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Lecture

CHAPTER 17 FINANCIAL STATEMENT ANALYSIS.docx

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Department
Finance
Course
FINE 2000
Professor
H A M D I D R I S S
Semester
Summer

Description
CHAPTER 17 FINANCIAL STATEMENT ANALYSIS 17.1 Financial Ratios  Leverage ratios show how heavily the company is in debt  Debt Ratio: financial leverage measure by the ratio of long-term debt to total long-term capital Long-term debt ratio= long-term debt+ value of leases/ long-term debt+ value of leases + preferred equity + common equity = long-term debt+ value of leases/ equity  Total debt ratio= total liabilities/ total assets  Time Interest Earned Ratio: extent to which interest is covered by earnings. Banks prefer to lend to firms whose earnings are far in excess of interest payments Time interest earned (TIE)= EBIT/ interest payments  Cash Coverage Ratio: extent to which interest is covered by the cash from operations Cash coverage ratio: EBIT + depreciation and amortization/ interest payments  Fixed charge coverage ratio: how many times greater EBIT plus depreciation and amortization is relative to the fixed charges the company is obliged to make  Liquidity ratios measure how easily the firm can lay its hands on cash  Liquidity: ability of an asset to be converted to cash quickly at low cost  Net working capital to total assets ratio: Difference between the current asses and current liabilities. Roughly measures the company’s potential reservoir of cash (usually positive but can be negative depending on the industry)  Current ratio: serves similar function as working capital ratio Current ratio= current assets/ current liabilities  Quick ( or Acid-test) ratio: some assets are closer to cash than others>> focus on most liquid assets, ignoring inventory Quick Ratio= cash + marketable securities + receivables/ current liabilities  Interval Measure: measure whether liquid assets are large relative to the firm’s regular outgoings. Interval measure= cash + marketable securities+ receivables/ average daily expenditures from operations  Cash Ratio: most liquid assets are cash and marketable securities Cash ratio= cash + marketable securities/ current liabilities  Efficiency or turnover ratios measure how productively the firm is using its assets  Asset Turnover ratio: how hard the firm’s assets are being put to use Sales/ total assets Highr atio compared to other firms in the industry means that they are working close to capacity. It may prove difficult to generate further business without additional investment  How particular types of capital are being put to use. For example, they might look at the value of sales per dollar invested in fixed assets. (sales/ fixed assets)  Average collection period: measures the speed with which customers pay their bills. It expresses accounts receivable in terms of daily sales Average collection period= receivables/ average daily sales  Inventory turnover ratio: how fast the company is turning over its inventory Inventory turnover= cost of goods sold/ inventory  Profitability ratios are used to measure the firm’s return on its investments  One group of profitability measures, known as profit margins, looks at profit on earnings as a fraction of sales. The other group, called return ratios, measure profits earned as a fraction of the assets used of the funds invested in the firm  Net profit margin  Proportion of revenue that finds its way to profits Net profit margin= net income/ sales  Operating profit margin  When companies are partly financed by debt, the profits are divided between the debt holders and the shareholders. We would not want to say that such a firm is less profitable simply because it employs debt finance and pays out part of its profits as interest. Therefore, when calculating the profit margin, it seems appropriate to add back the debt int
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