Analysis of Financial Statements
Financial Statement Analysis
Analysis of Financial
Statements
Examples of External Uses of
Statement Analysis
 Trade Creditors -- Focus on the liquidity of the
firm.
 Bondholders -- Focus on the long-term cash
flow of the firm.
 Shareholders -- Focus on the profitability and
long-term health of the firm.
 Financial Statements
 A Possible Framework for Analysis
 Ratio Analysis
 Trend Analysis
 Common-Size and Index Analysis
Examples of Internal Uses of
Statement Analysis
 Plan -- Focus on assessing the current financial
position and evaluating potential firm opportunities.
 Control -- Focus on return on investment for various
assets and asset efficiency.
 Understand -- Focus on understanding how suppliers
of funds analyze the firm.
K K Aggarwal, Dept of OR, DU
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Analysis of Financial Statements

Primary Types of Financial Financial Statements

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.

Income Statement Income Statement

Revenue
SALES SALES
- EXPENSES - EXPENSES
= PROFIT = PROFIT

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Income Statement Income Statement

SALES SALES •Cost of Goods Sold

- EXPENSES - EXPENSES
= PROFIT = PROFIT

Income Statement Income Statement

SALES •Cost of Goods Sold SALES •Cost of Goods Sold

•Operating Expenses •Operating Expenses
- EXPENSES - EXPENSES (marketing, administrative)

= PROFIT = PROFIT

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Income Statement Income Statement

SALES •Cost of Goods Sold SALES •Cost of Goods Sold

•Operating Expenses •Operating Expenses
- EXPENSES (marketing, administrative) - EXPENSES (marketing, administrative)
•Financing Costs •Financing Costs
= PROFIT = PROFIT
•Taxes

SALES Income Statement SALES Income Statement

- Cost of Goods Sold - Cost of Goods Sold
GROSS PROFIT GROSS PROFIT
- Operating Expenses - Operating Expenses
OPERATING INCOME (EBIT) OPERATING INCOME (EBIT)
- Interest Expense - Interest Expense
EARNINGS BEFORE TAXES (EBT) EARNINGS BEFORE TAXES (EBT)
- Income Taxes - Income Taxes
EARNINGS AFTER TAXES (EAT) EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends - Preferred Stock Dividends
- NET INCOME AVAILABLE - NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS TO COMMON STOCKHOLDERS

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

SALES Income Statement Balance Sheet

- Cost of Goods Sold
GROSS PROFIT
Outstanding
- Operating Expenses
Debt
OPERATING INCOME (EBIT)
Total Assets = +
- Interest Expense
EARNINGS BEFORE TAXES (EBT) Shareholders’
- Income Taxes Equity
EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS

Balance Sheet Balance Sheet

Assets

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Balance Sheet Balance Sheet

Assets Liabilities (Debt) & Equity Assets Liabilities (Debt) & Equity
Current Assets Current Liabilities
Cash Accounts Payable
Accrued Expenses
Marketable Securities Short-term notes
Accounts Receivable Long-Term Liabilities
Inventories Long-term notes
Prepaid Expenses Mortgages
Equity
Fixed Assets Preferred Stock
Machinery & Equipment Common Stock (Par value)
Buildings and Land Paid in Capital
Retained Earnings
Other Assets
Investments & patents

Assets Assets
 Current Assets:  Current Assets: assets that are relatively
liquid, and are expected to be converted to
cash within a year.

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements
Assets
 Current Assets: assets that are relatively
liquid, and are expected to be converted to
cash within a year.
 Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.
Assets
 Current Assets: assets that are relatively
liquid, and are expected to be converted to
cash within a year.
 Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.
 Fixed Assets: machinery
and equipment, buildings,
and land.
Assets
 Current Assets: assets that are relatively
liquid, and are expected to be converted to
cash within a year.
 Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.
 Fixed Assets:
Assets
 Current Assets: assets that are relatively
liquid, and are expected to be converted to
cash within a year.
 Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.
 Fixed Assets: machinery and equipment,
buildings, and land.
 Other Assets:
K K Aggarwal, Dept of OR, DU
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Analysis of Financial Statements
Assets
 Current Assets: assets that are relatively
liquid, and are expected to be converted to
cash within a year.
 Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.
 Fixed Assets: machinery and equipment,
buildings, and land.
 Other Assets: any asset that is not a
current asset or fixed asset.
Financing
 Debt Capital:
Assets
 Current Assets: assets that are relatively
liquid, and are expected to be converted to
cash within a year.
 Cash, marketable securities, accounts
receivable, inventories, prepaid expenses.
 Fixed Assets: machinery and equipment,
buildings, and land.
 Other Assets: any asset that is not a
current asset or fixed asset.
 Intangible assets such as patents and
copyrights.
Financing
 Debt Capital: financing provided by a
creditor.
K K Aggarwal, Dept of OR, DU
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Analysis of Financial Statements
Financing
 Debt Capital: financing provided by a
creditor.
 Short-term debt:
Financing
 Debt Capital: financing provided by a
creditor.
 Short-term debt: borrowed money that
must be repaid within the next 12 months.
 Accounts payable, other payables such as
interest or taxes payable, accrued expenses,
short-term notes.
Financing
 Debt Capital: financing provided by a
creditor.
 Short-term debt: borrowed money that
must be repaid within the next 12 months.
Financing
 Debt Capital: financing provided by a
creditor.
 Short-term debt: borrowed money that
must be repaid within the next 12 months.
 Accounts payable, other payables such as
interest or taxes payable, accrued expenses,
short-term notes.
 Long-term debt:
K K Aggarwal, Dept of OR, DU
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Analysis of Financial Statements

Financing Financing
 Debt Capital: financing provided by a  Equity Capital:
creditor.
 Short-term debt: borrowed money that
must be repaid within the next 12 months.
 Accounts payable, other payables such as
interest or taxes payable, accrued expenses,
short-term notes.
 Long-term debt: loans from banks or other
sources that lend money for longer than 12
months.

Financing Financing
 Equity Capital: shareholders’ investment  Equity Capital: shareholders’ investment
in the firm. in the firm.
 Preferred Stockholders:

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements
Financing
 Equity Capital: shareholders’ investment
in the firm.
 Preferred Stockholders: receive fixed
dividends, and have higher priority than
common stockholders in event of
liquidation of the firm.
Financing
 Equity Capital: shareholders’ investment
in the firm.
 Preferred Stockholders: received fixed
dividends, and have higher priority than
common stockholders in event of
liquidation of the firm.
 Common Stockholders: residual owners of
a business. They receive whatever is left
after creditors and preferred stockholders
are paid.
Financing
 Equity Capital: shareholders’ investment
in the firm.
 Preferred Stockholders: received fixed
dividends, and have higher priority than
common stockholders in event of
liquidation of the firm.
 Common Stockholders:
Cash Flow Statement
Cash collected from customers
- Cash paid to suppliers
- Operating Cash Outflows (marketing,
administrative and interest payments)
- Cash Tax Payments
+/- Cash Flow from Investments acquired or sold
+ Receipts from new stock issue
+ Increased borrowing
- Repayment of debt principal
- Common Stock Dividend Payments
Cash Flow Generated
K K Aggarwal, Dept of OR, DU
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Analysis of Financial Statements
Cash Flow Statement
Cash collected from customers
- Cash paid to suppliers
- Operating Cash Outflows (marketing,
administrative and interest payments)
- Cash Tax Payments
+/- Cash Flow from Investments acquired or sold
+ Receipts from new stock issue
+ Increased borrowing
- Repayment of debt principal
- Common Stock Dividend Payments
Cash Flow Generated
Financial Statement Analysis
 Are our decisions
maximizing
shareholder
wealth?
Cash Flow Statement
Cash collected from customers
- Cash paid to suppliers
- Operating Cash Outflows (marketing,
administrative and interest payments)
- Cash Tax Payments
+/- Cash Flow from Investments acquired or sold
+ Receipts from new stock issue
+ Increased borrowing
- Repayment of debt principal
- Common Stock Dividend Payments
Cash Flow Generated
We will want to answer
questions about the firm’s
 Liquidity
 Efficient use of Assets
 Leverage (financing)
 Profitability
K K Aggarwal, Dept of OR, DU
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Analysis of Financial Statements
We will want to answer
questions about the firm’s
 Liquidity
 Efficient use of Assets
 Leverage (financing)
 Profitability
Framework for
Financial Analysis
1. Analysis of the funds
needs of the firm.
2. Analysis of the financial
condition and profitability
of the firm.
Framework for
Financial Analysis
Trend / Seasonal Component
How much funding will be
required in the future?
1. Analysis of the funds
needs of the firm. Is there a seasonal
component?
Analytical Tools Used
Sources and Uses Statement
Statement of Cash Flows
Cash Budgets
Framework for
Financial Analysis
Health of a Firm Business risk relates to
the risk inherent in the
1. Analysis of the funds
Financial Ratios needs of the firm.
operations of the firm.
2. Analysis of the financial Examples::
Examples
condition and profitability
1. Individually of the firm. Volatility in sales
2. Over time 3. Analysis of the business Volatility in costs
risk of the firm.
3. In combination Proximity to break-
4. In comparison even point
K K Aggarwal, Dept of OR, DU
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Analysis of Financial Statements

Financial Ratios
Financial Ratios

A Financial Ratio is Types of  Financial managers use ratios to interpret the

Comparisons raw numbers on financial statements.
an index that relates  Tools that help us determine the financial health
two accounting of a company.
numbers and is Internal  We can compare a company’s financial ratios
obtained by dividing Comparisons with its ratios in previous years (trend analysis).
 We can compare a company’s financial ratios
one number by the
other. External with those of its industry (comparative ratio
Comparisons analysis)
 Ratios are used by financial managers, other
business managers, creditors, and investors.

External Comparisons and

Sources of Industry Ratios Ratio Analysis
Examples: Five Categories of Ratios
This involves
comparing the ratios  Profitability ratios
Robert Morris
of one firm with those Associates (Risk  Liquidity ratios
of similar firms or with Management Association)  Debt ratios
industry averages. Dun & Bradstreet  Asset activity ratios
 Market value ratios
Similarity is important Almanac of
as one should Business and
compare “apples to Industrial
apples.” Financial Ratios

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Ratio Analysis Ratio Analysis

Profitability Ratios Profitability Ratios
 Measure the overall effectiveness of the
firm’s management.
Gross Profit
Gross Profit Margin =
Sales

How effective is the firm at generating

revenue in excess of its cost of goods
sold?

Balance Sheet
Excalibur Corporation

Cash $175
Accounts Receivable 430
Accounts Payable
S-T Notes Payable
$115
115
Ratio Analysis
Inventories 625 Current Liabilities $230
Current Assets $1,230 Bonds $600
Plant & Equipment $2,500 Owner’s Equity Profitability Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Income Statement Total Owners’ Equity $1,700
Excalibur Corporation Total Liabilities and Operating Income
Sales $1,450 Owners Equity $2,530 Operating Profit Margin =
Cost of Goods Sold 875 Sales
Gross Profit $575
Operating Expenses 45
Depreciation 200 Gross
Net Operating Income $330 Gross Profit
Interest Expense 60
Profit =
Sales
How effective is the firm in keeping costs
Income Before Taxes $270 Margin of operations low?
Taxes (40%) 108
Net Income $162
$575
Common Dividends Paid 100 Gross Profit Margin = = 39.7%
Addition to Retained Earnings $62 $1,450

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Balance Sheet
Excalibur Corporation

Cash $175
Accounts Receivable 430
Accounts Payable
S-T Notes Payable
$115
115 Ratio Analysis
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Plant & Equipment $2,500 Owner’s Equity Profitability Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800 Note: Net Income equals Earnings Available to CS
Total Owners’ Equity $1,700
Income Statement when there is no preferred stock.
Excalibur Corporation Total Liabilities and
Owners Equity $2,530
Sales $1,450
Cost of Goods Sold 875
Gross Profit $575
Operating Expenses 45 Net Income
Depreciation 200 Net Profit Margin =
Operating Income $330
Operating
Operating Income
Sales
Interest Expense 60 Profit =
Sales
Income Before Taxes $270 Margin
Taxes (40%) 108
Net Income $162 How much net profit is being generated
$330
Common Dividends Paid 100 Oper. Profit Margin = = 22.8% from each dollar of sales?
Addition to Retained Earnings $62 $1,450

Balance Sheet
Excalibur Corporation
Assets Liabilities
Cash $175 Accounts Payable
Accounts Receivable 430 S-T Notes Payable
$115
115
Ratio Analysis
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Plant & Equipment $2,500 Owner’s Equity Profitability Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Income Statement Total Owners’ Equity $1,700
Excalibur Corporation Total Liabilities and
Sales $1,450 Owners Equity $2,530
Return on Assets = Net Income
Cost of Goods Sold 875
Gross Profit $575
Total Assets
Operating Expenses 45
Depreciation 200
Operating Income $330
Net
Net Income
Interest Expense 60 Profit = How effectively is the firm generating net
Sales
Income Before Taxes $270 Margin income from its assets ?
Taxes (40%) 108
Net Income $162 $162
Common Dividends Paid 100 Net Profit Margin = = 11.2%
$1,450
Addition to Retained Earnings $62

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Balance Sheet
Excalibur Corporation
Assets Liabilities
Cash $175 Accounts Payable
Accounts Receivable 430 S-T Notes Payable
$115
115
Ratio Analysis
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term debt $600
Plant & Equipment $2,500 Owner’s Equity Profitability Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Total Owners’ Equity $1,700 Return on Equity = Net Income
Income Statement Total Liabilities and Common Equity
Excalibur Corporation Owners Equity $2,530
Sales $1,450
Cost of Goods Sold 875
Gross Profit $575
Operating Expenses 45 How well is the firm generating return to
Depreciation 200 Return on Net Income
Operating Income $330
= Total Assets its equity providers?
Assets
Interest Expense 60
Income Before Taxes $270
Taxes (40) 108
Net Income% $162 $162
Common Dividends Paid 100 ROA = $2,530 = 6.4%
Addition to Retained Earnings $62

Balance Sheet
Excalibur Corporation
Assets Liabilities
Cash $175 Accounts Payable
Accounts Receivable 430 S-T Notes Payable
$115
115
Ratio Analysis
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Plant & Equipment $2,500 Owner’s Equity Liquidity Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600  Measure the ability of the firm to
Total Assets $2,530 Retained Earnings 800
Income Statement Total Owners’ Equity $1,700 meet its short-term financial obligations.
Excalibur Corporation Total Liabilities and
Sales $1,450 Owners Equity $2,530
Cost of Goods Sold 875
Gross Profit $575 Current Assets
Operating Expenses 45 Current Ratio =
Depreciation 200 Return on Equity = Net Income
Current Liabilities
Operating Income $330 Common Equity
Interest Expense 60
Income Before Taxes $270
Taxes (40%) 108 Are there sufficient current assets to pay off
ROE = $162 current liabilities? What is the cushion of
Net Income $162
Common Dividends Paid 100 = 9.53%
Addition to Retained Earnings $62 $1,700 safety?

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Balance Sheet

Assets
Excalibur Corporation
Liabilities Ratio Analysis
Cash $175 Accounts Payable $115
Accounts Receivable 430 S-T Notes Payable 115 Liquidity Ratios
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600  Measure the ability of the firm to meet
Plant & Equipment $2,500 Owner’s Equity
Less:Acc. Depr. (1,200) Common Stock $300 its short-term financial obligations.
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Total Owners’ Equity $1,700
Total Liabilities and Current Assets - Inventory
Owners Equity $2,530 Acid--Test Ratio =
Acid
Current Liabilities
Current Ratio = Current Assets
Current Liabilities
What happens to the firm’s ability to repay current
liabilities after what is usually the least liquid of the
Current Ratio = $1,230 = 5.35x current assets is subtracted?
$230

Balance Sheet
Excalibur Corporation
Assets Liabilities
Cash $175 Accounts Payable
Accounts Receivable 430 S-T Notes Payable
$115
115
Ratio Analysis
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Plant & Equipment $2,500 Owner’s Equity Debt Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets
Total Assets
$1,300 Capital in Excess of Par 600
$2,530 Retained Earnings 800
 Measure the relative size of the
Total Owners’ Equity $1,700 firm’s debt load and the firm’s
Total Liabilities and
Owners Equity $2,530 ability to pay off the debt.

Current Assets - Inventory

Acid-Test Ratio =
Current Liabilities

$1,230 -$625
Acid-Test Ratio = = 2.63x
$230

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Balance Sheet
Excalibur Corporation
Assets Liabilities

Ratio Analysis Cash $175 Accounts Payable

Accounts Receivable 430 S-T Notes Payable
$115
115
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Debt Ratios Plant & Equipment $2,500 Owner’s Equity
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Total Owners’ Equity $1,700
Debt Ratio = Total Debt Income Statement
Total Liabilities and
Excalibur Corporation
Total Assets Sales $1,450 Owners Equity $2,530
Cost of Goods Sold 875
Gross Profit $575
Operating Expenses 45
What proportion of the firm’s assets is Depreciation 200
Operating Income $330 Debt Ratio = Total Debt
financed with debt? Interest Expense 60 Total Assets
Income Before Taxes $270
Taxes (40%) 108
Net Income $162 Debt Ratio = $230 + $600 = 33%
Common Dividends Paid 100 $2,530
Addition to Retained Earnings $62

Balance Sheet
Excalibur Corporation
Assets Liabilities
Ratio Analysis Cash $175 Accounts Payable
Accounts Receivable 430 S-T Notes Payable
$115
115
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Debt Ratios Plant & Equipment $2,500 Owner’s Equity
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Total Debt Total Owners’ Equity $1,700
Debt to =
Income Statement
Excalibur Corporation Total Liabilities and
Equity Ratio Common Equity Sales $1,450 Owners Equity $2,530
Cost of Goods Sold 875
Gross Profit $575
Operating Expenses 45
Depreciation 200 Debt to Total Debt
What is the proportion of debt relative to Operating Income $330 Equity Ratio =
Common Equity
Interest Expense 60
equity financing for the firm? Income Before Taxes $270
Taxes (40%) 108
Net Income $162 D/E = $230 + $600 = 48.8%
Common Dividends Paid 100
Addition to Retained Earnings $62
$1,700

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Balance Sheet
Excalibur Corporation
Assets Liabilities

Ratio Analysis Cash $175 Accounts Payable

Accounts Receivable 430 S-T Notes Payable
$115
115
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Debt Ratios Plant & Equipment $2,500 Owner’s Equity
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Income Statement Total Owners’ Equity $1,700
Excalibur Corporation Total Liabilities and
Sales $1,450 Owners Equity $2,530
Operating Income Cost of Goods Sold 875
Times Interest Earned Ratio = Gross Profit $575
Interest Expense Operating Expenses 45
Depreciation 200 Times
Operating Income $330 Operating Income
Interest =
Interest Expense 60 Interest Expense
What is the firm’s ability to repay interest Income Before Taxes $270 Earned Ratio
Taxes (40%) 108
payments from its operating income? Net Income $162 $330
Common Dividends Paid 100 TIE Ratio = $60 = 5.50x
Addition to Retained Earnings $62

Ratio Analysis Ratio Analysis

Asset Activity Ratios Asset Activity Ratios
 Help assess how effectively the firm
is using assets to generate sales. Accounts Receivable
Average Collection Period =
Avg. Daily Credit Sales

How long does it take for the firm on

average to collect its credit sales from
customers?

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Balance Sheet
Excalibur Corporation
Additional Info: Assets Liabilities

We assume all
Cash $175 Accounts Payable
Accounts Receivable 430 S-T Notes Payable
$115
115
Ratio Analysis
Inventories 625 Current Liabilities $230
sales are credit Current Assets $1,230 Bonds $600
sales. Plant & Equipment $2,500 Owner’s Equity Asset Activity Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Income Statement Total Owners’ Equity $1,700
Total Liabilities and Sales/cost of goods sold
Excalibur Corporation Inventory Turnover Ratio =
Sales $1,450 Owners Equity $2,530 Inventory
Cost of Goods Sold 875
Gross Profit $575
Operating Expenses 45 Average
Depreciation 200 Collection =
Accounts Receivable Is inventory efficiently translating into
Operating Income $330 Avg. Daily Credit Sales sales for the firm?
Interest Expense 60
Period
Income Before Taxes $270
Taxes (40%) 108
$430
ACP = $1,450/365 = 108.24 days
Net Income $162
Common Dividends Paid 100 Days in a
Addition to Retained Earnings $62 year

Balance Sheet
Excalibur Corporation
Assets Liabilities
Cash $175 Accounts Payable
Accounts Receivable 430 S-T Notes Payable
$115
115
Ratio Analysis
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Plant & Equipment $2,500 Owner’s Equity Asset Activity Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Income Statement Total Owners’ Equity $1,700
Excalibur Corporation Total Liabilities and Sales
Sales $1,450 Owners Equity $2,530 Fixed Asset Turnover Ratio = Net Fixed Assets
Cost of Goods Sold 875
Gross Profit $575
Operating Expenses 45
Depreciation 200 Inventory
Sales
Operating Income $330 Turnover =
Interest Expense 60 Inventory How effective is the firm in using its fixed
Ratio
Income Before Taxes $270 assets to help generate sales?
Taxes (40%) 108
$1450
Net Income $162 Inventory Turnover = = 2.3x
Common Dividends Paid 100 $625
Addition to Retained Earnings $62

K K Aggarwal, Dept of OR, DU

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Analysis of Financial Statements

Balance Sheet
Excalibur Corporation
Assets Liabilities
Cash $175 Accounts Payable
Accounts Receivable 430 S-T Notes Payable
$115
115
Ratio Analysis
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Plant & Equipment $2,500 Owner’s Equity Asset Activity Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Income Statement Total Owners’ Equity $1,700
Excalibur Corporation Total Liabilities and Sales
Sales $1,450 Owners Equity $2,530 Total Asset Turnover Ratio = Total Assets
Cost of Goods Sold 875
Gross Profit $575
Operating Expenses 45
Depreciation 200 Fixed Asset
Operating Income $330 Turnover = Sales How effective is the firm in using its
Interest Expense 60 Ratio Net Fixed Assets overall assets to generate sales?
Income Before Taxes $270
Taxes (40%) 108
$1,450
Net Income $162 Fixed Asset Turnover = = 1.12x
Common Dividends Paid 100 $1,300
Addition to Retained Earnings $62

Balance Sheet
Excalibur Corporation
Assets Liabilities
Cash $175
Accounts Receivable 430
Accounts Payable
S-T Notes Payable
$115
115
Ratio Analysis
Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Plant & Equipment $2,500 Owner’s Equity
Market Value Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Total Owners’ Equity $1,700
Price to Earnings Ratio = Market Price per Share
Income Statement
Excalibur Corporation Total Liabilities and
Sales $1,450 Owners Equity $2,530 Earnings per Share
Cost of Goods Sold 875
Gross Profit $575
Operating Expenses 45
Total Asset
Depreciation 200 Sales How much are investors willing to pay per
Operating Income $330 Turnover = Total Assets
Interest Expense 60 Ratio dollar of earnings of the firm?
Income Before Taxes $270
Taxes (40%) 108 $1,450 (Indicator of investor’s attitudes toward
Net Income $162 Total Asset Turnover = = 0.57x
$2,530 future prospects of the firm and of the
Common Dividends Paid 100
Addition to Retained Earnings $62 firm’s risk.)

K K Aggarwal, Dept of OR, DU

22
Analysis of Financial Statements

Balance Sheet
Excalibur Corporation
Additional Info: Assets Liabilities

100 shares Cash $175 Accounts Payable

Accounts Receivable 430 S-T Notes Payable
$115
115
Ratio Analysis
$20.00 per Inventories
Current Assets
625 Current Liabilities
$1,230 Long-term Debt
$230
$600
share Plant & Equipment $2,500 Owner’s Equity Market Value Ratios
Less:Acc. Depr. (1,200) Common Stock $300
Net Fixed Assets $1,300 Capital in Excess of Par 600
Total Assets $2,530 Retained Earnings 800
Income Statement Total Owners’ Equity $1,700
Total Liabilities and Market Price per Share
Excalibur Corporation Market to Book Ratio =
Sales $1,450 Owners Equity $2,530 Book Value per Share
Cost of Goods Sold 875
Gross Profit $575
Operating Expenses 45
P/E How much are investors willing to pay per
Depreciation 200
= Market Price/Share
Operating Income $330 Ratio EPS
Interest Expense 60 dollar of book value?
Income Before Taxes $270
Taxes (40%) 108
Net Income $162 P/E ratio = $20.00
= 12.35x
Common Dividends Paid 100 $162/100
Addition to Retained Earnings $62

Balance Sheet
Excalibur Corporation
Assets Liabilities
Additional Info: Cash $175 Accounts Payable $115
Accounts Receivable 430 S-T Notes Payable 115 Ratio Industry Excalibur
100 shares Inventories 625 Current Liabilities $230
Current Assets $1,230 Long-term Debt $600
Profitability
$20.00 per Plant & Equipment $2,500 Owner’s Equity Gross Profit Margin 38% 39.7%
share Less:Acc. Depr. (1,200) Common Stock $300 Operating Profit Margin 20% 22.8%
Net Fixed Assets $1,300 Capital in Excess of Par 600 Net Profit Margin 12% 11.2%
Total Assets $2,530 Retained Earnings 800
Total Owners’ Equity $1,700
Return on Assets 9.0% 6.4%
Income Statement
Excalibur Corporation Total Liabilities and Return on Equity 13.4% 9.5%
Sales $1,450 Owners Equity $2,530
Cost of Goods Sold 875
Gross Profit $575
Operating Expenses 45
Excalibur is good at keeping operating
Depreciation 200 Market Price/Share costs down, but not as good at total
Operating Income $330 to = Common Equity/ # shares
Interest Expense 60 Book
costs. ROA and ROE are low mainly
Income Before Taxes $270 due to productivity problems.
Taxes (40%) 108
Net Income $162
M/B = $20.00
Common Dividends Paid 100
= 1.18x
$1,700/100
Addition to Retained Earnings $62

K K Aggarwal, Dept of OR, DU

23
Analysis of Financial Statements

Summary of Excalibur Corporation Ratios

Ratio Industry Excalibur Ratio Industry Excalibur

Liquidity Debt
Current Ratio 5.00x 5.35x Debt Ratio 35% 33%
Acid-Test Ratio 3.00x 2.63x Times Interest Earned 7.00x 5.50x
Debt to Equity 49% 48%

Looking at the current ratio it appears

that Excalibur is more liquid than the
industry.... however when looking at
Acid Test (a better measure) they are
not as liquid indicating that inventory
levels are probably too high.
While the debt ratio is close to the industry
average, Excalibur is not able to cover
interest payments as easily as the industry.
This indicates Excalibur may have too much
debt relative to what they can realistically
afford.

Ratio Industry Excalibur Ratio Industry Excalibur

Asset Activity Market Value
Avg. Collection Period 90 days 108 days Price Earnings 18.0 12.35
Inventory Turnover 3.00x 2.32x Market to Book 2.5 1.18
Fixed Asset Turnover 1.00x 1.12x
Total Asset Turnover 0.75x .57x Excalibur’s Investors are not willing to
Collection policies need examining, as Excalibur is pay as much per dollar of earnings or
slower than average at collecting receivables. per dollar of book value as they are for
Inventories are being sold more slowly than the shares in other firms in the industry.
industry average, again indicating inventories that This signals that they consider the firm’s
are too high. Excalibur is very efficient at converting
prospects to be worse than the average.
Fixed Assets to Sales (fixed assets are productive).
However, overall assets are not productive However, the firm is still selling for more
indicating Current Assets (e.g. inventories) are not than its accounting book value.
as productive as for the industry.

K K Aggarwal, Dept of OR, DU

24
Analysis of Financial Statements

Relationships Among Ratios: Relationships Among Ratios:

The Du Pont System The Du Pont System
 Ratio Analysis generally involves an The Du Pont Equation
examination of related ratios.
 Comparison of these relationships Return Net Total
on = Profit x Asset
over time helps to identify the
Assets Margin Turnover
company’s strengths and weaknesses.

Net Inc. = Net Inc. x Sales

Assets Sales Assets

Basket Wonders’ Balance

Relationships Among Ratios: Sheet (Asset Side)
The Du Pont System Basket Wonders Balance Sheet (thousands) Dec. 31, 2003a
The Modified Du Pont Equation Cash and C.E. $ 90 a. How the firm stands on a
Acct. Rec.c 394 specific date.
Return Net Total Equity Inventories 696 b. What BW owned.
on = Profit x Asset x Prepaid Exp d 5
Multiplier c. Amounts owed by
Equity Margin Turnover Accum Tax Prepay 10 customers.
Current Assetse $1,195 d. Future expense items
Fixed Assets (@Cost)f 1030 already paid.
Net Inc. = Net Inc. x Sales x Assets Less: Acc. Depr. g (329)
Equity Sales Assets Equity e. Cash/likely convertible to
Net Fix. Assets $ 701 cash within 1 year.
Investment, LT 50 f. Original amount paid.
Other Assets, LT 223
g. Acc. deductions for wear
Total Assets b $2,169
and tear.

K K Aggarwal, Dept of OR, DU

25
Analysis of Financial Statements

Basket Wonders’ Balance Basket Wonders’

Sheet (Liability Side) Income Statement
Basket Wonders Balance Sheet (thousands) Dec. 31, 2003 Basket Wonders Statement of Earnings (in thousands)
for Year Ending December 31, 2003a
Notes Payable $ 290 a. Note, Assets = Liabilities +
Acct. Payable c 94 Equity. Net Sales $ 2,211 a. Measures profitability over
Accrued Expenses d 16 b. What BW owed and Cost of Goods Sold b 1,599 a time period.
Other Accrued Liab. d 100 ownership position. Gross Profit $ 612 b. Received, or receivable,
Liab.. e $ 500 c. Owed to suppliers for
Current Liab SG&A Expenses c 402 from customers.
Long-Term Debt f 530 goods and services. EBITd $ 210 c. Sales comm., adv.,
Shareholders’ Equity d. Unpaid wages, salaries, Interest Expensee 59 officers’ salaries, etc.
Com. Stock ($1 par) g 200 etc. EBT f $ 151 d. Operating income.
Add Pd in Capital g 729 e. Debts payable < 1 year. Income Taxes 60 e. Cost of borrowed funds.
Retained Earnings h 210 f. Debts payable > 1 year. EATg $ 91
f. Taxable income.
Total Equity $1,139 Cash Dividends 38
g. Original investment. Increase in RE $ 53 g. Amount earned for
Liab//Equitya,b $2,169
Total Liab shareholders.
h. Earnings reinvested.

Liquidity Ratio
Liquidity Ratios Comparisons
Balance Sheet Ratios Current Current Ratio
Current Assets Year BW Industry
Liquidity Ratios Current Liabilities
2003 2.39 2.15
Shows a firm’s For Basket Wonders
December 31, 2003 2002 2.26 2.09
ability to cover its
current liabilities 2001 1.91 2.01
$1,195 = 2.39
with its current $500 Ratio is stronger than the industry average.
assets.

K K Aggarwal, Dept of OR, DU

26
Analysis of Financial Statements

Liquidity Ratio
Liquidity Ratios Comparisons
Balance Sheet Ratios Acid--Test (Quick)
Acid Acid--Test Ratio
Acid
Current Assets - Inv Year BW Industry
Liquidity Ratios Current Liabilities
2003 1.00 1.25
Shows a firm’s For Basket Wonders
December 31, 2003 2002 1.04 1.23
ability to meet
current liabilities 2001 1.11 1.25
$1,195 - $696 = 1.00
with its most liquid $500 Ratio is weaker than the industry average.
assets.

Summary of the Liquidity Current Ratio -- Trend

Ratio Comparisons Analysis Comparison
Ratio BW Industry
Trend Analysis of Current Ratio
Current 2.39 2.15
Acid-Test 1.00 1.25 2.5
2.3

Ratio Value
 Strong current ratio and weak acid-test 2.1
BW
ratio indicates a potential problem in 1.9 Industry
the inventories account. 1.7
1.5
 Note that this industry has a relatively 2001 2002 2003
high level of inventories. Analysis Year

K K Aggarwal, Dept of OR, DU

27
Analysis of Financial Statements

Acid-Test Ratio -- Trend

Acid- Summary of the Liquidity
Analysis Comparison Trend Analyses
Trend Analysis of Acid-Test Ratio  The current ratio for BW has been rising
at the same time the acid-test ratio has
1.5 been declining.
1.3  The current ratio for the industry has
Ratio Value

1.0 BW been rising slowly at the same time the

Industry
0.8
acid-test ratio has been relatively
stable.
0.5
2001 2002 2003  This indicates that inventories are a
Analysis Year significant problem for BW
BW.

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

K K Aggarwal, Dept of OR, DU

28
Analysis of Financial Statements

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

Financial Leverage
Financial Leverage Ratios Ratio Comparisons
Balance Sheet Ratios Total Capitalization Total Capitalization Ratio
(i.e., LT-Debt + Equity)
Total Debt Year BW Industry
Financial Leverage Total Capitalization
Ratios 2003 .62 .60
For Basket Wonders December
Shows the relative 31, 2003 2002 .62 .61
importance of long-term debt
to the long-term financing of 2001 .67 .62
the firm. $1,030 = .62
$1,669
BW has average long-term debt utilization
relative to the industry average.

K K Aggarwal, Dept of OR, DU

29
Analysis of Financial Statements

Coverage
Coverage Ratios Ratio Comparisons
Income Statement Interest Coverage Interest Coverage Ratio
Ratios EBIT
Year BW Industry
Interest Charges
Coverage Ratios 2003 3.56 5.19

Indicates a firm’s For Basket Wonders 2002 4.35 5.02

ability to cover December 31, 2003
2001 10.30 4.66
interest charges. $210 = 3.56
$59
BW has below average interest coverage
relative to the industry average.

Coverage Ratio -- Trend Summary of the Coverage

Analysis Comparison Trend Analysis
Trend Analysis of Interest Coverage Ratio  The interest coverage ratio for BW has
11.0 been falling since 2001. It has been
below industry averages for the past
9.0
two years.
Ratio Value

7.0 BW
Industry  This indicates that low earnings (EBIT)
5.0 may be a potential problem for BW
BW.
3.0  Note, we know that debt levels are in
2001 2002 2003
Analysis Year
line with the industry averages.

K K Aggarwal, Dept of OR, DU

30
Analysis of Financial Statements

Activity Ratios Activity Ratios

Income Statement / Receivable Turnover Income Statement / Avg Collection Period
(Assume all sales are credit sales.)
Balance Sheet Balance Sheet
Ratios Annual Net Credit Sales Ratios Days in the Year
Receivables Receivable Turnover

Activity Ratios
Indicates quality of
receivables and how
successful the firm is
in its collections.
For Basket Wonders December Activity Ratios For Basket Wonders
31, 2003 December 31, 2003
Average number of
$2,211 = 5.61 days that receivables 365
are outstanding. = 65 days
$394 5.61
(or RT in days)

Activity
Ratio Comparisons Activity Ratios
Average Collection Period Income Statement / Payable Turnover (PT)
(Assume annual credit
Balance Sheet purchases = $1,551.)
Year BW Industry Ratios
Annual Credit Purchases
2003 65.0 65.7
Activity Ratios Accounts Payable
2002 71.1 66.3
For Basket Wonders December
Indicates the
2001 83.6 69.2 31, 2003
promptness of $1551
BW has improved the average collection = 16.5
payment to suppliers $94
period to that of the industry average.
by the firm.

K K Aggarwal, Dept of OR, DU

31
Analysis of Financial Statements

Activity
Activity Ratios Ratio Comparisons
Income Statement / PT in Days Payable Turnover in Days
Balance Sheet Days in the Year
Ratios Year BW Industry
Payable Turnover
2003 22.1 46.7
Activity Ratios
For Basket Wonders 2002 25.4 51.1
Average number of December 31, 2003
2001 43.5 48.5
days that payables 365 = 22.1 days
16.5
BW has improved the PT in Days.
are outstanding.
Is this good?

Activity
Activity Ratios Ratio Comparisons
Income Statement / Inventory Turnover Inventory Turnover Ratio
Balance Sheet
Ratios Cost of Goods Sold Year BW Industry
Inventory
2003 2.30 3.45
Activity Ratios For Basket Wonders December
31, 2003 2002 2.44 3.76
Indicates the effectiveness
of the inventory 2001 2.64 3.69
management practices of $1,599 = 2.30
$696
BW has a very poor inventory turnover ratio.
the firm.

K K Aggarwal, Dept of OR, DU

32
Analysis of Financial Statements

Inventory Turnover Ratio --

Trend Analysis Comparison Activity Ratios
Trend Analysis of Inventory Turnover Ratio Income Statement / Total Asset Turnover
4.0 Balance Sheet
Ratios Net Sales
3.5 Total Assets
Ratio Value

3.0 BW
Industry
Activity Ratios For Basket Wonders December
2.5 31, 2003
Indicates the overall
2.0 effectiveness of the firm in
2001 2002 2003 utilizing its assets to $2,211 = 1.02
Analysis Year generate sales. $2,169

Activity
Ratio Comparisons Profitability Ratios
Total Asset Turnover Ratio Income Statement / Gross Profit Margin
Balance Sheet
Year BW Industry Ratios Gross Profit
Net Sales
2003 1.02 1.17
Profitability Ratios For Basket Wonders December
2002 1.03 1.14 31, 2003
Indicates the
2001 1.01 1.13
efficiency of $612 = .277
277
BW has a weak total asset turnover ratio. $2,211
operations and firm
Why is this ratio considered weak? pricing policies.

K K Aggarwal, Dept of OR, DU

33
Analysis of Financial Statements

Profitability Gross Profit Margin --

Ratio Comparisons Trend Analysis Comparison
Gross Profit Margin Trend Analysis of Gross Profit Margin
35.0
Year BW Industry

Ratio Value (%)

32.5
2003 27.7% 31.1% BW
30.0
Industry
2002 28.7 30.8 27.5

2001 31.3 27.6 25.0

2001 2002 2003
BW has a weak Gross Profit Margin. Analysis Year

Profitability
Profitability Ratios Ratio Comparisons
Income Statement / Net Profit Margin Net Profit Margin
Balance Sheet
Ratios Net Profit after Taxes Year BW Industry
Net Sales
2003 4.1% 8.2%
Profitability Ratios For Basket Wonders December
31, 2003 2002 4.9 8.1
Indicates the firm’s
profitability after taking 2001 9.0 7.6
account of all expenses and $91 = .041
income taxes. $2,211 BW has a poor Net Profit Margin.

K K Aggarwal, Dept of OR, DU

34
Analysis of Financial Statements

Net Profit Margin --

Trend Analysis Comparison Profitability Ratios
Trend Analysis of Net Profit Margin Income Statement / Return on Investment
10 Balance Sheet
9 Ratios Net Profit after Taxes
Ratio Value (%)

8 Total Assets
7 BW
Industry
Profitability Ratios
6 For Basket Wonders December
5 Indicates the profitability on 31, 2003
the assets of the firm (after
4
2001 2002 2003
all expenses and taxes). $91 = .042
Analysis Year $2,160

Profitability Return on Investment –

Ratio Comparisons Trend Analysis Comparison
Return on Investment Trend Analysis of Return on Investment
12
Year BW Industry

Ratio Value (%)

10
2003 4.2% 9.8% BW
8
Industry
2002 5.0 9.1 6

2001 9.1 10.8 4

2001 2002 2003
BW has a poor Return on Investment. Analysis Year

K K Aggarwal, Dept of OR, DU

35
Analysis of Financial Statements

Profitability
Profitability Ratios Ratio Comparisons
Income Statement / Return on Equity Return on Equity
Balance Sheet
Ratios Net Profit after Taxes
Year BW Industry
Shareholders’ Equity
2003 8.0% 17.9%
Profitability Ratios
For Basket Wonders December 2002 9.4 17.2
Indicates the profitability to 31, 2003
the shareholders of the firm 2001 16.6 20.4
(after all expenses and $91 = .08
taxes). $1,139 BW has a poor Return on Equity.

Return on Equity -- Return on Investment and

Trend Analysis Comparison the Du Pont Approach
Trend Analysis of Return on Equity Earning Power = Sales profitability X
21.0 Asset efficiency
Ratio Value (%)

17.5
ROI = Net profit margin X
14.0 BW Total asset turnover
Industry
10.5 ROI2003 = .041 x 1.02 = .042 or 4.2%
7.0 ROIIndustry = .082 x 1.17 = .098 or 9.8%
2001 2002 2003
Analysis Year

K K Aggarwal, Dept of OR, DU

36
Analysis of Financial Statements
Return on Equity and
the Du Pont Approach
Return On Equity = Net profit margin X
Total asset turnover X
Equity Multiplier
Total Assets
Equity Multiplier =
Shareholders’ Equity
ROE2003 = .041 x 1.02 x 1.90 = .080
ROEIndustry = .082 x 1.17 x 1.88 = .179
179
Summary of Ratio Analyses
 Inventories are too high.
 May be paying off creditors
(accounts payable) too soon.
 COGS may be too high.
 Selling, general, and
administrative costs may be too
high.
Summary of the Profitability
Trend Analyses
 The profitability ratios for BW have ALL
been falling since 2001. Each has been
below the industry averages for the past
three years.
 This indicates that COGS and
administrative costs may both be too
high and a potential problem for BW
BW.
 Note, this result is consistent with the low
interest coverage ratio.
Common--size Analysis
Common
An analysis of percentage
financial statements where all
balance sheet items are divided
by total assets and all income
statement items are divided by
net sales or revenues.
K K Aggarwal, Dept of OR, DU
37
Analysis of Financial Statements

Basket Wonders’ Common Basket Wonders’ Common

Size Balance Sheets Size Balance Sheets
Regular (thousands of $) Common-Size (%) Regular (thousands of $) Common-Size (%)
Assets 2001 2002 2003 2001 2002 2003 Liab+Equity 2001 2002 2003 2001 2002 2003
Cash 148 100 90 12.10 4.89 4.15 Note Pay 290 295 290 23.71 14.43 13.37
AR 283 410 394 23.14 20.06 18.17 Acct Pay 81 94 94 6.62 4.60 4.33
Inv 322 616 696 26.33 30.14 32.09 Accr Tax 13 16 16 1.06 0.78 0.74
Other CA 10 14 15 0.82 0.68 0.69 Other Accr 15 100 100 1.23 4.89 4.61
Tot CA 763 1,140 1,195 62.39 55.77 55.09 Tot CL 399 505 500 32.62 24.71 23.05
Net FA 349 631 701 28.54 30.87 32.32 LT Debt 150 453 530 12.26 22.16 24.44
LT Inv 0 50 50 0.00 2.45 2.31 Equity 674 1,086 1,139 55.11 53.13 52.51
Other LT 111 223 223 9.08 10.91 10.28 Tot L+E 1,223 2,044 2,169 100.0 100.0 100.0
Tot Assets 1,223 2,044 2,169 100.0 100.0 100.0

Basket Wonders’ Common

Size Income Statements Index Analyses
Regular (thousands of $) Common-Size (%)
2001 2002 2003 2001 2002 2003 An analysis of percentage financial
Net Sales 1,235 2,106 2,211 100.0 100.0 100.0
statements where all balance sheet
COGS 849 1,501 1,599 68.7 71.3 72.3
Gross Profit 386 605 612 31.3 28.7 27.7 or income statement figures for a
Adm. 180 383 402 14.6 18.2 18.2 base year equal 100.0 (percent) and
EBIT 206 222 210 16.7 10.5 9.5
Int Exp 20 51 59 1.6 2.4 2.7
subsequent financial statement
EBT 186 171 151 15.1 8.1 6.8 items are expressed as percentages
EAT 112 103 91 9.1 4.9 4.1
Cash Div 50 50 50 4.0 2.4 2.3
of their values in the base year.

K K Aggarwal, Dept of OR, DU

38
Analysis of Financial Statements

Basket Wonders’ Basket Wonders’

Indexed Balance Sheets Indexed Balance Sheets
Regular (thousands of $) Indexed (%) Regular (thousands of $) Indexed (%)
Assets 2001 2002 2003 2001 2002 2003 Liab+Equity 2001 2002 2003 2001 2002 2003
Cash 148 100 90 100.0 67.6 60.8 Note Pay 290 295 290 100.0 101.7 100.0
AR 283 410 394 100.0 144.9 139.2 Acct Pay 81 94 94 100.0 116.0 116.0
Inv 322 616 696 100.0 191.3 216.1 Accr Tax 13 16 16 100.0 123.1 123.1
Other CA 10 14 15 100.0 140.0 150.0 Other Accr 15 100 100 100.0 666.7 666.7
Tot CA 763 1,140 1,195 100.0 149.4 156.6 Tot CL 399 505 500 100.0 126.6 125.3
Net FA 349 631 701 100.0 180.8 200.9 LT Debt 150 453 530 100.0 302.0 353.3
LT Inv 0 50 50 100.0 inf. inf. Equity 674 1,086 1,139 100.0 161.1 169.0
Other LT 111 223 223 100.0 200.9 200.9 Tot L+E 1,223 2,044 2,169 100.0 167.1 177.4
Tot Assets 1,223 2,044 2,169 100.0 167.1 177.4

Basket Wonders’ Indexed

Example:
Income Statements
CyberDragon Corporation
Regular (thousands of $) Indexed (%)
2001 2002 2003 2001 2002 2003
Net Sales 1,235 2,106 2,211 100.0 170.5 179.0
COGS 849 1,501 1,599 100.0 176.8 188.3
Gross Profit 386 605 612 100.0 156.7 158.5
Adm. 180 383 402 100.0 212.8 223.3
EBIT 206 222 210 100.0 107.8 101.9
Int Exp 20 51 59 100.0 255.0 295.0
EBT 186 171 151 100.0 91.9 81.2
EAT 112 103 91 100.0 92.0 81.3
Cash Div 50 50 50 100.0 100.0 100.0

K K Aggarwal, Dept of OR, DU

39
Analysis of Financial Statements

Sales (all credit) $112,760

CyberDragon’s CyberDragon’s Income
Cost of Goods Sold (85,300)
Balance Sheet ($000) Statement
Gross Profit 27,460
Operating Expenses:
Assets: Liabilities & Equity: Selling (6,540)
Cash $2,540 Accounts payable 9,721 General & Administrative (9,400)
Marketable securities 1,800 Notes payable 8,500
Total Operating Expenses (15,940)
Accounts receivable 18,320 Accrued taxes payable 3,200
Earnings before interest and taxes (EBIT) 11,520
Inventories 27,530 Other current liabilities 4,102
Total current assets 50,190 Total current liabilities 25,523 Interest charges:
Plant and equipment 43,100 Long-term debt (bonds) 22,000 Interest on bank notes: (850)
less accum deprec. 11,400 Total liabilities 47,523 Interest on bonds: (2,310)
Net plant & equip. 31,700 Common stock ($10 par) 13,000
Total Interest charges (3,160)
Total assets 81,890 Paid in capital 10,000
Earnings before taxes (EBT) 8,360
Retained earnings 11,367
Total stockholders' equity 34,367 Taxes (assume 40%) (3,344)
Total liabilities & equity 81,890 Net Income 5,016

CyberDragon 1. Liquidity Ratios

Other Information
• Do we have enough liquid assets
Dividends paid on common stock $2,800 to meet approaching obligations?
Earnings retained in the firm 2,216
Shares outstanding (000) 1,300
Market price per share 20
Book value per share 26.44
Earnings per share 3.86
Dividends per share 2.15

K K Aggarwal, Dept of OR, DU

40
Analysis of Financial Statements

What is CyberDragon’s Current Ratio? What is CyberDragon’s Current Ratio?

50,190
25,523 = 1.97

What is CyberDragon’s Current Ratio? What is the firm’s Acid Test Ratio?

50,190
25,523 = 1.97

If the average current ratio for the

industry is 2.4, is this good or not?

K K Aggarwal, Dept of OR, DU

41
Analysis of Financial Statements

What is the firm’s Acid Test Ratio? What is the firm’s Acid Test Ratio?

50,190 - 27,530 = .89 50,190 - 27,530 = .89

25,523 25,523

Suppose the industry average is .92.

What does this tell us?

What is the firm’s Average Collection What is the firm’s Average Collection
Period? Period?

18,320 = 59.3 days

112,760/365

K K Aggarwal, Dept of OR, DU

42
Analysis of Financial Statements

What is the firm’s Average Collection 2. Operating Efficiency Ratios

Period?
• Measure how efficiently the
18,320 = 59.3 days
firm’s assets generate operating
112,760/365 profits.

If the industry average is 47 days,

what does this tell us?

What is the firm’s Operating Income What is the firm’s Operating Income
Return on Investment (OIROI)? Return on Investment (OIROI)?

11,520 = 14.07%
81,890

K K Aggarwal, Dept of OR, DU

43
Analysis of Financial Statements

What is the firm’s Operating Income What is the firm’s Operating Income
Return on Investment (OIROI)? Return on Investment (OIROI)?

11,520 = 14.07% 11,520 = 14.07%

81,890 81,890
•Slightly below the industry •Slightly below the industry
average of 15%. average of 15%.
•The OIROI reflects product
pricing and the firm’s ability to
keep costs down.

What is their Operating Profit Margin? What is their Operating Profit Margin?

11,520 = 10.22%
112,760

K K Aggarwal, Dept of OR, DU

44
Analysis of Financial Statements

What is their Operating Profit Margin? What is their Total Asset Turnover?

11,520 = 10.22%
112,760

•This is below the industry average of

12%.

What is their Total Asset Turnover? What is their Total Asset Turnover?

112,760 = 1.38 times 112,760 = 1.38 times

81,890 81,890

The industry average is 1.82 times.

The firm needs to figure out how to
squeeze more sales dollars out of its
assets.

K K Aggarwal, Dept of OR, DU

45
Analysis of Financial Statements

What is the firm’s Accounts Receivable What is the firm’s Accounts Receivable
Turnover? Turnover?

112,760 = 6.16 times

18,320

What is the firm’s Accounts Receivable

What is the firm’s Inventory Turnover?
Turnover?

112,760 = 6.16 times

18,320

CyberDragon turns their A/R over 6.16

times per year. The industry average
is 8.2 times. Is this efficient?

K K Aggarwal, Dept of OR, DU

46
Analysis of Financial Statements

What is the firm’s Inventory Turnover? What is the firm’s Inventory Turnover?

85,300 85,300
27,530 = 3.10 times 27,530 = 3.10 times
CyberDragon turns their inventory
over 3.1 times per year.
The industry average is 3.9 times.
Is this efficient?

Low inventory turnover: What is the firm’s Fixed Asset

Turnover?
The firm may have too much
inventory, which is expensive
because:
• Inventory takes up costly
warehouse space.
• Some items may become spoiled
or obsolete.

K K Aggarwal, Dept of OR, DU

47
Analysis of Financial Statements

What is the firm’s Fixed Asset What is the firm’s Fixed Asset
Turnover? Turnover?

112,760 112,760
31,700 = 3.56 times 31,700 = 3.56 times

If the industry average is 4.6 times, what

does this tell us about CyberDragon?

3. Leverage Ratios How does Leverage work?

(financing decisions)
• Suppose we have an all equity-
• Measure the impact of using debt financed firm worth $100,000. Its
capital to finance assets. earnings this year total $15,000.
• Firms use debt to lever (increase)
returns on common equity.

ROE =

(ignore taxes for this example)

K K Aggarwal, Dept of OR, DU

48
Analysis of Financial Statements

How does Leverage work? How does Leverage work?

• Suppose we have an all equity- • Suppose the same $100,000 firm is
financed firm worth $100,000. Its financed with half equity, and half
earnings this year total $15,000. 8% debt (bonds). Earnings are still
$15,000.

ROE = 15,000 = 15% ROE =

100,000

How does Leverage work? How does Leverage work?

• Suppose the same $100,000 firm is • Suppose the same $100,000 firm is
financed with half equity, and half financed with half equity, and half
8% debt (bonds). Earnings are still 8% debt (bonds). Earnings are still
$15,000. $15,000.

ROE = 15,000 - 4,000 = ROE = 15,000 - 4,000 = 22%

50,000 50,000

K K Aggarwal, Dept of OR, DU

49
Analysis of Financial Statements

What is CyberDragon’s Debt Ratio? What is CyberDragon’s Debt Ratio?

47,523 = 58%
81,890

What is CyberDragon’s Debt Ratio? What is CyberDragon’s Debt Ratio?

47,523 = 58% 47,523 = 58%

81,890 81,890
If the industry average is 47%, what If the industry average is 47%, what
does this tell us? does this tell us?

Can leverage make the firm more

profitable?
Can leverage make the firm riskier?

K K Aggarwal, Dept of OR, DU

50
Analysis of Financial Statements

What is the firm’s Times Interest What is the firm’s Times Interest
Earned Ratio? Earned Ratio?

11,520
3,160 = 3.65 times

What is the firm’s Times Interest 4. Return on Equity

Earned Ratio?

11,520
3,160 = 3.65 times

The industry average is 6.7 times. This

is further evidence that the firm uses How well are the firm’s managers
more debt financing than average.
maximizing shareholder wealth?

K K Aggarwal, Dept of OR, DU

51
Analysis of Financial Statements

What is CyberDragon’s What is CyberDragon’s

Return on Equity (ROE)? Return on Equity (ROE)?

5,016
34,367 = 14.6%

What is CyberDragon’s What is CyberDragon’s

Return on Equity (ROE)? Return on Equity (ROE)?

5,016 5,016
34,367 = 14.6% 34,367 = 14.6%
The industry average is 17.54%. The industry average is 17.54%.
Is this what we would expect,
given the firm’s leverage?

K K Aggarwal, Dept of OR, DU

52
Analysis of Financial Statements

Conclusion: The DuPont Model

• Even though CyberDragon has Brings together:

higher leverage than the industry
average, they are much less • Profitability
efficient, and therefore, less
profitable. • Efficiency
• Leverage

The DuPont Model The DuPont Model

ROE = Net Profit x Total Asset / (1- Debt
) ROE = Net Profit x Total Asset / (1- Debt
)
Margin Turnover Ratio Margin Turnover Ratio

Net Income Sales Total Debt

= Sales x Total Assets /(1- Total Assets )

K K Aggarwal, Dept of OR, DU

53
Analysis of Financial Statements

The DuPont Model The DuPont Model

ROE = Net Profit x Total Asset / (1- Debt
) ROE = Net Profit x Total Asset / (1- Debt
)
Margin Turnover Ratio Margin Turnover Ratio

Net Income Sales Total Debt Net Income Sales Total Debt
= Sales x Total Assets /(1- Total Assets ) = Sales x Total Assets /(1- Total Assets )

= 5,016 x 112,760 / (1 - 47,523 ) = 5,016 x 112,760 / (1 - 47,523 )

112,760 81,890 81,890 112,760 81,890 81,890
= 14.6%

K K Aggarwal, Dept of OR, DU

54