CH 4: Analysis of Financial Statements

What is the order of the CA?

Cash
Marketable Securities
AR
Inventory

What is another name for total assets

total capital (debt + equity)

What are the two things within Accruals

wages and taxes

EBIT is also called

Operating Income

EBT is also called

taxable income

NI available to common stockholders is called

NI

the Dividend Ratio and the Retention Ratio add up to

1.0

measures the ability of a firm to pay off debts due within a year

liquidity ratio

What are the liquidity ratios?

Current Ratio
Quick (acid test) Ratio

Current Ratio =

CA / CL

Quick (acid test) Ratio =

(CA - Inv) / CL

choosing the best company in the industry as a challenge

benchmarking

measures how efficiently the firm is using its assets

Asset Management Ratios

What are the Asset Management Ratios?

Inv Turnover
FA Turnover
Total Asset Turnover
DSO

Inventory Turnover =

Sales / Inv

Fixed Assets Turnover =

Sales / Net FA

Total Asset Turnover =

Sales / Total assets

DSO stands for

Days Sales Outstanding

DSO is also called

Average Collection Period (ACP)

how long is sales revenue in someone else’s pockets and not getting it back

DSO

DSO =

AR / Average Sales Per Day
OR
AR / (Annual sales / 365)

measures how the firm has financed its assets as well as firms ability to repay long term debt

Debt Management Ratios

What are the Debt Management Ratios

Debt Ratio
Times interest earned

indicate how risky the firm is and how much must be paid to bondholders instead of stockholders

Debt Management Ratios

Debt Ratio =

Debt / Invested Capital
OR
Debt / (A - AP - Accr)

Times interest Earned (TIE) =

EBIT / Interest

measures how profitably the firm is operating and utilizing its assets

Profitability Ratios

What are the Profitability Ratios

Profit Margin
Basic Earning Power Ratio (BEP)
Return on assets (ROA)
Return on Common Equity (ROE)
Return on invested capital

return = NI = Earnings =

profit

Profit margin is also called

Return on Sales

Profit Margin =

NI available to common stockholders / Sales

Basic Earning Power (BEP) Ratio =

EBIT / Total Assets

BEP ratio is also called

operating income power

Return on Assets (ROA) =

NI available to common SHers/ Total Assets

Return on common Equity (ROE)

NI available to SHers / Common Equity

Return on invested capital =

(EBIT (1-T)) / Invested Capital
OR
(EBIT (1-T)) / (A - AP - Accr)

Are you supposed to Max ROE>

NO

ROE increases as

debt to assets increases

measures what investors think about the firm and its future prospects

Market Value Ratios

EPS =

NI / # shares outstanding

What are the Market Value Ratios

Price/Earnings (P/E)
PEG
Price/Cash Flow
Market/Book Ratio

When PE increases,

investors believe their value will increase in the future

Price/Earnings (P/E) =

Price per Share / EPS

PEG =

(P/E) / 5 yr EPS growth rate

What is the General Rule of PEG

When PEG is about 1

What is the Specific Rule of PEG

PEG of a company will be about equal to that of the industry

Price / Cash Flow

Price Per Share / Cash Flow Per Share

Cash Flow Per Share (CFPS) =

(NI + Dep + Amort) / # shares outstanding

Market / Book Ratio =

Price Per Share / Book Value per Share

Book Value Per Share (BVPS) =

Common Equity / # shares outstanding

Du Pont Equation:
ROA =
OR
ROE=

ROA = Profit Margin x Total Assets Turnover
OR
ROA = NI / Total Assets

Extended Du Pont Equation:

ROE = ROA x Equity Multiplier
OR
ROE = NI / Equity

Equity Multiplier =

Total Assets / Common Equity

What are the limitations of using Ratio Analysis

Difficult to use for diversified comps
Attaining avg is not target
Inflation distorts analysis
Seasonality distorts analysis
Window Dressing affects Accuracy
Differences in accounting methods affect comparison
Difficult to make definite conclusions
Cannot make overall generalization of comp health

What are the weaknesses of ROE

Does not consider Risk
Size of mutually exclusive projects not considered
Bonus being determined by ROE encourages managers to not except good projects with low ROE

What is the most important ratio that management can control

ROE