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									Financial Statement
FIL 341
Prepared by Keldon Bauer
Ratio Analysis
   Financial ratios are the vital signs of the
       They are used to assess the health of the business.
       When they are off the norm, they should be taken
        together with all known information to get a
        correct diagnosis.
   Norms should be seen as a normal range, not
    just one number.
Ratio Analysis
   Ratios also allow for better comparison
    through time or between companies.
   As we look at each ratio, ask yourself what
    the ratio is trying to measure and why is that
    information important.
   Ratios are used both internally and externally.
Categories of Financial Ratios
   Short-term solvency or liquidity ratios
   Asset management or efficiency ratios
   Long-term solvency or financial leverage
   Debt coverage ratios
   Profitability ratio
   Market value ratios
Liquidity Ratios
   Relate short-term sources of and uses for
   Current Ratio:
Liquidity Ratios
   Quick (Acid Test) Ratio:
Liquidity Ratios
   Cash ratio:
Asset Management Ratios
   Purpose is to assess how well the firm is
    managing assets
   Inventory turnover ratio (IT):
Asset Management Ratios
   Accounts receivable turnover (ART):
Asset Management Ratios
   Accounts payable turnover (APT):
Asset Management Ratios
   Fixed asset turnover (FAT):
Efficiency Ratios
   Total Asset Turnover (TAT):
Leverage Ratios
   Relate debt to equity sources of investment
    funds .
   Debt Ratio:
Leverage Ratios
   Debt-Equity Ratio:
       Measures the proportion of debt to equity
        currently used to finance the firm.
Coverage Ratios
   Measure of ability to meet debt contracts.
   Times Interest Earned (TIE) Ratio:
       Measures how many times the interest expense
        could be covered by operating earnings.
Coverage Ratios
   EBITDA Ratio:
       Conservatively estimates how many times the
        principal and interest payments could be made
        from operating cash flow.
Profitability Ratios
   What’s the bottom line?
   Gross Profit Margin (GPM):
       Measures how much profit is gained due to
Profitability Ratios
   Operating Profit Margin (OPM):
       Measures how much profit can be pulled through
        ongoing operations.
Profitability Ratios
   Net Profit Margin (NPM):
       Measures how much money from every dollar is
        pulled through as net profit.
Profitability Ratios
   Basic earning power ratio (BEP):
Profitability Ratios
   Return on Total Assets (ROA):
       This is a measure of the return on assets owned.
       Therefore, it is a measure of return to all invested
Profitability Ratios
   Return on Equity (ROE):
       This is a measure of return to the equity holder
        (whether or not they get a dividend).
Profitability Ratios
   Return on Common Equity (ROCE):
       This is a measure of return to all equity holders.
Deriving the Du Pont Identity
   ROE = NI / TE
   Multiply by 1 and then rearrange
       ROE = (NI / TE) (TA / TA)
       ROE = (NI / TA) (TA / TE) = ROA * EM
   Multiply by 1 again and then rearrange
       ROE = (NI / TA) (TA / TE) (Sales / Sales)
       ROE = (NI / Sales) (Sales / TA) (TA / TE)
       ROE = PM * TAT * EM
Predicting Financial Distress
   Altman’s Z was developed using a Probit
    model to estimate the probability that a firm
    would go into bankruptcy.
       His model was not published.
   Since 1968, private firms have duplicated his
    work to give us a similar model (only
    published this time).
Predicting Financial Distress
   There are two models:
       For publicly traded companies:
           Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + X5
       For private firms:
           Z = 0.717X1+0.847X2+3.107X3+0.42X4+0.998X5
       Z is a normally distributed variable, where:
           Z<1.81 Bankruptcy is predicted within a year.
           1.81<Z<2.675 Financial distress, possible bankruptcy
           Z>2.675 No financial distress predicted
Predicting Financial Distress
       X1 = Net Working Capital /Total Assets
       X2 = Retained Earnings/Total Assets
       X3 = EBIT/Total Assets
       X4 = Market Value of All Equity/Book Value of
        Total Liabilities
           In the private firm model Book Value of Equity is
            substituted for Market Value of Equity
       X5 = Sales/Total Assets
   What does each variable measure?
Trend Analysis
   Seeing how ratios change over time.
       Are they getting better or worse over time?
   Helps to determine the direction the firm is
   Show example.
   Can be enhanced by graphing them.
Trend Analysis
Industry Averages
   To compare the firm’s performance to that of
    similar firms, many use industry averages:
       Risk Management Association (RMA)
           Focuses on private companies.
           The target audience is commercial lenders.
               The source is also lenders.
           Industries are defined using NAICS system.
           Data are organized by size (assets or sales).
           Most ratios include upper/lower quartiles as well as
Industry Averages
    Dunn and Bradstreets
        Focuses on publicly traded companies.
        Industries are defined using SIC system.
            Also used by SEC.
        Data are clumped together (no size adjustments).
        Most ratios include upper/lower quartiles as well as
            But there are not many ratios covered.
Dunn & Bradstreet
          Common Size Balance Sheet
Dunn & Bradstreet
           Key Financial Ratios
Excel Language
   Logical operator IF
       To have Excel automatically test cell addresses,
           =IF(Logical test, Value if true, Value if false)
               The logical test can use =, <, >, <>, <=, or >=.
               E.g. =IF(A5>1,6,0).
               Although the logical test usually uses values, it can use
           Value if true/false can be a value or a label.
               Values are entered directly.
               Labels are entered with quotation marks.
               Blanks are entered as “”.
Excel Language
   Logical operator IF – continued
       If the test is complex, either AND or OR should
        be used.
       AND can be used if more than one logical test
        must be passed for the values to be applied.
       OR can be used if at least one logical test must be
        passed for the values to be applied.
           E.g. =IF(OR(A5>3, A5<-3), “Cool”, “Bummer”)
Excel Language
   Logical operator IF – continued
       The IF statement can contain another, nested IF
           E.g. =IF(A5>2.65, “Great”, IF(A5<0.86, “Crap”,
           If many nested IF statements are contemplated, then
            you should probably use a lookup table rather than a
            nested IF statement.

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