equity+debt termlong
debt termlong=ratiodebt termLong
equity
debt termlong=ratioequity Debt term-Long
Leverage Ratios
Total debt ratio =total liabilities
total assets
Times interest earned =EBIT
interest payments
Cash coverage ratio =EBIT + depreciation
interest payments
Leverage Ratios calculation notes for Target & Wal-Mart Given our Financial Statement (B/S and I/S)
formatting from OneSource/Multitex: Long-term debt = Total long-term debt from the
B/S, which includes long-term borrowing and capital lease obligations.
Equity = Total Equity from B/S EBIT = Operating income + Interest Expense
from I/S Depreciation expense was listed on Target’s I/S,
but had to find Wal-Mart’s depreciation by the annual change in accumulated depreciation from B/S.
Target & Walmart’s Leverage Ratios
Target 2002 2001 2000 1999
Long-term debt ratio 0.519 0.507 0.464 0.435
Debt-equity ratio 1.079 1.029 0.864 0.771
Total debt ratio 0.670 0.675 0.666 0.658
Times interest Earned 5.551 5.666 5.819 5.926
Cash coverage ratio 7.612 7.947 8.026 8.099
Walmart 2002 2001 2000 1999
Long-term debt ratio 0.333 0.348 0.333 0.392
Debt-equity ratio 0.498 0.534 0.499 0.645
Total debt ratio 0.585 0.580 0.599 0.633
Times interest Earned 14.750 10.065 9.465 9.887
Cash coverage ratio 17.214 11.219 11.239 10.756
Best Leverage Management?
Liquidity Ratios
Net working capital
to total assets ratio=
Net working capital
Total assets
Current ratio =current assets
current liabilities
Liquidity Ratios
Cash ratio =cash + marketable securities
current liabilities
Quick ratio =cash + marketable securities + receivables
current liabilities
Liquidity Ratios calculation notes for Target & Wal-Mart
Given our Financial Statement (B/S and I/S) formatting from OneSource/Multitex: Net working capital = total current
assets – total current liabilities Cash and marketable securities are in
one account (cash and short-term investments)
Target & Walmart’s Liquidity Ratios
Target 2002 2001 2000 1999
NWC to assets 0.154 0.107 0.051 0.037
Current ratio 1.586 1.368 1.159 1.108
Quick ratio 0.840 0.614 0.365 0.352
Cash ratio 0.101 0.071 0.056 0.038
Walmart 2002 2001 2000 1999
NWC to assets -0.023 0.007 -0.031 -0.021
Current ratio 0.935 1.022 0.917 0.944
Quick ratio 0.149 0.153 0.132 0.124
Cash ratio 0.085 0.079 0.071 0.072
Best Liquidity Management?
Efficiency Ratios
Asset turnover ratio =Sales
Average total assets
NW Cturnover =sales
average net working capital
Efficiency Ratios
Days' sales in inventory =average inventory
cost of goods sold / 365
Inventory turnover ratio =cost of goods sold
average inventory
Average collection period =average receivables
average daily sales
Efficiency Ratios calculation notes for Target & Wal-Mart Given our Financial Statement (B/S
and I/S) formatting from OneSource/Multitex: Sales = Total Revenue from I/S Cost of Goods Sold = Cost of Revenue,
Total from I/S Average “whatever asset” = (beginning+
ending amounts from B/S)/2 Average Daily Sales or Cost of Goods
Sold = Amount form I/S divided by 365
Target & Walmart’s Efficiency Ratios
Target 2002 2001 2000 1999
Total asset turnover 1.665 1.825 2.012 2.054
Average collection period 39.046 26.450 18.710 18.915
Inventory turnover 6.521 6.348 6.340 6.404
Days' sales in inventories 55.975 57.495 57.575 56.996
Walmart 2002 2001 2000 1999
Total asset turnover 2.767 2.718 2.601 2.772
Average collection period 3.041 3.130 2.938 2.690
Inventory turnover 8.077 7.788 7.288 7.034
Days' sales in inventories 45.193 46.865 50.084 51.893
Best Efficiency Management?
Profitability Ratios
assets totalaverage
Interest IncomeNet =assetson Return
sales
incomenet =marginprofit Net
equity average
incomenet =equityon Return
sales
interest incomenet =marginprofit Operating
Profitability Ratios
Plowback ratio =earnings - dividends
earnings
= 1 - payout ratio
Payout ratio =dividends
earnings
xROEearnings
dividends-earnings=plowback fromequity in Growth
Profitability Ratios calculation notes for Target & Wal-Mart
Given our Financial Statement (B/S and I/S) formatting from OneSource/Multitex: Dividend information listed below the I/S:
Gross dividends = total annual dividends. Also can find EPS and Dividends per share here.
Earnings = Net Income from I/S
Target & Walmart’s Profitability RatiosTarget 2002 2001 2000 1999
Net profit margin 3.8% 3.4% 3.4% 3.4%
Operating profit margin 5.1% 4.6% 4.6% 4.6%
Return on assets 8.5% 8.4% 9.2% 9.4%
Return on equity 19.1% 19.0% 20.4% 20.4%
Payout ratio 13.2% 14.8% 15.3% 16.7%
Plowback ratio 86.8% 85.2% 84.7% 83.3%
Growth in equity from plowback 16.6% 16.2% 17.3% 17.0%
Walmart 2002 2001 2000 1999
Net profit margin 3.3% 3.0% 3.3% 3.2%
Operating profit margin 3.6% 3.6% 3.9% 3.8%
Return on assets 10.1% 9.7% 10.1% 10.6%
Return on equity 21.6% 20.1% 22.0% 22.9%
Payout ratio 16.5% 18.7% 17.0% 16.6%
Plowback ratio 83.5% 81.3% 83.0% 83.4%
Growth in equity from plowback 18.0% 16.3% 18.3% 19.1%
Best Profitability Management?
The DuPont System
A breakdown of ROE and ROA into component ratios
equity
stock commonfor available earnings=ROE
assets
interest IncomeNet =ROA
The DuPont System
sales
interestIncomeNet x
assets
sales=ROA
assetturnover
Operating profitmargin
The DuPont System
interestIncomeNet
IncomeNet x
sales
interestIncomeNet x
assets
salesx
equity
assets=ROE
leverageratio
assetturnover
Operating profitmargin
debtburden
The DuPont System: Simplification of ROE
The last two terms of the 4-part DuPont equation for ROE, operating profit margin and debt burden, can be simplified to one term, net profit margin.
Net profit margin = Net Income/Sales Also assets/equity can be written in terms of the total
debt ratio.
equity
sliabilitie total1
assets totalsliabilitie total
1
1
ratiodebt total1
1
equity
assets
sales
IncomeNet x
assets
salesx
equity
assets=ROE
Target vs. Walmart Du Pont SystemTarget 2002 2001 2000 1999
Asset turnover 1.665 1.825 2.012 2.054
Operating profit margin 5.1% 4.6% 4.6% 4.6%
ROA 8.5% 8.4% 9.2% 9.4%
Leverage ratio 3.049 3.035 2.959 2.930
Asset turnover 1.665 1.825 2.012 2.054
Operating profit margin 5.1% 4.6% 4.6% 4.6%
Debt burden 0.738 0.743 0.748 0.744
ROE 19.1% 19.0% 20.4% 20.4%
Walmart 2002 2001 2000 1999
Asset turnover 2.767 2.718 2.601 2.772
Operating profit margin 3.6% 3.6% 3.9% 3.8%
ROA 10.1% 9.7% 10.1% 10.6%
Leverage ratio 2.394 2.433 2.597 2.563
Asset turnover 2.767 2.718 2.601 2.772
Operating profit margin 3.6% 3.6% 3.9% 3.8%
Debt burden 0.897 0.849 0.840 0.840
ROE 21.6% 20.1% 22.0% 22.9%
Final Du Pont System comments
When a firm uses no debt financing, the leverage term = 1 and ROE = ROA.
Using more financial leverage will increase ROE when the return on new assets (investment) exceeds the interest rate on the new debt.
MVA & Economic Profit
A gauge of how much value management added for the year. Depends upon managerial decisions and stock market forces.
Market Value Added = The difference between the market value of common stock and its book value
MVA for Target and Wal-MartTarget 2002 2001 2000 Wal-
Mart2002 2001 1999
Stock Price
28.05 42.83 36.31 Stock Price
47.56 59.37 55.90
# of Shares
909.8 905.2 897.8 # of Shares
4395 4453 4470
MV of Equity
25520 38770 32599 MV of Equity
209,026 264,375 249,873
Total BV Eq
9443 7860 6519 Total BV Eq
39337 35102 31343
MVA 16,077 30,910 26,080 MVA 169,689 229,273 218,530
MV/BV 2.70 3.93 5.00 MV/BV 5.31 7.53 7.97
Residual Income & EVA
Economic Profit = capital invested multiplied by the spread between return on investment and the cost of capital.
Residual Income or EVA = Net Dollar return after deducting the cost of capital Investment Capital of Cost - Earned Income
required income - Earned Income
Income Residual
EVA
© EVA is copyrighted by Stern-Stewart Consulting Firm and used with permission.
Invested Capital ) (
Profit Economic
r ROI
EP
EVA for Target and Wal-Mart From Stern-Stewart (
www.sternstewart.com) EVA/MVA ranking in millions of dollars.
Target 2002 EVA: 341 2002 MVA rank: 44 1999 EVA: 710 1999 MVA rank: 92
Wal-Mart 2002 EVA: 2,928 2002 MVA rank: 3 1999 EVA: 2,233 1999 MVA rank: 6