Fundamentals of corporate finance 5e mcgraw chapter 017

Fundamentals of
Corporate
Finance

Chapter 17

Financial Statement
Analysis

Fifth Edition

Slides by
Matthew Will

McGraw-Hill/Irwin

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved


17- 2

Topics Covered
Financial Ratios
DuPont System
Using Financial ratios
Measuring Company Performance
The Role of Financial Ratios

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17- 3

Type of Financial Ratios
 Leverage ratios show how heavily the company is
in debt.
 Liquidity ratios measure how easily the firm can
lay its hands on cash.
 Efficiency or turnover ratios measure how
productively the firm is using its assets.
 Profitability ratios are used to measure the firm’s
return on its investments.

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17- 4

Financial Statements
 Income Statement - Financial statement that shows the
revenues, expenses, and net income of a firm over a period
of time.
 Common-Size Income - Statement Income statement that
presents items as a percentage of revenues.
 Balance Sheet - Financial statement that shows the value
of the firm’s assets and liabilities at a particular time.
 Common-Size Balance Sheet - Balance sheet that presents

items as a percentage of total assets.
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17- 5

Leverage Ratios
long term debt
Long term debt ratio =
long term debt + equity

long term debt
Debt equity ratio =
equity

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17- 6

Leverage Ratios
total liabilities
Total debt ratio =
total assets
EBIT
Times interest earned =

interest payments

Cash coverage ratio =

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EBIT + depreciation
interest payments

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17- 7

Liquidity Ratios
Net working capital
Net working capital
=
to total assets ratio
Total assets

current assets
Current ratio =
current liabilities

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17- 8

Liquidity Ratios
cash + marketable securities + receivables
Quick ratio =
current liabilities

cash + marketable securities
Cash ratio =
current liabilities

Interval measure =

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cash + marketable securities + receivables
average daily expenditures from operations

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17- 9

Efficiency Ratios
Sales
Asset turnover ratio =
Average total assets

sales
NWCturnover =

average net working capital

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17- 10

Efficiency Ratios
Average collection period =

average receivables
average daily sales

cost of goods sold
Inventory turnover ratio =
average inventory

average inventory
Days' sales in inventory =
cost of goods sold / 365

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17- 11

Profitability Ratios
net income
Net profit margin =
sales
net income + interest
Operating profit margin =
sales
Net Income + Interest
Return on assets =
average total assets

net income
Return on equity =
average equity
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17- 12

Profitability Ratios
dividends
Payout ratio =
earnings

earnings - dividends
Plowback ratio =
earnings
= 1 - payout ratio

earnings - dividends
Growth in equity from plowback =
earnings

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17- 13

Market Value Ratios
stock price
PE Ratio =
earnings per share

P0
Div1
1
Forecasted PE ratio =
=
x
avg EPS1 EPS1 r - g

dividend per share
Dividend yield =
stock price

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17- 14

Market Value Ratios
Price per share = P0

Div 1
=
r - g

stock price
Market to book ratio =
book value per share

market value of assets
Tobins Q =
estimated replcement cost

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17- 15

The DuPont System
A breakdown of ROE and ROA into
component ratios

Net Income + interest
ROA =
assets
earnings available for common stock
ROE =
equity
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17- 16

The DuPont System
sales Net Income + interest
ROA =
x
assets
sales

asset
turnover

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Operating profit
margin

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17- 17

The DuPont System
ROE =

assets sales Net Income + interest
Net Income
x
x
x
equity assets
sales
Net Income + interest

leverage asset
ratio turnover

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Operating
profit
margin

debt
burden

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17- 18

Using Financial Ratios

Source: U.S. Department of Commerce, Quarterly Financial Report for Manufacturing, Mining and Trade Corporations, December 2004.

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17- 19

MVA & Economic Profit
Market Value Added = The difference
between the market value of common stock
and its book value
Economic Profit = capital invested
multiplied by the spread between return on
investment and the cost of capital.

EP = Economic Profit
= ( ROI − r ) × Capital Invested
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17- 20

Residual Income & EVA
Residual Income or EVA = Net Dollar return
after deducting the cost of capital

EVA = Residual Income
= Income Earned - income required
= Income Earned - [ Cost of Capital × Investment]

© EVA is copyrighted by Stern-Stewart Consulting Firm and used with permission.
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17- 21

Measuring Performance

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17- 22

Measuring Performance

Note: Economic value added is the rate of return on capital less the cost of capital times the amount of capital invested; e.g., for Microsoft, EVA = (.329 –
.177) × $204,168 million
Source: Data provided by Stern Stewart & Co.

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17- 23

Financial Ratios and Default Risk

Note: EBITDA is earnings before interest, taxes, depreciation, and amortization.
Sources: Default rates from “Statement of Standard & Poor’s on Credit Rating Agencies to SEC,” Public Hearing, November
2002; all other data from Standard & Poor’s.

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