sld03 fin analysis
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Fundamental of Financial Management--Canadian VersionTRANSCRIPT
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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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Saxton Company Industry Average
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
Saxton Company Industry Average
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
Saxton Company Industry Average
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
Saxton Company Industry Average
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