Ch,3 - Evaluating a Firm’s
Financial Performance
? 2002,Prentice Hall,Inc,
Financial Statement Analysis
? Are our decisions
maximizing
shareholder
wealth?
We will want to answer
questions about the firm’s
? Liquidity
? Efficient use of Assets
? Leverage (financing)
? Profitability
We will want to answer
questions about the firm’s
? Liquidity
? Efficient use of Assets
? Leverage (financing)
? Profitability
Financial Ratios
? Tools that help us determine the
financial health of a company,
? We can compare a company’s
financial ratios with its ratios in
previous years (trend analysis),
? We can compare a company’s
financial ratios with those of its
industry,
Example,
CyberDragon Corporation
CyberDragon’s
Balance Sheet ($000)
Assets,Liabilities & Equity,
Cash $2,540 Accounts payable 9,721
Marketable securities 1,800 Notes payable 8,500
Accounts receivable 18,320 Accrued taxes payable 3,200
Inventories 27,530 Other current liabilities 4,102
Total current assets 50,190 Total current liabilities 25,523
Plant and equipment 43,100 Long-term debt (bonds) 22,000
less accum deprec,11,400 Total liabilities 47,523
Net plant & equip,31,700 Common stock ($10 par) 13,000
Total assets 81,890 Paid in capital 10,000
Retained earnings 11,367
Total stockholders' equity 34,367
Total liabilities & equity 81,890
Sales (all credit) $112,760
Cost of Goods Sold (85,300)
Gross Profit 27,460
Operating Expenses,
Selling (6,540)
General & Administrative (9,400)
Total Operating Expenses (15,940)
Earnings before interest and taxes (EBIT) 11,520
Interest charges,
Interest on bank notes,(850)
Interest on bonds,(2,310)
Total Interest charges (3,160)
Earnings before taxes (EBT) 8,360
Taxes (assume 40%) (3,344)
Net Income 5,016
CyberDragon’s Income
Statement
CyberDragon
Other Information
Dividends paid on common stock $2,800
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
1,Liquidity Ratios
? Do we have enough liquid assets
to meet approaching obligations?
What is CyberDragon’s Current Ratio?
What is CyberDragon’s Current Ratio?
50,190
25,523 = 1.97
What is CyberDragon’s Current Ratio?
If the average current ratio for the
industry is 2.4,is this good or not?
50,190
25,523 = 1.97
What is the firm’s Acid Test Ratio?
What is the firm’s Acid Test Ratio?
50,190 - 27,530
25,523 =,89
What is the firm’s Acid Test Ratio?
Suppose the industry average is,92,
What does this tell us?
50,190 - 27,530
25,523 =,89
What is the firm’s Average Collection
Period?
What is the firm’s Average Collection
Period?
18,320
112,760/365 = 59.3 days
What is the firm’s Average Collection
Period?
If the industry average is 47 days,
what does this tell us?
18,320
112,760/365 = 59.3 days
2,Operating Efficiency Ratios
? Measure how efficiently the
firm’s assets generate operating
profits,
What is the firm’s Operating Income
Return on Investment (OIROI)?
What is the firm’s Operating Income
Return on Investment (OIROI)?
11,520
81,890 = 14.07%
?Slightly below the industry
average of 15%,
What is the firm’s Operating Income
Return on Investment (OIROI)?
11,520
81,890 = 14.07%
?Slightly below the industry
average of 15%,
?The OIROI reflects product
pricing and the firm’s ability to
keep costs down,
What is the firm’s Operating Income
Return on Investment (OIROI)?
11,520
81,890 = 14.07%
What is their Operating Profit Margin?
What is their Operating Profit Margin?
11,520
112,760 = 10.22%
What is their Operating Profit Margin?
?This is below the industry average of
12%,
11,520
112,760 = 10.22%
What is their Total Asset Turnover?
What is their Total Asset Turnover?
112,760
81,890 = 1.38 times
What is their Total Asset Turnover?
The industry average is 1.82 times,
The firm needs to figure out how to
squeeze more sales dollars out of its
assets,
112,760
81,890 = 1.38 times
What is the firm’s Accounts Receivable
Turnover?
What is the firm’s Accounts Receivable
Turnover?
112,760
18,320 = 6.16 times
What is the firm’s Accounts Receivable
Turnover?
CyberDragon turns their A/R over 6.16
times per year,The industry average
is 8.2 times,Is this efficient?
112,760
18,320 = 6.16 times
What is the firm’s Inventory Turnover?
What is the firm’s Inventory Turnover?
85,300
27,530 = 3.10 times
What is the firm’s Inventory Turnover?
CyberDragon turns their inventory
over 3.1 times per year,
The industry average is 3.9 times,
Is this efficient?
85,300
27,530 = 3.10 times
Low inventory 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,
What is the firm’s Fixed Asset
Turnover?
What is the firm’s Fixed Asset
Turnover?
112,760
31,700 = 3.56 times
What is the firm’s Fixed Asset
Turnover?
If the industry average is 4.6 times,what
does this tell us about CyberDragon?
112,760
31,700 = 3.56 times
3,Leverage Ratios
(financing decisions)
? Measure the impact of using debt
capital to finance assets,
? Firms use debt to lever (increase)
returns on common equity,
How does Leverage work?
? Suppose we have an all equity-
financed firm worth $100,000,Its
earnings this year total $15,000,
ROE =
(ignore taxes for this example)
How does Leverage work?
? Suppose we have an all equity-
financed firm worth $100,000,Its
earnings this year total $15,000,
ROE = = 15%
15,000
100,000
How does Leverage work?
? Suppose the same $100,000 firm is
financed with half equity,and half
8% debt (bonds),Earnings are still
$15,000,
ROE =
How does Leverage work?
? Suppose the same $100,000 firm is
financed with half equity,and half
8% debt (bonds),Earnings are still
$15,000,
ROE = = 15,000 - 4,000 50,000
How does Leverage work?
? Suppose the same $100,000 firm is
financed with half equity,and half
8% debt (bonds),Earnings are still
$15,000,
ROE = = 22% 15,000 - 4,000 50,000
What is CyberDragon’s Debt Ratio?
What is CyberDragon’s Debt Ratio?
47,523
81,890 = 58%
What is CyberDragon’s Debt Ratio?
If the industry average is 47%,what
does this tell us?
47,523
81,890 = 58%
What is CyberDragon’s Debt Ratio?
47,523
81,890 = 58%
If the industry average is 47%,what
does this tell us?
Can leverage make the firm more
profitable?
Can leverage make the firm riskier?
What is the firm’s Times Interest
Earned Ratio?
What is the firm’s Times Interest
Earned Ratio?
11,520
3,160 = 3.65 times
What is the firm’s Times Interest
Earned Ratio?
The industry average is 6.7 times,This
is further evidence that the firm uses
more debt financing than average,
11,520
3,160 = 3.65 times
4,Return on Equity
How well are the firm’s managers
maximizing shareholder wealth?
What is CyberDragon’s
Return on Equity (ROE)?
What is CyberDragon’s
Return on Equity (ROE)?
5,016
34,367 = 14.6%
What is CyberDragon’s
Return on Equity (ROE)?
The industry average is 17.54%,
5,016
34,367 = 14.6%
What is CyberDragon’s
Return on Equity (ROE)?
5,016
34,367 = 14.6%
The industry average is 17.54%,
Is this what we would expect,
given the firm’s leverage?
Conclusion,
? Even though CyberDragon has
higher leverage than the industry
average,they are much less
efficient,and therefore,less
profitable,
The DuPont Model
Brings together,
? Profitability
? Efficiency
? Leverage
Net Profit Total Asset Debt
Margin Turnover Ratio ROE = x / (1- )
The DuPont Model
Net Profit Total Asset Debt
Margin Turnover Ratio
Net Income Sales Total Debt
Sales Total Assets Total Assets
ROE = x / (1- )
= x /(1- )
The DuPont Model
Net Profit Total Asset Debt
Margin Turnover Ratio
Net Income Sales Total Debt
Sales Total Assets Total Assets
5,016 112,760 47,523
112,760 81,890 81,890
ROE = x / (1- )
= x /(1- )
= x / (1 - )
The DuPont Model
ROE = x / (1- )
= x /(1- )
= x / (1 - )
= 14.6%
Net Profit Total Asset Debt
Margin Turnover Ratio
Net Income Sales Total Debt
Sales Total Assets Total Assets
5,016 112,760 47,523
112,760 81,890 81,890
The DuPont Model
Financial Performance
? 2002,Prentice Hall,Inc,
Financial Statement Analysis
? Are our decisions
maximizing
shareholder
wealth?
We will want to answer
questions about the firm’s
? Liquidity
? Efficient use of Assets
? Leverage (financing)
? Profitability
We will want to answer
questions about the firm’s
? Liquidity
? Efficient use of Assets
? Leverage (financing)
? Profitability
Financial Ratios
? Tools that help us determine the
financial health of a company,
? We can compare a company’s
financial ratios with its ratios in
previous years (trend analysis),
? We can compare a company’s
financial ratios with those of its
industry,
Example,
CyberDragon Corporation
CyberDragon’s
Balance Sheet ($000)
Assets,Liabilities & Equity,
Cash $2,540 Accounts payable 9,721
Marketable securities 1,800 Notes payable 8,500
Accounts receivable 18,320 Accrued taxes payable 3,200
Inventories 27,530 Other current liabilities 4,102
Total current assets 50,190 Total current liabilities 25,523
Plant and equipment 43,100 Long-term debt (bonds) 22,000
less accum deprec,11,400 Total liabilities 47,523
Net plant & equip,31,700 Common stock ($10 par) 13,000
Total assets 81,890 Paid in capital 10,000
Retained earnings 11,367
Total stockholders' equity 34,367
Total liabilities & equity 81,890
Sales (all credit) $112,760
Cost of Goods Sold (85,300)
Gross Profit 27,460
Operating Expenses,
Selling (6,540)
General & Administrative (9,400)
Total Operating Expenses (15,940)
Earnings before interest and taxes (EBIT) 11,520
Interest charges,
Interest on bank notes,(850)
Interest on bonds,(2,310)
Total Interest charges (3,160)
Earnings before taxes (EBT) 8,360
Taxes (assume 40%) (3,344)
Net Income 5,016
CyberDragon’s Income
Statement
CyberDragon
Other Information
Dividends paid on common stock $2,800
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
1,Liquidity Ratios
? Do we have enough liquid assets
to meet approaching obligations?
What is CyberDragon’s Current Ratio?
What is CyberDragon’s Current Ratio?
50,190
25,523 = 1.97
What is CyberDragon’s Current Ratio?
If the average current ratio for the
industry is 2.4,is this good or not?
50,190
25,523 = 1.97
What is the firm’s Acid Test Ratio?
What is the firm’s Acid Test Ratio?
50,190 - 27,530
25,523 =,89
What is the firm’s Acid Test Ratio?
Suppose the industry average is,92,
What does this tell us?
50,190 - 27,530
25,523 =,89
What is the firm’s Average Collection
Period?
What is the firm’s Average Collection
Period?
18,320
112,760/365 = 59.3 days
What is the firm’s Average Collection
Period?
If the industry average is 47 days,
what does this tell us?
18,320
112,760/365 = 59.3 days
2,Operating Efficiency Ratios
? Measure how efficiently the
firm’s assets generate operating
profits,
What is the firm’s Operating Income
Return on Investment (OIROI)?
What is the firm’s Operating Income
Return on Investment (OIROI)?
11,520
81,890 = 14.07%
?Slightly below the industry
average of 15%,
What is the firm’s Operating Income
Return on Investment (OIROI)?
11,520
81,890 = 14.07%
?Slightly below the industry
average of 15%,
?The OIROI reflects product
pricing and the firm’s ability to
keep costs down,
What is the firm’s Operating Income
Return on Investment (OIROI)?
11,520
81,890 = 14.07%
What is their Operating Profit Margin?
What is their Operating Profit Margin?
11,520
112,760 = 10.22%
What is their Operating Profit Margin?
?This is below the industry average of
12%,
11,520
112,760 = 10.22%
What is their Total Asset Turnover?
What is their Total Asset Turnover?
112,760
81,890 = 1.38 times
What is their Total Asset Turnover?
The industry average is 1.82 times,
The firm needs to figure out how to
squeeze more sales dollars out of its
assets,
112,760
81,890 = 1.38 times
What is the firm’s Accounts Receivable
Turnover?
What is the firm’s Accounts Receivable
Turnover?
112,760
18,320 = 6.16 times
What is the firm’s Accounts Receivable
Turnover?
CyberDragon turns their A/R over 6.16
times per year,The industry average
is 8.2 times,Is this efficient?
112,760
18,320 = 6.16 times
What is the firm’s Inventory Turnover?
What is the firm’s Inventory Turnover?
85,300
27,530 = 3.10 times
What is the firm’s Inventory Turnover?
CyberDragon turns their inventory
over 3.1 times per year,
The industry average is 3.9 times,
Is this efficient?
85,300
27,530 = 3.10 times
Low inventory 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,
What is the firm’s Fixed Asset
Turnover?
What is the firm’s Fixed Asset
Turnover?
112,760
31,700 = 3.56 times
What is the firm’s Fixed Asset
Turnover?
If the industry average is 4.6 times,what
does this tell us about CyberDragon?
112,760
31,700 = 3.56 times
3,Leverage Ratios
(financing decisions)
? Measure the impact of using debt
capital to finance assets,
? Firms use debt to lever (increase)
returns on common equity,
How does Leverage work?
? Suppose we have an all equity-
financed firm worth $100,000,Its
earnings this year total $15,000,
ROE =
(ignore taxes for this example)
How does Leverage work?
? Suppose we have an all equity-
financed firm worth $100,000,Its
earnings this year total $15,000,
ROE = = 15%
15,000
100,000
How does Leverage work?
? Suppose the same $100,000 firm is
financed with half equity,and half
8% debt (bonds),Earnings are still
$15,000,
ROE =
How does Leverage work?
? Suppose the same $100,000 firm is
financed with half equity,and half
8% debt (bonds),Earnings are still
$15,000,
ROE = = 15,000 - 4,000 50,000
How does Leverage work?
? Suppose the same $100,000 firm is
financed with half equity,and half
8% debt (bonds),Earnings are still
$15,000,
ROE = = 22% 15,000 - 4,000 50,000
What is CyberDragon’s Debt Ratio?
What is CyberDragon’s Debt Ratio?
47,523
81,890 = 58%
What is CyberDragon’s Debt Ratio?
If the industry average is 47%,what
does this tell us?
47,523
81,890 = 58%
What is CyberDragon’s Debt Ratio?
47,523
81,890 = 58%
If the industry average is 47%,what
does this tell us?
Can leverage make the firm more
profitable?
Can leverage make the firm riskier?
What is the firm’s Times Interest
Earned Ratio?
What is the firm’s Times Interest
Earned Ratio?
11,520
3,160 = 3.65 times
What is the firm’s Times Interest
Earned Ratio?
The industry average is 6.7 times,This
is further evidence that the firm uses
more debt financing than average,
11,520
3,160 = 3.65 times
4,Return on Equity
How well are the firm’s managers
maximizing shareholder wealth?
What is CyberDragon’s
Return on Equity (ROE)?
What is CyberDragon’s
Return on Equity (ROE)?
5,016
34,367 = 14.6%
What is CyberDragon’s
Return on Equity (ROE)?
The industry average is 17.54%,
5,016
34,367 = 14.6%
What is CyberDragon’s
Return on Equity (ROE)?
5,016
34,367 = 14.6%
The industry average is 17.54%,
Is this what we would expect,
given the firm’s leverage?
Conclusion,
? Even though CyberDragon has
higher leverage than the industry
average,they are much less
efficient,and therefore,less
profitable,
The DuPont Model
Brings together,
? Profitability
? Efficiency
? Leverage
Net Profit Total Asset Debt
Margin Turnover Ratio ROE = x / (1- )
The DuPont Model
Net Profit Total Asset Debt
Margin Turnover Ratio
Net Income Sales Total Debt
Sales Total Assets Total Assets
ROE = x / (1- )
= x /(1- )
The DuPont Model
Net Profit Total Asset Debt
Margin Turnover Ratio
Net Income Sales Total Debt
Sales Total Assets Total Assets
5,016 112,760 47,523
112,760 81,890 81,890
ROE = x / (1- )
= x /(1- )
= x / (1 - )
The DuPont Model
ROE = x / (1- )
= x /(1- )
= x / (1 - )
= 14.6%
Net Profit Total Asset Debt
Margin Turnover Ratio
Net Income Sales Total Debt
Sales Total Assets Total Assets
5,016 112,760 47,523
112,760 81,890 81,890
The DuPont Model
