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FINANCIAL ANALYSIS
TOPICS COVERED

• Value and Value Added

• Measuring Profitability

• Measuring Efficiency

• Measuring Leverage

• Measuring Liquidity
RATIO ANALYSIS
• Allows for better comparison through time & between
companies (finance.yahoo.com, bigpara.com, ...)
• Highlight weaknesses and strengths
• Used both internally and externally
• For each ratio, ask :
• How is it computed? What is it measuring? Why is that
information important?
• What is the unit of measurement (times, days percent)?

• What are the benchmarks used for comparison?

• How can we improve the company’s ratio?

 THE MAJOR CATEGORIES OF RATIOS
AND THE QUESTIONS THEY ANSWER
• Value and Value Added: How the market values the firm
relative to the book value? Do investors like what they see as
reflected in ratios?
• Profitability ratios: Do sales prices exceed unit costs, and are
sales high enough as reflected in ROE, and ROA?
• Turnover or efficiency ratios: Efficiency of asset use; do we
have the right amount of assets for the level of sales?
• Long-term solvency or financial leverage ratios: Do we
have the right mix of debt and equity? Can we meet long-term
obligations?
• Short-term solvency or liquidity ratios: Can we make
required payments as they fall due?
HOME DEPOT BALANCE SHEET($ MILLIONS)
2022 2021 2022 2021
Assets Liabilities and
Current assets: Shareholders' Equity
Cash and marketable Current liabilities:
securities 1,987 545 Debt due for repayment 30 1,042
Accounts receivable 1,245 1,085 Accounts payable 8,199 7,903
Inventories 10,325 10,625 Other current liabilities 1,147 1,177
Other current assets 963 1,224
Total current liabilities 9,376 10,122
Total current assets 14,520 13,479
Long‐term debt 10,758 8,707
Fixed assets:
Property plant and Other long‐term liabilities 2,486 2,407
equipment 38,975 38,385 Total liabilities 22,620 21,236
Less accumulated
depreciation 14,527 13,325 Common stock 87 86
Net tangible fixed Retained earnings and
assets 24,448 25,060 capital surplus 24,505 21,996
Treasury stock ‐6,694 ‐3,193
Long‐term investments 135 139
Intangible asset (goodwill) 1,120 1,187 Total shareholders'
equity 17,898 18,889
Other long‐term assets 295 260
Total assets 40,518 40,125 Total liabilities and
shareholders' equity 40,518 40,125
HOME DEPOT INCOME STATEMENT
2022 ($ MILLIONS)
 VALUE AND VALUE ADDED
1,537 million shares outstanding, Stock price = $44.60 per share
• Market-to-Book Ratio:
• Market value of Equity/Book value of Equity = $68,550/$17,898 = 3.8

• Market Capitalization:
• Number of shares outstanding × Share price =1,537×44.60=$68,550M

• Market Value Added

• Market capitalization -Book value of Equity =68,550-17,898=$50,652M
MEASURING HOME DEPOT’S PERFORMANCE
• Economic Value Added (EVA)
• Net income minus charge for cost of capital employed,
also called Residual Income
EVA  Residual Income
 After - tax interest  Net income   Cost of capital  Capital 

 After - tax interest  Net income 

EVA    Cost of capital   Total capital
 Total capital 

 (1  0.35)  606  3,883 

EVA    0.092   27,596
 27,596 
 $1,738 million
ACCOUNTING MEASURES OF COMPANY PERFORMANCE
($ MILLIONS)
PROFITABILITY RATIOS

Net income 3,883

Profit Margin =   0.055
Sales 70,395

After - tax interest  Net income

Return on capital =
Total capital

=
1  0.35 606  3,883  0.155
27,596
Net income 3,883
Return on equity =   0.206
Equity 18,889

After - tax interest  Net income

Return on assets =
Total assets
=
1 - 0.35 606  3,883  0.107
40,125
 MEASURING EFFICIENCY
• Asset Turnover Ratio
Sales Sales
Asset turn over ratio = OR
Total assets at start of year Average total assets

• Home Depot Asset Turnover

Sales 70,395
Asset turn over ratio =   1.75
Total assets at start of year 40,125
OR
Sales 70,395
Asset turn over ratio =   1.75
Average total assets (40,125  40,518) / 2
 MEASURING EFFICIENCY
Cost of goods sold 46,133
Inventory turnover ratio =   4.34
Inventory at start of year 10,625

Inventory at start of year 365

Average days in inventory =   84.1
Cost of goods sold/365 Inventory turnover ratio
How long inventory sits on average before it is sold

Sales 70,395
Receivables turnover =   64.9
Receivables at start of year 1,085

Receivables at start of year 365

Average collection period =   5.6
Average daily sales Receivables turnover

How long does it take for the firm to collect its credit sales
 MEASURING LEVERAGE
Long - term debt 10,758
Long - term debt ratio =   37.5%
Long - term debt + equity 10,758  17,898
Long - term debt
Debt equity ratio =  60.1%
Equity
Total liabilitie s 1 22,620
Total debt ratio =  1   55.8%
Total assets Equity multiplier 40,518

Total assets 40,518

Equity multiplier =   2.26
Total equity 17,898
EBIT 6,674
Times interest earned =   11 .01
interest payments 606

EBIT + depreciati on 6,674  1,573

Cash coverage ratio =   13.61
interest payments 606
 MEASURING LIQUIDITY

Current assets 14,520

Current ratio =   1.55
Current liabilitie s 9,376

Cash + Marketable securities + Receivables 1,987  1,245

Quick ratio =   0.34
Current liabilitie s 9,376

cash + marketable securities 1,987

Cash ratio =   0.21
current liabilitie s 9,376
 COMMON-SIZE BALANCE SHEET
U.S. COMPANIES IN S&P INDEX
Utilitiy Food
Industrial Paper Oil Chemical Metal Machinery Pharmaceutical Computer Software Semi-conductor Telecom Food Retailing
Cash &
securities 13 7 7 6 5 16 21 28 30 38 29 2 11 8
Receivables 12 13 14 12 12 17 10 12 13 8 18 5 11 3
Inventories 9 10 7 9 16 15 8 3 0 7 9 2 14 28
Other current
assets 2 4 2 1 3 4 4 5 7 4 4 3 4 3
Total current
assets 36 35 30 29 37 52 43 47 51 56 59 12 39 41
Fixed assets 55 72 95 105 68 31 28 14 19 44 25 97 59 71
Depreciation 25 41 36 62 38 16 14 8 11 25 16 31 33 20
Net fixed
assets 30 31 58 43 31 15 14 6 8 19 9 66 27 50
Other long-term
assets 34 34 11 27 32 33 43 47 41 24 32 22 34 9
Total assets 100 100 100 100 100 100 100 100 100 100 100 100 100 100
Short-term debt
3 2 2 4 2 4 3 3 3 3 2 4 4 4
Payables 8 9 17 7 8 7 4 9 4 5 7 3 11 17
Other current
liabilities 11 9 7 8 8 13 11 15 21 10 16 5 14 11
Total current
liabilities 21 21 26 19 19 24 18 27 28 18 25 13 28 32
Long-term debt
23 28 12 27 21 17 22 11 10 14 22 32 34 21
Other long-term
liabilities 15 16 18 22 21 11 11 9 12 9 9 27 14 12
Total liabilities 60 66 56 68 61 52 51 47 49 41 57 72 76 65
Stockholders'
equity 40 34 44 32 39 48 49 53 51 59 43 28 24 35
Total liabilities
and equity 100 100 100 100 100 100 100 100 100 100 100 100 100 100
 COMMON-SIZE INCOME STATEMENTS
U.S. COMPANIES IN S&P INDEX

Industrial Pharmaceutical Soft- Semi- Utility Food

Paper Oil Chemical Metal Machinery Computer ware conductor Telecom Food Retailing

100.0 100.0 100.0 100.0

Sales 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Costs 77.1 84.5 89.0 79.6 87.7 81.7 66.6 77.8 72.5 71.0 90.5 70.1 84.9 92.1
10.2
Depreciation 6.4 4.4 3.6 6.0 3.7 3.2 7.1 3.9 5.9 7.7 4.9 2.5 2.6
EBIT 16.4 11.1 7.3 14.4 8.6 15.0 26.3 18.3 21.6 21.3 4.6 19.7 12.6 5.2
Interest 2.6 2.0 0.5 1.7 1.4 1.2 1.9 0.9 1.7 1.1 1.2 6.4 1.6 0.8
Other items -0.7 -0.8 0.6 0.9 -0.5 -0.8 -3.2 -0.4 0.8 -2.5 -2.3 0.2 -2.7 -0.3
Pretax
income 13.1 8.3 7.4 13.6 6.7 13.0 21.1 17.0 20.7 17.6 1.2 13.5 8.3 4.1
Tax 3.8 2.4 3.1 3.5 2.0 3.1 4.5 4.1 5.2 4.0 0.9 4.1 2.7 1.6
Net income 9.0 5.7 4.2 9.9 4.4 10.0 16.0 12.8 15.5 13.6 0.2 9.0 5.6 2.5
 MEDIAN FINANCIAL RATIOS
U.S. COMPANIES IN S&P INDEX
Semi-
Industrial Machinery Pharmaceutical Soft- conductors Utility Food
Paper Oil Chemical Metal Computer ware Telecom Food Retailing
ROE, % 14.2 11.6 13.2 27.8 9.3 18.6 19.2 14.0 15.1 18.2 6.7 9.9 17.8 18.2
ROC, % 11.8 7.8 11.9 16.0 7.9 14.1 14.4 12.3 15.2 16.0 6.5 7.1 16.8 12.0
Sales-to-
assets ratio 0.7 1.0 1.7 0.8 0.9 0.8 0.6 0.6 0.6 0.7 0.9 0.3 1.3 2.1
Operating
profit margin,
% 10.8 6.2 4.0 10.0 5.5 10.6 16.6 12.9 15.5 15.5 4.9 12.9 8.5 3.9
Receivables
turnover 7.3 7.4 14.0 6.3 9.5 4.9 5.7 6.7 5.6 8.9 5.0 7.5 13.4 75.3
Inventory 14.3
turnover 11.2 8.8 35.2 9.2 7.7 6.2 8.7 29.1 59.5 12.5 10.1 9.5 8.8
Long-term
debt ratio, % 36.2 47.2 24.4 43.9 36.6 25.2 28.8 18.5 4.6 14.4 21.2 52.2 66.7 38.2
Current ratio 1.5 1.5 1.2 1.6 1.6 2.3 2.1 1.6 2.0 2.9 2.3 0.9 1.1 1.1
Quick ratio 1.0 1.0 0.8 0.9 0.8 1.3 1.6 1.3 1.9 2.5 1.8 0.5 0.7 0.3
Cash ratio 0.4 0.3 0.3 0.4 0.3 0.5 1.0 0.9 1.5 2.1 1.2 0.1 0.3 0.1
SELECTED FINANCIAL RATIOS
HOME DEPOT AND LOWE’S
SELECTED FINANCIAL RATIOS
HOME DEPOT AND LOWE’S
SELECTED FINANCIAL RATIOS
HOME DEPOT AND LOWE’S
POTENTIAL PROBLEMS

• There is no underlying theory, so there is no way to know

which ratios are most relevant

• Benchmarking is difficult for diversified firms e.g. Samsung,

GE

• Globalization and international competition makes

comparison more difficult because of differences in

accounting regulations
POTENTIAL PROBLEMS

• Varying accounting procedures, i.e. FIFO vs. LIFO

• Different fiscal years

• Extraordinary or one time events

• Seasonal factors can distort ratios

POTENTIAL PROBLEMS

• Window dressing techniques can make

statements and ratios look better

• Often, different ratios may give different signals,

so it may be difficult to tell, on balance, whether a

company is in a strong or weak financial condition
SOME QUALITATIVE FACTORS ANALYSTS SHOULD CONSIDER WHEN EVALUATING A
COMPANY’S LIKELY FUTURE FINANCIAL PERFORMANCE

• Are the company’s revenues tied to a single customer?

• To what extent are the company’s revenues tied to a

single product?
• To what extent does the company rely on a single
supplier?
• What percentage of the company’s business is
generated overseas?
POTENTIAL RED FLAGS
• Unexplained transactions that boost profits (selling

assets?)

• Unusual increase in A/R in relation to sales increases

(relaxing credit policies, artificially loading up its

distribution channels?)
POTENTIAL RED FLAGS
• Unusual increases in inventories in relation to
sales increases
• If it is due to an increase in finished goods, the demand for
the products may be slowing down,

• If it is an increase in work-in-progress inventory, it may

signal that managers expect an increase in sales,

• If it is a build up in raw materials, it could suggest

manufacturing/procurement inefficiencies; consequently an

increase in COGS, lower margins
POTENTIAL RED FLAGS
• An increasing gap between a firm’s reported income and its cash

flow from operating activities (expected is a steady relationship

between the two if the firm’s accounting policies remain the
same)

• Large fourth-quarter adjustments,

• If we are unsure of the quality of accounting applications, we can

try to undo the possible distortion.

• How? Using cash flow statement and foot notes (accounting

methods, employee stock ownership, errors in previous

statements, legal cases…)