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## Financial Ratios

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**Financial Ratios**Ratios**Ratio Analysis**• Measure firm performance • Compare over time • Compare with other firms or industries • Analyze ROE • Project financial statements into future Ratios**Ratios**• Profitability • Activity or Utilization • Liquidity • Leverage • Growth • Valuation Ratios**Profitability Ratios**1. Profit Margin (PM) = 2. Operating Profit Margin (not in the book) = 3. Return on Assets (ROA) = 4. Return on Equity (ROE) = Ratios**Liquidity Ratios**Current Ratio = Quick Ratio = Cash Ratio = Ratios**Activity or Utilization Ratios**Receivables Turnover = Average Collection Period = Inventory Turnover* = Fixed Asset Turnover = Total Asset Turnover = * Sometimes = Ratios**Leverage Ratios**Debt Ratio (DR) = Long-term Debt Ratio* = Time Interest Earned (XIE) = Cash Coverage = Fixed Charge Coverage (not in the book) = Debt to Equity = Equity Multiplier (EM) = *Also called Debt to Capital Ratio Ratios**Growth Rates**1. Percentage growth of Sales, Net Income, etc. Example: 2. Sustainable Growth = ROBE(1-PO) where PO is the payout ratio = Div/NI Ratios**Sustainable Growth**Growth financed through: • Internal equity funds • Supportable debt Such that: • Firm’s debt ratio is held constant SG (Grant’s approx.) (Book’s formula) Where b is the “plowback” or retention ratio Ratios**Valuation Ratios**Price Earnings (PE) = Market to Book = Ratios**P/E Ratio**Ratios**Price-earnings Ratios for Selected U.S. Companies**Jan. Jan. Jan. Jan. Jan. June July Corporation Industry 1983 1986 1990 1993 1996 1998 2004 Coca-Cola . . . . . Beverages 13 17 20 25 34 53 27 Disney . . . . . . Entertainment 25 20 19 26 23 38 23 Liz Claiborne . . . Clothing 13 19 11 19 17 29 13 McDonald’s . . . . Restaurants 10 16 18 20 24 28 22 NationsBank . . . Banking 7 10 9 10 10 21 Phelps Dodge . . . Copper 6 8 4 17 7 23 35 Southwest Air . . . Airlines 20 14 15 38 21 21 27 Texas Utilities . . . Public Utilities 6 7 8 15 14 14 Wal-Mart . . . . . Retail 26 28 24 39 18 38 25 Standard & Poor’s . . . (500 Stock Index) 11 14 15 22 17 25 20 Ratios**Du Pont Analysis**• ROE = • ROE = • = • 3. ROE = Profit Margin * Total Asset Turnover * Equity Multiplier (PM) (TAT) (EQ) Ratios**Sustainable Growth and Du Pont**Sales Asset Asset Equity PAT Sales 1 - PO Ratios**Du Pont Examples**Microsoft ROE = 24.6% * 0.867 * 1.21 = 25.7% Wal-Mart ROE = 3.5% * 2.547 * 2.46 = 21.8% Ratios**How Are They Doing Now?**MicrosoftWal-Mart Ratios**Things to Consider Concerning Financial Ratios**• What aspect of the firm or its operations are • we attempting to analyze? • Generally, the aspects are “fuzzy”, e.g., utilization • What goes into a particular ratio? • Historical cost? Market values? What accounting conventions? • What is the unit of measurement? • Dollars? Days? Turns? • What would a desirable ratio value be? • Always? Ratios**Income Statement for the Year 2004**Discrepancies 1. Revenue recognition (i.e., installment sales and leases) 2. Cost of goods sold (i.e., may use LIFO during inflation) 3. Extraordinary losses Ratios**Trends in Annual Reports**• Interactive On-line Reports http://www.intel.com/intel/finance • Plain Speaking http://www.berkshirehathaway.com/2003ar/2003ar.pdf • Filings, i.e. 10k annual reports http://www.edgar-online.com/bin/esearch/fullsearch.asp Ratios