Lecture Managerial finance - Chapter 4: Analysis of financial statements

CHAPTER 4
Analysis of Financial Statements

 

1


Topics in Chapter






Ratio analysis
Du Pont system
Effects of improving ratios
Limitations of ratio analysis
Qualitative factors

 

2


Income Statement
2007

2008E

Sales

5,834,400 

7,035,600

COGS

4,980,000 

5,800,000

Other expenses

720,000 

612,960

Deprec.

116,960 

120,000

5,816,960 

6,532,960

17,440 

502,640

176,000 

80,000

(158,560)

422,640

Taxes (40%)

(63,424)

169,056

Net income

(95,136)

253,584

   Tot. op. costs
   EBIT
Int. expense
   EBT

 

3

Balance Sheets: Assets
2007
7,282 
20,000 
632,160 
1,287,360 
1,946,802 
939,790 
2,886,592 

Cash
S­T invest.
AR
Inventories
   Total CA
   Net FA
Total assets
 

2008E
14,000
71,632
878,000
1,716,480
2,680,112
836,840
3,516,952
4

Balance Sheets: Liabilities & 
Equity
2007

2008E

Accts. payable

324,000 

359,800

Notes payable

720,000 

300,000

Accruals

284,960 

380,000

   Total CL

1,328,960 

1,039,800

Long­term debt

1,000,000 

500,000

Common stock

460,000 

1,680,936

Ret. earnings

97,632 

296,216

   Total equity

557,632 

1,977,152

2,886,592 

5 3,516,952

Total L&E

 


Other Data
Stock price
# of shares
EPS
DPS
Book val. per 
share
Lease payments
Tax rate
 

2007
$6.00
100,000 
­$0.95
$0.11

2008E
$12.17
250,000
$1.01
$0.22

$5.58

$7.91

$40,000
0.4

$40,000
0.4
6


Why are ratios useful?




Standardize numbers; facilitate 
comparisons
Used to highlight weaknesses and 
strengths

 

7


Five Major Categories of 
Ratios




Liquidity:  Can we make required 
payments as they fall due?
Asset management:  Do we have the 
right amount of assets for the level of 
sales?

(More…)

 

8


Ratio Categories (Continued)






Debt management:  Do we have the 
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?
 

9


Forecasted Current and Quick 
Ratios for 2008.
CA
CR08 = CL

$2,680
= $1,040 = 2.58x.

CA - Inv.
QR08 =
CL
$2,680 - $1,716
=
=
0.93x.
$1,040
 

10


Comments on CR and QR
2008E

2007

2006

Ind.

CR

2.58x

1.46x

2.3x

2.7x

QR

0.93x

0.5x

0.8x

1.0x





Expected to improve but still below the 
industry average.

Liquidity position is weak.
 

11


Inventory Turnover Ratio vs. 
Industry Average
Sales
Inv. turnover = Inventories
$7,036
=
= 4.10x.
$1,716
2008E
Inv. T. 4.1x
 

2007

2006

Ind.

4.5x

4.8x

6.1x
12

Comments on Inventory 
Turnover






Inventory turnover is below industry 
average.
Firm might have old inventory, or its 
control might be poor.
No improvement is currently forecasted.

 

13


DSO: average number of 
days from sale until cash 
received.

DSO =

Receivables
Average sales per day

= Receivables
Sales/365
= 45.5 days.
 

$878
= $7,036/365
14


Appraisal of DSO




Firm collects too slowly, and situation is 
getting worse.
Poor credit policy.

DSO

2008
45.5

2007
39.5
 

2006
37.4

Ind.
32.0
15


Fixed Assets and Total 
Assets
Turnover Ratios
Fixed assets
Sales
=
turnover
Net fixed assets
$7,036
=
= 8.41x.
$837
Total assets
=
turnover
 

Sales
Total assets
$7,036
=
= 2.00x.
$3,517
(More…)

16


Fixed Assets and Total 
Assets
Turnover Ratios




FA turnover is expected to exceed industry average.  
Good.
TA turnover not up to industry average.  Caused by 
excessive current assets (A/R and inventory).

2008E

2007

2006

Ind.

FA TO

8.4x

6.2x

10.0x

7.0x

TA TO

2.0x

2.0x

2.3x

2.5x

 

17


Calculate the debt, TIE, and 
EBITDA coverage ratios.
Total liabilities
Debt ratio =
Total assets
$1,040 + $500
=
=
43.8%.
$3,517
EBIT
TIE =

Int. expense
= $502.6 = 6.3x.
$80
 

(More…)

18


EBITDA Coverage (EC)

EBIT + Depr. & Amort. + Lease payments
Interest
Lease
+
+
Loan
pmt.
expense
pmt.
$502.6
+
$120
+
$40
=
$80 + $40 + $0
5.5x.
 

=
19


Debt Management Ratios vs. 
Industry Averages

D/A
TIE
EC

2008E
43.8%
6.3x
5.5x

2007 2006
Ind.
80.7% 54.8% 50.0%
0.1x 3.3x 6.2x
0.8x 2.6x 8.0x

Recapitalization improved situation,
but lease payments drag down EC.
 

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Profit Margin (PM)
NI
$253.6
PM = Sales = $7,036 = 3.6%.
PM

2008E 2007 2006
3.6% -1.6% 2.6%

Ind.
3.6%

Very bad in 2007, but projected to
meet industry average in 2008.
Looking good.
 

21


Basic Earning Power (BEP)
EBIT
BEP  =
Total assets
$502.6
=                = 14.3%.
$3,517

(More…)

 

22


Basic Earning Power vs. 
Industry Average
BEP removes effect of taxes and 
financial leverage.  Useful for 
comparison.
 Projected to be below average.
 Room for improvement.
2008E 2007 2006 Ind.
BEP 14.3% 0.6% 14.2% 17.8%


 

23


Return on Assets (ROA)
and Return on Equity (ROE)
NI
ROA  =
Total assets
$253.6
=                = 7.2%.
$3,517

(More…)

 

24


Return on Assets (ROA)
and Return on Equity (ROE)
NI
ROE  =
Common Equity
$253.6
=                = 12.8%.
$1,977

(More…)

 

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