Chapter 13 – Financial Ratios and Firm Performance

1. Chapter 13 – Financial Ratios and Firm Performance • Learning Objectives • Create common-size statements • Analyze performance with internal data and financial statements • Calculate and interpret some key financial ratios • Compare different company performances • Analyze performance from historical data • Appreciate the difference across industries of financial ratios

2. Financial Statements • Review • Income Statement • Balance Sheet • Sources and Uses of Cash • Accounting Identity • Assets ≡ Liabilities + Owner’s Equity • Double entry bookkeeping • Benchmarking – against self or competition

3. Benchmarking • Against Self • Comparisons across time • Growing Sales? • Growing Costs? • Growing Income? • Against Competition • Common Size Statements • Comparisons of percentages not actual dollars • Which firm is more efficient per sales dollar

4. Internal Uses of Financial Statements • Analyze firm performance • Comparison of actual performance to forecasts (budgets) • Use standard costs for comparison • Breakdown performance into key areas • Sales • Production • Labor • Overhead

5. Internal Uses of Financial Statements • Example – Sales Variance Analysis • Price Analysis • Actual Price x Actual Quantity vs. Forecasted Price x Actual Quantity • Actual > Forecast, favorable variance • Volume Analysis • Forecast Price x Actual Quantity vs. Forecast Price x Forecast Quantity • Actual > Forecast, favorable variance • Sum variance for total Sales Analysis

6. Internal Uses of Financial Statements • Other Variances • Production • Labor and Material • Overhead • EBIT Variance sum of Sales, Production, and Overhead • Be careful with interpreting favorable and unfavorable variances • Variance analysis is an aid to understanding the performance of the business…

7. Financial Ratios • Comparing accounts for analysis of firm performance or potential strengthens and weaknesses • Five areas • Liquidity • Solvency • Asset Management • Profitability • Market Value

8. Financial Ratios • Liquidity • Ability to meet short term cash outflow • Poor liquidity sign of trouble ahead in keeping operations going • Common Liquidity Ratios • Current Ratio • Cash Debt Coverage Ratio • Quick Ratio • Cash Ratio

9. Financial Ratios • Solvency • Long-term ability to meet cash outflow • Indicates borrowing capacity in future • Common Solvency Ratios • Debt Ratio • Times Interest Earned • Cash Coverage Ratio • Capital Expenditure Ratio

10. Financial Ratios • Asset Management • Utilization of assets by management • How assets are being used to generate profits • Common Asset Management Ratios • Inventory Turnover • Day’s Sales in Inventory • Receivables Turnover • Total Asset Turnover Ratio

11. Financial Ratios • Profitability • Overall performance of the firm • Return to the owners • Common Profitability Ratios • Profit Margin • Return on Assets • Return on Equity

12. Financial Ratios • Market Value • Concern of potential investors • DuPont Extension of components of ROE • Common Market Value Ratios • Earnings Per Share (EPS) • Price Earnings Ratio • PEG Ratio • DuPont Analysis • Operating efficiency, management efficiency, and financial leverage • ROE components

13. External Uses of Financial Statements • Financial Analysts provide external view of performance • Why? • For clients that are seeking to buy (make an investment) • For clients that need to sell (disinvest) • Finance is still about buying and selling • Comparing firms…Cola Wars • Which firm would you buy? • Why? • Across Industries – Ratios reveal operating standards

14. Homework • Problem 8 – Predict Net Income • Problem 10 – Common-size Statements • Problem 11 – Variance Analysis • Problem 18 – DuPont Identity • Problem 20 – Company Analysis