4 CHAPTER Foundations of Ratio and Financial Analysis
1. Introduction Financial statements users Equity investor Creditor short term creditor long term creditor Long term earning power liquidity solvency
Purpose and use of ratio analysis: • Can be used to compare the risk and return relationships of firms of different sizes; • Can provide a profile of a firm: • economic characteristics and competitive strategies • unique operating, financial and investment characteristics.
Categories of ratios: Four categories: Activity analysis Liquidity analysis solvency analysis Profitability analysis evaluates revenue and output generated by the firm’s assets. measures the adequacy of a firm’s cash resources to meet its near-term cash obligation. ability of the firm to satisfy its longer-term debt and investment obligations measures the income of the firm relative to its revenues and invested capital.
Cautionary Notes Economic assumptions Benchmarks Timing and window dressing Manipulation of ratios Negative Numbers Accounting methods
Ratio Management (window dressing) • Examples are: • Press the collection of receivables at year-end • Call in advances to officers for temporary repayment • Reduce inventory below normal levels • Delay normal purchases • Proceeds from these activities are then used to pay off current liabilities
2. Common-size statements Purpose : Evaluation of internal makeup of financial statements Evaluation of financial statement accounts across companies Output: • Proportionate size of assets, liabilities, equity, revenues, & expenses
P 115 Common size balance sheet
Example: ABC Common-Size Income Statements 2001 2000 Sales 100.0% 100.0% Cost of goods sold 65.5 59.9 Gross profit 34.5% 40.1% Selling, general and administrative expenses 21.0 19.0 Research and development costs 5.9 5.6 Restructuring Costs 5.0 (0.3) Earnings from operations 2.6% 15.8% Interest expense and other costs (credits) 0.6 1.8 Earnings before income taxes 0.8% 15.2% Provision for income taxes 0.2 5.2 Net earnings 0.6% 10.0%
3. Discussion of Ratios by Category Activity analysis: • Activity ratios describe the relationship between the firm’s level of operations (usually defined as sales) and the assets needed to sustain operating activities. • The higher the ratio, the more efficient the firm’s operations. • Trends in these ratios over time and in comparison to other firms in the same industry can indicate potential deficiencies or opportunities. • Activity ratio can also be used to forecast a firm’s capital requirements(both operating and long-term).
activity ratios Short-term (operating) activity ratios Long-term (investment) activity ratios inventory Fixed assets receivables Total assets payables Working capital
Short-term( operating) activity ratios: (1) Inventory Turnover: • Measure the efficiency of the firm’s inventory management. • This ratio is affected by the choice of accounting method.
360 Average No. Days of Inventory in Stock= Example: • Selected financial information from Macon Resources, Inc., for the end of Year 8 is reproduced below: • Sales $1,800,000 • Cost of goods sold 1,200,000 • Beginning inventory 200,000 • Ending inventory 400,000 Calculate : Inventory Turnover Average No. Days of Inventory in Stock
【思考题（Questions）】 1. 假设你是咨询师。假设你在King娱乐公司做管理咨询。你的一项任务是使存货成本更加合理。在考察了前期业绩和存货报告之后，你建议通过加强存货管理以减少存货。你预期现有的存货周转率将从20提高到25。节省下来的资金用于偿还流动负债——持有流动负债的年成本为10%。假设预期销售收入为1.5亿美元，预期销货成本为1亿美元，你预计会节约多少成本？
(2) Receivable Turnover: Sales Average trade receivables 360 365 Average No. Days receivables outstanding = Receivable Turnover • Measure the effectiveness of the firm’s credit policies; • Indicate the level of investment in receivables needed to maintain the firm’s sales level. Accounts Receivable Turnover
(3) Payables turnover Cost of good sold plus change in inventory Purchases Average amounts payable 365 Average No. Days Payables outstanding = Payables Turnover
(4) Working Capital Turnover: Sales Only operating assets and liabilities are included Average Working Capital • Working capital is • defined as the excess of current assets over current liabilities • Widely used measure of short-term liquidity • Deficient when current liabilities exceed current assets • In surplus when current assets exceed current liabilities • A margin of safety for creditors • A liquid reserve to meet contingencies and uncertainties • A constraint for technical default in many debt agreements
long-term (investment) activity ratios: Sales (1) Fixed assets turnover = Average fixed assets Sales (2) Total assets turnover = Average Total assets
Liquidity analysis: Company Liquidity refers to the ability to meet short-term obligations Liquidity is the ability to convert assets into cash or toobtain cash Short term is the longer of one-year or the company operating cycle
Liquidity is a matter of degree • Lack of liquidity can limit • Advantages of favorable discounts • Profitable opportunities • Management actions • Coverage of current obligations
营业周期 存货周转天数 应收账款周转天数 应付账款周转天数 现金周期 采购 付款 销售 收款 Length of cash cycle • Operating cycle • Cash cycle
Rule of Thumb Analysis (2:1) > 2:1 superior coverage of current liabilities (but not too high, suggesting inefficient use of resources and reduced returns) < 2:1 deficient coverage of current liabilities
Current Ratio — Limitations: • If liquidity is the ability to meet cash outflows with adequate cash inflows, then does the current ratio: • Measure and predict the pattern of future cash inflows and outflows? • Measure the adequacy of future cash inflows to outflows? • Answer is generally no to both these questions • Current ratio • Is a static measure • Does not have a causal relation to future cash inflows
Current Ratio — Limitations in Numerator • Adjustments often needed to counter various limitations such as • Failure to reflect open lines of credit • Adjust securities’ valuation since the balance sheet date • Reflect revolving nature of accounts receivable • Recognize profit margin in inventory • Adjust inventory values to market • Remove deferred charges of dubious liquidity from prepaid expenses
Three important qualifications • 1. Liquidity depends to a large extent on prospective cash flows • 2. No direct relation between working capital account balances and patterns of future cash flows • 3. Managerial policies are directed primarily at efficient and profitable asset utilization and secondly at liquidity • 4. Cash flow forecasts and pro forma financial statements are preferred over the current ratio for liquidity and solvency analysis • 5. Current ratio is a static measure of the ability of current assets to satisfy current liabilities
Two important elements are integral to use of the current ratio • 1. Quality of both current assets and current liabilities • 2. Turnover rate of both current assets and current liabilities
Cash ratio = Cash flow from operations Cash flow from operations ratio = Current liabilities Measures liquidity by comparing actual cash flows with current liabilities.
Defensive Interval = 365× estimated outflows Indicating the days a firm could maintain the current level of operations with is present cash resources but without considering any additional revenues.
案例分析 • 某企业2007年、2008年末的比较资产负债表中有关数据（单位：万元）如下表所示。 • 要求：根据上表资料对资产和权益的变动情况进行分析，并分析公司短期偿债能力的变动情况。
思考题 • 假设两家公司流动资产与流动负债金额相当，且流动资产和流动负债的构成相同，是否意味着两家公司具有相同的短期偿债能力？为什么？ • 假设某公司对存货的计价方法有先进先出法改为加权平均法，导致期末存货增加，进而增加公司流动资产。试问这种存货计价方法的改变是否影响到该公司的短期偿债能力？为什么？ • 某分析师指出，“流动比率越大公司的短期偿债能力越强，因此公司报告越高的流动资产越好。”你同意这一说法吗？试阐述理由。
Long-term Debt and Solvency analysis: Debt ratios: Total debt Debt to Total capital= Debt + Equity Total debt Debt to Equity = Total Equity
Interest Coverage ratios: EBIT Times Interest Earned= Interest Expense