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UV8057
May 21, 2020

Ratios Tell a Story—2019

As a child, Jillian Herbert had enjoyed spending many summer afternoons on her grandparents’ front porch
listening to her grandfather’s countless stories. Some were family histories, and some were fictitious yarns that
his creative mind wove together. In that realm, she recalled sitting enraptured by the exploits of courageous
heroes and heroines, the adventures of travelers (who sounded a lot like her siblings) to mysterious faraway
lands, and the mischievous antics of her talking pets brought to life in make-believe tales. In fact, even as an
adult, she believed in the power of stories to captivate, enlighten, create connections, facilitate memory, and
foster understanding.

As head of talent development at a major commercial bank, she knew financial information was invaluable
in understanding numerous aspects of a business. In her opening remarks at this month’s basic financial
statement analysis seminar for her new commercial lending hires, she had noted that ratio-focused
combinations of key financial data could actually convey a richer story about a company beyond the isolated
component parts of the company’s balance sheet or income statement. Indeed, she had made the analogy to
some parallels in everyday life. For example, a person’s ratio of weight and height could convey a story of
obesity or not. Grocery store prices were often displayed, in addition to the total purchase price for an item, in
terms of price per ounce or per pound. The speed of a car was denominated as miles per hour or kilometers
per hour. And an elementary school’s students-to-teacher ratio, in part, conveyed information about the
instructional attention each student was likely to receive at that school.

Herbert knew that to some extent, we all embraced the usefulness of such common measures and
developed a comfort and competence with them as inputs into our interpretation of things around us and about
us. For her new hires in the commercial lending group, and with a focus on the specifics of corporate financial
evaluation, she wanted to accomplish a similar richness of familiarity and insight. She wanted her aspiring
lending officers to embrace financial analysis as a process of crafting and deciphering the financial story of a
company at a particular point in time and for a particular period of time. She wanted them to be able to answer
such questions as: Was Nike financially healthy and improving, and was it financially conservative or aggressive?
Was Google more or less reliant on debt than Microsoft? To what extent did the Delta Air Lines revenue per
passenger increase or decrease this year, and how did it compare to that of United Airlines? Was Harley-
Davidson’s inventory on hand increasing or decreasing relative to its sales? In what financial ways was Coca-
Cola similar to PepsiCo? Was Citibank more or less optimistic about the collectability of its loan portfolio than
Wells Fargo? Was Salesforce.com’s revenue growth rate commensurate with Workday’s? Herbert wanted her
lending personnel to become adept at using financial data, and financial ratios in particular, to address such
questions.

This case was prepared by Mark E. Haskins, Professor of Business Administration, and has benefited from collaborations with various colleagues over
the years on earlier versions. It was written as a basis for discussion rather than to illustrate effective or ineffective handling of an administrative situation.
Copyright © 2020 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an email to
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A Context for Financial Analysis

The background reading Herbert had assigned the group of new hires for their first seminar posed several
possible underlying factors for consideration when evaluating and comparing an array of corporate financial
ratios and common-size balance sheets.1 One such factor was simply rooted in the nature of the industry in
which a company operated. For example, some industries required large investments in property, plant, and
equipment (PP&E), while others did not. In some industries, the competitive product-pricing structure
permitted companies to earn significant profits per sales dollar, while in other industries the product-pricing
structure necessitated a much lower profit margin. In most industries with low margins and low-priced goods,
companies often experienced a relatively high rate of product inventory turnover in comparison to companies
with much higher-priced products.

A second possible underlying factor pertained to a company’s management philosophy and policy. Some
companies reduced their manufacturing capacity to match more closely their immediate sales prospects, while
others carried excess production facilities in order to be prepared for future sales growth and spikes in demand.
Also, some companies chose to finance their assets with borrowed funds, while others were more conservative,
preferring to avoid the accumulation of debt. Some corporate management teams opted not to pay dividends
to their owners, preferring to reinvest those funds in the company. And some companies sought to grow
organically (i.e., increasing sales of internally developed products and/or services), while others focused on
mergers and acquisitions as their predominant means for growth.

Of course, another possibility for some of the variation in reported financial results across companies was
due to the differing competencies of management. Given the same industry characteristics and the same
management policies, different companies might report different financial results simply because their
management teams were more or less capable in running their companies and/or besting their competitors.

And last, one other possibility for differing corporate financial performance was that some industries, and
even some companies within an industry, were more susceptible to macroeconomic factors than others. This
could be true when macroeconomic conditions (e.g., foreign exchange rates and interest rates) were weak and
deteriorating, as well as when they were strong and improving. Moreover, some companies in the same industry
might be relatively new and growing while others were more stable and mature. Others might have been more
global in their operations while other companies were more domestic.

A Financial Story-Telling Task

As an end to the seminar’s first session on introductory financial statement analysis, Herbert had handed
out a task for the new hires to tackle. She wanted them to think about the insights discernable from some basic
financial statement analysis. To start, she wanted them to focus on just one of the possibilities for explaining
the financial differences between companies—industry characteristics. To do that, she had put together some
financial data for fiscal year 2019, for 13 companies, operating in 13 different industries. She presented the
financial data for those real, but unnamed, companies in Exhibit 1, noting that they were from the following
13 industries:

1 A common-size balance sheet simply expressed each line item in a company’s reported balance sheet as a percentage of total assets.

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 airline
 railway
 drug manufacturing—major
 commercial banking—regional
 consumer electronics
 discount general-merchandise retail
 electric utility
 restaurant (fast-food) chain
 wholesale food distribution
 grocery store chain
 internet retailing
 advertising agency services
 software application development

Herbert had asked the group of new hires to study the balance sheet profiles and the financial ratios for
each of the 13 companies as presented in Exhibit 1. She instructed them to use their intuition, common sense,
and basic understanding of the unique attributes of each listed industry to match each column in the exhibit
with one of the industries. They could do so by proceeding in any order they wanted, making the matches they
were most confident about first. As part of the task, they also had to be prepared to give the reasons for their
pairings, citing the data that seemed to be most consistent with the characteristics of the industry they had
selected. She also cautioned them that it was not a perfect financial world, so some of the financial indicators
might have been similar between companies even though they were in different industries. Thus they were also
instructed to identify the pieces of financial data that seemed to contradict a pairing they otherwise wanted to
propose. The only other bit of information she had shared with them was the formulas with which the financial
ratios were calculated. Those were:

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Net income
1. ROS (return on sales) = Net sales

Net sales
2. Asset turnover = Total assets

Net income
3. ROA (return on assets) = Total assets

or = ROS × Asset turnover

Total assets
4. Financial leverage = Total owners’ equity

Net income
5. ROE (return on equity) = Total owners’ equity

or = ROA × Financial leverage

Total current assets

6. Current ratio = Total current liabilities

Cost of goods sold

7. Inventory turnover = Ending inventory

Accounts receivable
8. Receivables collection = Net sales/365 days

This year’s net sales − Last year’s net sales

9. Revenue growth = Last year’s net sales

Net sales − Cost of goods sold

10. Gross margin = Net sales

Cash dividends
11. Dividend payout = Net income

12. R&D ratio = Research and development expense

Net sales

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Exhibit 1
Ratios Tell a Story—2019
Selected Financial Data for 13 Companies
(Balance sheet amounts are percentage of total assets)

1 2 3 4 5 6 7 8 9 10 11 12 13
Year end 12.31.19 2.1.20 11.29.19 12.31.19 12.31.19 12.31.19 2.1.20 12.31.19 9.28.19 12.31.19 6.29.19 12.31.19 12.31.19
Assets: Cash 1.7% 3.5% 20.1% 6.6% 16.1% 5.1% 6.0% 24.4% 29.7% 12.4% 2.9% 3.1% 1.9%
Accts. Receivable 2.1% 3.8% 7.4% 2.9% 29.2% 2.6% 0.0% 9.2% 6.8% 8.0% 23.3% 64.0% 4.7%
Inventory 0.6% 15.7% 0.0% 3.1% 4.7% 0.7% 21.0% 9.1% 1.2% 7.1% 17.9% 0.0% 0.1%
Other CA 2.9% 1.2% 3.8% 1.0% 4.4% 0.2% 3.1% 0.0% 10.4% 5.1% 1.3% 22.6% 0.8%
Total Current Assets 7.4% 24.1% 31.3% 13.7% 54.5% 8.6% 30.2% 42.8% 48.1% 32.6% 45.3% 7.5%

Net PP&E 75.6% 63.4% 6.2% 72.9% 7.7% 84.1% 66.7% 43.4% 11.0% 17.8% 25.1% 1.7% 78.8%
Goodwill 0.8% 6.8% 51.5% 6.8% 35.2% 0.0% 0.0% 6.6% 0.0% 23.0% 21.7% 2.5% 5.6%
Intangibles & oth 16.3% 5.8% 11.0% 6.6% 2.6% 7.3% 3.2% 7.2% 40.9% 26.6% 7.9% 6.1% 8.1%
Total Assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Liabilities: Accts. Pay. 2.0% 14.0% 1.0% 3.4% 43.9% 2.7% 23.2% 20.9% 13.7% 4.4% 24.0% 75.0% 2.1%
ST Debt 5.4% 5.7% 15.2% 4.8% 2.3% 0.6% 0.4% 6.4% 3.0% 4.3% 0.2% 0.8% 0.1%
Other 3.4% 11.8% 23.3% 22.3% 13.4% 2.3% 10.3% 11.7% 14.5% 17.6% 9.7% 1.4% 5.4%
Total Current Liabilities 10.8% 31.5% 39.4% 30.5% 59.7% 5.6% 33.9% 39.0% 31.2% 26.3% 34.0% 7.6%

LT Debt 31.9% 41.1% 4.8% 48.1% 25.4% 43.1% 31.8% 28.1% 27.1% 26.9% 45.2% 8.8% 98.7%
Other 25.9% 8.4% 5.1% 21.5% 2.3% 20.3% 6.7% 5.4% 14.9% 15.9% 6.7% 1.4% 11.0%
Total Liabilities 68.6% 81.1% 49.3% 100.2% 87.4% 69.0% 72.3% 72.4% 73.3% 69.2% 85.9% 87.5% 117.3%
Equity:Noncontrolling Int. 0.3% -0.1% 0.0% 0.0% 1.9% 0.0% 0.0% 0.0% 0.0% 0.1% 0.2% 0.0% 0.0%
Net Contr. Cap. 12.0% -25.9% -19.8% 6.6% -14.0% 2.9% 14.7% 14.1% 13.3% -17.2% -39.7% 1.0% -123.5%
Ret. Inc. + OCI 19.1% 44.9% 70.5% -6.8% 24.7% 28.0% 13.0% 13.4% 13.4% 47.9% 53.6% 11.5% 106.2%
Total Equity 31.4% 18.9% 50.7% -0.2% 12.6% 31.0% 27.7% 27.6% 26.7% 30.8% 14.1% 12.5% -17.3%
Total Liab. & Equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
ROS 11.5% 1.4% 26.4% 3.7% 9.0% 27.9% 4.2% 4.1% 21.2% 21.0% 2.8% 24.7% 28.6%
Asset Turnover 0.22 2.70 0.54 0.76 0.56 0.31 1.83 1.25 0.77 0.55 3.35 0.06 0.44

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ROA 2.5% 3.7% 14.2% 2.8% 5.0% 8.7% 7.7% 5.1% 16.3% 11.7% 9.3% 1.4% 12.7%
Financial Leverage 3.19 5.28 1.97 -508.43 7.94 3.22 3.62 3.63 3.74 3.25 7.08 7.99 -5.79
ROE 7.9% 19.4% 28.0% -1428.8% 39.7% 28.1% 27.7% 18.7% 61.1% 37.9% 66.0% 11.4% -73.4%
Current ratio 0.68 0.76 0.79 0.45 0.91 1.52 0.89 1.10 1.54 1.24 1.33 N/A 0.98
Receivables collection 36 5 50 14 191 30 0 27 32 53 25 4040 39
Inventory Turnover 3.1 13.5 N/A N/A N/A N/A 6.1 8.1 35.3 2.4 15.1 N/A 155.2
Gross margin 77.5% 22.1% 93.8% N/A N/A N/A 28.9% -3.2% 32.2% 69.9% 19.0% N/A 17.6%
Dividend payout 64.2% 29.3% 0.0% 10.6% 42.1% 22.9% 40.5% 0.0% 25.6% 57.9% 46.3% 31.1% 59.5%
Revenue growth 1.9% 0.4% 23.7% 2.8% -2.2% 10.4% 3.7% 20.5% -2.0% 10.7% 2.4% 22.8% 0.2%
R & D ratio 0.37% N/A 17.28% N/A N/A N/A N/A 12.81% 6.23% 21.08% N/A N/A N/A
CFFO (millions) 3,134 4,024 4,422 3,815 1,856 4,850 7,117 38,514 69,391 13,440 2,411 1,824 8,122

Note: PP&E = plant, property, and equipment; ROS = return on sales; ROA = return on assets; ROE = return on equity; CA = current assets; ST = short term; LT = long term; OCI = other comprehensive
income; CFFO = cash flow from operations; and Net Contributed Capital is net of stock buy backs (i.e., Treasury Stock purchases).
Source: Created by author.
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