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)