Financial Statement Analysis

Topic 5
Resources (1) Cayanan, A. & Borja (forthcoming). Business Finance.
Quezon City. Rex Bookstore. (2) Valencia and Roxas. Basic Accounting.
(3) Copies of sample financial statements (4) Exploring Small business and
Personal Finance by: Patricia Benito, tyrone Panzer Chan Pao, Kenneth L.
Yumang
 LEARNING OUTCOMES
The learners shall be able to…
1. prepare financial statements
2. define the measurement levels, namely,
liquidity, solvency, stability, and profitability
3. perform vertical and horizontal analyses of
financial statements of a single proprietorship
 LEARNING OUTCOMES

4. compute, analyze, and interpret financial

ratios such as current ratio, working capital,
gross profit ratio, net profit ratio, receivable
turnover, inventory turnover, debt-to- equity
ratio, and the like
 MOTIVATION (20 MINS)
Match the letter with the definition 8. Accounting Process (or
that corresponds to the following cycle)
terms:
9. Special Journals
1. Accounting System
2. Debit 10. General Journal
3. Credit 11. Account
4. Transactions 12. Ledger
5. Double-Entry Accounting 13. Posting
6. Journal Entry
14. General Ledger
7. Journals
15. Subsidiary Ledgers
 MOTIVATION (20 MINS)
A. Exchanges of goods or services
between/among two or more
entities or some other event
having an economic impact on
a business enterprise.
B. An accounting record used to
list a particular type of
frequently recurring transaction.
C. A record used to classify and
summarize the effects of
transactions.
D. An entry on the right side of an
account.
E. A record used as the basis for
analyzing and recording
transactions. Examples include
invoices, check stubs, and receipts.
F. A collection of accounts
maintained by a business.
G. Procedures used for analyzing,
recording, classifying, and
summarizing the information to be
presented in accounting reports.
 MOTIVATION (20 MINS)
H. An entry on the left side of an
account.
I. Procedures and methods used,
including data processing
equipment, to collect and report
accounting data.
J. An accounting record used to
record all business activities for
which a special journal is not
maintained.
K. The process of summarizing
transactions by transferring
amounts from the journals to the
ledger accounts.
L. The grouping of supporting
accounts that in total equal the
balance of a control account in
the general ledger.
M. The general ledger account
that summarizes the detailed
information in a subsidiary ledger.
 MOTIVATION (20 MINS)
N. A collection of all the
accounts used by a business
that could appear on the
financial statements.
O. A system of recording
transactions in a way that
maintains the equality of the
accounting equation.
P. Records in which
transactions are first entered,
providing a chronological
record of business activity.
Q. The recording of a
transaction in which debits
equal credits. It usually
includes a date and an
explanation of the
transaction.
 Definition of Accounting
is the language of business.

It would dwell on the analysis and interpretation of

the financial statements in the assumption that you
already know how to prepare them.
 Forms of Business Organizations
Three major categories:

1. Sole or Single Proprietorship

2. Partnership
3. Corporation
 Definition of Sole Proprietorship
Is a business owned by one person.

The simplest form of business organization in

terms of getting started, operating and
managing.
 Features of Sole Proprietorship
a. The life of the business is limited to life of
the owner.
b. the business income is taxed as personal
income.
c. The capital is limited to the wealth of the
owner.
 Definition of Partnership
Is a business organized by two or more owners called
partners.

Types of Partnership:
1. General Partnership
2. Limited Partnership
 General Partnership
Profits and losses are shared by all
partners, and everyone has unlimited
liability for all business debts.
The payment for liabilities of a general
partner extends to his personal assets.
 Limited Partnership
There should be at least one general
partner and limited partner.
 Limited Partners- who will not actively
participate in the management of the
business. Is limited only to his capital
contribution to the partnership .
 Corporation
Is the most complicated form of business
organization.
It is a legal person separate from its owners
(stockholders)
It involves the preparation of Articles of Incorporation
that contains so many legal matters including name,
life, purpose, number of shares and others.
 In a Corporation
Represented by shares of stock and can
be transferred.
Stockholders have limited liability for
business debts.
Must pay income taxes.
 Types of Business Activities
1. Service- offers products with no physical form like
skills, field of expertise and consultancy. (Ex. Laundry
shops, schools, salons, hotels, banks & law firms)
2. Merchandising- is the buy and sell business. Firms
under this classification buy products and sell the
same at a higher price without changing the form
of the products.(Ex. Convenience stores, grocery,
stores, and hardware stores)
 Continued
3. Manufacturing- buys products known as raw
materials, with an intention of transforming them into
new products.
Ex:
Car manufacturers
Food manufacturing companies
Examples of External Uses of Statement
Analysis
Trade Creditors -- Focus on the liquidity of
the firm.
Bondholders -- Focus on the long-term
cash flow of the firm.
Shareholders -- Focus on the profitability
and long-term health of the firm.
Examples of Internal Uses of Statement
Analysis
Plan -- Focus on assessing the current financial
position and evaluating potential firm
opportunities.
Control -- Focus on return on investment for
various assets and asset efficiency.
Understand -- Focus on understanding how
suppliers of funds analyze the firm.
 Primary Types of Financial Statements
Balance Sheet
A summary of a firm’s financial position on a given date that
shows total assets = total liabilities + owners’ equity.
Income Statement
 A summary of a firm’s revenues and expenses over a
specified period, ending with net income or loss for the
period.
 Primary Types of Financial Statements
Statement of Owner’s Equity
--These are also known as the Statement of
Changes in Equity.
--This reports the changes in the owner’s equity
over a period of time.
-- Because of this, the statement of owner’s equity
is often viewed as the connecting link between the
income statement and balance sheet.
 Primary Types of Financial Statements
 Statement of Cash Flows
--The statement of cash flows reports a
company’s cash inflows and outflows for a period.
-- This is used by managers in evaluating past
operations and in planning future investing and
financing activities.
--It is also used by external users such as investors
and creditors to assess a company’s profit potential
and ability to pay its debt and pay dividends.
 Basket Wonders’ Balance Sheet
(Asset Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007 (a)
Cash and C.E. $ 90
Acct. Rec.c 394 a. How the firm stands on a
Inventories 696 specific date.
Prepaid Exp d 5 b. What BW owned.
Accum Tax Prepay 10 c. Amounts owed by customers.
Current Assetse $1,195 d. Future expense items already
Fixed Assets (@Cost)f 1030 paid.
Less: Acc. Depr. g (329) e. Cash/likely convertible to cash
Net Fix. Assets $ 701 within 1 year.
Investment, LT 50 f. Original amount paid.
Other Assets, LT 223 g. Acc. deductions for wear and
Total Assets b $2,169 tear.
 Basket Wonders’ Balance Sheet
(Liability Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007
Notes Payable $ 290 a. Note, Assets = Liabilities + Equity.
Acct. Payablec 94 b. What BW owed and ownership
Accrued Taxes d 16
position.
Other Accrued Liab. d 100
c. Owed to suppliers for goods
Current Liab. e $ 500
and services.
Long-Term Debt f 530
Shareholders’ Equity d. Unpaid wages, salaries, etc.
Com. Stock ($1 par) g 200 e. Debts payable < 1 year.
Add Pd in Capital g 729 f. Debts payable > 1 year.
Retained Earnings h 210 g. Original investment.
Total Equity $1,139 h. Earnings reinvested.
Total Liab/Equitya,b $2,169
 Basket Wonders’ Income Statement
Basket Wonders Statement of Earnings (in thousands) for Year Ending
December 31, 2007a
Net Sales $ 2,211 a. Measures profitability over a
Cost of Goods Sold b 1,599 time period.
Gross Profit $ 612 b. Received, or receivable, from
SG&A Expenses c 402 customers.
EBITd $ 210 c. Sales comm., adv., officers’
Interest Expensee 59 salaries, etc.
d. Operating income.
EBT f $ 151
Income Taxes 60 e. Cost of borrowed funds.
EATg $ 91 f. Taxable income.
g. Amount earned for
Cash Dividends 38
shareholders.
Increase in RE $ 53
 Framework for Financial
Analysis
Trend / Seasonal Component
How much funding will be required in the
future?
1. Analysis of the funds
needs of the firm. Is there a seasonal component?

Analytical Tools Used

Sources and Uses Statement
Statement of Cash Flows
Cash Budgets
 Framework for Financial
Analysis

Health of a Firm

1. Analysis of the funds

needs of the firm.
Financial Ratios
2. Analysis of the financial
condition and profitability 1. Individually
of the firm. 2. Over time
3. In combination
4. In comparison
 Framework for Financial
Analysis

Business risk relates to the risk

inherent in the operations of the
1. Analysis of the funds
needs of the firm.
firm.
2. Analysis of the financial Examples:
condition and profitability
of the firm. Volatility in sales
3. Analysis of the business Volatility in costs
risk of the firm.
Proximity to break-even point
 Framework for Financial
Analysis
A Financial
Manager must
consider all
1. Analysis of the funds
needs of the firm. Determining three jointly
2. Analysis of the financial
the when
condition and profitability
financing
needs of
determining the
of the firm.
the firm. financing needs
3. Analysis of the business
risk of the firm.
of the firm.
 Framework for Financial
Analysis

1. Analysis of the funds

needs of the firm. Determining Negotiations
the with
2. Analysis of the financial suppliers of
financing
condition and profitability capital.
needs of
of the firm.
the firm.
3. Analysis of the business
risk of the firm.
 Performance Measurements
Financial Statement Analysis
Involves the assessment of a company’s past
performance and future potentials.
It serves as a communication tool for the internal
users to address weaknesses and at least maintain
strengths.
It helps external users like creditors, investors,
suppliers and customers to evaluate the financial
health of a business.
Vertical Analysis (common-size)
Is the process of comparing amounts in the financial
statements within the same accounting period.
It involves converting amounts as a percentage of a
common base.
For example: to compute for a common size IS,
divide each of the IS account by net sales and to
compute for a common size BS, divide each of the
BS account by total assets
 Common-size Analysis
An analysis of percentage financial statements
where all balance sheet items are divided by
total assets and all income statement items are
divided by net sales or revenues.
 Basket Wonders’ Common Size
Balance Sheets
Regular (thousands of $) Common-Size (%)
Assets 2005 2006 2007 2005 2006 2007
Cash 148 100 90 12.10 4.89 4.15
AR 283 410 394 23.14 20.06 18.17
Inv 322 616 696 26.33 30.14 32.09
Other CA 10 14 15 0.82 0.68 0.69
Tot CA 763 1,140 1,195 62.39 55.77 55.09
Net FA 349 631 701 28.54 30.87 32.32
LT Inv 0 50 50 0.00 2.45 2.31
Other LT 111 223 223 9.08 10.91 10.28
Tot Assets 1,223 2,044 2,169 100.0 100.0 100.0
 Basket Wonders’ Common Size
Balance Sheets
Regular (thousands of $) Common-Size (%)
Liab+Equity 2005 2006 2007 2005 2006 2007
Note Pay 290 295 290 23.71 14.43 13.37
Acct Pay 81 94 94 6.62 4.60 4.33
Accr Tax 13 16 16 1.06 0.78 0.74
Other Accr 15 100 100 1.23 4.89 4.61
Tot CL 399 505 500 32.62 24.71 23.05
LT Debt 150 453 530 12.26 22.16 24.44
Equity 674 1,086 1,139 55.11 53.13 52.51
Tot L+E 1,223 2,044 2,169 100.0 100.0 100.0
 Basket Wonders’ Common Size
Income Statements
Regular (thousands of $) Common-Size (%)
2005 2006 2007 2005 2006 2007
Net Sales 1,235 2,106 2,211 100.0 100.0 100.0
COGS 849 1,501 1,599 68.7 71.3 72.3
Gross Profit 386 605 612 31.3 28.7 27.7
Adm. 180 383 402 14.6 18.2 18.2
EBIT 206 222 210 16.7 10.5 9.5
Int Exp 20 51 59 1.6 2.4 2.7
EBT 186 171 151 15.1 8.1 6.8
EAT 112 103 91 9.1 4.9 4.1
Cash Div 50 50 50 4.0 2.4 2.3
 Horizontal Analysis
A.k.a trend analysis/ Index Analysis
Involves comparing amounts in the financial
statements of two or more consecutive periods.
The absolute change or difference is computed by
deducting the amount of the current figures from the
amount for the previous period.
 Index Analyses

An analysis of percentage financial statements where

all balance sheet or income statement figures for a
base year equal 100.0 (percent) and subsequent
financial statement items are expressed as
percentages of their values in the base year.
 Basket Wonders’
Indexed Balance Sheets
Regular (thousands of $) Indexed (%)
Assets 2005 2006 2007 2005 2006 2007
Cash 148 100 90 100.0 67.6 60.8
AR 283 410 394 100.0 144.9 139.2
Inv 322 616 696 100.0 191.3 216.1
Other CA 10 14 15 100.0 140.0 150.0
Tot CA 763 1,140 1,195 100.0 149.4 156.6
Net FA 349 631 701 100.0 180.8 200.9
LT Inv 0 50 50 100.0 inf. inf.
Other LT 111 223 223 100.0 200.9 200.9
Tot Assets 1,223 2,044 2,169 100.0 167.1 177.4
 Basket Wonders’
Indexed Balance Sheets
Regular (thousands of $) Indexed (%)
Liab+Equity 2005 2006 2007 2005 2006 2007
Note Pay 290 295 290 100.0 101.7 100.0
Acct Pay 81 94 94 100.0 116.0 116.0
Accr Tax 13 16 16 100.0 123.1 123.1
Other Accr 15 100 100 100.0 666.7 666.7
Tot CL 399 505 500 100.0 126.6 125.3
LT Debt 150 453 530 100.0 302.0 353.3
Equity 674 1,086 1,139 100.0 161.1 169.0
Tot L+E 1,223 2,044 2,169 100.0 167.1 177.4
 Basket Wonders’ Indexed Income
Statements
Regular (thousands of $) Indexed (%)
2005 2006 2007 2005 2006 2007
Net Sales 1,235 2,106 2,211 100.0 170.5 179.0
COGS 849 1,501 1,599 100.0 176.8 188.3
Gross Profit 386 605 612 100.0 156.7 158.5
Adm. 180 383 402 100.0 212.8 223.3
EBIT 206 222 210 100.0 107.8 101.9
Int Exp 20 51 59 100.0 255.0 295.0
EBT 186 171 151 100.0 91.9 81.2
EAT 112 103 91 100.0 92.0 81.3
Cash Div 50 50 50 100.0 100.0 100.0
 Basic performance measurement in
analyzing FS
1.Liquidity
2.Solvency & Stability
3.Profitability
 Basic performance measurement in
analyzing FS
Liquidity
-- is the ability of the business to pay its currently
maturing liabilities as they fall due.
-- comparing current assets and current liabilities
assesses liquidity.
-- most important to short term creditors, it is also
important to long term creditors.
 Basic performance measurement in
analyzing FS
Solvency & Stability
-- is the ability to pay long- term liabilities.
-- are assessed using the capital structure that is
composed of the business debts and equity.
Long-term creditors- are interested in the solvency of a
business because they are concerned about
receiving interest payments and more so of the
principal payment for the loan granted to the
company.
 Basic performance measurement in
analyzing FS
Profitability
-- addresses a very basic goal of any business- to
earn the highest possible profit or return on its
investment.
Costs- include cost of goods sold, operating expenses
and financing cost.
Asset Utilization- refers to how well the company is
using its assets to generate sales and or profit.
 Use of Financial Ratios

A Financial Ratio is an index Types of Comparisons

that relates two
accounting numbers and is Internal Comparisons
obtained by dividing one External Comparisons
number by the other.
 External Comparisons and Sources
of Industry Ratios
This involves comparing the Examples:
ratios of one firm with those of Risk Management
similar firms or with industry Association
averages. Dun & Bradstreet
Similarity is important as one Almanac of Business
should compare “apples to and Industrial Financial
apples.” Ratios
 Liquidity Ratios
Balance Sheet Ratios Current

Current Assets
Liquidity Ratios Current Liabilities

Shows a firm’s ability to For Basket Wonders

cover its current liabilities December 31, 2007
with its current assets.
$1,195 = 2.39
$500
 Liquidity Ratio Comparisons

Current Ratio
Year BW Industry
2007 2.39 2.15
2006 2.26 2.09
2005 1.91 2.01

Ratio is stronger than the industry average.

 Liquidity Ratios
Balance Sheet Ratios Acid-Test (Quick)

Current Assets - Inv

Liquidity Ratios Current Liabilities

Shows a firm’s ability to For Basket Wonders

meet current liabilities with December 31, 2007
its most liquid assets.
$1,195 - $696 = 1.00
$500
 Liquidity Ratio Comparisons

Acid-Test Ratio
Year BW Industry
2007 1.00 1.25
2006 1.04 1.23
2005 1.11 1.25

Ratio is weaker than the industry average.

 Summary of the Liquidity Ratio
Comparisons
Ratio BW Industry
Current 2.39 2.15
Acid-Test 1.00 1.25
• Strong current ratio and weak acid-test ratio indicates
a potential problem in the inventories account.
• Note that this industry has a relatively high level of
inventories.
 Current Ratio -- Trend Analysis
Comparison
Trend Analysis of Current Ratio

2.5
2.3
Ratio Value

2.1
BW
1.9 Industry
1.7
1.5
2005 2006 2007
Analysis Year
 Acid-Test Ratio -- Trend Analysis
Comparison
Trend Analysis of Acid-Test Ratio

1.5

1.3
Ratio Value

1.0 BW
Industry
0.8

0.5
2005 2006 2007
Analysis Year
 Summary of the Liquidity Trend
Analyses
 The current ratio for BW has been rising at the same time
the acid-test ratio has been declining.

 The current ratio for the industry has been rising slowly
at the same time the acid-test ratio has been
relatively stable.
 This indicates that inventories are a significant
problem for BW.
 Financial Leverage Ratios
Balance Sheet Ratios Debt-to-Equity

Total Debt
Financial Leverage Shareholders’ Equity
Ratios
For Basket Wonders
December 31, 2007
Shows the extent to which
the firm is financed by debt. $1,030 = .90
$1,139
 Financial Leverage
Ratio Comparisons
Debt-to-Equity Ratio
Year BW Industry
2007 .90 .90
2006 .88 .90
2005 .81 .89

BW has average debt utilization

relative to the industry average.
 Financial Leverage Ratios
Balance Sheet Ratios Debt-to-Total-Assets

Total Debt
Financial Leverage Total Assets
Ratios
For Basket Wonders December
Shows the percentage of the 31, 2007
firm’s assets that are
supported by debt financing. $1,030 = .47
$2,169
 Financial Leverage
Ratio Comparisons
Debt-to-Total-Asset Ratio
Year BW Industry
2007 .47 .47
2006 .47 .47
2005 .45 .47

BW has average debt utilization

relative to the industry average.
 Financial Leverage Ratios
Balance Sheet Ratios Total Capitalization
(i.e., LT-Debt + Equity)

Financial Leverage Long-term Debt

Ratios Total Capitalization

Shows the relative importance of For Basket Wonders December

long-term debt to the long-term 31, 2007
financing of the firm. $530 = .32
$1,669
 Financial Leverage
Ratio Comparisons
Total Capitalization Ratio
Year BW Industry
2007 .32 .30
2006 .32 .31
2005 .37 .32

BW has average long-term debt utilization

relative to the industry average.
 Coverage Ratios
Income Statement Interest Coverage
Ratios
EBIT
Interest Charges
Coverage Ratios
For Basket Wonders December
Indicates a firm’s ability to 31, 2007
cover interest charges.
$210 = 3.56
$59
 Coverage
Ratio Comparisons
Interest Coverage Ratio
Year BW Industry
2007 3.56 5.19
2006 4.35 5.02
2005 10.30 4.66

BW has below average interest coverage

relative to the industry average.
 Coverage Ratio -- Trend Analysis
Comparison
Trend Analysis of Interest Coverage Ratio
11.0

9.0
Ratio Value

7.0 BW
Industry
5.0

3.0
2005 2006 2007
Analysis Year
 Summary of the Coverage Trend
Analysis
 The interest coverage ratio for BW has been falling since
2005. It has been below industry averages for the past two
years.

 This indicates that low earnings (EBIT) may be a

potential problem for BW.
 Note, we know that debt levels are in line with the
industry averages.
 Activity Ratios
Income Statement / Receivable Turnover
(Assume all sales are credit sales.)
Balance Sheet
Ratios Annual Net Credit Sales
Receivables
Activity Ratios
For Basket Wonders December
Indicates quality of receivables 31, 2007
and how successful the firm is in
its collections. $2,211 = 5.61
$394
 Activity Ratios
Income Statement / Avg Collection Period
Balance Sheet
Days in the Year
Ratios
Receivable Turnover

Activity Ratios For Basket Wonders December 31,

2007
Average number of days that
receivables are outstanding.
(or RT in days) 365 = 65 days
5.61
 Activity
Ratio Comparisons
Average Collection Period
Year BW Industry
2007 65.0 65.7
2006 71.1 66.3
2005 83.6 69.2

BW has improved the average collection

period to that of the industry average.
 Activity Ratios
Income Statement / Payable Turnover (PT)
(Assume annual credit
Balance Sheet purchases = $1,551.)
Ratios
Annual Credit Purchases
Accounts Payable
Activity Ratios
For Basket Wonders December 31,
Indicates the promptness of
2007
payment to suppliers by the
firm. $1551
= 16.5
$94
 Activity Ratios
Income Statement / PT in Days
Balance Sheet
Ratios Days in the Year
Payable Turnover
Activity Ratios
For Basket Wonders December 31,
2007
Average number of days that
payables are outstanding. 365 = 22.1 days
16.5
 Activity
Ratio Comparisons
Payable Turnover in Days
Year BW Industry
2007 22.1 46.7
2006 25.4 51.1
2005 43.5 48.5

BW has improved the PT in Days.

Is this good?
 Activity Ratios
Income Statement / Inventory Turnover
Balance Sheet
Ratios Cost of Goods Sold
Inventory
Activity Ratios
For Basket Wonders December 31,
2007
Indicates the effectiveness of
the inventory management $1,599
practices of the firm. = 2.30
$696
 Activity
Ratio Comparisons
Inventory Turnover Ratio
Year BW Industry
2007 2.30 3.45
2006 2.44 3.76
2005 2.64 3.69

BW has a very poor inventory turnover ratio.

 Inventory Turnover Ratio --Trend
Analysis Comparison
Trend Analysis of Inventory Turnover Ratio
4.0

3.5
Ratio Value

3.0 BW
Industry
2.5

2.0
2005 2006 2007
Analysis Year
 Activity Ratios
Income Statement / Total Asset Turnover
Balance Sheet
Ratios Net Sales
Total Assets
Activity Ratios
For Basket Wonders December 31,
2007
Indicates the overall
effectiveness of the firm in $2,211
utilizing its assets to generate = 1.02
$2,169
sales.
 Activity
Ratio Comparisons
Total Asset Turnover Ratio
Year BW Industry
2007 1.02 1.17
2006 1.03 1.14
2005 1.01 1.13

BW has a weak total asset turnover ratio.

Why is this ratio considered weak?
 Profitability Ratios
Income Statement / Gross Profit Margin
Balance Sheet
Ratios Gross Profit
Net Sales
Profitability Ratios
For Basket Wonders December 31,
2007
Indicates the efficiency of
operations and firm pricing $612
policies. = .277
$2,211
 Profitability
Ratio Comparisons
Gross Profit Margin
Year BW Industry
2007 27.7% 31.1%
2006 28.7 30.8
2005 31.3 27.6

BW has a weak Gross Profit Margin.

 Gross Profit Margin --
Trend Analysis Comparison
Trend Analysis of Gross Profit Margin
35.0
Ratio Value (%)
32.5

30.0 BW
Industry
27.5

25.0
2005 2006 2007
Analysis Year
 Profitability Ratios
Income Statement / Net Profit Margin
Balance Sheet
Ratios Net Profit after Taxes
Net Sales
Profitability Ratios
For Basket Wonders December 31,
2007
Indicates the firm’s profitability
after taking account of all $91
expenses and income taxes. = .041
$2,211
 Profitability Ratio
Comparisons
Net Profit Margin
Year BW Industry
2007 4.1% 8.2%
2006 4.9 8.1
2005 9.0 7.6

BW has a poor Net Profit Margin.

 Net Profit Margin --
Trend Analysis Comparison
Trend Analysis of Net Profit Margin
10
9
Ratio Value (%)

8
7 BW
Industry
6
5
4
2005 2006 2007
Analysis Year
 Profitability Ratios
Income Statement / Return on Investment
Balance Sheet
Ratios Net Profit after Taxes
Total Assets
Profitability Ratios
For Basket Wonders December 31,
Indicates the profitability on the 2007
assets of the firm (after all
expenses and taxes). $91 = .042
$2,160
 Profitability Ratio
Comparisons
Return on Investment
Year BW Industry
2007 4.2% 9.8%
2006 5.0 9.1
2005 9.1 10.8

BW has a poor Return on Investment.

 Return on Investment –
Trend Analysis Comparison
Trend Analysis of Return on Investment
12
Ratio Value (%)
10

8 BW
Industry
6

4
2005 2006 2007
Analysis Year
 Profitability Ratios
Income Statement / Return on Equity
Balance Sheet
Ratios Net Profit after Taxes
Shareholders’ Equity
Profitability Ratios
For Basket Wonders December 31,
Indicates the profitability to the 2007
shareholders of the firm (after all
expenses and taxes). $91 = .08
$1,139
 Profitability Ratio
Comparisons
Return on Equity
Year BW Industry
2007 8.0% 17.9%
2006 9.4 17.2
2005 16.6 20.4

BW has a poor Return on Equity.

 Return on Equity --
Trend Analysis Comparison
Trend Analysis of Return on Equity
21.0
Ratio Value (%)
17.5

14.0 BW
Industry
10.5

7.0
2005 2006 2007
Analysis Year
 Return on Investment and the Du
Pont Approach
Earning Power = Sales profitability X
Asset efficiency
ROI = Net profit margin X
Total asset turnover
ROI2007 = .041 x 1.02 = .042 or 4.2%
ROIIndustry = .082 x 1.17 = .098 or 9.8%
 Return on Equity and
the Du Pont Approach
Return On Equity = Net profit margin X
Total asset turnover X
Equity Multiplier
Total Assets
Equity Multiplier =
Shareholders’ Equity
ROE2007 = .041 x 1.02 x 1.90 = .080
ROEIndustry = .082 x 1.17 x 1.88 = .179
 Summary of the Profitability Trend
Analyses
 The profitability ratios for BW have ALL been falling since
2005. Each has been below the industry averages for
the past three years.
 This indicates that COGS and administrative costs may
both be too high and a potential problem for BW.
 Note, this result is consistent with the low interest
coverage ratio.
 Summary of Ratio Analyses

• Inventories are too high.

• May be paying off creditors (accounts
payable) too soon.
• COGS may be too high.
• Selling, general, and administrative costs may
be too high.