Chapter 3 - Outline
Chapter 3 - Outline
Chapter 3 - Outline
Chapter 3
Chapter 3 - Outline
Financial
LT 3-1
Financial Analysis
Analysis 4 Categories of Financial Ratios Importance of Ratios Inflation and its Impact on Profits
McGraw-Hill/Irwin
LT 3-2
4 Categories of Ratios
Profitability
LT 3-3
a firms financial performance Analyzing ratios or numerical calculations Comparing a company to its industry
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McGraw-Hill/Irwin
Classification System
PPT 3-1
Classification System
C. Liquidity ratios.
9. Current ratio. 10. Quick ratio.
PPT 3-1
We will separate 13 significant ratios into four primary categories. A. Profitability Ratios.
1. Profit margin. 2. Return on assets (investment). 3. Return on equity.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Profitability Ratios
Show how profitable a company is. The ratios express:
LT 3-4
Profit Margin or Return on Sales (%) Return on Assets or Return on Investment (%) Return on Equity (%)
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Profitability Ratios
Saxton Company 1. Profit margin = Net income
sales $200,000 = 5% $4,000,000
10% 10%
b. Net income
5% 2.5 = 12.5%
$200,000 = 20% $1,000,000 0.125 = 20% 1 0.375
3. Return on equity = a. b.
Net income Stockholders equity Return on assets (investment) (1 Debt/Assets)
15% 15%
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McGraw-Hill/Irwin
PPT 3-5 TABLE 3-2 Return of Wal-Mart versus May Department Stores using the Du Pont method of analysis, 2002
LT 3-5
Show how effectively a company uses its assets. The ratios express:
Receivables Turnover (times) Average Collection Period (days) Inventory Turnover (times) Fixed Asset Turnover (times) Total Asset Turnover (times)
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Industry Average
Industry Average
10 times
5.4 times
$350,000 = 32 $11,111
36 days
1.5 times
7 times
McGraw-Hill/Irwin 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
LT 3-6
Liquidity Ratios
LT 3-7
Show how liquid a company is or how much $ it has to meet S/T needs. The ratios express:
Current Ratio (times) Quick Ratio or Acid-Test Ratio (times)
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Liquidity Ratios
Saxton Company 9. Current ratio =
Current assets Current liabilities $800,000 = 2.67 $300,000
LT 3-8
Show how well a company is managing or using debt. The ratios express:
Debt-to-Total Assets (%) Times Interest Earned (times) Fixed Charge Coverage (times) (Fixed Charges = lease payments, i expense)
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2.1
1.0
McGraw-Hill/Irwin
PPT 3-8
PPT 3-9
Industry Average
33%
$550,000 $50,000
= 11
7 times
$600,000 =6 $100,000
5.5 times
McGraw-Hill/Irwin
Importance of Ratios
LT 3-9
Which ratio is most important? It depends on your perspective. Suppliers and banks (lenders) are most interested in liquidity ratios. Stockholders are most interested in profitability ratios. A long-run trend analysis over a 5-10 year period is usually performed by an analyst.
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LT 3-10
PPT 3-12 TABLE 3-7 Comparison of replacement cost accounting and historical cost accounting TABLE 3-8
PPT 3-13
McGraw-Hill/Irwin
McGraw-Hill/Irwin