9/27/2022

LECTURE 4: FINANCIAL ANALYSIS

Module 2: Financial Ratios Analysis and Market Tests
Dr. Tien Nguyen
2021

FINANCIAL RATIO ANALYSIS

• Understand the inter-relationships …

• between the financial ratios, themselves, and
• between the ratios and the strategies, business models and industry
environment
• Identify key factors that explain the situation of the firm and focus on them in
your analysis
• Relevance of ratios depends on the state of the firm, E.g.
• P/E & Earnings are more relevant for profitable firms
• Book Value of equity is more relevant for firms in distress

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FINANCIAL RATIO ANALYSIS

Evaluating Drivers of Profitability

Overall Profitability
ROE = Profit Margin * Tot Assets T/O * Fin Leverage Assessing Operational Mgt
Gross Profit Margin
= Profit/Sales * Sales/Tot Assets * Tot Assets/Equity OPERATING
SG&A Expenses to Sales

Assessing Operational and

Investing Efficiency
INVESTING FINANCING Assessing Financing Activities
Working Capital Turnover
Short-term liquidity: CCC/Current
Long-term Assets Turnover
Debt & Long-term Solvency: D/E

FINANCIAL RATIO ANALYSIS

Evaluating Drivers of Profitability

Overall Profitability
ROE = Profit Margin * Tot Assets T/O * Fin Leverage
= Profit/Sales * Sales/Tot Assets * Tot Assets/Equity OPERATING

INVESTING FINANCING

Liquidity & CFS Analysis

Market tests

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ASSESSING
OPERATIONAL MANAGEMENT
(Profitability)
Measures to look at:
 Gross Profit Margin
 SG&A to Sales

ASSESSING OPERATIONAL MANAGEMENT

Note: depends on
GROSS PROFIT MARGIN  Degree of competitors
 Customer powers (low)
 Substitution (low)
pricing strategy (uniqueness of the product)
vs. cost structure Note: depends on
• This ratio allows a focus on average unit mark-ups  Supplier power (ability to
access low-cost materials)
Gross_Profit = sales - COGS  Degree of new/updated
GPM  prod. process

Sales

• A high GPM implies that firm has relatively more flexible in product pricing and
less vulnerable to change in cost
• Other margins include: net profit margin (NI/Sales), EBIT margin (EBIT/Sales)

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• E.g. Huu Lien Asia JSC. (HOSE: HLA) is a Vietnamese steel manufacturer.
Its historical margin ratios are as follow:

2009 2010 2011 2012 2013

* Gross Profit Margin (GM) 10% 11% 8% 6% 0.3%
* NI Margin (NM) 2.6% 0.5% 0.06% 0.3% Loss

* Sales growth rate 39% 14% 13% 52% -18%

* COGS growth rate 34% 12% 16% 56% -14%
* COGS / sale 90% 89% 92% 94% 99.7%

HLC reported net loss of –VND235b. in 2013

ASSESSING OPERATIONAL MANAGEMENT

SG&A TO SALES

• This ratio focuses on SG&A expense that is incurred relative to the dollar amount
of revenue the company generated over the same period of time

SG & A
SGA 
Sales

• A high SGA can be negative signals about future firm performance

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ASSESSING OPERATIONAL &

INVESTING EFFICIENCY
Measures to look at:
 Working Capital Turnover;
 AR Turnover;
 Inventory Turnover
 Fixed Assets Turnover

ASSESSING OPERATIONAL
and INVESTING EFFICIENCY

Measures reflects effectiveness of a firm’s investing management

 How efficiently is the firm using assets?
 What’s the amount of capital required to generate specific sale volumes?

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ASSESSING OPERATIONAL EFFICIENCY

ACCOUNT RECEIVABLE TURNOVER

• This ratio measures how soon sales will become cash

credit sale
Net_Sales Ex: AR T/O = 2,400/400 = 6 times
AR_turnover 
Avg_AR

• Perhaps a more intuitive measure of the rate at which AR are being collected is
the days receivable outstanding
Days_Receivables_Outstanding  365/AR_turnover
Rule of thumb: Days_Receivables_outstanding < 1.5 x credit term
Ex: Days_= 365/6 = 60 days

ASSESSING OPERATIONAL EFFICIENCY

INVENTORY TURNOVER

• This ratio measures how quickly inventory being sold

net sale

COGS
INV_turnov er 
Avg_INV
• Perhaps a more intuitive measure of the rate at which inventory are being sold is
the days inventory held:

Days_Inventory_held  365/Inv_turnover

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• E.g. The Vietnamese aqua-product industry has an industry inventory

T/O of 4.08 (2011) and 3.46 (2012)

Minh Phu Seafood Corp. (MPC) 2009 2010 2011 2012 MPC, 2012:
- Growth inventory 98%
* Inventory T/O 3.6 4.4 3.3 3 - Growth COGS 18%

*Inventory Days Outstanding 102 83 111 120

Marine Product No. 3 Company 2009 2010 2011 Marine No. 3, 2012:
- Stop operating in
* Inventory T/O 24.6 30.6 22.28
seafood product
*Inventory Days Outstanding 15 12 16

ASSESSING INVESTING EFFICIENCY

LONG-TERM ASSETS TURNOVER

• This ratio measures the relation between sales and the investment in PPE

Sales
Fixed_Asse ts_turnove r 
Avg_Fixed_ Assets

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• E.g. Lamson Sugar Cane (HOSE Ticker: LSS) is a Vietnamese sugar

producer. Historically the company has reported the following turnover ratio.
What do we know about the efficiency?

2010 2011 2012 2013

* Tangible Fixed Assets T/O 6.63 9.02 2.81 1.54

* Sale growth rate 22% 51% -7% -2%

*Tangible fixed assets growth rate 9% 2.93% 363% 17%

ASSESSING
FINANCING ACTIVITIES
Measures to look at:
 Debt ratio,
 Interest coverage
 Leverage (capital structure)

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ASSESSING FINANCING ACTIVITIES

LONG-TERM SOLVENCY

• Measure a firm’s ability to meet interest and principal payments on LT debt when
they come due
• Common measures should include:
• firm’s capital structure, and
• its ability to generate earnings over a period of years

ASSESSING FINANCING ACTIVITIES

DEBT RATIO
ST_D LT-D (exclude
non-interest-bearing
debt)
int_bearing_Debt
Debt_ratio 
int_bearing_Debt  Shareholders' Equity 

int_bearing_Debt
Debt/Equity_ratio 
Shareholders' Equity

total_liabilities
Liabilities/Assets_ratio 
total_assets

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ASSESSING FINANCING ACTIVITIES

INTEREST COVERAGE RATIO

NI  Interest_Expense  IncomeTax_Expense
Interest_Coverage 
Interest_Expense

• Measures how many times a firm’s net income before interest expense and income
taxes (EBIT) exceeds its interest expense.
• Rule of thumb: interest coverage ratios less than 2.0 suggest a risky situation

• E.g. Minh Phu Seafood Corp. (HOSE: MPC) is a Vietnamese shrimp

producer. The capital structure and its interest coverage are as follow:

Ticker: MPC 2010 2011 2012 2013

* Debt / Equity 2.55 4.64 4.88 5.02

* LT Debt / Equity 0.85 1.29 0.94 0

* Total Liabilities / Total Assets 0.64 0.74 0.78 0.73

* Interest Coverage 3.6 1.83 1.08 2.46

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OVERALL
PROFITABILITY




OVERALL PROFITABILITY
ROE VS. ROA

NI  pref.div NI  int(1  t)
ROE  ROA 
Avg_Common_Shareholders' Equity Avg_Total_Assets

 Rate earned on shareholders’ equity  Rate earned on total assets (ROA):

(ROE): measure a firm’s ability to measure a firm’s ability to generate
generate return on shareholders’ return on total assets
investment

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OVERALL PROFITABILITY
DUPONT ANALYSIS

• ROE = ROA x LEVERAGE

NI NI ASSETS
= x
EQUITY ASSETS EQUITY

NI NI SALES ASSETS
= x x
EQUITY SALES ASSETS EQUITY

LEVERAGE
PROFITABILITY EFFICIENCY
PROFIT MARGIN ASSETS T/O ROE > ROA
when ROA exceeds
DIFFERENTIATION LOW-COST the cost of debt

Analysis of LEVERAGE

Profitable if:
Cost of capital < rate of return
Kd + Ke < Re

• Leverage shows the extent to which firm relies on debt financing in its capital
structure
• Since cost of debt is typically less than cost of equity, it is optimal for firm to use
some debt in their capital structure to take advantage of leverage

tax shield + less risk

+ without losing control over BOD

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Analysis of LEVERAGE
default
Profitable if:
Cost of capital < rate of return
Kd + Ke < Re

• Given that increases in financial leverage increase ROE, why are all companies
not 100% debt financed?
• The answer is that: debt is risky
• Increased risk increases the expected return investors require to provide
capital to the firm
• Higher financial leverage also results in a higher interest rate on the
company’s debt
• S&P’s and Moody’s ratings partly determine the debt’s interest rate: lower quality ratings yield
higher interest rates.
• If all else equal, higher financial leverage lowers a company’s debt rating and increases the
interest rate it must pay

Using of DUPONT IDENTITY

Table. The DUPONT breakdown for Vietnam Airline (HVN) and Vietjet Air (VJC)
ROE = Profit margin Asset turnover Equity Multiplier
HVN
2016 0.1296 0.0300 0.7265 5.9392
2017 0.1525 0.0321 0.9368 5.0795
2018 0.1392 0.0268 1.1750 4.4124
2019 0.1364 0.0258 1.2848 4.1088

ROE = Profit margin Asset turnover Equity Multiplier

VJC
2016 0.5272 0.0908 1.3707 4.2380
2017 0.4789 0.1199 1.3362 2.9883
2018 0.3800 0.0996 1.3707 2.7842
2019 0.2555 0.0752 1.0357 3.2785

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• E.g. Saigon General Service Corp. (HOSE: SVC) is a retail trading company in
automobile and real estate. What strategy do you expect SVC to follow?

high-value strategy
2009 2010 2011 2012 2013

unprofitable product line * ROE 14% 12% 11% 6% 8%

excess capacity @ high FC * Net margin 3.2% 2.1% 1.3% 0.8% 0.9%
excess SG&A
* Asset T/O 1.72 1.77 2.26 1.99 2.35

* Leverage 2.54 3.22 3.68 3.7 3.78

ASSESSING LIQUIDITY

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




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ASSESSING LIQUIDITY MANAGEMENT

SHORT-TERM LIQUIDITY

• Sheds light on a firm’s ability to pay for obligations that come due
during its operating cycle (e.g. wages, purchases of inventory, ..)
• Common measures used include:
• Current ratio
• Quick ratio
• CCC
• CFO to liabilities

ASSESSING LIQUIDITY MANAGEMENT

CURRENT RATIO

Note: the analysis of CR should be

Current_As sets based on:
 Type of business
CR 
Current_Li abilities  Components of CA and T/Os
 The level of CFO (predictable?)

• This ratio matches the amount of cash and other current assets that will become cash
within one year against the obligations that come due in the next year.
• Generally, firms prefer a higher current ratio
• However, an excessively high current ratio indicates inefficient asset use.

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• E.g. Pomina Steel (HOSE: POM), a Vietnamese steel-maker. The current ratio of the
company are as follow. What can you say about the liquidity of the company?

2018 2019 2020 2021

* Current ratio 1.05 1.01 0.94 0.93

* Quick ratio 0.49 0.39 0.39 0.27

ASSESSING LIQUIDITY MANAGEMENT

QUICK RATIO

factoring
cash  MktSecurities  AR CA  Inv cash  AR
QR   
Current_Liabilties CL CL

• A variation of the current ratio is quick ratio (or Acid-test ratio)

• Include in the numerator only those current assets that the firm could convert
quickly into cash
• Rule of thumb 0.6 – 0.8

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• E.g. Minh Phu Seafood Corp. (HOSE: MPC) is a Vietnamese shrimp producer. The
current and quick ratio of the company are as follow.
• What can you say about the liquidity of the company?
(Note: in the previous slide we already saw a low inventory T/C)

2009 2010 2011 2012 2013

* Current ratio 2.04 1.56 1.2 1.08 1.05

* Quick ratio 0.76 0.81 0.52 0.53 0.6

2009 2010 2011 2012

* Inventory T/O 3.6 4.4 3.3 3

• E.g. Pomina Steel (HOSE: POM), a Vietnamese steel-maker. The current ratio of the
company are as follow. What can you say about the liquidity of the company?

2018 2019 2020 2021

* Current ratio 1.05 1.01 0.94 0.93

* Quick ratio 0.49 0.39 0.39 0.27

* Inventory T/O 5.75 4.13 3.69 4.00

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ASSESSING LIQUIDITY MANAGEMENT

CASH CONVERSION CYCLE

CCC = days inventory held + days sale outstanding – payables deferred period
• CCC measures the financing gap in term of time. As CCC increases, the firm’s
financing needs grow larger.
• E.g.,

inventory stock 52 days inventory sold 15 days cash received

Days inventory held Days sales outstanding

Days payables outstanding Cash conversion period

cash disbursed
40 days 27 days

Cash Operating Cycle for Apple and 3M

 The negative cash cycle for Apple implies that it can invest the cash it
receives from sales for 52.7 days before making payment to suppliers.
 3M is a more typical cash operating cycle.

© Cambridge Business Publishers, 2018

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ASSESSING LIQUIDITY MANAGEMENT

CASH CONVERSION CYCLE

CCC = days inventory held + days sale outstanding – payables deferred period
• How to use CCC:
 Track over multiple periods
 Compare to its competitors, using a combination of factors
 Internal management of AR and AP
 Apply to specific industry only

ASSESSING LIQUIDITY MANAGEMENT

CFO TO LIABILITIES

CFO
Avg_Curren t_Liabilit ies

• The advantage is that this measure is based on cash flow AFTER the funding
needs for working capital (i.e. AR and inventory) been made

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CASH FLOW
STATEMENT ANALYSIS

RELEVANT OF CASH FLOW STATEMENT

• Undo the current period accrual adjustments affecting

• Help users address questions such as:
• How much cash is generated from or used in operations?
• What expenditures are made with cash from operations?
• How are dividends paid when confronting an operation loss?
• What is the source for debt payment, stock redemption, or investment?
• Why is cash lower when income increased?
• What is the use of cash received from new financing?

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RELEVANT OF CASH FLOW STATEMENT

• Operating activities:
• Are there significant discrepancy between NI and CFO? Does this gap
change over time?
• Is it possible to identify the source of this difference?

RELEVANT OF CASH FLOW STATEMENT

• Investing activities:
 Management’s expectation:
• increased investments only if high growth is forecast
 Effect of the nature of business:
• capital intensive vs. Distribution/retailing
 What does cash largest flows come from? Does it provide useful
information about “operational” investments?
• E.g. Compare ROS FLC 2017 – 2020 for Sale and Purchase of
marketable securities.

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• E.g. ROS 2017 - 2020

• What does it tell us about “cash-burn” & “operational”?

FLC Faros Construction JSC (Ticker: ROS)

Consolidated Statement of Cash Flows
(in thousands)
2020 2019 2018 2017
Purchase of fixed assets (153,852) (1,130,846) (1,256,211) (1,281,305)
Purchase of marketable securities (4,721) (1,210,483) (2,903,862) (1,236,827)
Sales and maturity of marketable securities 51,439 910,826 2,370,681 1,644,867
Investments / Di-investment in affiliates 233,400 707,267 1,404,000 (1,634,383)
Interest from investment in securities 41,914 113,315 182,065 813,048
Net cash flows from investing activities 168,180 (609,921) (203,327) (1,694,600)

RELEVANT OF CASH FLOW STATEMENT

• Financing activities:
• Related to current operating performance
• Growth associated with investing and financing
• Effect of the nature of business
• E.g. Amazon 1999
• What type of financing do you expect?

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• E.g. Amazon 1999

• What type of financing do you expect?
• Is this debt financing?
AMAZON.COM, INC.
CONSOLIDATED STATEMENTS OF CASHFLOWS
(in thousands)

Year Ended December 31,

2000 1999 1998
CONVERTIBLE
FINANCING ACTIVITIES: NOTES
Proceeds from exercise stock options 44,697 64,469 14,366
Proceeds from long-term debt 681,499 1,263,639 325,987
Repayment of long-term debt (16,927) (188,886) (78,108)
Financing costs (16,122) (35,151) (7,783)
Net cash provided by financing activities 693,147 1,104,071 254,462

OTHER SUGGESTIONS

Cash Flows Cash Flows Cash Flows

General
from from from
Explanation
Operating Investing Financing
Building up pile of cash. Possibly mature
1. + + +
looking for acquisition.

Operating cash flow being used to

2. + – – expansion
buy fixed assets and pay down debt.

Operating cash flow and sale of fixed

3. + + –
assets being used to pay down debt. mature

Operating cash flow and borrowed expansion

4. + – +
money being used to expand.

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OTHER SUGGESTIONS

Cash Flows Cash Flows Cash Flows

General
from from from
Explanation
Operating Investing Financing
Operating cash flow problems
5. – + + covered by sale of fixed assets,
borrowing, and contributions.
Rapid growth, short falls in operating
6. – – + cash flow, and purchase of fixed
assets.
Sale of fixed assets is financing
7. – + – operating cash flow shortages.

Company is using cash reserves to

8. – – – finance cash flow short falls and pay
creditors.

MARKET TESTS
Measures to look at:
 PE
 PB
 Dividend yield

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RATIOS for STOCK PICKING

PRICE-TO-EARNINGS (PE) ratio: How it is derived:

• Compare the stock price to the firm’s EPS
• The EPS can be either for the past 12
months (historical or trailing PE) or the
coming 12 months (forward or leading PE)
• Is usually expressed in terms of x, which
simply means “times.”
• For instance, a P/E ratio of 5x means that a firm’s
stock price is five times its annual EPS
NI  DIV_Pref. shares
where: EPS 
# outstandin g_common shares

RATIOS for STOCK PICKING

PRICE-TO-EARNINGS (PE) ratio: How it is derived:

What are PE ratios useful for?
• Reflects the value/worth of a firm’s stock
compared to similar stocks across an industry or to
the market
• A high PE: implies either a firm’s stock
is overvalued by the market, or the market expects
it to perform well in the future.
• A low PE: implies either a firm’s stock
is undervalued by the market, or the market expects
it to perform poorly in the future NI  DIV_Pref. shares
where: EPS 
# outstandin g_common shares

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RATIOS for STOCK PICKING

PRICE-TO-EARNINGS (PE) ratio:

What are PE ratios useful for?
• Reflects the value/worth of a firm’s stock
compared to similar stocks across an industry or to
the market
• A high PE: implies either a firm’s stock An investor interested in short selling might look for
is overvalued by the market, or the market expects firms with high PE ratios - yet week fundamentals
it to perform well in the future.  bet on stock prices going down over time
• A low PE: implies either a firm’s stock
is undervalued by the market, or the market expects
it to perform poorly in the future

RATIOS for STOCK PICKING

PRICE-TO-BOOK (PB) ratio: How it is derived:

• Compare the price of the stock to the
firm’s book value (BVE)
• The book value is the net value of the
company's total assets minus its total
liabilities. That is, what the shareholders
may be left with if the company goes
bankrupt.
• Is usually expressed in terms of x, which
simply means “times.”

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RATIOS for STOCK PICKING

DIVIDEND YIELD ratio: How it is derived:

• Measure the percentage return received
from dividends relative to its market price
• Is usually expressed in terms of
percentage

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