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Agricultural Finance
419(AEC)

Lecture 3 : Financial Statements Analysis (1)

 Primary Types of
Financial Statements
Balance Sheet
 A summary of a firm’s financial position on
a given date that shows total assets = total
liabilities + owners’ equity.
Income Statement
 A summary of a firm’s revenues and
expenses over a specified period, ending
with net income or loss for the period.
6-2
 Basket Wonders’ Balance
Sheet (Asset Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003a
Cash and C.E. $ 90 a. How the firm stands on
Acct. Rec.c 394 a specific date.
Inventories 696 b. What BW owned.
Prepaid Exp d 5 c. Amounts owed by
Accum Tax Prepay 10 customers.
Current Assetse $1,195 d. Future expense items
Fixed Assets (@Cost)f 1030 already paid.
Less: Acc. Depr. g (329) e. Cash/likely convertible
Net Fix. Assets $ 701 to cash within 1 year.
Investment, LT 50 f. Original amount paid.
Other Assets, LT 223 g. Acc. deductions for
6-3 Total Assets b $2,169 wear and tear.
 Basket Wonders’ Balance
Sheet (Liability Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003
Notes Payable $ 290 a. Note, Assets =
Acct. Payablec 94 Liabilities + Equity.
Accrued Taxes d 16 b. What BW owed and
Other Accrued Liab. d 100 ownership position.
Current Liab. e $ 500 c. Owed to suppliers for
Long-Term Debt f 530 goods and services.
Shareholders’ Equity d. Unpaid wages,
Com. Stock ($1 par) g 200 salaries, etc.
Add Pd in Capital g 729 e. Debts payable < 1 year.
Retained Earnings h 210 f. Debts payable > 1 year.
Total Equity $1,139 g. Original investment.
a,b
6-4 Total Liab/Equity $2,169 h. Earnings reinvested.
 Basket Wonders’
Income Statement
Basket Wonders Statement of Earnings (in thousands)
for Year Ending December 31, 2003a
Net Sales $ 2,211 a. Measures profitability
Cost of Goods Sold b 1,599 over a time period.
Gross Profit $ 612 b. Received, or receivable,
SG&A Expenses c 402 from customers.
EBITd $ 210 c. Sales comm., adv.,
Interest Expensee 59 officers’ salaries, etc.
EBT f $ 151 d. Operating income.
Income Taxes 60 e. Cost of borrowed funds.
EATg $ 91 f. Taxable income.
Cash Dividends 38 g. Amount earned for
6-5
Increase in RE $ 53 shareholders.
 Use of Financial Ratios

A Financial Ratio is Types of

an index that relates Comparisons
two accounting
numbers and is Internal
obtained by dividing Comparisons
one number by the External
other. Comparisons

6-6
6-7
 Liquidity Ratios
Balance Sheet Ratios Current

Current Assets
Liquidity Ratios Current Liabilities

Shows a firm’s For Basket Wonders

ability to cover its December 31, 2003
current liabilities
$1,195 = 2.39
with its current $500
6-8
assets.
 Liquidity Ratio
Comparisons
Current Ratio
Year BW Industry
2003 2.39 2.15
2002 2.26 2.09
2001 1.91 2.01
Ratio is stronger than the industry average.
6-9
 Liquidity Ratios
Balance Sheet Ratios Acid-Test (Quick)

Current Assets - Inv

Liquidity Ratios Current Liabilities

Shows a firm’s For Basket Wonders

ability to meet December 31, 2003
current liabilities
$1,195 - $696 = 1.00
with its most liquid $500
6-10
assets.
 Liquidity Ratio
Comparisons
Acid-Test Ratio
Year BW Industry
2003 1.00 1.25
2002 1.04 1.23
2001 1.11 1.25
Ratio is weaker than the industry average.
6-11
 Summary of the Liquidity
Ratio Comparisons
Ratio BW Industry
Current 2.39 2.15
Acid-Test 1.00 1.25
 Strong current ratio and weak acid-test
ratio indicates a potential problem in the
inventories account.
 Note that this industry has a relatively
high level of inventories.
6-12
 Current Ratio -- Trend
Analysis Comparison
Trend Analysis of Current Ratio

2.5
2.3
Ratio Value

2.1
BW
1.9 Industry
1.7
1.5
2001 2002 2003
Analysis Year
6-13
 Acid-Test Ratio -- Trend
Analysis Comparison
Trend Analysis of Acid-Test Ratio

1.5
Ratio Value

1.3

1.0 BW
Industry
0.8

0.5
2001 2002 2003
Analysis Year
6-14
 Summary of the Liquidity
Trend Analyses
 The current ratio for BW has been rising
at the same time the acid-test ratio has
been declining.
 The current ratio for the industry has
been rising slowly at the same time the
acid-test ratio has been relatively stable.
 This indicates that inventories are a
significant problem for BW.
6-15
6-16
 Financial Leverage Ratios
Balance Sheet Ratios Debt-to-Equity

Total Debt
Financial Leverage Shareholders’ Equity
Ratios
For Basket Wonders
December 31, 2003
Shows the extent to
which the firm is $1,030 = .90
financed by debt. $1,139
6-17
 Financial Leverage
Ratio Comparisons
Debt-to-Equity Ratio
Year BW Industry
2003 .90 .90
2002 .88 .90
2001 .81 .89
BW has average debt utilization
6-18
relative to the industry average.
 Financial Leverage Ratios
Balance Sheet Ratios Debt-to-Total-Assets

Total Debt
Financial Leverage Total Assets
Ratios
For Basket Wonders
Shows the percentage December 31, 2003
of the firm’s assets
that are supported by $1,030 = .47
debt financing. $2,169
6-19
 Financial Leverage
Ratio Comparisons
Debt-to-Total-Asset Ratio
Year BW Industry
2003 .47 .47
2002 .47 .47
2001 .45 .47
BW has average debt utilization
6-20
relative to the industry average.
 Financial Leverage Ratios
Balance Sheet Ratios Total Capitalization
(i.e., LT-Debt + Equity)

Financial Leverage Total Debt

Ratios Total Capitalization

Shows the relative For Basket Wonders

importance of long-term December 31, 2003
debt to the long-term $1,030 = .62
financing of the firm. $1,669
6-21
 Financial Leverage
Ratio Comparisons
Total Capitalization Ratio
Year BW Industry
2003 .62 .60
2002 .62 .61
2001 .67 .62
BW has average long-term debt utilization
6-22
relative to the industry average.
6-23
 Coverage Ratios
Income Statement Interest Coverage
Ratios
EBIT
Interest Charges
Coverage Ratios
For Basket Wonders
Indicates a firm’s December 31, 2003
ability to cover
interest charges. $210 = 3.56
$59
6-24
 Coverage
Ratio Comparisons
Interest Coverage Ratio
Year BW Industry
2003 3.56 5.19
2002 4.35 5.02
2001 10.30 4.66
BW has below average interest coverage
6-25
relative to the industry average.
 Coverage Ratio -- Trend
Analysis Comparison
Trend Analysis of Interest Coverage Ratio
11.0

9.0
Ratio Value

7.0 BW
Industry
5.0

3.0
2001 2002 2003
Analysis Year
6-26
 Summary of the Coverage
Trend Analysis
 The interest coverage ratio for BW has
been falling since 2001. It has been
below industry averages for the past
two years.
 This indicates that low earnings (EBIT)
may be a potential problem for BW.
 Note, we know that debt levels are in
line with the industry averages.
6-27
6-28