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04 Notes

This document discusses various financial ratios that can be used to analyze a company's performance and financial health. It addresses ratios related to liquidity, debt and solvency, profitability, and activity. Key points include that ratios should be compared across firms of similar size and industry, and that nonlinear factors can impact ratios. Benchmarks and industry norms can provide useful comparisons. The document also discusses integrating different ratio analyses and how various ratios are composites or derivatives of other ratios.

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Mychael Ndugga
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84 views22 pages

04 Notes

This document discusses various financial ratios that can be used to analyze a company's performance and financial health. It addresses ratios related to liquidity, debt and solvency, profitability, and activity. Key points include that ratios should be compared across firms of similar size and industry, and that nonlinear factors can impact ratios. Benchmarks and industry norms can provide useful comparisons. The document also discusses integrating different ratio analyses and how various ratios are composites or derivatives of other ratios.

Uploaded by

Mychael Ndugga
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Ratios and Financial Analysis

Ndejje University

Ratios and Financial Analysis


Ratios : Why Comparability among firms of different sizes Provides a profile of the firm Caution: Economic assumption of Linearity Proportionality Nonlinearity can cause problems: Fixed costs, EOQ for inventories Benchmarks: Is high Current ratio good? For whom? Industry-wide norms. Accounting Methods; Timing & Window Dressing Current ratio: 300/200 to 200/100 is it getting better? 2

Negative numbers
Firm A
B 33.33% C -20.00% Who has the highest payout ratio ? NOT B $1,000 $(5,000)

Payout Ratios
20.00%

Dividend $1,000
$1,000

Income $5,000
$3,000

Common Size Statements


All figures divided by the same figure Balance Sheet: Total Assets = Liabilities + Equity Income Statement: Revenue Divide by

Divide by

Analysis across statements (activity analysis) not possible. i.e. can not divide a Income Statement by Balance Sheet number Industry Comparison [Robert Morris Associates] Yahoo Finance

1 Activity Analysis
An Income Statement
Inventory Turnover =

A Balance Sheet Figure


Cost of Goods Sold Average Inventory

Receivables Turnover = Sales Average Receivables


Fixed Asset Turnover = Sales Average Fixed Assets Asset Turnover = Sales Average Total Assets [365 / Turnover] is days outstanding. More Turnover is it always good / bad

Payables Turnover =

Purchases Average Payables


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2 Liquidity Analysis
Cash Cycle= Days Inventory Outstanding + Days Receivables Outstanding - Days Payable Outstanding ------------------------------------------------Current Ratio =

Quick Ratio =

Cash + Marketable Securities + Accounts receivable Current Liabilities

Cash flow from= Cash flow from operations operations ratio Current Liabilities ------------------------------------------------Dell: 2004 10-K Look at pages 22 and 31
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3 Long term Debt and Solvency Analysis


Important for Bond Covenants Debt = Short-term debt + Long-term debt Total capital = Debt + Equity

Debt to Equity =
Times Interest Earned =

Debt Debt to total capital = Total capital Total Assets Leverage = Equity
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Balance Sheet - reported


Short-term Payables Short-term debt Long-term Payables Assets
e.g. retirement benefits, Deferred taxes

Long-term debt
Equity

Balance Sheet - rearrange


Short-term Payables Long-term Payables
e.g: retirement benefits Deferred taxes

No Interest Paid Interest Paid

Assets

Short-term debt

Long-term debt
Equity

Balance Sheet
Cost/return

Operating Liabilities

Assets

Debt

Int. Exp (1-t)

Equity

Net Income

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Returns
Cost/return

Operating Liabilities

Int. Exp (1-t) Net Income

Debt

After tax Interest Rate

Equity

ROE

11

4-1 Profitability Analysis


Gross Margin =
Gross Profit Sales

Margin Before Interest & Taxes = Asset Turnover =

EBIT Sales

Sales Assets

NI + (1-tax) Int Exp Return on Assets = Assets

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42 Profitability Analysis
Return on Total capital (ROTC) =

= Net Income = (EBIT Interest Expense) (1 tax)

Return on Equity

Debt = average Debt;

Equity = Average Equity 13

Ratios Integrated Analysis


Economic relationships: higher sales leads to higher inventories Overlap of components: Asset TO ratio is related to individual TO ratios.

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Ratios as composite of other ratios

Page 148

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Returns
Cost/return

Operating Liabilities

Int. Exp (1-t) + Net Income

Debt + Equity = Total Capital

ROTC

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ROE from ROTC

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ROTC from ROA

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4-12 : ROE and ROA (Book)


ROE = = = Net Income Equity NI + (1-t) Interest Exp (1-t) Interest Exp Equity Equity NI + (1-t) Interest Exp Assets Assets Equity (1-t) Interest Exp Assets Assets Equity

(1-t) Interest Exp Assets = ROA :page 142 last Assets Equity [also in 4-12]

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Total leverage Components


Operating Leverage Financial Leverage Contribution Margin After Tax NOPAT = NOPAT Net Income Contribution Margin After Tax = Net Income

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M1: ROE from ROA

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Total leverage
Total Leverage Change in Net Income Revenue = Net Income Change in Revenue Change in units x CM per unit x (1 - Tax rate) = Net Income Units x Unit price Change in Units X Unit Price Units x CM per unit x (1 - Tax rate) = Net Income Contribution Margin After Tax Net Income
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