FINMAN_CHAPTER 4 FINANCIAL STATEMENT ANALYSIS

-to compare firm with other entities in the same industry

-evaluate trends in the firm’s FS

1. Liquidity ratios, which give an idea of the firm’s ability to pay off debts that are
maturing within a year.
-concerned with the continuity of a business
-relationship of cash and other current assets to current liabiltiies

: Can we make the required payments?

Formulas

Current Ratio = Current Asset/Current Liability

Scenarios
-comapre to industry ratio, kapag mas mababa edi weaker yung liquidity
-kapag mas mabilis tumaas ang current payables kesa assets, weak ang ratio na to
-too much deviation from industry ratios should encourage firm to check and evaluate
performance further

Quick or acid ratio test = Current Assets – Inventories / Current Liabilities

Since inventories ang least liquid, eliminate na lang siya from the solution para mas
Makita yung capanility ni firm maghandle ng short term assets and obligations,
makakaapekto pa kasi if hindi maganda sales so inalis na lang si inventories

Inventories are not quick assets

Quick assets – cash or non cash na immediately pwedeng maging cash

Note: Substituions in case na iba ang given sa problem

2. Asset management ratios, which give an idea of how efficiently the firm is using
its assets.
-are assets too high or too low in view of current and projected sales

: Right amount of asset vs sales

: Will adding or deducting asset improve sales?

Formulas

Turnover ratio –Sales over certain assets

-like ilang beses nagturn over yung assets para makuha yung ganun sales
-mas mataas na turnover rate, mas effective ang asset management kasi kita na
namaximize assets and god performing sales

Inventory Turnover Ratio = Sales / Inventories

Scenarios:
-kapag mababa, pwedeng hindi maximized ang gamit ng inventories kaya mahina ang
turnover -> pwedeng ievaluate inventories or iremedy para mas maging maayos ang
paggamit sa kanya

: kapag mababa, yung ikot ni inventory is hindi maganda benta

Add

Alternative:
Inventory Turnover Ratio = COGS / Inventories

Average Inventory Value = Annual/Sum of Monthly Figures / 12

Average Inventory Value = Beg and Ending / 2

Days Sale Outstanding DSO Ratio

-days a firm must wait after sale before receiving cash
-average collection period

DSO = Receivables / Average Sales per Day

or = Receivables / Annual Sales/365 days

-can also be analyzed using credit terms: compare credit terms with DSO and if mas
mataas si DSO, ibig sabihin there’s something wrong kasi late nagbabayad ang
consumers, hindi namemeet nang ayos si credit terms
: the longer it takes, the worse it gets
: can be due to poor credit policy

Fixed Asset Turnover Ratio = Sales / Fixed Assets

-a measure of how efficiently the firm uses its plant and equipment
-conflict sa historical and current values ng assets due to depreciation and inflation
: number of times FA create revenue per peso
: every one peso FA we invested, it creates ratio revenue

Total Assets Turnover Ratio = Sales / Total Assets

-measure ng turnover ng lahat ng assets sa sales

-assets should maximize sales

: kapag mababa, it may be caused by excessive current assets

3. Debt management ratios, which give an idea of how the firm has financed its assets
as well as the firm’s ability to repay its long-term debt.

: Right mix of debt and equity

(1) They check the balance sheet to determine the proportion of total funds represented
by debt
(2) They review the income statement to see the extent to which interest is covered by
operating profits.

-if we compare a company na walang debt sa merong debt, scenario would look like
Walang debt – mas mataas na net income, stable na ROE
May debt – lower net income pero mas mataas na ROE compared pag walang debt

Mas mataas ROE kapag may debt kasi yung portion ng capital na ininvest niya is hindi
buo, lower compared kapag walang debt so yung return nung capital niya nga nay un is
mas mataas kasi portion lang ininvest niya and yung kabilang portion is debt

Formulas

Total Debt to Total Capital = Total debt / Total Capital

or Total debt / Total debt + Equity

Debt Ratio = Total debt / Total assets

-debt does not include accruals and accounts payable, it pertains to short term and long
term interest bearing debts

Creditor POV – mas lower ang debt ratio kasi in case of loss upon liquidation, lower din
risks nila

Stockholders POV – higher leverage sa debt ratio kasi it may magnify possible earnings

Entity POV – high debt ratios is a red flag kasi it may mean mismanaged ang debt and
mas nagfufund pa sa entity ang investors kesa yung mga operations mismo
-high debt ratio may mean that entity would have difficulties borrowing money

Times-Interest-Earned (TIE) Ratio = EBIT / Interest Charges

EBIT – earnings before interest and tax – hindi net income kasi interest charges ay
walang kinalaman sa taxes

-measure how many times kaya ni operating income icover yung interest charges

: if I borrow, am I earning
: is it worth borrowing

Add:

4. Profitability ratios, which give an idea of how profitably the firm is operating and
utilizing its assets.
-shows combined effects ng liquidity, asset management and debt ratios
-net result of firm’s operating decisions and financial policies

: Do sales exceed unit costs or are sales enough

: income lagi ang numerator

Formulas

Operating Margin – the operating margin per dollar of sales

Operating Margin = EBIT / Sales

-kapag mababa ang operating margin, it may mean na masyadong mataas ang
operating costs kaya super less ang sales

Profit Margin = Net Income / Sales

-measures net income per dollar of sales

-influencing factor para bumabab ang net income = kapag mataas ang debt and interest
charges

Return on Assets (ROA) = Net Income / Total Assets

-return of assets over the net income na

-what may influence low ROA = high interest expenses and high debts kasi may effect
siya sa computation ng net income

Return on Common Equity (ROE) = Net Income / Common Equity

-good results in ROE may mean na mas maraming debts, as discussed previously

Return on Invested Capital (ROIC) = EBIT (1-T) / Total Invested Capital

or EBIT (1-T) / Debt + Equity

-notice na may (1-T) kasi ihihiwalay tax expenses kasi kukunin lang yung income na
availabke sa stockholders kasi nga this is a ratio measuring yug returns ni entity sa
investors nila
Try try try

Profit Margin = NI / Sales

= 1B / 20B
= 5%

ROA = NI / Total Assets

= 1B / 10B
=10%

ROE = NI / Common Equity

= 1B / 5B
= 20%

ROIC = EBIT (1-T) / Total Equity

Guide ni Jess
Situation, iwowork back income statement

Edi meron kang Net Income, Tax Rate, Interest rate and others na needed

Una muna (1-T) halimbawa 40% tax rate

1 – 0.4 = 0.6

Then itong sagot divide kay NI

1B / .6 = yung EBT or earnings before tax
So bali tax is EBT x 40% tax rate

Kulang pa ng interest so kuha muna by kuha ng interest sa debt so yung makukuhang

interest add kay EBT para maging EBIT
Basic Earning Power (BEP) = EBIT / Total Assets

EBIT is operating income

-performance of operating income over total assets before influences of tax and debt
-useful kapag comparing firms na may super magkaibang debt and tax policies

: what percent of my asset earns interest

: for evey one peso of asset invested, I earn ratio cents

5. Market value ratios, which give an idea of what investors think about the firm and its
future prospects.
-after ni liquidity, ni debt ratio, asset management ratio and profitability ratio and may
doubts pa, si market value ratios ang huling hatol

(1) by investors when they are deciding to buy or sell a stock

(2) by investment bankers when they are Setting the share price for a new stock issue
(an IPO)
(3) by firms when they are deciding how much to offer for another firm in a potential
merger

: Do investors like what they see as reflected in P/E and M/B ratio

Price Earnings Ratio = Price per share / Earnings per share

- shows the dollar amount investors will pay for $1 of current earnings.
-often varies overtime and across firms
Book Value per Share = Common Equity / Shares Outstanding

Market/Book (M/B) Ratio = Market price per share / book value per share
The DuPont Equation

ROE = PM x Asset Turnover x Equity Multiplier

ROE = NI/Sales x Sales/TA x TA/Equity

Focus on expense control (PM), asset utilization (TA TO) and equity multiplier

Conglomerate – corp with many businesses kaya hirap maidentify kung sang industry
sila cocompare

Qualitative Factors when evaluating company’s future financial performance

1. Entities should not be dependent on one customer. Product, supplier
2. overseas revenue
3. firm’s competitive envi – maintains competition and adjust to be better lage
4. future prospects
5. legal and regulatory environment
Questions

4-1
Financial ratio analysis is conducted by three main groups of analysts: credit analysts,
stock analysts, and managers. What is the primary emphasis of each group, and how
would that emphasis affect the ratios on which they focus?

Credit analysts : debt ratios, sa movement ng debt, TIE formula

Short term creditors – checks also he liquidity
Long term creditor – current ratio or whole asset management

Stock analysts : sila investos ng shares/stockholders

Sees profitability of company, income
Riskiness sa entity
Equity commitment – declaration of dividends

Managers
Entity strengths and weaknesses
Internal control
Standing sa investors and competitiions

4-2
Why would the inventory tunover ratio be more important for someone analyzing a
grocery store chain than an insurance company?

Inventory current, merchandise, bigger as an asset kasi grocery nga

Insruance future pa

4-3
Over the past year, M.D. Ryngaert & Co. had an increase in its current ratio and a
decline in its total assets turnover ratio. However, the company’s sales, cash and
equivalents, DSO, and fixed assets turnover ratio remained constant. What balance
sheet accounts must have changed to produce the indicated changes?

Nasa asset ang influence – inventory

4-4
Profit margins and turnover ratios vary from one industry to another. What differences
would you expect to find between the turnover ratios, profit margins, and DuPont equa-
tions for a grocery chain and a steel company?

Grocery ay super iba sa steel company

G – merchandise generates the profits
S – relies sa construction industry

Higher turnover – grocery syempre kasi low values, mabilis napalitn tlg

4-5
Inflation distort ratio analysis comparisons for one company over time (trend analysis)
and for different companies that are being compared? Are only balance sheet items or
both balance sheet and income statement items affected?

The income statement should go up kasi prices go up kahit quantity is the same kasi
nga inflation

Movie bpx foffice example

Inflation affects both IS and BS

4-6
If ROE is low and management wants to improve it, explain how using more debt might
help?

Magdagdag ng debt para hati si debt and equity

DuPont
ROE = PM x Asset Turnover x Equity Multiplier
ROE = NI/Sales x Sales/TA x TA/Equity

4-7
Give some examples that illustrate how (a) seasonal factors and (b) different growth
rates ‘might distort a comparative ratio analysis. How might these problems be
alleviated?

A – kapag me election, may abnormal cash circulation in the country for example,
printing businesses
-maiiba beginning accounts sa year end accounts

4-8
Why is it sometimes misleading to compare a company’s financial ratios with those of
other firms that operate in the same industry?

Different methods of computing figures

Differ in investments
Differ in inventory management
Differ in financing

4-9
Suppose you were comparing a discount merchandiser with a high-end merchandiser.
Suppose further that both companies had identical ROEs. If you applied the DuPont
equation to both firms, would you expect the three components to be the same for each
company? If not, explain what balance sheet and income statement items might lead to
the component differences

DuPont
ROE = PM x Asset Turnover x Equity Multiplier
ROE = NI/Sales x Sales/TA x TA/Equity

DM – pwedeng less sales, higher turnover

HEM – more sales, lower turnover

Numerator up = ratio up
Denominator up = ratio down
Presentation
DuPONT AND ROE A firm has a profit margin of 2% and an equity multiplier of 2.0. Its.
sales are $100 million, and it has total assets of $50 million.

DuPont
ROE = PM x Asset Turnover x Equity Multiplier
ROE = NI/Sales x Sales/TA x TA/Equity

ROE = 2M / 100M x 100 / 50M x 2.0

ROE = 2% x 2 x 2.0
= 0.08 or 8%

P/E = Price per share / EPS

= 20 / 2.00
= 10
4-1

DSO = AR / Annual Sales

40 days = AR / 7.3M/365 days
40 days = AR / 20,000
AR = 800,000

4-2
= Total debt / Total debt + Equity
= 55,000,000 / 55,000,000 + 70,000,000
= 55,000,000 / 125,000,000
= .44 or 44%

4-3
ROE = PM x Asset Turnover x Equity Multiplier
ROE = NI/Sales x Sales/TA x TA/Equity

15% = 2% x 5% x Equity Multiplier

15% = 2% x 5% x 1.5

4-4
Book Value per share = Equity / Shares Outstanding
= 6B / 800M
= 7.5

M/B = Market Share / Book Value per Share

= 32 / 7.5
= 4.267
P/E = Price per share / EPS
= 24 / 2.00
= 10

DuPONT AND ROE A firm has a profit margin of 2% and an equity multiplier of 2.0. Its
sales are $100 million, and it has total assets of $50 million.

DuPont
ROE = PM x Asset Turnover x Equity Multiplier
ROE = NI/Sales x Sales/TA x TA/Equity

ROE = 2% x 100 / 50M x 2.0

ROE = 2% x 2 x 2.0
= 0.08 or 8%
Total Debt to Total Capital = Total debt / Total Capital
or Total debt / Total debt + Equity

120M / ? = ?
Price Earnings Ratio = Price per share / Earnings per share

Book Value per Share = Common Equity / Shares Outstanding

Market/Book (M/B) Ratio = Market price per share / book value per share
AR
DSO = AR / Annual Sales
40.55 days = AR / 1,000,000,000 / 365 days
AR = 40.55 x 1,000,000,000 / 365
AR = 40.55 x 2,739,726
AR = 111,095,889

Current Assets
Current Ratio = Current Assets / Current Liab
3.00 = CA / 105,500,000
CA = 3.00 x 105,500,000
CA = 316,500,000

Total Assets
100,000,000 + 316,500,000 + 111,095,726 + 283,500,000 = 811,095,726

ROA
Net Income / Total Assets
50,000,000 / 811,095,726
=0.06 / 6%

Common Equity and Long Term Debt

A=L+E
811,095,726 = 105,500,000 + 20,000,000 + 685,595,726 (Equity and Long Term
Debt)
Common Equity and Long Term Debt
A=L+E
811,095,726 = 105,500,000 + 20,000,000 + 685,595,726 (Equity and Long Term
Debt)

811,095,726 = 105,500,000 + 20,000,000 + 416,666,667 + 268,929,059

ROE
Net Income / Common Equity
12% = 50,000,000 / Common Equity
Common Equity = 50,000,000 / 12%
=416,666,667

AR
DSO = AR / Annual Sales
30.4 days = 111,100,000 / Annual Sales
Sales = 111,100,000 / 30.4
Sales = 3,654,605
x 365 days = 1,333,930,825

AR = 40.55 x 1,000,000,000 / 365

AR = 40.55 x 2,739,726
AR = 111,095,889

AR
DSO = AR / Annual Sales
30.4 days = AR / 1,000,000,000 / 365 days
AR = 30.4 x 1,000,000,000 / 365
AR = 30.4 x 2,739,726
AR = 111,095,889