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FinancialAnalysis
ChapterOutlineRatioanalysisanditsimportanceUseofratiosasmeasurementtoolTheDuPontsystemofanalysisTrendanalysisEvaluationofreportedincometoidentifysourcesofdistortionRatioAnalysisFinancialratiosUsedtoweighandevaluatetheoperatingperformanceofafirmNumericalcalculationsandanalyzingratiosUsedtocompareperformancerecordasagainstsimilarfirmsintheindustryAdditionalevaluationofcompanymanagement,physicalfacilitiesandotherfactorsSuchdataisprovidedbyvariousorganizationsRatiosandtheirClassificationA. Profitabilityratios1.Profitmargin2.Returnonassets(investment)3.ReturnonequityB. Assetutilizationratios4.Receivableturnover5.Averagecollectionperiod6.Inventoryturnover7.Fixedassetturnover8.TotalassetturnoverRatiosandtheirClassification(cont’d)C. Liquidityratios9.Currentratio10.QuickratioD. Debtutilizationratios11.Debttototalassets12.Timesinterestearned13.FixedchargecoverageTypesofRatiosProfitabilityratiosMeasurethefirm’sabilitytoearnadequatereturnon:SalesAssetsInvestedcapitalAssetutilizationratiosMeasurethespeedatwhichthefirmisturningover:AccountsreceivableInventoryLong-termassetsTypesofRatios(cont’d)LiquidityratiosEmphasizesthefirm’sabilitytopayoffshort-termobligationsastheycomedueDebtutilizationratiosEstimatestheoveralldebtpositionofthefirmEvaluatesinthelightofassetbaseandearningpowerImportanceofRatiostoUsersofFinancialStatementsForpotentialinvestors/securityanalysts:Primaryconsiderations–profitabilityratiosSecondaryconsiderations–liquidityanddebtutilizationForbankerortradecreditor–liquidityratiosForlong-termcreditors–debtutilizationratiosandprofitabilityratiosFinancialStatement
forRatioAnalysisProfitabilityRatiosDuPontSystemofAnalysisAsatisfactoryreturnonassetsmightbederivedthrough:ahighprofitmargin,orarapidturnoverofassets(generatingmoresalesperdollarofitsassets)oracombinationofbothReturnonassets(investment)=Profitmargin×Assetturnover
DuPontSystemofAnalysis(cont’d)Asatisfactoryreturnonequitymightbederivedthrough:ahighreturnontotalassetsagenerousutilizationofdebtoracombinationofbothReturnonequity=Returnonassets(investment)(1–Debt/Assets)DuPontAnalysisReturnofWal-MartversusAbercrombieusingtheDuPontmethodofanalysis,2009AssetUtilizationRatiosTheseratiosrelatethebalancesheet(assets)totheincomestatement(sales)**Thisratiomayalsobecomputedbyusing“Costofgoodssold”inthenumerator.AssetUtilizationRatios(cont’d)
LiquidityRatios
TheseratiosdetermineifthefirmcanmeeteachmaturingobligationasitcomesdueDebtUtilizationRatiosMeasurestheprudenceofthedebtmanagementpoliciesofthefirmDebtUtilizationRatios(cont’d)Fixedchargecoveragemeasuresthefirm’sabilitytomeetallfixedobligationsratherthaninterestpaymentsalone
Incomebeforeinterestandtaxes………………..$550,000 Leasepayments……50,000 Incomebeforefixedchargesandtaxes…………$600,000
RatioAnalysisTrendAnalysisGivesapictureofperformanceoveranumberofyearsagainstindustryaveragesTrendAnalysis
intheComputerIndustryImpactofInflation
onFinancialAnalysisInflationRevenueisstatedincurrentdollarsPlant,equipment,orinventorymayhavebeenpurchasedatlowerpricelevelsProfitsmaybemoreafunctionofincreasingpricesthanofsatisfactoryperformanceFinancialreportsgetdistortedfornoconsiderationofinflationfactor,whichinturnwillaffectthefinancialanalysisComparisonofReplacementandHistoricalCostAccountingJeffGarnettandGeoffreyA.Hirt,“ReplacementCostData:AStudyoftheChemicalandDrugIndustryforYears1976through1978.”ComparisonofReplacementandHistoricalCostAccounting(cont’d)Replacementcost–reducesincomebutincreasesassetsanincreaseinassetslowersthedebt-to-assetsratioalowerdebt-to-assetsratioindicatesdecreaseinthefinancialleverageofthefirmadecliningincomeresultsinadecreasedabilitytocoverinterestcostsImpactofDisinflation
onFinancialAnalysisDisinflation–asituationofdeclininginflationarypressuresWillnotimpairthepurchasingpowerofthedollarReductionininvestors’expectationofreturnsonfinancialassetsFinancialassetssuchasstocksandbondshavethepotentialtodowellDeflationActualreductionofpricesaffectingeverybodyduetobankruptciesanddecliningprofitsOtherElementsofDistortion
inReportedIncomeEffectofchangingpricesReportingofrevenuesTreatmentofnonrecurringitemsTaxwrite-offpoliciesIncomeStatementsExplanationofDiscrepanciesSalesFirmmaydeferrevenuerecognitionuntileachpaymentreceivedorfullrecognitionatearliestpossibledateCostofgoodssoldUseofdifferentaccountingprinciples–LIFOversusFIFOVaryingtreatmentofR&Dcostsetc.ExplanationofDiscrepancies(cont’d)Extraordinarygains/losses
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