Embed Size (px)
Citation preview
Finance 206 Evaluating a firm’s Financial Performance
Finance 206 Evaluating a firm’s Financial Performance
How Liquid is the Firm?
Are the firm’s managers generating adequate operating profits on the firm’s assets?
How is the firm financing its assets?
Are the firm’s managers creating shareholders value?
Table 4-1 Income Statement for Davies Inc. Ending Dec 31, 2007 ($ millions))
Sales 600Cost of Goods Sold 460Gross Profit 140
Operating expenses Selling expenses $ 20 General and administrative exp 15 Depreciation exp. 30
Total operating expenses $ 65
Operating Income (EBIT) 75
Interest 15Earnings before Taxes 60Income Taxes 18
Net Income 42
Number of Common Shares outstanding 20Earnings per share (EPS) 2.10Dividends per share (EPS) 0.50
Table 4-1 Balance Sheet for Davies Inc. Ending Dec 31, 2007 ($ millions)
ASSETS_____________________________________________Cash $ 20Accounts receivable 36Inventories 84Other Current Assets 3
Total Current Assets 143
Gross Fixed Assets $ 410Accumulated depreciation (115)Net Fixed Assets 295Total Assets 438
DEBT AND EQUITY______________________________________________Accounts Payable 42Accrued Expenses 10Short-term notes 12Total current liabilities 64Long-term debt 171
Total Liabilities 235
EQUITY______________________________________________Common Stockholder’s Equity Common-Stock per value 11Paid-in Capital 75Retained earnings 117Total Common Equity 203Total Liabilities and Equity 438
Let us look at the balance sheet and compare the firm’s “liquid“ assets (current assets) to short-term) liabilities. CURRENT RATIO:
Current assets Current ratio = ____________
Current Liabilities
143 M Current ratio = ____________ = 2.23
64 M
Based on the current ratio, Davies, Inc. is more liquid than the average firm in the peer group. The company has $2.23 in current assets for every $1 in short-term debt, compared to a peer-group ratio of $1.80The measurement of liquidity is a measurement for the future. The best numbers are between 1.5 and 2. When the number is too much above the value of 2 it indicates the firm may be holding on two much cash. If less than 1.5 it may not be able to pay its upcoming bills in the next 12 months.
Table 4-1 Balance Sheet for Davies Inc. Ending Dec 31, 2007 ($ millions)
ASSETS_____________________________________________Cash $ 20Accounts receivable 36Inventories 84Other Current Assets 3
Total Current Assets 143
Gross Fixed Assets $ 410Accumulated depreciation (115)Net Fixed Assets 295Total Assets 438
DEBT AND EQUITY______________________________________________Accounts Payable 42Accrued Expenses 10Short-term notes 12Total current liabilities 64Long-term debt 171
Total Liabilities 235
EQUITY______________________________________________Common Stockholder’s Equity Common-Stock per value 11Paid-in Capital 75Retained earnings 117Total Common Equity 203Total Liabilities and Equity 438
Cash + Accounts Receivable Acid-test ratio = ________________________
Current Liabilities
20 M + 36 M acid-test ratio = ____________ = 0.88
64 M
Peer group acid-test ratio 0.94
Based on the acid-test, Davies Inc. appears to be slightly less liquid. It has $0.88 in cash and accounts receivable per $1 in current debt, compared to $0.94 for the average company in the peer group.This value should be about the number 1 range, otherwise a cash flow problem could arise.
Table 4-1 Balance Sheet for Davies Inc. Ending Dec 31, 2007 ($ millions)
ASSETS_____________________________________________Cash $ 20Accounts receivable 36Inventories 84Other Current Assets 3
Total Current Assets 143
Gross Fixed Assets $ 410Accumulated depreciation (115)Net Fixed Assets 295Total Assets 438
DEBT AND EQUITY______________________________________________Accounts Payable 42Accrued Expenses 10Short-term notes 12Total current liabilities 64Long-term debt 171
Total Liabilities 235
EQUITY______________________________________________Common Stockholder’s Equity Common-Stock per value 11Paid-in Capital 75Retained earnings 117Total Common Equity 203Total Liabilities and Equity 438
How long does it take to convert the firm’s receivables into cash?
We can answer this by computing a firm’s sales outstanding, or its average collection period.
Average Collection period = Accounts receiable _________________
annual credit sales/365
Average Collection period = 36 M _________________
600 M/365
Average Collection period = 36 M __________________
1.64M/day
= 21.95 Days
21.95 days Davies Inc. collects accounts receiable compared to 25 days for the peer group,, which suggests the firm’s is more liquid than those of competing firms.
Table 4-1 Balance Sheet for Davies Inc. Ending Dec 31, 2007 ($ millions)
ASSETS_____________________________________________Cash $ 20Accounts receivable 36Inventories 84Other Current Assets 3
Total Current Assets 143
Gross Fixed Assets $ 410Accumulated depreciation (115)Net Fixed Assets 295Total Assets 438
INCOME STATEMENT
Table 4-1 Income Statement for Davies Inc. Ending Dec 31, 2007
Sales 600Cost of Goods Sold 460Gross Profit 140
How many times are Account Receivable are “rolled over” during the year, using the account receivable turnover ratio.
Average receiable turnover = Annual credit sales _________________
Accounts receivable
Average receiable turnover = 600 M _________________
36 M
= 16.67 Days
Peer group accounts receivable turnover 14.60 X
Davies Inc, collects accounts receivable more quickly than its competing firms. [This ratio depends on the type of business is being measured. It is best to compare the inventory turnover for several years and it will be best to see this number increase each year.]
Table 4-1 Balance Sheet for Davies Inc. Ending Dec 31, 2007 ($ millions)
ASSETS_____________________________________________Cash $ 20Accounts receivable 36Inventories 84Other Current Assets 3
Total Current Assets 143
Gross Fixed Assets $ 410Accumulated depreciation (115)Net Fixed Assets 295Total Assets 438
INCOME STATEMENT
Table 4-1 Income Statement for Davies Inc. Ending Dec 31, 2007
Sales 600Cost of Goods Sold 460Gross Profit 140
Operating profits is the income generated from the firm’s assets without regard to how they the assets are financed. Lets examine level of operating profits relative to the firm’s total assets we use the operating return on assets (OROA).
Operating return on assets = Operating Profits _________________
total assets
Operating return on assets = 75 M _________________
438 M
= 0.171 = 17.1 %
Peer group operating return on assets 17.8%
Davies Inc. is earning a slightly lower return on the assets relative to the peer group of 17.8 %. This value indicates that Davis Inc. earned 17.1 cents per $1 dollar of assets.
Income Statement Table 4-1 Davies Inc.
Operating Income (EBIT) 75 M
Table 4-2 Balance Sheet Davies Inc.
Total Assets 438 M
