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Analysis:
Ratio Analysis
Financial Analysis
Financial Analysis
Lenders:
To evaluate the likelihood
that borrowers will be able to pay off loans;
II.
Categories
We divide the ratios into five categories:
1. Liquidity ratios: give us an idea of the firms ability to
pay off debts that are maturing within a year.
2. Asset management ratios: give us an idea of how
efficiently the firm is using its assets.
3. Debt management ratios: give us an idea of how the firm
has financed its assets as well as the firms ability to repay
its long-term debt.
Categories
4. Profitability ratios: give us an idea of how profitably the
firm is operating and utilizing its assets.
5. Market value ratios: bring in the stock price and give us an
idea of what investors think about the firm and its future
prospects.
Liquidity ratios
1.
CurRENT Ratio
2.
3.
4.
Word Problem:
Baker Brothers has a DSO of 40 days, and its
annual sales are $7,300,000. What is its
accounts receivable balance? Assume that it
uses a 365-day year.
ASSET MANAGEMENT
RATIOS
Turnover ratios: divide sales by some asset: i.e.
Sales/Various assets.
1.
2.
3.
4.
5.
6.
Word problem
Timberland Corporation has ending inventory
of $352,600, and cost of goods sold for the year
just ended was $1,586,700. What is the
inventory turnover? The days sales in
inventory?
How long on average did a unit of inventory sit
on the shelf before it was sold?
DEBT MANAGEMENT
RATIOS
Two procedures that analysts use to examine the
firms debt:
i.
ii.
Word Problem
Fried Chicken Company has a debt-equity ratio of
1.20. Return on assets is 6.5 percent, and total
equity is $210,000. What is the equity multiplier?
Return on equity? Net income?
DEBT MANAGEMENT
RATIOS
1.
2.
3.
Equity Multiplier
4.
5.
Times-Interest-Earned Ratio
6.
PROFITABILITY RATIOS
1. Operating Margin
2. Profit Margin
3. Return on Total Assets
4. Basic Earning Power (BEP) Ratio
5. Return on Common Equity
$ 100.00
Fixed assets
283.50
Sales
Net income
Current liabilities
1,000.00
50.00
105.50
Current ratio
DSO*
ROE
3.00
40.55 days
12.00%
1.
Price/Earnings Ratio
2.
Market/Book Ratio
Word Problem:
Assume that if a company is currently trading at $43 a share
and earnings over the last 12 months were $1.95 per share,
what is its P/E?
Things to Remember
Generally a high P/E ratio means that investors
are anticipating higher growth in the future.
The average market P/E ratio is 20-25 times
earnings.
The p/e ratio can use estimated earnings to get the
forward looking P/E ratio.
Companies that are losing money do not have a
P/E ratio.
Things to Remember
Proposition: Other things held equal, higher growth
rms will have higher PE ratios than lower growth
rms.
Proposition: Other things held equal, higher risk
rms will have lower PE ratios than lower risk rms
Proposition: Other things held equal, rms with
lower reinvestment needs will have higher PE ratios
than rms with higher reinvestment rates.
DuPont Analysis
A method of performance measurement that was started by the
DuPont Corporation in the 1920s. With this method, assets are
measured at their gross book value rather than at net book
value in order to produce a higher return on equity (ROE). It is
also known as "DuPont identity".
DuPont analysis tells us that ROE is affected by three things:
Operating efficiency, which is measured by profit margin
Asset use efficiency, which is measured by total asset
turnover
Financial leverage, which is measured by the equity
multiplier
LIMITATIONS OF RATIOS
Seasonal factors
Window Dressing techniques
Different accounting
comparisons.
practices
can
distort