Financial

Financial Statement
Statement
Analysis
Analysis

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 Financial
Financial
Statement
Statement Analysis
Analysis
 Financial Statements
 A Possible Framework for Analysis
 Balance Sheet Ratios
 Income Statement and Income
Statement/Balance Sheet Ratios
 Trend Analysis

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 Examples
Examples of
of External
External Uses
Uses
of
of Statement
Statement Analysis
Analysis
 Trade Creditors -- Focus on the
liquidity of the firm.
 Bondholders -- Focus on the
long-term cash flow of the firm.
 Shareholders -- Focus on the
profitability and long-term health of
the firm.
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 Examples
Examples of
of Internal
Internal Uses
Uses
of
of Statement
Statement Analysis
Analysis
 Plan -- Focus on assessing the current
financial position and evaluating
potential firm opportunities.
 Control -- Focus on return on investment
for various assets and asset efficiency.
 Understand -- Focus on understanding
how suppliers of funds analyze the firm.
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 Framework
Framework for
for
Financial
Financial Analysis
Analysis
Trend / Seasonal Component
How much funding will be
required in the future?
1. Analysis of the funds
needs of the firm. Is there a seasonal
component?

Analytical Tools Used

Sources and Uses Statement
Statement of Cash Flows
Cash Budgets
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 Framework
Framework for
for
Financial
Financial Analysis
Analysis
Health of a Firm

1. Analysis of the funds Financial Ratios

needs of the firm.
2. Analysis of the financial
condition and profitability
1. Individually
of the firm. 2. Over time
3. In combination
4. In comparison

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 Framework
Framework for
for
Financial
Financial Analysis
Analysis

Business risk relates to

the risk inherent in the
1. Analysis of the funds
needs of the firm.
operations of the firm.
2. Analysis of the financial Examples:
condition and profitability
of the firm. Volatility in sales
3. Analysis of the business
risk of the firm. Volatility in costs
Proximity to break-even
point
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 Framework
Framework for
for
Financial
Financial Analysis
Analysis
A Financial
Manager
must
1. Analysis of the funds
needs of the firm. Determining consider all
2. Analysis of the financial
the three jointly
financing
condition and profitability
needs of
when
of the firm. determining
the firm.
3. Analysis of the business
risk of the firm.
the
financing
needs of the
8 firm.
 Framework
Framework for
for
Financial
Financial Analysis
Analysis

1. Analysis of the funds

needs of the firm. Determining Negotiations
the
2. Analysis of the financial with
financing
condition and profitability suppliers of
needs of
of the firm. capital.
the firm.
3. Analysis of the business
risk of the firm.

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 Use
Use of
of Financial
Financial Ratios
Ratios

A Financial Ratio is Types of

an index that relates Comparisons
two accounting
numbers and is Internal
obtained by dividing Comparisons
one number by the External
other. Comparisons

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 External
External Comparisons
Comparisons and
and
Sources
Sources of
of Industry
Industry Ratios
Ratios
This involves Examples:
comparing the ratios Risk Management
of one firm with those Association
of similar firms or with
industry averages. Dun & Bradstreet
Almanac of
Similarity is important Business and
as one should Industrial
compare “apples to Financial Ratios
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apples.”
 Liquidity
Liquidity Ratios
Ratios
Balance Sheet Ratios Current

Current Assets
Liquidity Ratios Current Liabilities

Shows a firm’s For Basket Wonders

ability to cover its December 31, 2007
current liabilities
$1,195 = 2.39
with its current
$500
assets.
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 Liquidity
Liquidity Ratio
Ratio
Comparisons
Comparisons
Current Ratio
Year BW Industry
2007 2.39 2.15
2006 2.26 2.09
2005 1.91 2.01
Ratio is stronger than the industry average.
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 Liquidity
Liquidity Ratios
Ratios
Balance Sheet Ratios Acid-Test (Quick)

Current Assets - Inv

Liquidity Ratios Current Liabilities

Shows a firm’s For Basket Wonders

ability to meet December 31, 2007
current liabilities
$1,195 - $696 = 1.00
with its most liquid $500
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assets.
 Liquidity
Liquidity Ratio
Ratio
Comparisons
Comparisons
Acid-Test Ratio
Year BW Industry
2007 1.00 1.25
2006 1.04 1.23
2005 1.11 1.25
Ratio is weaker than the industry average.
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 Summary
Summary of
of the
the Liquidity
Liquidity
Ratio
Ratio Comparisons
Comparisons
Ratio BW Industry
Current 2.39 2.15
Acid-Test 1.00 1.25
 Strong current ratio and weak acid-test
ratio indicates a potential problem in the
inventories account.
 Note that this industry has a relatively
high level of inventories.
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 Current
Current Ratio
Ratio --
-- Trend
Trend
Analysis
Analysis Comparison
Comparison
Trend Analysis of Current Ratio

2.5
2.3
Ratio Value

2.1
BW
1.9 Industry
1.7
1.5
2005 2006 2007
Analysis Year
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 Acid-Test
Acid-Test Ratio
Ratio --
-- Trend
Trend
Analysis
Analysis Comparison
Comparison
Trend Analysis of Acid-Test Ratio

1.5

1.3
Ratio Value

1.0 BW
Industry
0.8

0.5
2005 2006 2007
Analysis Year
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 Summary
Summary of
of the
the Liquidity
Liquidity
Trend
Trend Analyses
Analyses
 The current ratio for BW has been rising
at the same time the acid-test ratio has
been declining.
 The current ratio for the industry has
been rising slowly at the same time the
acid-test ratio has been relatively stable.
 This indicates that inventories are a
significant problem for BW.
BW
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 Financial
Financial Leverage
Leverage Ratios
Ratios
Balance Sheet Ratios Debt-to-Equity

Total Debt
Financial Leverage Shareholders’ Equity
Ratios
For Basket Wonders
December 31, 2007
Shows the extent to
which the firm is $1,030 = .90
financed by debt. $1,139
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 Financial
Financial Leverage
Leverage
Ratio
Ratio Comparisons
Comparisons
Debt-to-Equity Ratio
Year BW Industry
2007 .90 .90
2006 .88 .90
2005 .81 .89
BW has average debt utilization
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relative to the industry average.
 Financial
Financial Leverage
Leverage Ratios
Ratios
Balance Sheet Ratios Debt-to-Total-Assets

Total Debt
Financial Leverage Total Assets
Ratios
For Basket Wonders
Shows the percentage December 31, 2007
of the firm’s assets
that are supported by $1,030 = .47
debt financing. $2,169
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 Financial
Financial Leverage
Leverage
Ratio
Ratio Comparisons
Comparisons
Debt-to-Total-Asset Ratio
Year BW Industry
2007 .47 .47
2006 .47 .47
2005 .45 .47
BW has average debt utilization
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relative to the industry average.
 Financial
Financial Leverage
Leverage Ratios
Ratios
Balance Sheet Ratios Total Capitalization
(i.e., LT-Debt + Equity)

Financial Leverage Long-term Debt

Ratios Total Capitalization

Shows the relative For Basket Wonders

importance of long-term December 31, 2007
debt to the long-term $530 = .32
financing of the firm. $1,669
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 Financial
Financial Leverage
Leverage
Ratio
Ratio Comparisons
Comparisons
Total Capitalization Ratio
Year BW Industry
2007 .32 .30
2006 .32 .31
2005 .37 .32
BW has average long-term debt utilization
25
relative to the industry average.
 Coverage
Coverage Ratios
Ratios
Income Statement Interest Coverage
Ratios
EBIT
Interest Charges
Coverage Ratios
For Basket Wonders
Indicates a firm’s December 31, 2007
ability to cover
interest charges. $210 = 3.56
$59
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 Coverage
Coverage
Ratio
Ratio Comparisons
Comparisons
Interest Coverage Ratio
Year BW Industry
2007 3.56 5.19
2006 4.35 5.02
2005 10.30 4.66
BW has below average interest coverage
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relative to the industry average.
 Coverage
Coverage Ratio
Ratio --
-- Trend
Trend
Analysis
Analysis Comparison
Comparison
Trend Analysis of Interest Coverage Ratio
11.0

9.0
Ratio Value

7.0 BW
Industry
5.0

3.0
2005 2006 2007
Analysis Year
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 Summary
Summary of
of the
the Coverage
Coverage
Trend
Trend Analysis
Analysis
 The interest coverage ratio for BW has
been falling since 2005. It has been
below industry averages for the past
two years.
 This indicates that low earnings (EBIT)
may be a potential problem for BW.
BW
 Note, we know that debt levels are in
line with the industry averages.
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 Activity
Activity Ratios
Ratios
Income Statement / Receivable Turnover
(Assume all sales are credit sales.)
Balance Sheet
Ratios Annual Net Credit Sales
Receivables
Activity Ratios
For Basket Wonders
Indicates quality of December 31, 2007
receivables and how
successful the firm is in $2,211 = 5.61
its collections. $394
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 Activity
Activity Ratios
Ratios
Income Statement / Avg Collection Period
Balance Sheet
Days in the Year
Ratios
Receivable Turnover

Activity Ratios For Basket Wonders

December 31, 2007
Average number of days
that receivables are
outstanding. 365 = 65 days
(or RT in days) 5.61
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 Activity
Activity
Ratio
Ratio Comparisons
Comparisons
Average Collection Period
Year BW Industry
2007 65.0 65.7
2006 71.1 66.3
2005 83.6 69.2
BW has improved the average collection
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period to that of the industry average.
 Activity
Activity Ratios
Ratios
Income Statement / Payable Turnover (PT)
(Assume annual credit
Balance Sheet purchases = $1,551.)
Ratios
Annual Credit Purchases
Accounts Payable
Activity Ratios
For Basket Wonders
Indicates the
December 31, 2007
promptness of payment
to suppliers by the firm. $1551
= 16.5
$94
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 Activity
Activity Ratios
Ratios
Income Statement / PT in Days
Balance Sheet
Ratios Days in the Year
Payable Turnover
Activity Ratios
For Basket Wonders
December 31, 2007
Average number of days
that payables are 365
outstanding. = 22.1 days
16.5
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 Activity
Activity
Ratio
Ratio Comparisons
Comparisons
Payable Turnover in Days
Year BW Industry
2007 22.1 46.7
2006 25.4 51.1
2005 43.5 48.5
BW has improved the PT in Days.
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Is this good?
 Activity
Activity Ratios
Ratios
Income Statement / Inventory Turnover
Balance Sheet
Ratios Cost of Goods Sold
Inventory
Activity Ratios
For Basket Wonders
December 31, 2007
Indicates the
effectiveness of the $1,599 = 2.30
inventory management $696 Avg age
practices of the firm.
36 of Inv
 Activity
Activity
Ratio
Ratio Comparisons
Comparisons
Inventory Turnover Ratio
Year BW Industry
2007 2.30 3.45
2006 2.44 3.76
2005 2.64 3.69
BW has a very poor inventory turnover ratio.
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 Inventory
Inventory Turnover
Turnover Ratio
Ratio --
--
Trend
Trend Analysis
Analysis Comparison
Comparison
Trend Analysis of Inventory Turnover Ratio
4.0

3.5
Ratio Value

3.0 BW
Industry
2.5

2.0
2005 2006 2007
Analysis Year
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 Activity
Activity Ratios
Ratios
Income Statement / Total Asset Turnover
Balance Sheet
Ratios Net Sales
Total Assets
Activity Ratios
For Basket Wonders
December 31, 2007
Indicates the overall
effectiveness of the firm $2,211 = 1.02
in utilizing its assets to $2,169
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generate sales.
 Activity
Activity
Ratio
Ratio Comparisons
Comparisons
Total Asset Turnover Ratio
Year BW Industry
2007 1.02 1.17
2006 1.03 1.14
2005 1.01 1.13
BW has a weak total asset turnover ratio.
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Why is this ratio considered weak?
 Profitability
Profitability Ratios
Ratios
Income Statement / Gross Profit Margin
Balance Sheet
Ratios Gross Profit
Net Sales
Profitability Ratios
For Basket Wonders
December 31, 2007
Indicates the efficiency
of operations and firm $612 = .277
pricing policies. $2,211
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 Profitability
Profitability
Ratio
Ratio Comparisons
Comparisons
Gross Profit Margin
Year BW Industry
2007 27.7% 31.1%
2006 28.7 30.8
2005 31.3 27.6
BW has a weak Gross Profit Margin.
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 Gross
Gross Profit
Profit Margin
Margin --
--
Trend
Trend Analysis
Analysis Comparison
Comparison
Trend Analysis of Gross Profit Margin
35.0

32.5
Ratio Value (%)

30.0 BW
Industry
27.5

25.0
2005 2006 2007
Analysis Year
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 Profitability
Profitability Ratios
Ratios
Income Statement / Net Profit Margin
Balance Sheet
Ratios Net Profit after Taxes
Net Sales
Profitability Ratios
For Basket Wonders
December 31, 2007
Indicates the firm’s
profitability after taking $91 = .041
account of all expenses $2,211
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and income taxes.
 Profitability
Profitability
Ratio
Ratio Comparisons
Comparisons
Net Profit Margin
Year BW Industry
2007 4.1% 8.2%
2006 4.9 8.1
2005 9.0 7.6
BW has a poor Net Profit Margin.
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 Net
Net Profit
Profit Margin
Margin --
--
Trend
Trend Analysis
Analysis Comparison
Comparison
Trend Analysis of Net Profit Margin
10
9
Ratio Value (%)

8
7 BW
6 Industry

5
4
2005 2006 2007
Analysis Year
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 Profitability
Profitability Ratios
Ratios
Income Statement / Return on Investment
Balance Sheet
Ratios Net Profit after Taxes
Total Assets
Profitability Ratios
For Basket Wonders
Indicates the December 31, 2007
profitability on the
assets of the firm (after $91 = .042
all expenses and taxes). $2,160
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 Profitability
Profitability
Ratio
Ratio Comparisons
Comparisons
Return on Investment
Year BW Industry
2007 4.2% 9.8%
2006 5.0 9.1
2005 9.1 10.8
BW has a poor Return on Investment.
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 Return
Return on
on Investment
Investment ––
Trend
Trend Analysis
Analysis Comparison
Comparison
Trend Analysis of Return on Investment
12

10
Ratio Value (%)

8 BW
Industry
6

4
2005 2006 2007
Analysis Year
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 Profitability
Profitability Ratios
Ratios
Income Statement / Return on Equity
Balance Sheet
Ratios Net Profit after Taxes
Shareholders’ Equity
Profitability Ratios
For Basket Wonders
Indicates the profitability December 31, 2007
to the shareholders of
the firm (after all $91 = .08
expenses and taxes). $1,139
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 Profitability
Profitability
Ratio
Ratio Comparisons
Comparisons
Return on Equity
Year BW Industry
2007 8.0% 17.9%
2006 9.4 17.2
2005 16.6 20.4
BW has a poor Return on Equity.
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 Return
Return on
on Equity
Equity --
--
Trend
Trend Analysis
Analysis Comparison
Comparison
Trend Analysis of Return on Equity
21.0

17.5
Ratio Value (%)

14.0 BW
Industry
10.5

7.0
2005 2006 2007
Analysis Year
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 Return
Return on
on Investment
Investment and
and
the
the Du
Du Pont
Pont Approach
Approach
Earning Power = Sales profitability X
Asset efficiency
ROI = Net profit margin X
Total asset turnover
ROI2007 = .041 x 1.02 = .042 or 4.2%
ROIIndustry = .082 x 1.17 = .098 or 9.8%

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 Return
Return on
on Equity
Equity and
and
the
the Du
Du Pont
Pont Approach
Approach
Return On Equity = Net profit margin X
Total asset turnover X
Equity Multiplier
Total Assets
Equity Multiplier =
Shareholders’ Equity

ROE2007 = .041 x 1.02 x 1.90 = .080

ROEIndustry = .082 x 1.17 x 1.88 = .179
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 Summary
Summary of
of the
the Profitability
Profitability
Trend
Trend Analyses
Analyses
 The profitability ratios for BW have ALL
been falling since 2005. Each has been
below the industry averages for the past
three years.
 This indicates that COGS and
administrative costs may both be too
high and a potential problem for BW.
BW
 Note, this result is consistent with the low
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interest coverage ratio.
 Summary
Summary of
of Ratio
Ratio Analyses
Analyses
 Inventories are too high.
 May be paying off creditors
(accounts payable) too soon.
 COGS may be too high.
 Selling, general, and
administrative costs may be too
high.
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