某地区咨询战略管理知识方案英文版

Author:CollinsQianRatioAnalysisMarch19981Agenda

UsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeaways2AnalyzingRatios

Ratiosinisolationaremeaningless.Acompany'sratiosmustbeexaminedovertimeand/oragainstitscompetitors’ratios.HistoricalcomparisonCompetitivecomparisonComparepresentratioswithsamecompany'shistoricalratiosInstablesituations,historicalratiosmaybeusedtoprojectfutureperformanceCompareacompany’sratioswithsimilarfirms’ratiosorwithindustryaveragesatthesamepointintimeLookfortrendsLookatrelativeperformance3TheArtofRatioAnalysis

Whichratiosaremostimportantinagivensituation?Whatitemsshouldbeincluded/excludedincalculatingtheratios?Howmuchinfluencedoesmanagementhaveovertheratios?Whatdotheratiossayaboutthefirm’sstrategy?Ratioanalysisisanartaswellasascience.4TheNeedforJudgment

PotentialProblemManagementcansubstantiallyinfluencefinancialsintheshorttermImplicationsNeedtousejudgmenttounderstandfinancialsRatioanalysisrequireskeenjudgment.Financialstatementdataishistorical,notproformaCross-companycomparisonsaremeaninglessifadjustmentsarenotmadefordifferentaccountingconventionsThetimingofthereportingperiodinfluencesfundsflowsandrequirementsNeedtounderstandthathistorydoesNOTnecessarilypredictfutureNeedtobeverysensitiveaboutindustry-specificseasonalityandcyclicalityNeedtostandardizeacrosscompaniestoadjustfordifferentaccountingmethods5Agenda

UsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeaways6TypesofRatiosRatioshelpusunderstandhowwellacompanyisperforming.Specifically,howmuchreturnisitgeneratingwithwhatlevelofrisk?Howwelldoesthecompanymanagecostsrelativetorevenues?ReturnRiskCoverageInterestchargeFixedchargecoverageLiquidityCurrentratioQuickratioLeverageAssettoequityDebttoequityDebttototalcapitalTurnoverReceivablesInventoryPayablesAssetProfitabilityOperatingmarginROSGrossmarginHoweffectiveisthecompanyinmanagingitsresources?Whataretherespectiveclaimsofdebtandequityowners?Howriskyisthebusiness?Isthecompanyabletomeetitsshort-termobligations?Isthecompanyabletomeetitslong-termobligations?7ProfitabilityRatios-Definitions*Thisisnotaprofitabilityratio,butitdoesimpactROSProfitabilityratiosuselineitemsfromtheincomestatement.RatiosDefinitionsGrossprofitmargin(orgrossmargin)Sales-costofgoodssoldSalesOperatingprofitmargin(oroperatingmargin)EarningsbeforeinterestandtaxesSalesReturnonsales(ROS)ProfitaftertaxSalesEffectivetaxrate*TaxesProfitbeforetax8ProfitabilityRatios-Description

Profitability(ormargin)ratiosareafunctionofboththeindustryandacompany'spositionwithintheindustryboundariesaresetbytheoperatingcharacteristicsoftheindustrywithintheseboundariesprofitabilityratiosaredeterminedbyaplayer’srelativepositionBaintypicallyusesgrossprofitandoperatingprofittomeasureprofitabilityROScanbealteredbynon-operatingactivities,suchassourcesoffinancingortaxratemanipulationsExtraordinaryitems,becausetheyareforunusualevents,suchasdiscontinueditemsorassetsales,areexcludedwhenweanalyzetheperformanceofthebasebusinessProfitabilityratiosmeasureafirm’sabilitytomanagecostsrelativetorevenues.9ProfitabilityRatios-OverTime

Grossprofitmarginshouldstayconstantorincreasebecausecostofgoodssoldshouldbeaconstantpercentofsalesorshoulddecreaseascompanygetspriceincreasesand/orvolumediscountsOperatingmarginshouldincreaseasfixedadministrativeandsalescostsarespreadoveragreaternumberofunitsEffectivetaxrateshouldstayconstantordecreasesincealargerfirmisabletotakeadvantageofmoretaxsheltersAsacompanygrows,itsreturnonsalesshouldincrease.Higherreturnonsales10ProfitabilityRatios-MarketLeaderGrossprofitmarginshouldbehighersinceamarketleadercantypicallychargemoreforitsgoodsand/orreceivethegreatestvolumediscountsfromsuppliersOperatingprofitmarginshouldbesignificantlyhigher,becausehighervolumemeansfixedcostsarespreadovermoreunitsandbecausethegrossprofitmarginishigherThereshouldbenosignificantdifferenceintheeffectivetaxrateReturnonsalesshouldbesignificantlyhigherbecausetheoperatingmarginshouldbesignificantlyhigherThemarketleaderinanindustryshouldhavethebestprofitabilityratios.ThisisconsistentwiththeROS/RMSconceptwhichsaysthatcompanieswithhighrelativemarketsharehavehighreturnsonsales11TurnoverRatios-DefinitionsNote:Average=(YearBeginning+YearEnd)/2*Salesisoftenagoodproxy**Costofgoodssoldisoftenagoodproxy***Typicallyweuse365days(i.e.,1year)fortheperiodTurnoverratiosuseacombinationofincomestatementandbalancesheetitems.RatiosDefinitionsReceivablesturnoverCreditsalesinperiod*AccountsreceivableaveragebalanceInventoryturnoverCostofgoodssoldinperiodAverageinventoryinperiodPayablesturnoverPurchasesonaccount**AccountspayableaveragebalanceAssetturnoverSalesinperiodAverageassetsAnyturnoverratiocanbeexpressedasaperiodratiowhichmeasuresthenumberofdaysinthecycleDaysinperiod***TurnoverratioPeriodratio=12TurnoverRatios-TransactionCycle*Accountspayable,inventory,andaccountsreceivablearethemajorcomponentsofworkingcapitalItiscriticalforafirmtomanageitspayables,inventory,andreceivables.*CashinflowCashcollectedforsalesmadeCashoutflowRawmaterialspurchasedCashdisbursedforrawmaterialspurchasedFinishedgoodsinventorySalesmadeAccountsreceivableperiodAccountspayableperiodXXX13TurnoverRatios-DescriptionTurnoverratiosmeasureshowmanytimesperyearagivenresourceisconsumedPeriodratiosmeasurethenumberofdaysthatistakesforagivenresourceto““turnover”Management’sobjectiveistostretchouttheaccountspayableperiod(i.e.,havelowaccountspayableturnover)andshortentheperiodsforaccountsreceivableandinventory(i.e.,havehighaccountsreceivableandinventoryturnover)Turnoverratiosmeasurehowwellafirmismanagingitsresources.14TurnoverRatios-TradeoffsRatioImprovementsDecreasethereceivablescollectionperiodi.e.,collecttheaccountsreceivablefasterDecreasetheinventoryholdingperiodi.e.,sellcompletedproductsfasterIncreasetheaccountpayableperiodi.e.,takelongertopaysuppliersStrategicTradeoffIfthereceivablescollectionperiodistooshort,customersmaybuyatacompetitorthathasmoregenerouscreditterms.(Oftenthisperiodisdictatedbyindustrynorms)Iftheinventoryholdingperiodistooshortthecompanymaynothaveenoughinventorytofillabigorder.Also,thecompanymaynotbeabletooutlastastrike,eitheratitsownfacilityoratoneofitsprimarysuppliers’’facilitiesIftheaccountspayableperiodistoolong,supplierscouldraisetheirprices,chargeinterest(oftenatveryhighrates),orevenrefusetosupplythefirmoncredit.Also,workersmaygetrestlessiftheyhavetowaitlongertoreceivetheirpaychecks.Managingturnoverratiosmeansmanagingstrategictrade-offs.15LeverageRatios-Definitions*Allthreeratiosherearecalled““leverage””ratiosbydifferentpeople,sobesuretounderstandwhichratioisbeingusedwhensomeoneistalkingaboutleverageLeverageratiosuselineitemsfromthebalancesheet.Ratios*DefinitionsDuPontleverageratioAssetsEquityDebttoequityratioLong-termdebtEquityDebttototalcapitalordebttototalassetsratioTotalliabilitiesDebt+equityTotalliabilitiesAssets=16LeverageRatios-DescriptionMoneycanberaisedfromdebtsources(banks,bondmarkets)orequitysources(stockholders)LeverageratiosreflectboththefinancingpoliciesofthefirmandtheriskinessofthebusinessInordertoanalyzeafirm’sleverageratios,oneneedstounderstandthedefinitionsofdebtandequityLeverageratiosmeasuretherespectiveclaimsofdebtandequityholders.17DebtVersusEquityContractualpaymentsoverthelifeoftheloanInvestorlegallyguaranteedfullreturnofprincipleplusinterestnothingabovethatIncaseofliquidation,debtorhaspreferentialclaimonproceedsfromsaleofassetsNoguaranteedpaymentsfromcommonstockInvestor“owns”partoffirmrighttoappreciationoffirm’svalueIncaseofliquidation,equityownertakeswhatisleft(maybenothing)Debtandequityhaveverydifferentcharacteristics.Debt=anythingthatcontractuallyrequirespaymentstobemadebeforetheequityholdershaveaccesstothefirm’searningsEquity=thevalueofthefirmleftoverafterallthedebtholdershavebeenpaidLowerrisktoinvestor;investordemandslowerreturnHigherrisktoinvestor;investordemandshigherreturn18DebtQuestions-DebtandEquityDebtinLeverageRatiosBaintypicallylooksonlyatlong-termdebt(debtwithatermof1yearormore)Accountantsmeasuredebtasshort-termdebtpluslongtermdebtEquityinLeverageRatiosBaintypicallyusesthemarketvalueofequity(I.e.,thesharepricemultipliedbythenumberofshares).Othersmayusethebookvalueofequity,whichistheamountshownonthebalancesheet19DebtQuestionsAccountspayable ?Short-termdebt?Long-termdebt?Cancelableleases ?Noncancelableleases?Preferredstock?Commonstock ?Deferredtax ?Wouldyoudefinethefollowingasdebt?20DebtAnswersAccountspayableShort-termdebtLong-termdebtCancelableleasesNoncancelableleasesSomeitemsareclearlydebt,othersareclearlynotdebt,stillothersaredebatable.Notdebt.Itispartofworkingcapital,andis“secured”bytheinventoryandreceivablesthatitisusedtofinanceDebt,ifitusedtofinancecapitalexpansionsofthecompanyNotdebt,ifitusedtofinanceworkingcapitalDebt.Notdebt.Becausetheyarecancelable,theyarenotcontractualobligationsDebt.Becausetheyarenon-cancelable,theyarecontractualobligations.(ForallpubliclytradedUScompanies,thepresentvalueofallthenoncancelableleasepaymentsmustbedisclosedinbalancesheetfootnotes.)DebatableArgumentforequity-contractualobligationstopaydividendsonpreferredstockaremetafterdebtholders’claimsaremetArgumentfordebt-thereisacontractualobligationtopaydividendsonpreferredstockbeforecommonstockdividendpaymentscanbemadeNotdebt.ItisequityCommonstockDebt,butdebatable.Oftenconsidereddebtgivenlong-termnatureDeferredtaxPreferredstock21LiquidityandCoverageRatios-DefinitionsLiquidityratiosuselineitemsfromthebalancesheet.Coverageratiosuselineitemsfromtheincomestatement.RatiosDefinitionsCurrentratioCurrentassetsCurrentliabilitiesQuickratio(acidtest)Cash+marketablesecurities+receivablesCurrentliabilitiesInterestcoverageratioEarningsbeforeinterestandtaxesInterestexpenseFixedchargecoverageEarningsbeforeinterestandtaxesAllessentialpayments(includingleasepayments)Liquidity:Coverage:22LiquidityandCoverageRatios-DescriptionAcceptablevaluesfortheseratiosdifferbyindustry.However,whenthecurrentratioorcoverageratiosfallbelow1thatmeansthefirmisunabletomeetitsobligationsItisausefulexercisetocalculatehowmuchrevenuecoulddrop(orcostsrise)beforecoveragewoulddropbelow1Liquidityratiosmeasurethefirm’sabilitytomeetitsshort-termobligations.Coverageratiosmeasurethefirm’sabilitytomeetitslong-termobligations.23AgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeaways24ReturnonEquityReturnonequityisdefinedasprofitaftertax(earnings)dividedbyequity.Itrelateseconomicoutputs(profit)toinputs(equity).Ittellsustheamountofprofitsthecompanyearnedoneachdollarthestockholdersinvestedinthefirm.Itisimportanttonotethatnotalloftheearningsarepaidtothestockholderswhentheyareearned.Onlysomeportionoftheearningswillbereturnednowintheformofdividends.Theremainder(retainedearnings)willbere-investedinthecompanytofinancegrowthThesizeofthedividedisdecidedbytheboardofdirectors;anindividualstockholderhasnoinfluenceoverwhenhe/sheactuallyreceivesthereturnthathe/shehasearnedItisacombinationofprofitability,turnover,andleverageratiosReturnonequity,ROE,istheacidtestofsuccessforabusiness.25DuPontFormulaByseparatingROEintoitscomponents,onecangaininsightintohowtoimprovetheperformanceofabusiness.ROE=ProfitaftertaxEquityROE=ProfitaftertaxSalesSalesAssetsAssetsEquityXXReturnonAssetsLeverageROSAssetturnoverThisisknownastheDuPontformulaROE=ProfitabilityXTurnoverXLeverage26AgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeaways27UnidentifiedIndustriesExerciseTheobjectiveofthisexerciseistotestyourunderstandingoffinancialratios.Exercise:Thebalancesheets(inpercentageform)andselectedratiosforsixindustriesaregivenonthefollowingpage.PleasematcheachofthesixindustriestothefinancialinformationCoalminingGrocerystoresHotelsandmotelsLegalservicesPackagedsoftwarePotatochipsandsnacks28UnidentifiedIndustriesExercise-DataIndustryBalanceSheet(%)ABCDEF*Ratiosdonottietobalancesheetitemsbecausetheywerecalculatedusingaslightlydifferentdataset.**ThisisNOTinventoryturns.InventoryturnswouldbeCOGStoinventory.***SalestoassetsSource:"IndustryNormsKeyBusinessRatios,"Dun&BradstreetCashAccountsreceivableNotesreceivableInventoryOthercurrentTotalcurrentassetsFixedassetsOthernon-currentassetsTotalassetsAccountspayableBankloansNotespayableOthercurrentliabilitiesTotalcurrentliabilitiesOtherlong-termliabilitiesDeferredcreditsNetworthTotalliabilities&networthRatios*Quickratio(times)Currentratio(times)Totalliabilitiestonetworth(%)Collectionperiod(days)Salestoinventory(times)**Assetsturns***(times)Grossmargin(%)Returnonsales(%)Returnonassets(%)Returnonequity(%)

9.8%4.00.61.44.620.465.114.5

100.0%3.60.12.411.817.944.60.337.2

100.0%0.7x1.2x127%9.1days78.5x0.7x64%7%5%14%

9.3%21.20.22.02.735.451.712.9100.0%15.23.315.133.625.540.9

100.0%0.9x1.1x87%52.2days7.9x1.9x38%3%7%16%

4.8%28.614.64.552.535.112.4

100.0%15.40.40.414.030.217.51.750.6

100.0%1.6x2.5x62%30.9days23.7x2.9x29%2%5%7%

14.1%5.30.932.63.956.830.412.8

100.0%15.70.23.011.630.522.00.347.2100.0%0.6x1.9x93%2.6days19.0x5.0x22%1%6%13%

31.0%18.80.80.713.965.226.08.8

100.0%4.00.44.826.335.510.81.252.5

100.0%1.4x1.9x67%51.8days63.1x4.0x57%12%20%29%

22.1%32.20.54.78.568.018.613.4100.0%10.60.22.023.336.110.31.652.0

100.0%1.5x2.0x74%65.3days39.9x1.9x59%6%10%19%29UnidentifiedIndustriesExercise-AnswerCharacteristics:Financialratios:Companies:HotelsandMotelsVeryhighfixedassetsLowinventoryShortcollectionperiodLowassetturnoverHighgrossmarginHighleverageFixedassets=65%Inventory=1%Collectionperiod=9daysAssetturns=0.7xGrossmargin=64%Totalliabilitiestonetworth=127%ACoalMiningVeryhighfixedassetsLowinventoryLongcollectionperiodFixedassets=52%Inventory=2%Collectionperiod=52daysBPotatoChips&SnacksLowpercentageofcashLongcollectioncycleCash=5%Collection=31daysCGroceryStoresHighpercentageofcashLowaccountsreceivableShortcollectionperiodHighinventoryGoodliquidityratiosCash=14%Accountsreceivable=5%Collectionperiod=3daysInventory=33%Quickratio=0.6x;currentratio=1.9xDLegalServicesHighpercentageofcashAlmostzeroinventoryHighassetturnoverHighprofitabilityLongcollectionperiodCash=31%Inventory=1%Assetsturns=4.0xGrossmargin=57%;ROS=12%;ROE=29%Collectionperiod=52daysEPrepackagedSoftwareHighpercentageofcashHighaccountsreceivableLowinventoryHighgrossmarginLowfixedassetsSignificantintangibleassets(patents)Cash=22%Accountsreceivable=32%Inventory=5%Grossmargin=59%Fixedassets=19%Othernon-currentassets=13.4%F30GilletteExerciseExercise:PleasecalculateGilletteCompany’’skeyfinancialratiosbasedonits1996annualreportProfitabilityTurnoverLeverageLiquidityandcoverageTheobjectiveofthisexerciseistotestyourabilitytocalculatekeyfinancialratios.Note:Forthisexercise,donotincludemerger-relatedcostsinthecalculations.31GilletteExercise-ProfitabilityRatios*Thisisnotaprofitabilityratio,butitdoesimpactROS**Excludingmerger-relatedcosts.Non-operatingchargesshouldnotbeincludedintheoperatingprofitmargin.RatiosGilletteRatioCalculationsGrossprofitmargin(orgrossmargin)Sales-costofgoodssoldSalesOperatingprofitmargin(oroperatingmargin)Earningsbeforeinterestandtaxes**SalesReturnonsales(ROS)Profitaftertax**SalesEffectivetaxrate*TaxesProfitbeforetax6,016.09,697.7==62%2,049.39,697.7==21.1%1,231.79,697.7==12.7%576.31,525.0==37.8%(p.24)(p.24)(p.24,p.27)(p.24)PageNumberin1996AnnualReport1,636.3+413.09,697.7=948.7+283.09,697.7=32GilletteExercise-TurnoverRatiosNote:Average=(YearBeginning+YearEnd)/2*Salesisoftenagoodproxy**CostofgoodssoldisoftenagoodproxyRatiosGilletteRatioCalculationsReceivablesturnoverCreditsalesinperiod*Accountsreceivableaveragebalance9,697.7(2,724.6+2,290.8)/2==3.87(p.24,p.25)or3653.87=94daysInventoryturnoverCostofgoodssoldinperiodAverageinventoryinperiod3,681.7(1,358.2+1,267.6)/2=2.80(p.24,p.25)or3652.80=130days=PayablesturnoverPurchasesonaccount**Accountspayableaveragebalance3,681.7(547.3+498.0)/2=7.04(p.24,p.29)or3657.04=52days=3651.00AssetturnoverSalesinperiodAverageassets9,697.7(10,435.3+8,940.1)/2=1.00(p.24,p.25)or=365days=PageNumberin1996AnnualReport33GilletteExercise-LeverageRatios*Allthreeratiosherearecalled““leverage””ratiosbydifferentpeople,sobesuretounderstandwhichratioisbeingusedwhensomeoneistalkingaboutleverage.**Theinclusionofdeferredincometaxesinlong-termdebtisdebatable.Ratios*GilletteRatioCalculationsDuPontleverageratioAssetsEquityDebttoequityratioLong-termdebt**EquityDebttototalcapitalordebttototalassetsratio10,435.34,490.9==2.32(p.25)14.5+1,490.4+298.94,490.9==0.40(p.25)5,944.410,435.3==0.57(p.25)PageNumberin1996AnnualReport1,803.84,490.9=TotalliabilitiesDebt+equityTotalliabilitiesAssets=34GilletteExercise-LiquidityandCoverageRatiosRatiosGilletteRatioCalculationsCurrentratioCurrentassetsCurrentliabilitiesQuickratio(acidtest)Cash+marketablesecurities+receivablesCurrentliabilitiesInterestcoverageratioEarningsbeforeinterestandtaxes*InterestexpenseFixedchargecoverageEarningsbeforeinterestandtaxes*Allessentialpayments(includingleasepayments)Liquidity:Coverage:4,753.22,934.7==1.62(p.25)76.9+7.0+2,724.62,934.7==0.96(p.25)2,049.3-44.476.8-9.9==29.97(p.24)2,049.3-44.4(76.8-9.9)+93.0==12.54(p.24,p.31)PageNumberin1996AnnualReport*”Othercharges-net”undernon-operatingchargeshavebeenincludedherebecausetheyappeartoberecurringandthuswillimpactthecompany’sabilitytomakeitsinterestpayments.35AgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeaways36ForecastingExercise-Data*FinancialstatementshavebeenconstructedforthisexercisebasedinpartonTheGilletteCompany’s1996AnnualReport.Sincethedatahavebeenchangedsignificantly,youshouldnotusethemtoanalyzeGillette’sfinancialperformance.Forthisexercise,assumethathistoricaldataisagoodindicatorof1997financials.** Networkingcapitalinyear1994is$854million***CumulativeCAPEXattheendof1994is$3,139millionTheNewEnglandRazorCompanyStatementofOperations($Millions)Revenues-COGS=Grossprofit-SG&A=EBIT-Taxes=NetincomeWorkingCapitalBalanceSheet(yearend)($Millions)Accountsreceivable+Inventory-Accountspayable=Networkingcapital**CashFlowStatement($Millions)EBIT+Depreciation-Increaseinworkingcapital-Taxespaid-Capitalexpenditure***=Cashflow1995$8,834(6,769)2,065(266)1,799667$1,132$2,291269(1,610)$950$1,799266(96)(667)(593)$7091996$9,698(7,356)2,342(293)2,049(760)$1,289$2,725309(1,965)$1,069$2,049293(119)(760)(729)$7341997AssumptionsUsingabbreviatedfinancialstatementsforTheNewEnglandRazorCompanyin1995and1996,forecastthestatementsfor1997.*37ForecastingExercise-AnswerTheNewEnglandRazorCompanyStatementofOperations($Millions)Revenues-COGS=Grossprofit-SG&A=EBIT-Taxes=NetincomeWorkingCapitalBalanceSheet(yearend)($Millions)Accountsreceivable+Inventory-Accountspayable=NetworkingcapitalCashFlowStatement($millions)EBIT+Depreciation-Increaseinworkingcapital-Taxespaid-Capitalexpenditure=Cashflow1995$8,834(6,769)2,065(266)1,799(667)$1,132$2,291269(1,610)$950$1,799266(96)(667)(593)$7091996$9,698(7,356)2,342(293)2,049(760)$1,289$2,725309(1,965)$1,069$2,049293(119)(760)(729)$7341997Assumptions$10,668(8,129)2,539(320)2,219(823)$1,396$2,891333(2,057)$1,167$2,219358(98)(823)(763)$89310%annualgrowth76.2%ofsales3.0%ofsales37.1%effectivetaxrate27.1%ofsales4.1%ofCOGS25.3%ofCOGS6.5%ofsalesin1998$11,73519987.4%ofcumulativeCAPEX38ForecastingExercise-Assumptions(p.1)Assumptionsshouldbemadebasedonthecompany’shistoricalfinancialdata,aswellasyourjudgmentregardingfuturetrends.LineItemAssumptions(Rationale)AlternativemethodofmakingassumptionRevenuegrowthHistoricalgrowthrateof10%(Historicalratejudgedtobeagoodpredictoroffuturerate)IndustryforecastedgrowthrateCOGSAverageratioofCOGS/Salesin1995and1996(COGSisdirectlyrelatedtosales)EstimatefixedandvariableportionsofCOGSandthenapplyratioofvariablecosttosalestothesaleforecastPotentialimprovementofcoststructurecouldalsobeconsideredDepreciationAverageratioofdepreciationtocumulativeCAPEX(DepreciationisbasedoncumulativeCAPEX)EstimatetheaveragelifeofthePPEassetsandcalculatedepreciationbasedontheassetlivesTaxesHistoricaleffectivetaxrateof37.1%isused39ForecastingExercise-Assumptions(p.2)AccountsreceivableAverageratioofA/Rtosales(A/Risdirectlyrelatedtosales)EstimatenumberofdaysofsalesInventoryAverageratioofinventorytoCOGS(InventoryismorerelatedtoCOGSthantosales)EstimatenumberofdaysofinventoryAccountspayableAverageratioofA/PtoCOGS(A/Pisthemoneypayabletosuppliers,thereforeitismorerelatedtoCOGSthantosales)EstimatenumberofdaysofCOGSCapitalexpenditureAverageratioofCAPEXtonextyear’ssales(Inagrowingbusiness,thecompanyshouldkeepcapitalspendinginlinewithitssalesprojection)AssumenetPPEhasconstantrelationwithsalesgrowth,andthenplugCAPEXLineItemAssumptions(Rationale)Alternativemethodofmakingassumption40ForecastingExercise-DetailedAnswer*(Yearbeginning+Yearend)/2TheNewEnglandRazorCompanyStatementofOperationsRevenue1997:Revenue1996x1.1=9,698x1.1=10,668Revenue1998:Revenue1997x1.1=10,668x1.1=11,735(Revenue1998isneededtocalculateCAPEXlater)COGS1997:Revenue1997x0.762=10,668x0.762=8,129Grossprofit:10,668-8,129=2,539SG&A:10,668x0.03=320EBIT:Grossprofit-SG&A=2,539-320=2,219Taxes:EBITxeffectivetaxrate=2,219x37.1%=823NetIncome:EBIT-taxes=2,219-823=1,39619941995 1996 1997CumulativeCAPEX(yearend)$3,139 $3,732 $4,461$5,224AveragecumulativeCAPEX* $3,436 $4,097$4,843Depreciationas%ofaveragecum.CAPEX7.7% 7.2% 7.4%Depreciation:AveragecumulativeCAPEXin1997x7.4%=4,843x0.074=358Accountreceivable:Salesx27.1%=10,668x0.271=2,891Inventory:COGSx4.1%=8,129x0.041=333Accountpayable:COGSx25.3%=8,129x0.253=2,057Networkingcapital:A/R+inventory-A/P=2,891+333-2,057=1,167WorkingCapitalBalanceSheetCashFlowStatementEBIT:2,219Depreciation:358Increaseinworkingcapital:(NWC)1997-(NWC)1996=1,167-1,069=98Taxespaid:823Capitalexpenditure:Salesin1998x6.5%=11,735x0.065=763Cashflow:EBIT+depreciation-increaseinworkingcapital-taxespaid-CAPEX=89341AgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeaways42AbbreviationsA/P= AccountspayableA/R= AccountsreceivableCAPEX =CapitalexpendituresCOGS=CostofgoodssoldEBIT= EarningsbeforeinterestandtaxesNWC= NetworkingcapitalPAT= ProfitaftertaxPBT= ProfitbeforetaxPPE= Property,plant,andequipmentROA= ReturnonassetsROE= ReturnonequityROS= ReturnonsalesSG&A= Selling,general,andadministrativeWC =Workingcapital43AgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeaways44KeyTakeawaysRatioshelponeunderstandhowwellacompanyisperforming.Specifically,howmuchreturnisitgeneratingwithwhatlevelofrisk?Ratiosinisolationaremeaningless.Acompany’sratiosmustbeexaminedovertimeand/oragainstcompetitors’ratiosRatioanalysisisbothanartandascienceRatioanalysisrequireskeenjudgmentThefivemajorcategoriesofratiosandthequestionstheyanswerare:TypeQuestionProfitability Howwelldoesthecompanymanagecostsrelativetorevenues?TurnoverHoweffectiveisthecompanyinmanagingitsresources?LeverageWhataretherespectiveclaimsofdebtandequityowners?Howriskyisthebusiness?Liquidity Isthecompanyabletomeetitsshort-termobligations?CoverageIsthecompanyabletomeetitslong-termobligations?ROEcanbewrittenas:Returnonequityistheacidtestofsuccessforabusiness.IttellustheamountofprofitsthecompanyearnedoneachdollarthestockholdersinvestedROE=ProfitaftertaxSalesSalesAssetsAssetsEquityXX=ProfitaftertaxEquityROE=ProfitabilityTurnoverLeverageXX45TakeawaySlides(1of3)TypesofRatiosProfitabilityRatiosTurnoverRatiosLeverageRatiosHowwelldoesthecompanymanagecostsrelativetorevenues?ReturnRiskCoverageInterestchargeFixedchargecoverageLiquidityCurrentratioOutsideratioLeverageAssettoequityDebttoequityDebttototalcapitalTurnoverReceivablesInventoryPayablesAssetProfitabilityOperatingmarginROSGrossmarginHoweffectiveisthecompanyinmanagingitsresources?Whataretherespectiveclaimsofdebtandequityowners?Howriskyisthebusiness?Isthecompanyabletomeetitsshort-termobligations?Isthecompanyabletomeetitslong-termobligations?RatiosDefinitionsReceivablesturnoverCreditsalesinperiodAccountsreceivableaveragebalanceInventoryturnoverCostofg