Financial Statement & Ratio

Analysis
K. Stephen Haggard, Ph.D.
 Making Comparisons
We need to be able to compare
• between companies, and
• between time periods for the same company.
Comparing accounts between unadjusted
financial statements is not advisable due to
differences in scale.
Americhem/PolyOne Comparison
Common-size financial statements
To facilitate comparisons, we can standardize
the balance sheet and the income statement to
create “common-size” financial statements.
• On the balance sheet, divide all accounts by
Total Assets.
• On the income statement, divide all accounts
by Total Sales (statement might say “Total
Revenues” or similar, just use the first line of
the income statement).
 Financial Ratios
• Common-size statement analysis produces many
of the financial ratios we are about to discuss.
• However, common-size statements only contain
ratios where we are dividing by total assets
(balance sheet) or total sales (income statement)
• Other ratios are important for assessing a firm’s
performance.
• Financial ratios can be used for competitive
analysis, internal analysis, or external analysis
(equity analysts, suppliers, banks, bondholders)
Short-term solvency (liquidity) measures

• Current ratio = CA / CL
• Quick ratio (acid test) = (CA – Inventory) / CL
• Cash ratio = Cash / CL

Who cares about these measures?

• Suppliers
• Short-term creditors
 Long-term solvency measures
Leverage measures
• Total Debt Ratio = (TA – TE) / TA = TD / TA
• Debt-equity Ratio = (TA – TE) / TE = TD / TE
• Equity multiplier = TA / TE = 1 + (TD/TE)
Interest coverage measures
• Times interest earned (TIE) = EBIT / Interest
• Cash coverage ratio = (EBIT + Dep) / Interest

Who cares about these measures?

• Long-term creditors
 Asset Management or Turnover Measures

• Inventory turnover (turns) = COGS / Inventory

• Days’ sales in inventory = 365 / Inventory turns
• Receivables turnover (turns) = Sales / A.R.
• Days’ sales in receivables = 365 / Receivables turns
• Total asset turnover = Sales / Total Assets

Who cares about these measures?

• Firm managers concerned about performance
• Equity analysts & competitors
Managing Receivables
 Profitability Measures
• Profit Margin = NI / Sales
• EBITDA margin = EBITDA / Sales
• Return on Assets (ROA) = NI / TA
• Return on Equity (ROE) = NI / TE

Who cares about these measures?

• Firm managers concerned about performance
• Equity analysts & competitors
 Market Value Measures
• Earnings per share (EPS) = NI / Shares outstanding
• Price-to-earnings (P/E) = Price per share / EPS
• Market-to-book ratio = market value per share/
book value per share
• Market capitalization = price per share * shares
outstanding
• Enterprise value (EV) = Market capitalization +
market value of interest-bearing debt – cash
• EV Multiple = EV / EBITDA
Ratio Comparisons: Final Thoughts

• Only compare ratios between companies in

the same industry. Optimum levels vary widely
among industries and even among players in
the same industry with different strategies.
• Many times you cannot apply a “bigger (or
smaller) is better” mentality to ratios.
Example: Liquidity ratios.