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X100 Introduction to Business

X100 Introduction to Business. Finance. Financial Analysis & Ratios. Professor Kenneth EA Wendeln. Financial Management.

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X100 Introduction to Business

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  1. X100Introduction to Business Finance Financial Analysis & Ratios Professor Kenneth EA Wendeln

  2. Financial Management How to manage the financial health of a company – decisions regarding the acquisition & ‘use of money’ to maximize the value of the company while achieving corporate objectives. Types of Financial Management and Planning Tools: • Capital Budgeting • Capital Structure • Financial Ratios Used to gain insight on how a firm operates as well as its RISK and RETURN Financial Analysis & Ratios

  3. Key Financial Ratios Profitability Liquidity Current Ratio # n.nn Return on Owners’ Equity % EPS – Earnings per Share $ DD.00 Acid Test or Quick Ratio # n.nn Asset Turnover Return on Sales % Accounts Receivable Turnover X (times/year) or # days Financial Leverage Total Liabilities to Equity % Inventory Turnover X (times/year) or # days Financial Analysis & Ratios

  4. Total Liabilities to Owners’ Equity Ratio Total Liabilities Owners’ Equity This financial leverage ratio indicates the degree to which a firm’s operations are financed through debt & borrowings - and is used to determine a firm’s ‘conservatism’ and ability to borrow money. The liabilities to owners’ equity ratio typically ranges between 33 and 50%. The higher this ratio, the riskier the situation for lenders and shareholders. Financial Analysis & Ratios

  5. Zimmer - Total Liabilities to Owners’ Equity 12/31/06 12/31/05 ‘Debt’ = Total Liabilities ‘Equity’ = Stockholders (or Owners) Equity $ in millions Total Liabilities to Owners Equity = 21.4 % ($1051.2)/($4920.5) Financial Analysis & Ratios

  6. Return on Owners’ Equity Net Income (after taxes) Owners’ (Shareholders’) Equity Profitability ratio that provides an overall measure of a business’s performance. Net income earned (after tax) per dollar of owners’ investment. Typically between 15% and 25% for profitable companies Financial Analysis & Ratios

  7. Zimmer Return on Owners’ Equity 12/31/06 12/31/05 Net Income ‘Equity’ = ‘Stockholders’ (or ‘Owners’) Equity Return on Owners’ Equity = 17.0% ($834.5)/($4920.5) Financial Analysis & Ratios

  8. Capital Structure - LeverageLow&High Liabilities to Equity & High Liabilities & OE –with LOW Debt Short-Term Liabilities $100,000 Long-Term Loan (@10%) 100,000 Total Liabilities (Debt)$200,000 Owner’s equity $700,000 Total Liabilities + OE $900,000 Year-end Earnings Operating profit $150,000 Interest on Debt (@10%) -10,000 Taxes @ 40% PBT -56,000 Net income after taxes $ 84,000 Liabilities/Equity 28.6% ($200,000/$700,000) Return on Owners Equity 12.0% ($84,000/$700,000) Liabilities & OE –with HIGH Debt Short-Term Liabilities $100,000 Long-Term Loan (@12%) 300,000 Total Liabilities (Debt) $400,000 Owner’s equity $500,000 Total Liabilities + OE $900,000 Year-end Earnings Operating profit $150,000 Interest on Debt (@12%) -36,000 Taxes @ 40% PBT -45,600 Net income after taxes $68,400 Liabilities/Equity 80.0% ($400,000/$500,000) Return on Owners Equity 13.7% ($68,400/$500,000) Financial leverage increases RISK as well as the Debt/Equity & Return on Owners’ Equity Ratios. 12% 12% Lower Risk to Lenders & Shareholders Financial Analysis & Ratios Higher Risk to Lenders & Shareholders

  9. EPSEarnings per Share Net Income or Loss (after taxes) Average # Shares of Common Stock Outstanding This profitability ratio tells the owner of a share of stock how much of the net earnings for the year belongs to him or her. These earnings may be paid to the stockholders as dividends . . . orreinvested back into the business to fund its growth. Financial Analysis & Ratios

  10. Zimmer Earnings per Share EPS = $3.43 per share ($834.5)/(#243.0 average shares outstanding) Financial Analysis & Ratios

  11. Return on Salesor Net Profit Margin Net Income (after taxes) Net Sales Revenue This profitability ratio measures how well the company generated net profit (after tax) per dollar of net sales revenue. This ratio is best evaluated by analyzing a firm’s year to year trends and by comparing to businesses within appropriate industries. Financial Analysis & Ratios

  12. Zimmer Return on Sales 2006 2005 ROS = 23.9% ($834.5)/($3495.4) ROS = 22.3% ($732.5)/($3286.1) Financial Analysis & Ratios

  13. Current Ratio Current Assets Current Liabilities Measures liquidity - the capacity of a firm to meet its current obligations using liquid assets that are in cash or other resources that can be quickly converted to cash. A high current ratio, typically >1.0, indicates that a firm can pay its current liabilities using its current assets. Financial Analysis & Ratios

  14. ZimmerCurrent Ratio Current Ratio = 2.78 ($1746.2)/($628.2) Financial Analysis & Ratios

  15. Acid-Test or Quick Ratio Current Assets - Inventory Current Liabilities Measures liquidity - the ability of a firm to pay current liabilities ‘quickly’ – without selling inventory. For all businesses the desired acid-test ratio is > 1.0 indicating firm can pay its current liabilities from its non-inventory current assets. Financial Analysis & Ratios

  16. Zimmer Acid-Test or Quick Ratio Quick Ratio = 1.76 ($1746.2 – 638.3)/($628.2) Financial Analysis & Ratios

  17. Accounts Receivable Asset Turnover Ratio Net Sales Average Accounts Receivable Determines the number of times during the year a company is ‘turning over’ or collecting its accounts receivable. Measured in X times per year. Can be converted to ‘days outstanding’ by dividing turnover ratio into 365 days. A high A/R turnover is better than a low one, but depends on company & industry terms of sale. 6X turnover is equivalent to 60 days of outstanding receivables, 9X is 45 days, 12X is 30 days. Financial Analysis & Ratios

  18. ZimmerAccounts Receivable Use average $574.9 A/R Turnover = 6.1X or 60 days ($3495.4)/($574.9) or (365 days/6.1X) Financial Analysis & Ratios

  19. Inventory Asset Turnover Ratio Cost of Goods Sold Average Inventory Determines the number of times during the year a company is ‘turning over’ its inventory. Measured in X times per year. Can also be converted to ‘days of inventory’ by dividing ratio into 365 days. The average inventory turnover for all firms is about 9 times per year, or about once every 45 days. It varies considerable by industry. Supermarkets have turnover rates exceeding 20X (or 18 days) per year. Financial Analysis & Ratios

  20. ZimmerInventory Turnover Use average $611.0 Inventory Turnover = 1.28X or 286 days ($780.1)/($611.0) or (365 days/1.28X) Financial Analysis & Ratios

  21. Key Financial Ratios Profitability Liquidity Current Ratio Return on Owners’ Equity EPS – Earnings per Share Acid Test or Quick Ratio Asset Turnover Return on Sales Accounts Receivable Turnover Current Assets Current Liabilities Net Income or Loss (after taxes) Average # of Common Stock Shares Outstanding Cost of Goods Sold Average Inventory Current Assets - Inventory Current Liabilities Net Sales . Average Accounts Receivable Total Liabilities Owners’ Equity Net Income (after taxes) Owners’ Equity Net Income (after taxes) Net Sales Revenue Financial Leverage Total Liability to Equity Ratio Inventory Turnover Financial Analysis & Ratios

  22. Common Financial Ratios Return to Investors Asset Management Leverage /Debt Management Profitability Liquidity Margins Returns Return to Investors Amount of Debt Coverage of Debt Short Run Solvency Current Assets Operating Efficiency *Net Profit Margin (ROS) *Return on Equity *Return on Equity *Total Liabilities/ Equity Times Interest Earned *Current Ratio *A/R Average Collection Period *A/R Turnover Operating Profit Margin Return on Total Assets (ROA) Return on Total Assets (ROA) Debt/ Equity Fixed Charge Coverage *Quick or Acid Test Ratio *Days Inventory Held *Inventory Turnover Gross Profit Margin Cash Return on Assets *Earnings Per Share LEVERAGE Assets/ Equity Cash Flow Adequacy Cash Flow Liquidity Ratio Days Payables Out- standing Fixed Asset Turnover Product Contri- bution Margin Price to Earnings Ratio Debt/ Assets Cash Interest Coverage Days of Working Capital Total Asset Turnover Cash Flow Margin Dividend Yield LT Debt/ Total Capital- ization Return on Total Assets (ROA) * ‘Key’ X100 Financial Ratios Other Common Ratios Derived from: Fraser/Ormiston, Understanding the Corporate Annual Report; Understanding Financial Statements 6e Financial Analysis & Ratios

  23. Key Financial Statements Balance Sheet Period Ending Cash Flow Statement Income Statement for Period ● Cash ● A/R ● Inventories Current(12mo) ● Units Sold ● @ Price ● less Returns & Allowances Net Sales Net Income ● Income Statement ● Accrual Based ● PPE ● Fixed Assets Long-Term Adjustments for Non-cash Items ● Depreciation ● A/R & A/P ● Inventory ● Other Accruals TOTAL REVENUES TOTAL ASSETS ● Units Sold ● @ Material ● @ Labor ● @ Overhead ● A/P ● ST Debt Cost of Goods Sold Current (12mo) CASH provided (used) by OPERATING Activities Long-Term ● LT Debt ∆Cash=Operating +Investing+Financing ● R & D ● Marketing ● Distribution ● Sales ● Admin Expenses for Period PPE ● (Additions) Sale TOTAL LIABILITIES Assets =Liabilities+ Owners’ Equity Revenues –Expenses=Net Income Other Investments ● (Additions) Sale CASH provided (used) by INVESTING Activities TOTAL OP EXPENSES ● Stock @ par ● Paid-in Capital Contributed Capital Operating Profit Stock ● Sale (Purchase) Dividends ● Interest ● Taxes ● One-time Other Expenses ● Accumulated Net Income ● less Dividends ● (Paid) Retained Earnings ● Increase (Decrease) Debt/ Borrowing TOTAL NET INCOME or (LOSS) TOTAL OWNERS’/ SHAREHOLDERS’ EQUITY CASH provided (used) by FINANCING Activities Change in cash - Sources & (Uses) - between Periods Financial Analysis & Ratios

  24. Financial Analysis & Ratios

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