Chapter 6

Financial
Financial Statement
Statement
Analysis
Analysis

1
 Basket
Basket Wonders’
Wonders’ Balance
Balance
Sheet
Sheet (Asset
(Asset Side)
Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007a
Cash and C.E. $ 90 a. How the firm stands on
Acct. Rec.c 394 a specific date.
Inventories 696 Prepaid Exp d b. What BW owned.
5 Accum Tax Prepay c. Amounts owed by
10 customers.
Current Assetse d. Future expense items
$1,195 Fixed Assets (@Cost) f
already paid.
1030 Less: Acc. Depr. g
e. Cash/likely convertible
(329) Net Fix. Assets $ 701
to cash within 1 year.
Investment, LT 50 Other
Assets, LT 223 Total
f. Original amount paid.
Assets b $2,169 g. Acc. deductions for
2 wear and tear.
 Basket
Basket Wonders’
Wonders’ Balance
Balance
Sheet
Sheet (Liability
(Liability Side)
Side)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007
Notes Payable $ 290 a. Note, Assets =
Acct. Payablec 94 Liabilities + Equity.
Accrued Taxes d 16 Other b. What BW owed and
Accrued Liab. d 100 ownership position.
Current Liab. e $ 500 c. Owed to suppliers for
Long-Term Debt f 530 goods and services.
Shareholders’ Equity d. Unpaid wages, salaries,
Com. Stock ($1 par) g 200 etc.
Add Pd in Capital g 729 e. Debts payable < 1 year.
Retained Earnings h 210 f. Debts payable > 1 year.
Total Equity $1,139 g. Original investment.
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Total Liab/Equitya,b $2,169 h. Earnings reinvested.
 Basket
Basket Wonders’
Wonders’
Income
Income Statement
Statement
Basket Wonders Statement of Earnings (in thousands)
for Year Ending December 31, 2007a
Net Sales $ 2,211 a. Measures profitability
Cost of Goods Sold b 1,599 over a time period.
Gross Profit $ 612 b. Received, or receivable,
SG&A Expenses c 402 from customers.
EBITd $ c. Sales comm., adv.,
210 Interest Expensee officers’ salaries, etc.
59 EBT f $ d. Operating income.
151 Income Taxes e. Cost of borrowed funds.
60 EATg $ 91 f. Taxable income.
Cash Dividends 38 g. Amount earned for
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Increase in RE $ 53 shareholders.
 Liquidity
Liquidity Ratios
Ratios

Health of a Firm

1. Analysis of the funds Financial Ratios

needs of the firm.

1. Individually
2. Over time
3. In combination
4. In comparison

5
 Liquidity
Liquidity Ratios
Ratios

Business risk relates to

the risk inherent in the
1. Analysis of the funds
needs of the firm.
operations of the firm.
2. Analysis of the financial Examples:
condition and profitability
of the firm. Volatility in sales
3. Analysis of the business
risk of the firm. Volatility in costs
Proximity to break-even
point
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 Liquidity
Liquidity Ratios
Ratios
Balance Sheet Ratios Current

Current Assets
Liquidity Ratios Current Liabilities

Shows a firm’s ability For Basket Wonders

to cover its current December 31, 2007
liabilities with its
current assets. $1,195 = 2.39
$500
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 Liquidity
Liquidity Ratio
Ratio
Comparisons
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.
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 Liquidity
Liquidity Ratios
Ratios
Balance Sheet Ratios Acid-Test (Quick)

Current Assets - Inv

Liquidity Ratios Current Liabilities

Shows a firm’s For Basket Wonders

ability to meet December 31, 2007
current liabilities
$1,195 - $696 = 1.00
with its most liquid $500
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assets.
 Liquidity
Liquidity Ratio
Ratio
Comparisons
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.
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 Summary
Summary of
of the
the Liquidity
Liquidity
Ratio
Ratio Comparisons
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.
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 Current
Current Ratio
Ratio --
-- Trend
Trend
Analysis
Analysis Comparison
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
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 Acid-Test
Acid-Test Ratio
Ratio --
-- Trend
Trend
Analysis
Analysis Comparison
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
13
 Summary
Summary of
of the
the Liquidity
Liquidity
Trend
Trend Analyses
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.
BW
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 Activity
Activity Ratios
Ratios
Income Statement / Receivable Turnover
(Assume all sales are credit sales.)
Balance Sheet
Ratios Annual Net Credit Sales
Receivables
Activity Ratios
For Basket Wonders
Indicates quality of December 31, 2007
receivables and how
successful the firm is in $2,211 = 5.61
its collections. $394
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 Activity
Activity Ratios
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. 365 = 65 days
(or RT in days) 5.61
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 Activity
Activity
Ratio
Ratio Comparisons
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
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period to that of the industry average.
 Activity
Activity Ratios
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
Indicates the
December 31, 2007
promptness of payment
to suppliers by the firm. $1551
= 16.5
$94
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 Activity
Activity Ratios
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 365
outstanding. = 22.1 days
16.5
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 Activity
Activity
Ratio
Ratio Comparisons
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.
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Is this good?
 Activity
Activity Ratios
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 $1,599 = 2.30
inventory management $696
practices of the firm.
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 Activity
Activity
Ratio
Ratio Comparisons
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.
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 Inventory
Inventory Turnover
Turnover Ratio
Ratio
--Trend
--Trend Analysis
Analysis
Comparison
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
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 Activity
Activity Ratios
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 $2,211 = 1.02
in utilizing its assets to $2,169
generate sales.
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 Activity
Activity
Ratio
Ratio Comparisons
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.
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Why is this ratio considered weak?
 Summary
Summary of
of Ratio
Ratio Analyses
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.
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