Download CHAPTER 3 Financial Statement Analysis

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CHAPTER 3
Analysis of Financial Statements
Ratio analysis
Du Pont system
Effects of improving ratios
Limitations of ratio analysis
Qualitative factors
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Balance Sheet: Assets
Cash
AR
Inventories
Total CA
Gross FA
Less: Deprec.
Net FA
Total assets
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2001E
85,632
878,000
1,716,480
2,680,112
1,197,160
380,120
817,040
3,497,152
2000
7,282
632,160
1,287,360
1,926,802
1,202,950
263,160
939,790
2,866,592
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Liabilities and Equity
2001E
2000
Accounts payable
436,800
524,160
Notes payable
600,000
720,000
Accruals
408,000
489,600
Total CL
1,444,800 1,733,760
Long-term debt
500,000 1,000,000
Common stock
1,680,936
460,000
Retained earnings
(128,584) (327,168)
Total equity
1,552,352
132,832
Total L & E
3,497,152 2,866,592
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Income Statement
Sales
COGS
Other expenses
EBITDA
Depreciation
EBIT
Interest exp.
EBT
Taxes (40%)
Net income
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2001E
2000
7,035,600 5,834,400
5,728,000 5,728,000
680,000
680,000
627,600 (573,600)
116,960
116,960
510,640 (690,560)
88,000
176,000
422,640 (866,560)
169,056 (346,624)
253,584 (519,936)
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Other Data
2001E
2000
250,000
100,000
EPS
$1.014
($5.199)
DPS
$0.220
$0.110
Shares out.
Stock price
$12.17
$2.25
Lease pmts
$40,000
$40,000
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Why are ratios useful?
Standardize numbers; facilitate
comparisons
Used to highlight weaknesses and
strengths
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What are the five major categories of
ratios, and what questions do they
answer?
Liquidity: Can we make required
payments?
Asset management: Right amount
of assets vs. sales?
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Debt management: Right mix of
debt and equity?
Profitability: Do sales prices exceed
unit costs, and are sales high
enough as reflected in PM, ROE, and
ROA?
Market value: Do investors like what
they see as reflected in P/E and M/B
ratios?
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3-9
Calculate D’Leon’s forecasted current
and quick ratios for 2001.
$2,680
CA
CR01 = CL = $1,445 = 1.85x.
CA - Inv.
QR01 =
CL
$2,680 – $1,716
=
=
0.67x.
$1,445
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Comments on CR and QR
2001
2000
1999
Ind.
CR
1.85x
1.1x
2.3x
2.7x
QR
0.67x
0.4x
0.8x
1.0x
 Expected to improve but still below
the industry average.
 Liquidity position is weak.
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What is the inventory turnover ratio vs.
the industry average?
Sales
Inv. turnover = Inventories
$7,036
=
= 4.10x.
$1,716
2001
2000
1999
Ind.
Inv. T. 4.1x
4.5x
4.8x
6.1x
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Comments on Inventory Turnover
Inventory turnover is below
industry average.
D’Leon might have old inventory,
or its control might be poor.
No improvement is currently
forecasted.
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DSO is the average number of days
after making a sale before receiving
cash.
Receivables
DSO = Average sales per day
Receivables
$878
= Sales/360 = $7,036/360 = 44.9.
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Appraisal of DSO
DSO
2001
44.9
2000
39.0
1999
36.8
Ind.
32.0
 D’Leon collects too slowly, and is getting
worse.
 D’Leon has a poor credit policy.
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F.A. and T.A. turnover vs.
industry average
Fixed assets
Sales
=
turnover
Net fixed assets
$7,036
=
= 8.61x.
$817
Total assets
=
turnover
Sales
Total assets
$7,036
=
= 2.01x.
$3,497
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2001
FA TO 8.6x
TA TO 2.0x
2000
6.2x
2.0x
1999
10.0x
2.3x
Ind.
7.0x
2.6x
FA turnover projected to exceed
industry average. Good.
TA turnover not up to industry
average. Caused by excessive
current assets (A/R and Inv.)
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3 - 17
Calculate the debt ratio, TIE, and
EBITDA coverage ratios.
Total debt
Debt ratio = Total assets
= $1,445 + $500 = 55.6%.
$3,497
EBIT
TIE =
Int. expense
= $510.6 = 5.8x.
$88
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EBITDA coverage =
EBITDA + Lease payments (in cash)
Interest Lease
Loan
expense + pmt. + repayments
$510.6
+
$117.0
+
$40
=
$88 + $40 + $0
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= 5.2x.
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How do the debt management ratios
compare with industry averages?
D/A
TIE
EBITDA
coverage
2001 2000 1999
Ind.
55.6% 95.4% 54.8% 50.0%
5.8x -3.9x 3.3x 6.2x
5.2x
-3.3x
3.6x
8.0x
Too much debt, but projected to
improve.
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3 - 20
Profit margin vs. industry average?
NI
$253.6
P.M. = Sales = $7,036 = 3.6%.
P.M.
2001
3.6%
2000
-8.9%
1999 Ind.
2.6% 3.5%
Very bad in 2000, but projected to
exceed industry average in 2001.
Looking good.
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BEP vs. Industry Average?
EBIT
BEP =
Total assets
$510.6
= $3,497 = 14.6%.
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BEP
2001
14.6%
2000
1999
-24.1% 14.2%
Ind.
19.1%
BEP removes effect of taxes and
financial leverage. Useful for
comparison.
Projected to be below average.
Room for improvement.
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Return on Assets
Net
income
ROA =
Total assets
$253.6
= $3,497 = 7.3%.
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Net income
ROE = Common equity
= $253.6 = 16.3%.
$1,552
ROA
ROE
2001
2000 1999
Ind.
7.3% -18.1% 6.0% 9.1%
16.3% -391.4% 13.3% 18.2%
Both below average but improving.
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Effects of Debt on ROA and ROE
ROA is lowered by debt--interest
lowers NI, which also lowers ROA =
NI/Assets.
But use of debt lowers equity,
hence could raise ROE = NI/Equity.
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Calculate and appraise the P/E,
P/CF, and M/B ratios.
Price = $12.17.
NI
$253.6
EPS = Shares out. = 250 = $1.01.
Price per share $12.17
P/E =
= $1.01 = 12x.
EPS
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Typical industry average P/E ratios
Industry
P/E ratio
Banking
17.15
Computer Software Services
33.01
Drug
41.81
Electric Utilities (Eastern U.S.) 19.40
Internet Services*
290.35
Semiconductors
78.41
Steel
12.71
Tobacco
11.59
Water Utilities
21.84
* Because many internet companies have negative earnings and no
P/E, there was only a small sample of internet companies.
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3 - 28
NI
+
Depr.
CF per share =
Shares out.
= $253.6 + $117.0 = $1.48.
250
Price per share
P/CF =
Cash flow per share
$12.17
= $1.48 = 8.21x.
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Com. equity
BVPS =
Shares out.
$1,552
=
= $6.21.
250
Mkt. price per share
M/B =
Book value per share
$12.17
= $6.21 = 1.96x.
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3 - 30
2001
2000
1999
Ind.
P/E
12.0x
-0.4x
9.7x
14.2x
P/CF 8.21x
-0.6x
8.0x
11.0x
M/B
1.96x
1.7x
1.3x
2.4x
 P/E: How much investors will pay for
$1 of earnings. High is good.
 P/CF: How much investors will pay for
$1 of cash flow. High is good.
 M/B: How much paid for $1 of BV.
Higher is better.
 P/E and M/B are high if ROE is high,
risk is low.
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3 - 31
(
Profit
margin
)(
TA
turnover
)(
Equity
multiplier
) = ROE
NI
Sales
TA
Sales x TA x CE = ROE.
1999 2.6% x 2.3
2000 -8.9% x 2.0
2001 3.6% x 2.0
Ind.
3.5% x 2.6
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x
x
x
x
2.2
21.6
2.3
2.0
= 13.3%
= -391.4%
= 16.3%
= 18.2%
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Dupont Analysis
Return on Equity
Net Income/Total Equity
Return on Assets
Net Income/Total Assets
Profit Margin
Net Income/Sales
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Equity Multiplier
Total Assets/Total Equity
(or 1/(1-D/A))
Total Asset Turnover
Sales/Total Assets
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D’Leon Dupont Analysis
Return on Equity
16.3 percent
Return on Assets
7.3 percent
Profit Margin
3.6 percent
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Equity Multiplier
2.25 times
Total Asset Turnover
2.01 times
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The Du Pont system focuses on:
Expense control (P.M.)
Asset utilization (TATO)
Debt utilization (Eq. Mult.)
It shows how these factors combine
to determine the ROE.
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3 - 35
What are some potential problems and
limitations of financial ratio analysis?
Comparison with industry averages
is difficult if the firm operates many
different divisions.
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“Average” performance not
necessarily good.
Seasonal factors can distort ratios.
“Window dressing” techniques can
make statements and ratios look
better.
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Different operating and accounting
practices distort comparisons.
Sometimes hard to tell if a ratio is
“good” or “bad.”
Difficult to tell whether company is,
on balance, in strong or weak
position.
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3 - 38
What are some qualitative factors
analysts should consider when
evaluating a company’s likely future
financial performance?
Are the company’s revenues tied to 1
key customer?
To what extent are the company’s
revenues tied to 1 key product?
To what extent does the company
rely on a single supplier?
(More…)
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What percentage of the company’s
business is generated overseas?
Competition
Future prospects
Legal and regulatory environment
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