Presentation Transcript

1. Ratio Analysis Made Easy John W. Nelson III CONSULTANCY
2. Statements Used in Ratio Analysis Balance Sheet Profit & Loss
3. Statements Used Remember A balance sheet is only a picture in time A P&L is a moving picture in time This difference must be reconciled The period of time from the last fiscal date in days must be computed One year = 365 days 1st quarter = 90 days 3rd quarter = 270 days (and so forth)
4. The banker’s easy method Everything is broken down to a day, a dollar or a percent Now they can be compared to like periods for the same business, i.e.. This year to last year This quarter to last quarter Or compared to industry standards
5. Ratio comparisons Industry Standards RMA To get the NAICS number, go to: http://www.census.gov/epcd/www/naics.html For more industry comparisons, go to: http://sbdcnet.utsa.edu/ http://www.bizstats.com/ Trade publications
6. Financial Statements used in ratio analysis Balance Sheet Assets Current Fixed Other Liabilities Current Long Term Net Worth or Equity
7. What Your Balance Sheet Tells You ASSETS Current (turn to cash within 12 months) Cash Accounts Receivable Inventory Deposits & Pre-paid
8. Balance Sheet Continues Liabilities Current Liabilities Long Term Liabilities Loans Due Affiliates or Owners Net Worth Common Stock or Equity Paid In Capital Retained Earnings Owners Draw (Partnership, LLC or Proprietorship)
9. Balance Sheet CAPITAL, NET WORTH OR EQUITY Assets minus the liabilities Net book value of the business How leveraged the business is Treasury Stock for corporations Value of the stock for a corporation Owners equity for partnerships, proprietorships or LLC’s
10. Statements used in ratio analysis Operating Statement, a/k/a Income & Expense Statement, Profit & Loss Statement or just P&L Revenue or sales Less Cost of Goods Sold (none if a service business) Beginning Inventory Plus purchases Less ending inventory Equals Cost of Goods Sold Equals Gross Profit
11. P&L Continues Less All Expenses Operating Expenses Administrative Expenses Selling Expenses Equals Net Income Plus Other Income Less Other Expenses Equals Net Profit Before Taxes
12. Operating Statement (P&L) & What It Shows You How you are doing, your report card If sales are up or down compared to last like period Your Cost of Goods Sold Your Gross Profit All expenses Profit or loss
13. Ratio Analysis Ratios take the temperature of a business Ratios are computed by using the Balance Sheet & Operating Statement numbers They will tell you how liquid a company is They will tell you how it collects its money They will tell you how they pay their bills They will tell you how leveraged they are
14. Liquidity Ratios Current ratio = current assets/current liabilities Current Assets $170,000 Current Liabilities $150,000 Equals 1.13 or $1.13 in current assets to pay for each $1 in current liabilities. Bankers like 2 or higher.
15. Liquidity Assets (cont.) Working Capital considers what’s left after paying current debt Current Assets minus Current Liabilities Current Assets $170,000 Current Liabilities $150,000 Equals $ 20,000 left Bankers like a positive number.
16. Liquidity Ratios (cont.) Acid test or Quick Ratio considers that inventory is not saleable, therefore eliminated Currents Assets – Inventory/Current Liabilities Current Assets $170,000 Minus Inventory $ 85,000 Equals $ 85,000 Divided by Current Liabilities of $150,000 Equals .56 or $.56 in Current. Assets to pay for each $1 in Current Liabilities. Bankers like 1 or higher.
17. Asset Management Ratios Accounts Receivable Turnover tells you how long it takes to collect them Accounts Receivable times 365 days/Annual Sales (days must match period for which the ratio is being computed) Accounts Receivable (from bal. sheet) $75,000 X 365 days = $27,375,000 (just a # to get to the answer) Divided by Ann. Sales $900,000 Equals 30.4 days to collect, say 30 days Bankers like to see this at industry standards
18. Accts. Rec. Turnover Assume your client needs $9,000 in working capital and can’t borrow it. Solution… Accts. Rec. of $75,000 divided by 30 days (A/R turnover) = $2,250 per day Collect the A/R in 26 days (4 days quicker) rather than 30 days 4 days X $2,250 = $9,000 now in cash
19. Inventory Turnover Inventory Turnover Ratio tells how long it takes to sell the inventory Inventory times 365 days/Cost of Goods Sold (days must match period for which the ratio is being computed) Inventory (from bal. sheet) $85,000 X 365 days = $31,025,000 (just a # to get to the answer) Divided by Cost of Goods Sold of $540,000 Equals 57.5 or 58 days to sell Bankers like to see this at industry standards
20. Inventory Turnover Cont. Maximize working capital thru inventory control Inventory turns every 58 days & is $85,000 58 days into $85,000 = $1,466 per day Inventory can be restocked in 30 days, therefore you only need a 30 inventory on hand 58 days – 30 days = 28 days (less inventory needed) X $1,466 = $41,048 now in the checking account rather than in inventory
21. Debt Management Ratios Debt to Net Worth or Debt to Worth tells how leveraged a company is Total Debt divided by Total Liabilities Total Debt $204,000 Total Liabilities $ 87,000 Equals 2.34 or for each $1 in net worth, creditors have $2.34, leverage 2.34 to 1. Bankers like 3 or lower.
22. Debt Management Ratios (cont.) Accounts Payable Turnover tells how long a company takes to pay it’s bills Formula is Accts. Payable times 365 days divided by Cost of Goods Sold Accts. Payable $4,000 (from bal. sheet) X 365 days = $14,965,000 (a # just to get to the answer) divided by: Cost of Goods Sold $350,000 Equals 42.75 or within 43 days bills are pd Bankers like to see this 30 to 45 days or less
23. Accts. Payable Cont. Accts. Payable of $41,000 divided by 43 days (turnover) = $953 per day owed Usual terms due A/P are 2% 10 days, net 30 days, so lets see if we can pay in 10 days 43 days – 10 days = 33 days X $953 (A/P per day) = $31,449 needs to be pd. to get to 10 days Using the $41,048 saved in inventory, pay the payables down within 10 days & have $9,599 left for working capital, then take the 2% discount and save $7,000 (2% X $350K C of GS)
24. Accts. Payable Cont. Besides saving $7,000 taking the discounts consider this: 2%, 10 days Three 10 day period per month 3 X 2% = 6% savings per month 12 months X 6% = 72% This assumes that you invest what you would have paid & the interest was figured like this.
25. Summary of Savings Dug $9,000 out of Accts. Payable Dug $41,048 out of Inventory Saved $7,000 from taking discounts A total savings of $57,048 Got a 72% ROI on amount saved
26. Profitability Ratios Profit margin or the percent of profit from sales Net Profits divided by Net Sales Net Profit $ 53,000 Net Sales $900,000 Equals .0588 or 5.9% net profit
27. Profitability Ratios (cont.) Debt Service Coverage or how much $ do you have to pay current loan payments Formula is Net Profit plus Depreciation divided by Current Portion Long Term Debt (CPLTD) Net Profit $53,000 + $25,000 Depreciation= $78,000 cash flow for this year CPLTD is $6,000 (from bal. sheet) divided into $78,000 = 13.0 Or you have $13 to pay every $l of term debt Bankers like to see 2 or higher
28. The End – Thank Goodness Thanks For your time For you attention If you need further information: John W. Nelson III 16 Park St. Newport, RI 02840-2104 Phone/fax 401-847-3083 E-mail: jwn3rd@aol.com www.johnwnelson3rd.com For copies of my publications: www.newground@newgroundpublications.com