RATIO ANALYSIS-OVERVIEW Ratios

RATIO ANALYSIS-OVERVIEW

Ratios:

1. Provide a method of standardization

2. More important - provide a profile of firm¡¯s economic characteristics and

competitive strategies.

?

Although extremely valuable as analytical tools, financial ratios also have

limitations. They can serve as screening devices , indicate areas of

potential strength or weakness, and reveal matters that need further

investigation.

?

Should be used in combinations with other elements of financial

analysis.

?

There is no one definitive set of key ratios; there is no uniform definition

for all ratios; and there is no standard that should be met for each ratio.

?

There are no "rules of thumb" that apply to the interpretation of financial

ratios.

Caveats:

? economic assumptions - linearity assumption

? benchmark

? manipulation - timing

accounting methods

? negative numbers

Ratios - 1

Common Size Financial Statements

Differences in firm size may confound cross sectional and time series

analyses. To overcome this problem, common size statements are used.

A common size balance sheet expresses each item on the balance

sheet as a percentage of total assets

A common size income statement expresses each income statement

category as a percentage of total sales revenues

Sales

1

$ 101,840

2

$ 109,876

3

$ 115,609

4

$ 126,974

COGS

$ 78,417

$ 83,506

$ 85,551

$ 93,326

SG&A

$ 20,368

$ 24,722

$ 27,168

$ 31,109

PROFIT

$

$

$

$

3,055

1

1,648

2,890

2

3

2,539

4

Sales

100.0%

100.0%

100.0%

100.0%

COGS

77.0%

76.0%

74.0%

73.5%

SG&A

20.0%

22.5%

23.5%

24.5%

PROFIT

3.00%

1.50%

2.50%

2.00%

1

2

3

4

Sales

100%

108%

114%

125%

COGS

100%

106%

109%

119%

SG&A

100%

121%

133%

153%

PROFIT

100%

54%

95%

83%

Ratios - 2

Problem 4-8

A. Aerospace

B. Airline

C. Chemicals & Drugs

D. Computer Software

E. Consumer Foods

F. Department Stores

Common size statements

Balance Sheet

Company

1

Cash and short-term

investments

Receivables

Inventory

Other current assets

Current assets

G. Consumer Finance

H. Newspaper Publishing

I. Electric Utility

2

3

4

5

6

7

8

9

2%

17

15

6

40 %

13 %

8

52

73 %

37 %

22

15

5

79 %

1%

28

23

1

53 %

1%

23

14

4

42 %

3%

5

2

2

12 %

1%

11

2

2

16 %

22 %

16

1

39 %

6%

8

5

19 %

26

44

63

Gross property

Less: Accumulated

depreciation

Net property

86

40

(50)

36 %

(19)

21 %

(8)

18 %

(15)

29 %

(23)

40 %

(45)

67 %

Investments

Intangibles and other

Total assets

3

21

100 %

1

5

100 %

3

100 %

18

100 %

3

15

100 %

11

4

9

24 %

21

43

64 %

22

3

25 %

13

6

19 %

20

16

60 %

40

100 %

5

69 %

31

100 %

12

1

38 %

62

100 %

Income statement

Company

1

2

Revenues

100 %

Trade payables

Debt payable

Other current liabilities

Current liabilities

Long-term debt

Other liabilities

Total liabilities

Equity

Total liabilities & equity

Cost of goods sold

Operating expenses

Research % development

Advertising

Operating income

Net interest expense

112

65

1

106

(28)

37 %

1%

(34)

72 %

14

7

100 %

16

31

100 %

55

5

100 %

9

100 %

26

4

1

31 %

7

6

4

17 %

11

2

1

14 %

46

16

62 %

20

4

8

32 %

27

21

67 %

33

100 %

23

16

70 %

30

100 %

34

12

63 %

37

100 %

24

13

51 %

49

100 %

27

5

94 %

6

100 %

21

12

65 %

35

100 %

3

4

5

6

7

8

9

100 %

100 %

100 %

100 %

100 %

100 %

100 %

100 %

58

21

7

3

11 %

1

81

7

5

7%

(1)

58

24

9

3

6%

-

63

28

2

7%

2

52

33

1

5

9%

2

84

16 %

6

59

29

12 %

3

55

45 %

41

91

2

7%

1

10 %

8%

6%

5%

7%

10 %

9%

4%

6%

Income from continuing

operations before tax

Asset turnover ratio

0.96

1.12

0.94

1.38

Ratios - 3

1.82

0.45

0.96

0.15

0.96

Four categories of ratios to be covered are:

1 . Activity ratios - the liquidity of specific assets and the efficiency of

managing assets

2.

Liquidity ratios - firm's ability to meet cash needs as they arise;

3.

Debt and Solvency ratios - the extent of a firm's financing with

debt relative to equity and its ability to cover fixed charges; and

4.

Profitability ratios - the overall performance of the firm and its

efficiency in managing investment (assets, equity, capital)

These categories are not distinct as we shall see

activity -------> liquidity

activity ---------> profitability

solvency profitability

Ratios - 4

A.

ACTIVITY RATIOS: ASSET MANAGEMENT & EFFICIENCY

1. Short-term (operating) activity ratios:

Inventory Turnover Ratio (COGS)/(Average inventory)

Measures the efficiency of the firm in managing and selling inventory.

Inventory does not languish on shelves. High ratio represent fewer

funds tied up in inventories -- efficient management. High inventory

can also represent understocking and lost orders. Low turnover can

also represent legitimate reasons such as preparing for a strike,

increased demand, etc. Ratio depends on industry -perishable goods

etc.)

Average # of days inventory in stock = 365 / (Inventory Turnover Ratio)

Receivable Turnover Ratio Sales/(Average receivable)

How many times receivables are turned into cash Relatively low turnover may

indicate inefficiency, cutback in demand, or earnings manipulations.

Average # of days receivable are outstanding = 365/(Receivable

Turnover)

(When available, the figure for credit sales can be substituted for net sales

since credit sales produce the receivables.)

Provides information about the firm's credit policy.

Should be

compared with the firm's stated policy (i.e., if firm policy is 30 days and

average collection period is 60 days, company is not stringent in

collection effort.)

High/low relative to the industry should be examined (i.e., low might

indicate loss sales to competitors).

Low turnover ratios may imply

? firm¡¯s income overstated

? future production cutbacks

? future liquidity problems

Ratios - 5

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download