Financial Ratio Analysis
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Financial Ratio Analysis
How can published financial statements be used to assess
financial performance?
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Financial Ratio Types
• Market Value
• Profitability
• Asset Activity
• Leverage
• Liquidity
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Market Value Ratios
• Examples: Market-to-Book; Price-Earnings
• Questions: How do securities markets value the company’s assets? Earnings?
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Profitability Ratios
• Examples: Return on assets, equity, invested capital; gross, net profit margin
• Questions: How profitable is the company per dollar invested in the business; per dollar of sales?
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Asset Activity Ratios
• Examples: asset turnover, average collection period, inventory conversion period, payables deferral period
• Questions: How efficiently does the company use its assets? How long does it take assets or liabilities to turn into cash?
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Leverage Ratios
• Examples: Debt/assets; Debt/equity; Interest coverage
• Questions: How much of a burden does debt pose relative to assets, equity or cash flow? How risky is the company?
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Liquidity Ratios
• Examples: Current ratio, quick ratio, interval measure
• Questions: How easily can the company meet its immediate cash requirements? How risky is the company?
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Financial Ratios Relative to What?
• By themselves, financial ratios have no meaning. We need to compare to:
– Past data for the same company– Data for similar companies (e.g., same
industry)– Other ratios (i.e., DuPont ratios, Cash
Conversion Cycle)
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A Good Source of Company Ratios
www.investor.reuters.com
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Dell and Gateway: Margin Trends
2005 2004 2003 2002 2001 2000 1999 1998 1997
Dell
Gross Margin 18.6 18.2 17.9 17.7 20.2 20.7 22.5 22.1 21.5
Net Margin 6.6 6.4 6 4 6.8 6.6 8 7.7 6.7
Gateway
Gross Margin 9.1 13.6 13.6 14.1 21.4 20.5 18.3 17.1 18.6
Net margin 0.5 -15.1 -7.1 -17.4 2.5 4.8 4.5 1.7 5
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Dell, Gateway and Computer Hardware
Dell Gateway Industry
Gross Margin 18.6 9.1 31.1
Net Margin 6.6 0.5 7.2
Asset Turnover 2.4 2.1 1.5
Inventory Turnover 91.6 16.4 45
Rec. Turnover 12.6 11.9 8.6
ROIC 40.8 3.2 19.6
ROE 58.4 44.4 31.9
Quick Ratio 0.9 0.8 1.3
Mkt/Book 13.6 3.7 6.9
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DuPont Ratios
Net Income x Sales x Assets = Net Income
Sales Assets Equity Equity
Net profit X Asset x Equity = ROE
margin turnover multiplier
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DuPont Analysis: Selected Companies
ROE S/A NI/S A/E
Burlington Northern Santa Fe 0.138 0.128 0.337 3.219
Citicorp 0.165 0.102 0.114 14.121
Consolidated Edison 0.113 0.495 0.098 2.340
Merck 0.375 0.943 0.195 2.038
Safeway 0.334 3.203 0.025 4.209
Wal-Mart Stores 0.198 2.776 0.030 2.384
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THE CASH CONVERSION CYCLE DAYS SALES IN INVENTORY DAYS SALES IN RECEIVABLES INVENTORY/(COGS/DAY) RECEIVABLES/(SALES/DAY) INVENTORIES SALES SUPPLIERS PAID CASH RECEIVED PURCHASED BOOKED IN CASH FOR SALES PAYABLES/((COGS+SG&A)/DAY) DAYS SALES IN PAYABLES CASH CONVERSION CYCLE
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Cash Conversion Cycle: Selected Companies
Company Inv. Conv.Ave. Coll.
Op. CyclePay. Def.
Cash Conv.
Hewlett-Packard
89.8 65.1 154.9 65.9 89
Merck 70 42.7 112.7 66 46.7
Boeing 74.1 22 96.1 54.4 41.7
Wal-Mart Stores
64.4 2.8 67.2 37.4 29.8
Safeway 33.9 2.8 36.7 35.3 1.4
American Airlines
15.1 24.7 39.8 70.9 -31.1
McDonald's 3.9 7.1 11 62.2 -51.2