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Evaluating a Firm’s Financial Performance

Evaluating a Firm’s Financial Performance.  2002 , Prentice Hall, Inc. Financial Statement Analysis. Are our decisions maximizing shareholder wealth?. We will want to answer questions about the firm’s Liquidity Efficient use of Assets Leverage (financing) Profitability.

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Evaluating a Firm’s Financial Performance

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  1. Evaluating a Firm’s Financial Performance  2002, Prentice Hall, Inc.

  2. Financial Statement Analysis • Are our decisions maximizing shareholder wealth?

  3. We will want to answer questions about the firm’s • Liquidity • Efficient use of Assets • Leverage (financing) • Profitability

  4. We will want to answer questions about the firm’s • Liquidity • Efficient use of Assets • Leverage (financing) • Profitability

  5. Financial Ratios • Tools that help us determine the financial health of a company. • We can compare a company’s financial ratios with its ratios in previous years (trend analysis). • We can compare a company’s financial ratios with those of its industry.

  6. Example:CyberDragon Corporation

  7. CyberDragon’s Balance Sheet ($000) Assets: Liabilities & Equity: Cash $2,540 Accounts payable 9,721 Marketable securities 1,800 Notes payable 8,500 Accounts receivable 18,320 Accrued taxes payable 3,200 Inventories 27,530 Other current liabilities 4,102 Total current assets 50,190Total current liabilities 25,523 Plant and equipment 43,100Long-term debt (bonds) 22,000 less accum deprec. 11,400Total liabilities 47,523 Net plant & equip. 31,700 Common stock ($10 par) 13,000 Total assets 81,890 Paid in capital 10,000 Retained earnings 11,367 Total stockholders' equity 34,367 Total liabilities & equity 81,890

  8. CyberDragon’s Income Statement Sales (all credit)$112,760 Cost of Goods Sold (85,300) Gross Profit27,460 Operating Expenses: Selling (6,540) General & Administrative (9,400) Total Operating Expenses (15,940) Earnings before interest and taxes (EBIT)11,520 Interest charges: Interest on bank notes: (850) Interest on bonds: (2,310) Total Interest charges (3,160) Earnings before taxes (EBT)8,360 Taxes (assume 40%) (3,344) Net Income5,016

  9. CyberDragonOther Information Dividends paid on common stock $2,800 Earnings retained in the firm 2,216 Shares outstanding (000) 1,300 Market price per share 20 Book value per share 26.44 Earnings per share 3.86 Dividends per share 2.15

  10. 1. Liquidity Ratios • Do we have enough liquid assets to meet approaching obligations?

  11. What is CyberDragon’s Current Ratio?

  12. 50,190 25,523 = 1.97 What is CyberDragon’s Current Ratio?

  13. 50,190 25,523 = 1.97 What is CyberDragon’s Current Ratio? If the average current ratio for the industry is 2.4, is this good or not?

  14. What is the firm’s Acid Test Ratio?

  15. 50,190 - 27,530 25,523 = .89 What is the firm’s Acid Test Ratio?

  16. 50,190 - 27,530 25,523 = .89 What is the firm’s Acid Test Ratio? Suppose the industry average is .92. What does this tell us?

  17. What is the firm’s Average Collection Period?

  18. 18,320 112,760/365 = 59.3 days What is the firm’s Average Collection Period?

  19. 18,320 112,760/365 = 59.3 days What is the firm’s Average Collection Period? If the industry average is 47 days, what does this tell us?

  20. 2. Operating Efficiency Ratios • Measure how efficiently the firm’s assets generate operating profits.

  21. What is the firm’s Operating Income Return on Investment (OIROI)?

  22. 11,520 81,890 = 14.07% What is the firm’s Operating Income Return on Investment (OIROI)?

  23. 11,520 81,890 = 14.07% What is the firm’s Operating Income Return on Investment (OIROI)? • Slightly below the industry average of 15%.

  24. 11,520 81,890 = 14.07% What is the firm’s Operating Income Return on Investment (OIROI)? • Slightly below the industry average of 15%. • The OIROI reflects product pricing and the firm’s ability to keep costs down.

  25. What is their Operating Profit Margin?

  26. 11,520 112,760 = 10.22% What is their Operating Profit Margin?

  27. 11,520 112,760 = 10.22% What is their Operating Profit Margin? • This is below the industry average of • 12%.

  28. What is their Total Asset Turnover?

  29. 112,760 81,890 = 1.38 times What is their Total Asset Turnover?

  30. 112,760 81,890 = 1.38 times What is their Total Asset Turnover? The industry average is 1.82 times. The firm needs to figure out how to squeeze more sales dollars out of its assets.

  31. What is the firm’s Accounts Receivable Turnover?

  32. 112,760 18,320 = 6.16 times What is the firm’s Accounts Receivable Turnover?

  33. 112,760 18,320 = 6.16 times What is the firm’s Accounts Receivable Turnover? CyberDragon turns their A/R over 6.16 times per year. The industry average is 8.2 times. Is this efficient?

  34. What is the firm’s Inventory Turnover?

  35. 85,300 27,530 = 3.10 times What is the firm’s Inventory Turnover?

  36. 85,300 27,530 = 3.10 times What is the firm’s Inventory Turnover? CyberDragon turns their inventory over 3.1 times per year. The industry average is 3.9 times. Is this efficient?

  37. Low inventory turnover: The firm may have too much inventory, which is expensive because: • Inventory takes up costly warehouse space. • Some items may become spoiled or obsolete.

  38. What is the firm’s Fixed Asset Turnover?

  39. 112,760 31,700 = 3.56 times What is the firm’s Fixed Asset Turnover?

  40. 112,760 31,700 = 3.56 times What is the firm’s Fixed Asset Turnover? If the industry average is 4.6 times, what does this tell us about CyberDragon?

  41. 3. Leverage Ratios(financing decisions) • Measure the impact of using debt capital to finance assets. • Firms use debt to lever (increase) returns on common equity.

  42. How does Leverage work? • Suppose we have an all equity-financed firm worth $100,000. Its earnings this year total $15,000. ROE = (ignore taxes for this example)

  43. How does Leverage work? • Suppose we have an all equity-financed firm worth $100,000. Its earnings this year total $15,000. ROE = = 15% 15,000 100,000

  44. How does Leverage work? • Suppose the same $100,000 firm is financed with half equity, and half 8% debt (bonds). Earnings are still $15,000. ROE =

  45. How does Leverage work? • Suppose the same $100,000 firm is financed with half equity, and half 8% debt (bonds). Earnings are still $15,000. ROE = = 15,000 - 4,000 50,000

  46. How does Leverage work? • Suppose the same $100,000 firm is financed with half equity, and half 8% debt (bonds). Earnings are still $15,000. ROE = = 22% 15,000 - 4,000 50,000

  47. What is CyberDragon’s Debt Ratio?

  48. 47,523 81,890 = 58% What is CyberDragon’s Debt Ratio?

  49. 47,523 81,890 = 58% What is CyberDragon’s Debt Ratio? If the industry average is 47%, what does this tell us?

  50. 47,523 81,890 = 58% What is CyberDragon’s Debt Ratio? If the industry average is 47%, what does this tell us? Can leverage make the firm more profitable? Can leverage make the firm riskier?

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