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Analysis of Financial
Statements
Ratio Analysis
Du Pont system
Effects of improving ratios
Limitations of ratio analysis
Qualitative factors
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RATIO ANALYSIS
Financial statements report both on a firms position at a
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RATIO ANALYSIS
LIQUIDITY RATIOS
ASSET MANAGEMENT RATIOS
DEBT MANAGEMENT RATIOS
PROFITABILITY RATIOS
MARKET VALUE RATIOS
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LIQUIDITY RATIOS
Liquid Asset
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OBLIGATIONS:
CURRENT RATIO
This ratio indicates the extent to which current liabilities
are covered by those assets expected to be converted
to cash in the near future.
This ratio is calculated by dividing current assets by
current liabilities.
Current assets normally include cash, marketable
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Note that sales occur over the entire year, whereas the
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RATIO
The total assets turnover ratio, measures the turnover of all
the firms assets
It is calculated by dividing sales by total assets
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debt.
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TIMES-INTEREST-EARNED
RATIO
Times Interest Earned (TIE) is a measure of the
meet interest charges on its debt, but this ratio has two
shortcomings:
Interest is not the only fixed financial charge companies
must also reduce debt on schedule, and many firms lease
assets and thus must make lease payments. If they fail to
repay debt or meet lease payments, they can be forced into
bankruptcy.
EBIT does not represent all the cash flow available to
service debt, especially if a firm has high depreciation
and/or amortization charges.
1. To account for these deficiencies, bankers and others have
developed the EBITDA coverage ratio, defined as follows:
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PROFITABILITY RATIOS
A group of ratios that show the combined effects of liquidity, asset
This sub-par result occurs because costs are too high. High costs, in
turn, generally occur because of inefficient operations. However,
Allieds low profit margin is also a result of its heavy use of debt.
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Ratio
This ratio indicates the ability of the firms assets to generate operating
Because of its low turnover ratios and low profit margin on sales, Allied
is not earning as high a return on its assets as is the average foodprocessing company.
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Allieds price/cash flow ratio is also below the industry average, once again suggesting that its growth prospects are below
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MARKET/BOOK RATIO
The ratio of a stocks market price to its book value
It gives an indication of how investors regard the company.
Companies with relatively high rates of return on equity generally sell at higher multiples of book value than those with low returns. First, we find Allieds
Investors are willing to pay less for a dollar of Allieds book value than for one of an average food-processing company.
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TREND ANALYSIS
An analysis of a firms financial ratios over time
It is used to estimate the likelihood of
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Du Pont Equation
A formula which shows that the rate of return on
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Consider one last problem with ROE. Assume that you manage
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