Chapter 13 financial ratios and firm performance
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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

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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


Financial statements l.jpg
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


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    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


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    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


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    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


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    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…


    Financial ratios l.jpg
    Financial Ratios

    • Comparing accounts for analysis of firm performance or potential strengthens and weaknesses

    • Five areas

      • Liquidity

      • Solvency

      • Asset Management

      • Profitability

      • Market Value


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    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


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    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


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    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


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    Financial Ratios

    • Profitability

      • Overall performance of the firm

      • Return to the owners

    • Common Profitability Ratios

      • Profit Margin

      • Return on Assets

      • Return on Equity


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    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


    External uses of financial statements l.jpg
    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


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    Homework

    • Problem 8 – Predict Net Income

    • Problem 10 – Common-size Statements

    • Problem 11 – Variance Analysis

    • Problem 18 – DuPont Identity

    • Problem 20 – Company Analysis


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