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CHAPTER 18 Chapter 18: FINANCIAL STATEMENT ANALYSIS Remember summative presentation will be December 17 and 18. Paper or Report is due December 19 Ratio Analysis • Ratio Analysis expresses the relationships between selected financial statement items. •There are 3 types of ratio analysis: 1. Liquidity Ratios : Measure short-term ability of the enterprise to pay its debts and to meet unexpected needs for cash. 2. Solvency ratios : Measure the ability of the enter prise to survive over a long period of time. 3. Profitability ratios: Measure the income or operating success of an enterprise for a given period of time. PROFITABILITY RATIOS • • • • • Profit margin Gross profit margin Asset turnover Return on assets Return on common shareholders’ equity • Earnings per share (EPS) • Price-earnings (PE) ratio • Payout ratio ASSET TURNOVER • Measures how efficiently assets are used to generate sales (The higher the better) • It shows how much sales did $1 asset make? Asset turnover = Net sales Average total assets (Discussed in Chapter 10) Asst Turnover 2004: 1837000 / (1M + 1.09M)/2 = 1.8 2005: 1997000 / (1M + 1M)/2 = 2.0 Industry average = 2.4 Canadian Tire = 1.4 • In 2005, Home Tire generated $2 of net sales for each dollar of assets. • Since this ratio increased from 2004, it is a positive sign. • Since 2 is higher than 1.4, but it is lower than industry average, investors will feel neutral about their ratio. RETURN ON ASSETS • Measures overall profitability of assets • The higher the better. • It shows how much net income did $1 asset make? Return on assets = Net income Average total assets (Discussed in Chapter 10) Return on Assets • • • • • • 2004: 75000 / (1M + 1.09M)/2 = 7.2% 2005: 82000 / (1M + 1M)/2 = 8.2% Industry Average: 12.3 Canadian Tire: 5.9% Higher the better Since the ratio increased year over year, it is a positive sign. • But it is lower than industry average – negative • It is higher than Canadian Tire – somewhat positive • Every 1$ asset made 0.082$ in 2005 RETURN ON COMMON SHAREHOLDERS’ EQUITY • Measures profitability of common shareholders’ investment • It shows how much net income did one share make? Return on common shareholders’ equity = Net income Average common shareholders’ equity • ACSE = # of shares X share price (Discussed in Chapter 14) Example Apple’s Net Income = 10 million $ # of shares = 1 million shares Apple declared 50 cents per share Each share = $5 EPS=?, ROE=? And Payout ratio=? • Answer: EPS = NI / # shares = 10 million / 1 million =$10 per share • ROE = NI / Total shares = 10 million / (5 X 1 million) = 2 • Payout ratio = (0.5 X 1 million) / 10 million $ = 0.05 or 5% PAYOUT RATIO • Measures % of earnings distributed in the form of cash dividends • What is the percentage of cash dividends out of net income? Payout ratio = Cash dividends Net income (Discussed in Chapter 15) Classwork / Homework • P960 E18.9, E18.10, E18.11 • P964 P18.3 – only the ratios we learned so far Optional : It is a good practice, but I do not want to give you too many questions. I will not make it a mandatory question. (Discussed in Chapter 15)