3 - 1
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Ratio analysis
?Du Pont system
?Effects of improving ratios
?Limitations of ratio analysis
?Qualitative factors
CHAPTER 3
Analysis of Financial Statements
3 - 2
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Balance Sheet,Assets
2002E 2001
Cash 14,000 7,282
ST investments 71,632 0
AR 878,000 632,160
Inventories 1,716,480 1,287,360
Total CA 2,680,112 1,926,802
Gross FA 1,197,160 1,202,950
Less,Deprec,380,120 263,160
Net FA 817,040 939,790
Total assets 3,497,152 2,866,592
3 - 3
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Liabilities and Equity
2002E 2001
Accounts payable 436,800 524,160
Notes payable 600,000 720,000
Accruals 408,000 489,600
Total CL 1,444,800 1,733,760
Long-term debt 500,000 1,000,000
Common stock 1,680,936 460,000
Retained earnings (128,584) (327,168)
Total equity 1,552,352 132,832
Total L&E 3,497,152 2,866,592
3 - 4
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Income Statement
2002E 2001
Sales 7,035,600 5,834,400
COGS 6,100,000 5,728,000
Other expenses 312,960 680,000
Depreciation 120,000 116,960
Tot,op,costs 6,532,960 6,524,960
EBIT 502,640 (690,560)
Interest exp,80,000 176,000
EBT 422,640 (866,560)
Taxes (40%) 169,056 (346,624)
Net income 253,584 (519,936)
3 - 5
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Other Data
2002E 2001
Shares out,250,000 100,000
EPS $1.014 ($5.199)
DPS $0.220 $0.110
Stock price $12.17 $2.25
Lease pmts $40,000 $40,000
3 - 6
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Standardize numbers; facilitate
comparisons
?Used to highlight weaknesses and
strengths
Why are ratios useful?
3 - 7
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Liquidity,Can we make required
payments as they fall due?
?Asset management,Do we have
the right amount of assets for the
level of sales?
What are the five major categories of
ratios,and what questions do they
answer?
(More…)
3 - 8
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Debt management,Do we have the
right mix of debt and equity?
?Profitability,Do sales prices exceed
unit costs,and are sales high
enough as reflected in PM,ROE,and
ROA?
?Market value,Do investors like what
they see as reflected in P/E and M/B
ratios?
3 - 9
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Calculate the firm’s forecasted current
and quick ratios for 2002.
CR02 = = = 1.85x.
QR02 =
= = 0.67x.
CA
CL
$2,680
$1,445
$2,680 - $1,716
$1,445
CA - Inv.
CL
3 - 10
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Expected to improve but still below
the industry average.
?Liquidity position is weak.
Comments on CR and QR
2002E 2001 2000 Ind.
CR 1.85x 1.1x 2.3x 2.7x
QR 0.67x 0.4x 0.8x 1.0x
3 - 11
Copyright ? 2002 Harcourt,Inc,All rights reserved.
What is the inventory turnover ratio as
compared to the industry average?
Inv,turnover =
= = 4.10x.
Sales
Inventories
$7,036
$1,716
2002E 2001 2000 Ind.
Inv,T,4.1x 4.5x 4.8x 6.1x
3 - 12
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Inventory turnover is below
industry average.
?Firm might have old inventory,or
its control might be poor.
?No improvement is currently
forecasted.
Comments on Inventory Turnover
3 - 13
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Receivables
Average sales per day
DSO is the average number of days
after making a sale before receiving
cash.
DSO =
= =
= 44.9 days.
Receivables
Sales/360
$878
$7,036/360
3 - 14
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Appraisal of DSO
? Firm collects too slowly,and
situation is getting worse.
? Poor credit policy.
2002E 2001 2000 Ind.
DSO 44.9 39.0 36.8 32.0
3 - 15
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Fixed Assets and Total Assets
Turnover Ratios
Fixed assets
turnover
Sales
Net fixed assets=
= = 8.61x.$7,036$817
Total assets
turnover
Sales
Total assets=
= = 2.01x.$7,036$3,497
(More…)
3 - 16
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?FA turnover is expected to exceed
industry average,Good.
?TA turnover not up to industry
average,Caused by excessive
current assets (A/R and inventory).
2002E 2001 2000 Ind.
FA TO 8.6x 6.2x 10.0x 7.0x
TA TO 2.0x 2.0x 2.3x 2.5x
3 - 17
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Calculate the debt,TIE,and EBITDA
coverage ratios.
Total debt
Total assetsDebt ratio =
= = 55.6%.$1,445 + $500$3,497
EBIT
Int,expenseTIE =
= = 6.3x.$502.6$80
(More…)
3 - 18
Copyright ? 2002 Harcourt,Inc,All rights reserved.
All three ratios reflect use of debt,but
focus on different aspects.
EBITDA
coverage = EC
= = 5.5x.
EBIT + Depr,& Amort,+ Lease payments
Interest Lease Loan pmt.
expense pmt,+ +
$502.6 + $120 + $40
$80 + $40 + $0
3 - 19
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Too much debt,but projected to
improve.
How do the debt management ratios
compare with industry averages?
2002E 2001 2000 Ind.
D/A 55.6% 95.4% 54.8% 50.0%
TIE 6.3x -3.9x 3.3x 6.2x
EC 5.5x -2.5x 2.6x 8.0x
3 - 20
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Very bad in 2001,but projected to
meet industry average in 2002,
Looking good.
Profit Margin (PM)
PM = = = 3.6%.NI Sales $253.6$7,036
2002E 2001 2000 Ind.
PM 3.6% -8.9% 2.6% 3.6%
3 - 21
Copyright ? 2002 Harcourt,Inc,All rights reserved.
BEP =
= = 14.4%.
Basic Earning Power (BEP)
EBIT
Total assets
$502.6
$3,497
(More…)
3 - 22
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?BEP removes effect of taxes and
financial leverage,Useful for
comparison.
?Projected to be below average.
?Room for improvement.
2002E 2001 2000 Ind.
BEP 14.4% -24.1% 14.2% 17.8%
3 - 23
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Return on Assets (ROA)
and Return on Equity (ROE)
ROA =
= = 7.3%.
Net income
Total assets
$253.6
$3,497
(More…)
3 - 24
Copyright ? 2002 Harcourt,Inc,All rights reserved.
ROE =
= = 16.3%.
Net income
Common equity
$253.6
$1,552
Both below average but improving.
2002E 2001 2000 Ind.
ROA 7.3% -18.1% 6.0% 9.0%
ROE 16.3% -391.0% 13.3% 18.0%
3 - 25
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?ROA is lowered by debt--interest
expense lowers net income,which
also lowers ROA.
?However,the use of debt lowers
equity,and if equity is lowered
more than net income,ROE would
increase.
Effects of Debt on ROA and ROE
3 - 26
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Calculate and appraise the
P/E,P/CF,and M/B ratios.
Price = $12.17.
EPS = = = $1.01.
P/E = = = 12x.
NI
Shares out.
$253.6
250
Price per share
EPS
$12.17
$1.01
(More…)
3 - 27
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Typical industry average P/E ratios
* Because many internet companies have negative earnings and no
P/E,there was only a small sample of internet companies,
Industry P/E ratio
Banking 17.15
Computer Software Services 33.01
Drug 41.81
Electric Utilities (Eastern U.S.) 19.40
Internet Services* 290.35
Semiconductors 78.41
Steel 12.71
Tobacco 11.59
Water Utilities 21.84
3 - 28
Copyright ? 2002 Harcourt,Inc,All rights reserved.
NI + Depr,
Shares out.CF per share =
= = $1.49.$253.6 + $120.0250
Price per share
Cash flow per shareP/CF =
= = 8.2x.$12.17$1.49
3 - 29
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Com,equity
Shares out.BVPS =
= = $6.21.$1,552250
Mkt,price per share
Book value per shareM/B =
= = 2.0x.$12.17$6.21
(More…)
3 - 30
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?P/E,How much investors will pay
for $1 of earnings,High is good.
?M/B,How much paid for $1 of book
value,Higher is good.
?P/E and M/B are high if ROE is high,
risk is low.
2002E 2001 2000 Ind.
P/E 12.0x -0.4x 9.7x 14.2x
P/CF 8.2x -0.6x 8.0x 7.6x
M/B 2.0x 1.7x 1.3x 2.9x
3 - 31
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Common Size Balance Sheets:
Divide all items by Total Assets
Assets 2000 2001 2002E Ind.
Cash 0.6% 0.3% 0.4% 0.3%
ST Invest,3.3% 0.0% 2.0% 0.3%
AR 23.9% 22.1% 25.1% 22.4%
Invent,48.7% 44.9% 49.1% 41.2%
Total CA 76.5% 67.2% 76.6% 64.1%
Net FA 23.5% 32.8% 23.4% 35.9%
TA 100.0% 100.0% 100.0% 100.0%
3 - 32
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Divide all items by
Total Liabilities & Equity
2000 2001 2002E Ind.
AP 9.9% 18.3% 12.5% 11.9%
Notes pay,13.6% 25.1% 17.2% 2.4%
Accruals 9.3% 17.1% 11.7% 9.5%
Total CL 32.8% 60.5% 41.3% 23.7%
LT Debt 22.0% 34.9% 14.3% 26.3%
Total equ,45.2% 4.6% 44.4% 50.0%
Total L&E 100.0% 100.0% 100.0% 100.0%
3 - 33
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Analysis of Common Size Balance
Sheets
?Computron has higher proportion of
current assets (49.1%) than Industry
(41.2%).
?Computron has slightly less equity
(which means more debt) than Industry.
?Computron has more short-term debt
than industry,but less long-term debt
than industry.
3 - 34
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Common Size Income Statement:
Divide all items by Sales
2000 2001 2002E Ind.
Sales 100.0% 100.0% 100.0% 100.0%
COGS 83.4% 98.2% 86.7% 84.5%
Other exp,9.9% 11.7% 4.4% 4.4%
Depr,0.6% 2.0% 1.7% 4.0%
EBIT 6.1% -11.8% 7.1% 7.1%
Int,Exp,1.8% 3.0% 1.1% 1.1%
EBT 4.3% -14.9% 6.0% 5.9%
Taxes 1.7% -5.9% 2.4% 2.4%
NI 2.6% -8.9% 3.6% 3.6%
3 - 35
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Analysis of Common Size Income
Statements
?Computron has higher COGS (86.7)
than industry (84.5),but lower
depreciation,Result is that
Computron has similar EBIT (7.1) as
industry.
3 - 36
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Percentage Change Analysis,Find
Percentage Change from First Year (2000)
Income St,2000 2001 2002E
Sales 0.0% 70.0% 105.0%
COGS 0.0% 100.0% 113.0%
Other exp,0.0% 100.0% -8.0%
Depr,0.0% 518.8% 534.9%
EBIT 0.0% -430.3% 140.4%
Int,Exp,0.0% 181.6% 28.0%
EBT 0.0% -691.1% 188.3%
Taxes 0.0% -691.1% 188.3%
NI 0.0% -691.1% 188.3%
3 - 37
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Analysis of Percent Change Income
Statement
?We see that 2002 sales grow 105%
from 2000,and that NI grows 188%
from 2000.
?So Computron has become more
profitable.
3 - 38
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Percentage Change Balance Sheets
Assets 2000 2001 2002E
Cash 0.0% -19.1% 55.6%
ST Invest,0.0% -100.0% 47.4%
AR 0.0% 80.0% 150.0%
Invent,0.0% 80.0% 140.0%
Total CA 0.0% 71.4% 138.4%
Net FA 0.0% 172.6% 137.0%
TA 0.0% 95.2% 138.1%
3 - 39
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Liab,& Eq,2000 2001 2002E
AP 0.0% 260.0% 200.0%
Notes pay,0.0% 260.0% 200.0%
Accruals 0.0% 260.0% 200.0%
Total CL 0.0% 260.0% 200.0%
LT Debt 0.0% 209.2% 54.6%
Total equity 0.0% -80.0% 133.9%
Total L&E 0.0% 95.2% 138.1%
3 - 40
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Analysis of Percent Change Balance
Sheets
?We see that total assets grow at a
rate of 138%,while sales grow at a
rate of only 105%,So asset
utilization remains a problem.
3 - 41
Copyright ? 2002 Harcourt,Inc,All rights reserved.
( )( )( ) = ROEProfitmargin TAturnover Equitymultiplier
NI
Sales
Sales
TA
TA
CE
2000 2.6% x 2.3 x 2.2 = 13.2%
2001 -8.9% x 2.0 x 21.6 = -391.0%
2002 3.6% x 2.0 x 2.3 = 16.3%
Ind,3.6% x 2.5 x 2.0 = 18.0%
Explain the Du Pont System
x x = ROE.
3 - 42
Copyright ? 2002 Harcourt,Inc,All rights reserved.
The Du Pont system focuses on:
?Expense control (PM)
?Asset utilization (TATO)
?Debt utilization (EM)
It shows how these factors combine
to determine the ROE.
3 - 43
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Simplified Firm Data
A/R $ 878 Debt $1,945
Other CA 1,802 Equity 1,552
Net FA 817
Total assets $3,497 L&E $3,497
Q,How would reducing DSO to 32
days affect the company?
Sales $7,035,600
day 360= = $19,543.
3 - 44
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Effect of reducing DSO from
44.9 days to 32 days:
Old A/R = $19,543 x 44.9= $878,000
New A/R = $19,543 x 32.0= 625,376
Cash freed up,$252,624
Initially shows up as additional cash.
3 - 45
Copyright ? 2002 Harcourt,Inc,All rights reserved.
What could be done with the new
cash? Effect on stock price and risk?
New Balance Sheet
Added cash $ 253 Debt $1,945
A/R 625 Equity 1,552
Other CA 1,802
Net FA 817
Total assets $3,497 Total L&E $3,497
3 - 46
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Potential use of freed up cash
?Repurchase stock,Higher ROE,
higher EPS.
?Expand business,Higher profits.
?Reduce debt,Better debt ratio;
lower interest,hence higher NI.
(More…)
3 - 47
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Inventories are also too high,Could
analyze the effect of an inventory
reduction on freeing up cash and
increasing the quick ratio and asset
management ratios,Such an
analysis would be similar to what was
done with DSO in previous slides.
?All these actions would likely
improve stock price.
3 - 48
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Would you lend money
to this company?
?Maybe,The situation could
improve,and the loan,with a high
interest rate to reflect the risk,
could be a good investment.
?However,company should not have
relied so heavily on debt financing
in the past.
3 - 49
Copyright ? 2002 Harcourt,Inc,All rights reserved.
What are some potential problems and
limitations of financial ratio analysis?
?Comparison with industry averages
is difficult if the firm operates many
different divisions.
?“Average” performance is not
necessarily good.
?Seasonal factors can distort ratios.
(More…)
3 - 50
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Window dressing techniques can make
statements and ratios look better.
?Different accounting and operating
practices can distort comparisons.
?Sometimes it is difficult to tell if a ratio
value is,good” or,bad.”
?Often,different ratios give different
signals,so it is difficult to tell,on
balance,whether a company is in a
strong or weak financial condition.
3 - 51
Copyright ? 2002 Harcourt,Inc,All rights reserved.
What are some qualitative factors
analysts should consider when
evaluating a company’s likely future
financial performance?
?Are the company’s revenues tied to a
single customer?
?To what extent are the company’s
revenues tied to a single product?
?To what extent does the company
rely on a single supplier? (More…)
3 - 52
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?What percentage of the company’s
business is generated overseas?
?What is the competitive situation?
?What does the future have in store?
?What is the company’s legal and
regulatory environment?
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Ratio analysis
?Du Pont system
?Effects of improving ratios
?Limitations of ratio analysis
?Qualitative factors
CHAPTER 3
Analysis of Financial Statements
3 - 2
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Balance Sheet,Assets
2002E 2001
Cash 14,000 7,282
ST investments 71,632 0
AR 878,000 632,160
Inventories 1,716,480 1,287,360
Total CA 2,680,112 1,926,802
Gross FA 1,197,160 1,202,950
Less,Deprec,380,120 263,160
Net FA 817,040 939,790
Total assets 3,497,152 2,866,592
3 - 3
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Liabilities and Equity
2002E 2001
Accounts payable 436,800 524,160
Notes payable 600,000 720,000
Accruals 408,000 489,600
Total CL 1,444,800 1,733,760
Long-term debt 500,000 1,000,000
Common stock 1,680,936 460,000
Retained earnings (128,584) (327,168)
Total equity 1,552,352 132,832
Total L&E 3,497,152 2,866,592
3 - 4
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Income Statement
2002E 2001
Sales 7,035,600 5,834,400
COGS 6,100,000 5,728,000
Other expenses 312,960 680,000
Depreciation 120,000 116,960
Tot,op,costs 6,532,960 6,524,960
EBIT 502,640 (690,560)
Interest exp,80,000 176,000
EBT 422,640 (866,560)
Taxes (40%) 169,056 (346,624)
Net income 253,584 (519,936)
3 - 5
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Other Data
2002E 2001
Shares out,250,000 100,000
EPS $1.014 ($5.199)
DPS $0.220 $0.110
Stock price $12.17 $2.25
Lease pmts $40,000 $40,000
3 - 6
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Standardize numbers; facilitate
comparisons
?Used to highlight weaknesses and
strengths
Why are ratios useful?
3 - 7
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Liquidity,Can we make required
payments as they fall due?
?Asset management,Do we have
the right amount of assets for the
level of sales?
What are the five major categories of
ratios,and what questions do they
answer?
(More…)
3 - 8
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Debt management,Do we have the
right mix of debt and equity?
?Profitability,Do sales prices exceed
unit costs,and are sales high
enough as reflected in PM,ROE,and
ROA?
?Market value,Do investors like what
they see as reflected in P/E and M/B
ratios?
3 - 9
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Calculate the firm’s forecasted current
and quick ratios for 2002.
CR02 = = = 1.85x.
QR02 =
= = 0.67x.
CA
CL
$2,680
$1,445
$2,680 - $1,716
$1,445
CA - Inv.
CL
3 - 10
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Expected to improve but still below
the industry average.
?Liquidity position is weak.
Comments on CR and QR
2002E 2001 2000 Ind.
CR 1.85x 1.1x 2.3x 2.7x
QR 0.67x 0.4x 0.8x 1.0x
3 - 11
Copyright ? 2002 Harcourt,Inc,All rights reserved.
What is the inventory turnover ratio as
compared to the industry average?
Inv,turnover =
= = 4.10x.
Sales
Inventories
$7,036
$1,716
2002E 2001 2000 Ind.
Inv,T,4.1x 4.5x 4.8x 6.1x
3 - 12
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Inventory turnover is below
industry average.
?Firm might have old inventory,or
its control might be poor.
?No improvement is currently
forecasted.
Comments on Inventory Turnover
3 - 13
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Receivables
Average sales per day
DSO is the average number of days
after making a sale before receiving
cash.
DSO =
= =
= 44.9 days.
Receivables
Sales/360
$878
$7,036/360
3 - 14
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Appraisal of DSO
? Firm collects too slowly,and
situation is getting worse.
? Poor credit policy.
2002E 2001 2000 Ind.
DSO 44.9 39.0 36.8 32.0
3 - 15
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Fixed Assets and Total Assets
Turnover Ratios
Fixed assets
turnover
Sales
Net fixed assets=
= = 8.61x.$7,036$817
Total assets
turnover
Sales
Total assets=
= = 2.01x.$7,036$3,497
(More…)
3 - 16
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?FA turnover is expected to exceed
industry average,Good.
?TA turnover not up to industry
average,Caused by excessive
current assets (A/R and inventory).
2002E 2001 2000 Ind.
FA TO 8.6x 6.2x 10.0x 7.0x
TA TO 2.0x 2.0x 2.3x 2.5x
3 - 17
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Calculate the debt,TIE,and EBITDA
coverage ratios.
Total debt
Total assetsDebt ratio =
= = 55.6%.$1,445 + $500$3,497
EBIT
Int,expenseTIE =
= = 6.3x.$502.6$80
(More…)
3 - 18
Copyright ? 2002 Harcourt,Inc,All rights reserved.
All three ratios reflect use of debt,but
focus on different aspects.
EBITDA
coverage = EC
= = 5.5x.
EBIT + Depr,& Amort,+ Lease payments
Interest Lease Loan pmt.
expense pmt,+ +
$502.6 + $120 + $40
$80 + $40 + $0
3 - 19
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Too much debt,but projected to
improve.
How do the debt management ratios
compare with industry averages?
2002E 2001 2000 Ind.
D/A 55.6% 95.4% 54.8% 50.0%
TIE 6.3x -3.9x 3.3x 6.2x
EC 5.5x -2.5x 2.6x 8.0x
3 - 20
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Very bad in 2001,but projected to
meet industry average in 2002,
Looking good.
Profit Margin (PM)
PM = = = 3.6%.NI Sales $253.6$7,036
2002E 2001 2000 Ind.
PM 3.6% -8.9% 2.6% 3.6%
3 - 21
Copyright ? 2002 Harcourt,Inc,All rights reserved.
BEP =
= = 14.4%.
Basic Earning Power (BEP)
EBIT
Total assets
$502.6
$3,497
(More…)
3 - 22
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?BEP removes effect of taxes and
financial leverage,Useful for
comparison.
?Projected to be below average.
?Room for improvement.
2002E 2001 2000 Ind.
BEP 14.4% -24.1% 14.2% 17.8%
3 - 23
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Return on Assets (ROA)
and Return on Equity (ROE)
ROA =
= = 7.3%.
Net income
Total assets
$253.6
$3,497
(More…)
3 - 24
Copyright ? 2002 Harcourt,Inc,All rights reserved.
ROE =
= = 16.3%.
Net income
Common equity
$253.6
$1,552
Both below average but improving.
2002E 2001 2000 Ind.
ROA 7.3% -18.1% 6.0% 9.0%
ROE 16.3% -391.0% 13.3% 18.0%
3 - 25
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?ROA is lowered by debt--interest
expense lowers net income,which
also lowers ROA.
?However,the use of debt lowers
equity,and if equity is lowered
more than net income,ROE would
increase.
Effects of Debt on ROA and ROE
3 - 26
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Calculate and appraise the
P/E,P/CF,and M/B ratios.
Price = $12.17.
EPS = = = $1.01.
P/E = = = 12x.
NI
Shares out.
$253.6
250
Price per share
EPS
$12.17
$1.01
(More…)
3 - 27
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Typical industry average P/E ratios
* Because many internet companies have negative earnings and no
P/E,there was only a small sample of internet companies,
Industry P/E ratio
Banking 17.15
Computer Software Services 33.01
Drug 41.81
Electric Utilities (Eastern U.S.) 19.40
Internet Services* 290.35
Semiconductors 78.41
Steel 12.71
Tobacco 11.59
Water Utilities 21.84
3 - 28
Copyright ? 2002 Harcourt,Inc,All rights reserved.
NI + Depr,
Shares out.CF per share =
= = $1.49.$253.6 + $120.0250
Price per share
Cash flow per shareP/CF =
= = 8.2x.$12.17$1.49
3 - 29
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Com,equity
Shares out.BVPS =
= = $6.21.$1,552250
Mkt,price per share
Book value per shareM/B =
= = 2.0x.$12.17$6.21
(More…)
3 - 30
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?P/E,How much investors will pay
for $1 of earnings,High is good.
?M/B,How much paid for $1 of book
value,Higher is good.
?P/E and M/B are high if ROE is high,
risk is low.
2002E 2001 2000 Ind.
P/E 12.0x -0.4x 9.7x 14.2x
P/CF 8.2x -0.6x 8.0x 7.6x
M/B 2.0x 1.7x 1.3x 2.9x
3 - 31
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Common Size Balance Sheets:
Divide all items by Total Assets
Assets 2000 2001 2002E Ind.
Cash 0.6% 0.3% 0.4% 0.3%
ST Invest,3.3% 0.0% 2.0% 0.3%
AR 23.9% 22.1% 25.1% 22.4%
Invent,48.7% 44.9% 49.1% 41.2%
Total CA 76.5% 67.2% 76.6% 64.1%
Net FA 23.5% 32.8% 23.4% 35.9%
TA 100.0% 100.0% 100.0% 100.0%
3 - 32
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Divide all items by
Total Liabilities & Equity
2000 2001 2002E Ind.
AP 9.9% 18.3% 12.5% 11.9%
Notes pay,13.6% 25.1% 17.2% 2.4%
Accruals 9.3% 17.1% 11.7% 9.5%
Total CL 32.8% 60.5% 41.3% 23.7%
LT Debt 22.0% 34.9% 14.3% 26.3%
Total equ,45.2% 4.6% 44.4% 50.0%
Total L&E 100.0% 100.0% 100.0% 100.0%
3 - 33
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Analysis of Common Size Balance
Sheets
?Computron has higher proportion of
current assets (49.1%) than Industry
(41.2%).
?Computron has slightly less equity
(which means more debt) than Industry.
?Computron has more short-term debt
than industry,but less long-term debt
than industry.
3 - 34
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Common Size Income Statement:
Divide all items by Sales
2000 2001 2002E Ind.
Sales 100.0% 100.0% 100.0% 100.0%
COGS 83.4% 98.2% 86.7% 84.5%
Other exp,9.9% 11.7% 4.4% 4.4%
Depr,0.6% 2.0% 1.7% 4.0%
EBIT 6.1% -11.8% 7.1% 7.1%
Int,Exp,1.8% 3.0% 1.1% 1.1%
EBT 4.3% -14.9% 6.0% 5.9%
Taxes 1.7% -5.9% 2.4% 2.4%
NI 2.6% -8.9% 3.6% 3.6%
3 - 35
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Analysis of Common Size Income
Statements
?Computron has higher COGS (86.7)
than industry (84.5),but lower
depreciation,Result is that
Computron has similar EBIT (7.1) as
industry.
3 - 36
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Percentage Change Analysis,Find
Percentage Change from First Year (2000)
Income St,2000 2001 2002E
Sales 0.0% 70.0% 105.0%
COGS 0.0% 100.0% 113.0%
Other exp,0.0% 100.0% -8.0%
Depr,0.0% 518.8% 534.9%
EBIT 0.0% -430.3% 140.4%
Int,Exp,0.0% 181.6% 28.0%
EBT 0.0% -691.1% 188.3%
Taxes 0.0% -691.1% 188.3%
NI 0.0% -691.1% 188.3%
3 - 37
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Analysis of Percent Change Income
Statement
?We see that 2002 sales grow 105%
from 2000,and that NI grows 188%
from 2000.
?So Computron has become more
profitable.
3 - 38
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Percentage Change Balance Sheets
Assets 2000 2001 2002E
Cash 0.0% -19.1% 55.6%
ST Invest,0.0% -100.0% 47.4%
AR 0.0% 80.0% 150.0%
Invent,0.0% 80.0% 140.0%
Total CA 0.0% 71.4% 138.4%
Net FA 0.0% 172.6% 137.0%
TA 0.0% 95.2% 138.1%
3 - 39
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Liab,& Eq,2000 2001 2002E
AP 0.0% 260.0% 200.0%
Notes pay,0.0% 260.0% 200.0%
Accruals 0.0% 260.0% 200.0%
Total CL 0.0% 260.0% 200.0%
LT Debt 0.0% 209.2% 54.6%
Total equity 0.0% -80.0% 133.9%
Total L&E 0.0% 95.2% 138.1%
3 - 40
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Analysis of Percent Change Balance
Sheets
?We see that total assets grow at a
rate of 138%,while sales grow at a
rate of only 105%,So asset
utilization remains a problem.
3 - 41
Copyright ? 2002 Harcourt,Inc,All rights reserved.
( )( )( ) = ROEProfitmargin TAturnover Equitymultiplier
NI
Sales
Sales
TA
TA
CE
2000 2.6% x 2.3 x 2.2 = 13.2%
2001 -8.9% x 2.0 x 21.6 = -391.0%
2002 3.6% x 2.0 x 2.3 = 16.3%
Ind,3.6% x 2.5 x 2.0 = 18.0%
Explain the Du Pont System
x x = ROE.
3 - 42
Copyright ? 2002 Harcourt,Inc,All rights reserved.
The Du Pont system focuses on:
?Expense control (PM)
?Asset utilization (TATO)
?Debt utilization (EM)
It shows how these factors combine
to determine the ROE.
3 - 43
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Simplified Firm Data
A/R $ 878 Debt $1,945
Other CA 1,802 Equity 1,552
Net FA 817
Total assets $3,497 L&E $3,497
Q,How would reducing DSO to 32
days affect the company?
Sales $7,035,600
day 360= = $19,543.
3 - 44
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Effect of reducing DSO from
44.9 days to 32 days:
Old A/R = $19,543 x 44.9= $878,000
New A/R = $19,543 x 32.0= 625,376
Cash freed up,$252,624
Initially shows up as additional cash.
3 - 45
Copyright ? 2002 Harcourt,Inc,All rights reserved.
What could be done with the new
cash? Effect on stock price and risk?
New Balance Sheet
Added cash $ 253 Debt $1,945
A/R 625 Equity 1,552
Other CA 1,802
Net FA 817
Total assets $3,497 Total L&E $3,497
3 - 46
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Potential use of freed up cash
?Repurchase stock,Higher ROE,
higher EPS.
?Expand business,Higher profits.
?Reduce debt,Better debt ratio;
lower interest,hence higher NI.
(More…)
3 - 47
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Inventories are also too high,Could
analyze the effect of an inventory
reduction on freeing up cash and
increasing the quick ratio and asset
management ratios,Such an
analysis would be similar to what was
done with DSO in previous slides.
?All these actions would likely
improve stock price.
3 - 48
Copyright ? 2002 Harcourt,Inc,All rights reserved.
Would you lend money
to this company?
?Maybe,The situation could
improve,and the loan,with a high
interest rate to reflect the risk,
could be a good investment.
?However,company should not have
relied so heavily on debt financing
in the past.
3 - 49
Copyright ? 2002 Harcourt,Inc,All rights reserved.
What are some potential problems and
limitations of financial ratio analysis?
?Comparison with industry averages
is difficult if the firm operates many
different divisions.
?“Average” performance is not
necessarily good.
?Seasonal factors can distort ratios.
(More…)
3 - 50
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?Window dressing techniques can make
statements and ratios look better.
?Different accounting and operating
practices can distort comparisons.
?Sometimes it is difficult to tell if a ratio
value is,good” or,bad.”
?Often,different ratios give different
signals,so it is difficult to tell,on
balance,whether a company is in a
strong or weak financial condition.
3 - 51
Copyright ? 2002 Harcourt,Inc,All rights reserved.
What are some qualitative factors
analysts should consider when
evaluating a company’s likely future
financial performance?
?Are the company’s revenues tied to a
single customer?
?To what extent are the company’s
revenues tied to a single product?
?To what extent does the company
rely on a single supplier? (More…)
3 - 52
Copyright ? 2002 Harcourt,Inc,All rights reserved.
?What percentage of the company’s
business is generated overseas?
?What is the competitive situation?
?What does the future have in store?
?What is the company’s legal and
regulatory environment?
