Chapter 13 – Financial Ratios and
Firm Performance
 Learning Objectives
 Create common-size statements
 Analyze performance with internal data and
financial statements
 Calculate and interpret some key financial
ratios
 Compare different company performances
 Analyze performance from historical data
 Appreciate the difference across industries of
financial ratios
Financial Statements
 Review
 Income Statement
 Balance Sheet
 Sources and Uses of Cash
 Accounting Identity
 Assets ≡ Liabilities + Owner’s Equity
 Double entry bookkeeping
 Benchmarking – against self or
competition
Benchmarking
 Against Self
 Comparisons across time
 Growing Sales?
 Growing Costs?
 Growing Income?
 Against Competition
 Common Size Statements
 Comparisons of percentages not actual dollars
 Which firm is more efficient per sales dollar
Internal Uses of Financial Statements
 Analyze firm performance
 Comparison of actual performance to
forecasts (budgets)
 Use standard costs for comparison
 Breakdown performance into key areas
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Sales
Production
Labor
Overhead
Internal Uses of Financial Statements
 Example – Sales Variance Analysis
 Price Analysis
 Actual Price x Actual Quantity vs. Forecasted Price
x Actual Quantity
 Actual > Forecast, favorable variance
 Volume Analysis
 Forecast Price x Actual Quantity vs. Forecast Price
x Forecast Quantity
 Actual > Forecast, favorable variance
 Sum variance for total Sales Analysis
Internal Uses of Financial Statements
 Other Variances
 Production
 Labor and Material
 Overhead
 EBIT Variance sum of Sales, Production, and
Overhead
 Be careful with interpreting favorable and
unfavorable variances
 Variance analysis is an aid to understanding the
performance of the business…
Financial Ratios
 Comparing accounts for analysis of firm
performance or potential strengthens and
weaknesses
 Five areas
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Liquidity
Solvency
Asset Management
Profitability
Market Value
Financial Ratios
 Liquidity
 Ability to meet short term cash outflow
 Poor liquidity sign of trouble ahead in keeping
operations going
 Common Liquidity Ratios
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Current Ratio
Cash Debt Coverage Ratio
Quick Ratio
Cash Ratio
Financial Ratios
 Solvency
 Long-term ability to meet cash outflow
 Indicates borrowing capacity in future
 Common Solvency Ratios
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Debt Ratio
Times Interest Earned
Cash Coverage Ratio
Capital Expenditure Ratio
Financial Ratios
 Asset Management
 Utilization of assets by management
 How assets are being used to generate profits
 Common Asset Management Ratios
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Inventory Turnover
Day’s Sales in Inventory
Receivables Turnover
Total Asset Turnover Ratio
Financial Ratios
 Profitability
 Overall performance of the firm
 Return to the owners
 Common Profitability Ratios
 Profit Margin
 Return on Assets
 Return on Equity
Financial Ratios
 Market Value
 Concern of potential investors
 DuPont Extension of components of ROE
 Common Market Value Ratios
 Earnings Per Share (EPS)
 Price Earnings Ratio
 PEG Ratio
 DuPont Analysis
 Operating efficiency, management efficiency, and
financial leverage
 ROE components
External Uses of Financial Statements
 Financial Analysts provide external view of
performance
 Why?
 For clients that are seeking to buy (make an investment)
 For clients that need to sell (disinvest)
 Finance is still about buying and selling
 Comparing firms…Cola Wars
 Which firm would you buy?
 Why?
 Across Industries – Ratios reveal operating
standards
Homework
 Problem 8 – Predict Net Income
 Problem 10 – Common-size Statements
 Problem 11 – Variance Analysis
 Problem 18 – DuPont Identity
 Problem 20 – Company Analysis