Upload
faizan-sheikh
View
223
Download
0
Embed Size (px)
Citation preview
8/8/2019 Financial Ratio Analysis Chap 2_2
1/40
Financial RatioFinancial Ratio
AnalysisAnalysis
Brief Revision/ OverviewBrief Revision/ Overview
of Financial Statementsof Financial Statements
Liquidity RatiosLiquidity RatiosLeverage RatiosLeverage Ratios
Efficiency RatiosEfficiency Ratios
Profitability RatiosProfitability RatiosEquity RatiosEquity Ratios
8/8/2019 Financial Ratio Analysis Chap 2_2
2/40
Brief Revision/ Overviewof Financial Statements
Useful to the Firms Managers inManaging the Firm
Provide Information to Present &Potential Creditors, Lenders,Investors & Other InterestedParties
End Result of the process ofrecording, classifying &Summarizing firms transactions.
8/8/2019 Financial Ratio Analysis Chap 2_2
3/40
Balance Sheet
A Statement of Firms Financial Position ata Specific Point in time
Income Statement
A Statement Summarizing theFirms Revenues & Expenses OverAn Accounting Period, generally a
Quarter or a Year.
8/8/2019 Financial Ratio Analysis Chap 2_2
4/40
Balance Sheet & Income Statements are impFinancial Statements however they do not provideanswers to Qs Such as
Does the Firm have too much inventory on hand ? Is the firm too Debt heavy ?
Is the firm well managed ?
To seek answers the financial Mgr or Analystcombines & transforms selective B/S & I/S items to
calculate ratios & Compare them to similar ratiosfor the industry & for other firms in the Industry
Facilitates Evaluation of Financial Statements
8/8/2019 Financial Ratio Analysis Chap 2_2
5/40
Financial Ratios
Liquidity RatiosLiquidity Ratios
Leverage RatiosLeverage Ratios
Efficiency RatiosEfficiency Ratios
Profitability RatiosProfitability Ratios
Equity RatiosEquity Ratios
8/8/2019 Financial Ratio Analysis Chap 2_2
6/40
Liquidity Ratios
Measures the Ability of the Firmto Meet its Short term Financial
Obligations
Show The Relationship of a Firms
Cash & Other Current Assets toits Current Liabilities
8/8/2019 Financial Ratio Analysis Chap 2_2
7/40
Current RatioBest Indicator of the extent to which the
claims of short term creditors (currentliabilities) are covered by assets expected tobe converted to cash in near future.
Well managed firms are above Industry
Average while good firms are below it. If a firms ratios are far removed from the Avg.
of its Industry , an analyst should beconcerned about why this variance occurs.
A deviation from Industry Avg. should signal
the analyst (or management) to check further.
8/8/2019 Financial Ratio Analysis Chap 2_2
8/40
Quick Ratio
The ratio is same as Current Ratioexcept that it excludes inventories,presumably the least liquid portion
of current assets.Measures the firms ability to pay off
short term obligations without
relaying on sale of its inventoriesThe ratio provides a more
penetrating measure of liquiditythan does the current ratio.
8/8/2019 Financial Ratio Analysis Chap 2_2
9/40
Debt Financing/ FinancialLeverage
Three Implications By Raising Funds through Debt,
Stockholders can maintain control of thefirm without increasing their investment.
Creditors look to the Equity, or OwnSupplied Fund, to provide a Margin ofSafety, so the higher the proportion of totalcapital provided by stockholders, the lessthe Risk faced by creditors
Firm earns more on Inv Financed withborrowed funds than it pays in interest, thereturn on the owners capital is magnifiedor leveraged
8/8/2019 Financial Ratio Analysis Chap 2_2
10/40
Leverage Ratios
Accomplishes Two Goals Measure Of The Extent to Which Firms Finance
their Assets through Debt
Indicators of Financial Risk of the Firm
Leverage as a Debt Financing Indicator is Imp b/cWhenever a Firms Rate of Return is in Access ofInterest Rate, the Profits to Equity Inv areMagnified in Direct Proportions to Increases inLeverage.
8/8/2019 Financial Ratio Analysis Chap 2_2
11/40
Leverage Ratios
On the Contrary, Whenever a FirmsRate of Return falls below InterestRate, the Profits to Inv Decline with
increases in Leverage. If the Firm is sufficiently levered,
interest expense may be so high thatunder advance economic conditions
the firm may not be capable of payingthem i.e. financial risk is directlyproportional to leverage.
8/8/2019 Financial Ratio Analysis Chap 2_2
12/40
Leverage Ratios
Firms with relatively high debt ratios havehigher expected returns when the economy isnormal, but they are exposed to risk of losswhen the economy goes in to a recession.
Therefore, decisions about the use of debtrequire firms to balance higher expectedreturns against increased risk.
Ratios varies according to the nature ofbusiness & the volatility of cash flows.
8/8/2019 Financial Ratio Analysis Chap 2_2
13/40
Leverage Ratios
Total Debt to Total Asset Ratio
Times Interest Earned
Funded Capital to Net WorkingCapital
8/8/2019 Financial Ratio Analysis Chap 2_2
14/40
Total Debt to Total AssetRatio
Also Known as Debt RatioDebt Ratio = Total Liab/Total
Assets
Creditors Prefer Low Debt Ratiosb/c lower the ratio, the greater thecushion against creditors losses inthe event of Liquidation
On the Contrary, Stockholders maywant more Leverage coz itmagnifies expected earnings.
8/8/2019 Financial Ratio Analysis Chap 2_2
15/40
Total Debt to Total AssetRatio
A debt Ratio of 53.2 % reflects thatcreditors have supplied for more thanhalf of the total financing
For Companies having such high debt
ratios, it is imp that they should raisemore equity capital before borrowingadditional funds.
Creditors may be reluctant to lend
money to such firms & Mgmt would besubjecting the firm to the risk ofbankruptcy if it increased the Debt Ratioby Borrowing Additional Funds
8/8/2019 Financial Ratio Analysis Chap 2_2
16/40
Times Interest Earned
EBIT/Interest Charges
Ratio measures the extent towhich the firm is capable ofservicing its interest expense fromfunds available from Operations.
Ratio measures the extent to
which the Income can declinebefore the firm is unable to meetits annual interest costs.
8/8/2019 Financial Ratio Analysis Chap 2_2
17/40
Times Interest Earned
As a Rule, a value of at least 3.0 &Preferably closer to 5 is suggested.
Suppose Firms EBIT is $ 418000 &Interest Expenses amount to $ 93,000,
then the Ratio comes to around 4.5If the firms EBIT Shrinks by 78%,the
firm would still be able to pay interest itowns.
Thus it is a good margin of safety.
8/8/2019 Financial Ratio Analysis Chap 2_2
18/40
Funded Debtto Net Working Capital
Funded Debt is defined as Debtwith a Maturity of more than 1
Year that includes Bonds,
Debentures, Term Loans &Mortgages.
Net Working Capital is defined as
the difference between CurrentAssets & Current Liabilities
8/8/2019 Financial Ratio Analysis Chap 2_2
19/40
Efficiency Ratios
Indicator of managerial capabilities ineffectively utilizing the firms asset
Capture firms managerial efforts in
managing Inventories of Raw & FinishedGoods, its Production Process, Its Credit &Asset Management Policies & theEffectiveness of its Marketing & SalesForce
Useful in in Judging the performance ofthe firm
8/8/2019 Financial Ratio Analysis Chap 2_2
20/40
Efficiency Ratios
Avg Collection Period
Avg Payment Period
Inventory TurnoverTotal Assets Turnover
Net Working Capital Turnover
8/8/2019 Financial Ratio Analysis Chap 2_2
21/40
Average Collection Period
Also Known as Days Sales OutstandingUseful in Evaluating credit & collection
Policies.
ACP = A/R/Avg Sales Per Day
Sales Per Day = Annual Sales/ 365Meaningful in relation to firms credit
terms
However, for accurate Analysis u needto know the credit terms extended toCustomers
8/8/2019 Financial Ratio Analysis Chap 2_2
22/40
Average Payment Period
Useful in Evaluating Payment Policies.
APP = A/P/Avg Purchases Per Day
Purchases Per Day = Annual Purchases/
365Meaningful in relation to Credit terms
extended to the Firm.
The Difficulty in calculating this Ratio
stems from the need to find annualPurchases.
8/8/2019 Financial Ratio Analysis Chap 2_2
23/40
Average Payment PeriodThis Value is generally not available in
the Financial StatementsOrdinarily Purchases are estimated as
given %age of CoGS.
However, for accurate Analysis u need to
know the credit terms extended to theFirm.
Prospective Lenders & Suppliers of TradeCredit are specially interested in APP,since it provides them sense of bill payingpatterns of the firm.
8/8/2019 Financial Ratio Analysis Chap 2_2
24/40
Inventory Turnover
Measures the Activity, or Liquidityof a firms inventory.
Sales/Inventories
CoGS/Avg. InvExcess Inv is unproductive, b/c it
represents investment with a zerorate of return
For Seasonal Industries (like SugarInd) it is better to use Avg InvFormula.
8/8/2019 Financial Ratio Analysis Chap 2_2
25/40
Total Asset TurnoverTotal Asset Turnover
Indicates the Efficiency with which thefirm uses all its assets to generate sales.
Sales/ Total Assets
Generally higher the ratio, the moreefficiently its assets have been used.
This measure is of greatest interest to theManagement, since it indicates whether ornot the firms Operations have been
financially efficient.
8/8/2019 Financial Ratio Analysis Chap 2_2
26/40
Fixed Asset TurnoverFixed Asset Turnover
Indicates the Efficiency withwhich the firm uses all its fixedassets to generate sales.
Sales/ Net Fixed AssetsGenerally higher ratio is
preferred, since they reflect
greater efficiency of fixed AssetUtilization.
8/8/2019 Financial Ratio Analysis Chap 2_2
27/40
Net Working CapitalTurnover
Net Sales / Net Working CapitalNet Working Capital is the difference
between current Assets & CurrentLiabilities = CA - CL
An intuitive interpretation is that NetWorking Capital could be viewed as thefirms conscious commitment in currentassets to generate sales.
This Ratio is a direct measure of firmsproductivity in generating sales
8/8/2019 Financial Ratio Analysis Chap 2_2
28/40
Profitability Ratios
Measure of the profitability of the firm
Key Ratios that are strong Measure of firmsoverall performance
Shows the combined effects of Liquidity, Asset
Management & Debt on Operating Results2 Types
Showing Profitability in Relation to Sales
Showing Profitability in Relation to Investment
8/8/2019 Financial Ratio Analysis Chap 2_2
29/40
Profitability Ratios
Profit Margin
Return on Total Assets
Return on Net Worth.
Return on Net Working Capital.
8/8/2019 Financial Ratio Analysis Chap 2_2
30/40
Profit Margin
Gross Profit Margin
Oprating Profit Margin
Net Profit Margin
8/8/2019 Financial Ratio Analysis Chap 2_2
31/40
Gross Profit Margin
Measures the %age of each sales$ remaining after the firm haspaid for its goods
Sales CoGS/Sales = GrossProfit/Sales
The higher the ratio, the better& lower the relative cost ofmerchandise sold.
8/8/2019 Financial Ratio Analysis Chap 2_2
32/40
Operating Profit Margin
Measures Pure Profits earned oneach sales Dollar.
They Are Pure in the sense that
they ignore any financial or GovtCharges & measures only theprofits earned on operations.
= Operating Profit/SalesThe higher ratio is preferred.
8/8/2019 Financial Ratio Analysis Chap 2_2
33/40
Net Profit Margin
Measures the %age of each sales$ remaining after all theexpenses, including taxes have
been deducted.= Net Profit (after taxes)/Sales
The higher the ratio, the better.
Commonly Citied Measure offirms success with respect toearnings on sales.
8/8/2019 Financial Ratio Analysis Chap 2_2
34/40
Return on Total Assets
Reflects the Earning Productivity ofTotal Assets.
= Net Profits/ Total Assets
Return on Net Worth
Is the Measure of the Returns to theFirms Stockholders.
= Net Profits/Net Worth
8/8/2019 Financial Ratio Analysis Chap 2_2
35/40
Return on Net WorkingCapital
Viewed as the Firms DirectEfforts in Generating Sales andthe ratio of return on net working
capital identifies the profitabilityof managerial decisions regardinginvestment on current assets.
= Net Profits/Net Working Capital
8/8/2019 Financial Ratio Analysis Chap 2_2
36/40
Equity Ratios
Primary Interest to the Firms StockHolders
It Includes
Price to Earnings RatioDividend Payout
Dividend Yield
Book Value Per Share
8/8/2019 Financial Ratio Analysis Chap 2_2
37/40
Price to Earning Ratio
Commonly Known as P/E Ratio.
= Price/Earning
Is an overall measure of theDesirability of the Firm
The more attractive the firm is tothe Investor, the higher the P/ERatio.
8/8/2019 Financial Ratio Analysis Chap 2_2
38/40
Dividend Payout Ratio
Is the Ratio of Dividends per Shareto Earnings per Share or totaldividends to Net Income.
= Dividend/ShareEarnings/Share
%age of Earning Paid out as
Dividends.
8/8/2019 Financial Ratio Analysis Chap 2_2
39/40
Different Stakeholders haveSpecific Interests
Trade CreditorsTrade Creditors -- Primarily Interested inPrimarily Interested inLiquidity of Firm. As their claims are shortLiquidity of Firm. As their claims are shortterm so they go for Liquidity Ratiosterm so they go for Liquidity Ratios
Bondholders -Bondholders - HaveHave Long-term claims claims interested in analyzing cash flow ability,interested in analyzing cash flow ability,
capital structure, sources & uses of funds &capital structure, sources & uses of funds &profitability over time, projections of futureprofitability over time, projections of futureprofitability Leverage Ratios/ Equity Ratiosprofitability Leverage Ratios/ Equity Ratios& Profitability Ratios& Profitability Ratios
Investors Investors Concerned Principally withConcerned Principally with
Present & Expected Future Earnings &Present & Expected Future Earnings &stability of these earnings Profitabilitystability of these earnings ProfitabilityRatiosRatios
8/8/2019 Financial Ratio Analysis Chap 2_2
40/40
Different Stakeholders haveSpecific Interests
Management Interested in allaspects of financial analysis although concerned with all
ratios but specifically withProfitability & Efficiency Ratios