Chapter 17
Financial Statement Analysis
Topics Covered
o
o
o
o
o
Financial Ratios
DuPont System
Using Financial ratios
Measuring Company Performance
The Role of Financial Ratios
1
Ratio Analysis
o Examines firm’s management of
various facets of the company’s
business through its financial
statements.
o Scales balance sheet and income
statement information for easy
comparison across time or to other
companies.
Two common approaches
o Trend Analysis - looks at changes in
one company’s ratios over time.
o Comparison or Industry Analysis compares company’s ratios against a
similar company or against industrywide ratios.
o We will look at both with Coca-Cola
and Pepsi.
2
Areas Examined by Ratio
Analysis
o Leverage - measures the use of financial
leverage (debt) and its impact
o Liquidity - measures the ability to meet
short-term obligations
o Efficiency - measures the ability to contain
the growth of assets, and the ability to
effectly utilize assets
o Profitability - measures the profitability of
various segments of a company
Leverage Ratios
Long term debt ratio =
long term debt
long term debt + equity
Long - term Debt equity ratio =
long term debt
equity
3
Leverage Ratios
total liabilities
total assets
Total debt ratio =
Times interest earned =
Cash coverage ratio =
EBIT
interest payments
EBIT + depreciation
interest payments
Leverage Ratios calculation
notes for Target & Wal-Mart
o Given our Financial Statement (B/S and
I/S) formatting from OneSource/Multitex:
n Long-term debt = Total long-term debt from the
B/S, which includes long-term borrowing and
capital lease obligations.
n Equity = Total Equity from B/S
n EBIT = Operating income + Interest Expense
from I/S
n Depreciation expense was listed on Target’s I/S,
but had to find Wal-Mart’s depreciation by the
annual change in accumulated depreciation from
B/S.
4
Target & Walmart’s Leverage
Ratios
Target
2002
2001
2000
1999
Long -term debt ratio
0.519
0.507
0.464
0.435
Debt- equity ratio
1.079
1.029
0.864
0.771
Total debt ratio
0.670
0.675
0.666
0.658
Times interest Earned
5.551
5.666
5.819
5.926
Cash coverage ratio
7.612
7.947
8.026
8.099
Walmart
2002
2001
2000
1999
Long -term debt ratio
0.333
0.348
0.333
0.392
Debt- equity ratio
0.498
0.534
0.499
0.645
Total debt ratio
0.585
0.580
0.599
0.633
Times interest Earned
14.750
10.065
9.465
9.887
Cash coverage ratio
17.214
11.219
11.239
10.756
Best Leverage Management?
5
Liquidity Ratios
Net working capital
to total assets ratio
=
Current ra tio =
Net working capital
Total assets
current assets
current liabilities
Liquidity Ratios
Quick ratio =
cash + marketable securities + receivables
current liabilities
Cash ratio =
cash + marketable securities
current liabilities
6
Liquidity Ratios calculation
notes for Target & Wal-Mart
o Given our Financial Statement (B/S
and I/S) formatting from
OneSource/Multitex:
n Net working capital = total current
assets – total current liabilities
n Cash and marketable securities are in
one account (cash and short-term
investments)
Target & Walmart’s Liquidity Ratios
Target
2002
2001
2000
1999
NWC to assets
0.154
0.107
0.051
0.037
Current ratio
1.586
1.368
1.159
1.108
Quick ratio
0.840
0.614
0.365
0.352
Cash ratio
0.101
0.071
0.056
0.038
2002
2001
2000
1999
NWC to assets
-0.023
0.007
-0.031
-0.021
Current ratio
0.935
1.022
0.917
0.944
Quick ratio
0.149
0.153
0.132
0.124
Cash ratio
0.085
0.079
0.071
0.072
Walmart
7
Best Liquidity Management?
Efficiency Ratios
Asset turnover ratio
NWCturnover =
=
Sales
Average total assets
sales
average net working capital
8
Efficiency Ratios
Average collection period =
Inventory turnover ratio =
Days' sales in inventory =
average receivables
average daily sales
cost of goods sold
average inventory
average inventory
cost of goods sold / 365
Efficiency Ratios calculation
notes for Target & Wal-Mart
o Given our Financial Statement (B/S
and I/S) formatting from
OneSource/Multitex:
n Sales = Total Revenue from I/S
n Cost of Goods Sold = Cost of Revenue,
Total from I/S
n Average “whatever asset” = (beginning+
ending amounts from B/S)/2
n Average Daily Sales or Cost of Goods
Sold = Amount form I/S divided by 365
9
Target & Walmart’s Efficiency
Ratios
Target
2002
2001
2000
1999
1.665
1.825
2.012
2.054
39.046
26.450
18.710
18.915
6.521
6.348
6.340
6.404
55.975
57.495
57.575
56.996
2002
2001
2000
1999
Total asset turnover
2.767
2.718
2.601
2.772
Average collection period
3.041
3.130
2.938
2.690
Inventory turnover
8.077
7.788
7.288
7.034
45.193
46.865
50.084
51.893
Total asset turnover
Average collection period
Inventory turnover
Days' sales in inventories
Walmart
Days' sales in inventories
Best Efficiency Management?
10
Profitability Ratios
Net profit margin =
Operating profit margin =
Return on assets =
net income
sales
net income + interest
sales
Net Income + Interest
average total assets
Return on equity =
net income
average equity
Profitability Ratios
Payout ratio =
dividends
earnings
earnings - dividends
earnings
= 1 - payout ratio
Plowback ratio =
Growth in equity from plowback =
earnings - dividends
xROE
earnings
11
Profitability Ratios calculation
notes for Target & Wal-Mart
o Given our Financial Statement (B/S
and I/S) formatting from
OneSource/Multitex:
n Dividend information listed below the
I/S: Gross dividends = total annual
dividends. Also can find EPS and
Dividends per share here.
n Earnings = Net Income from I/S
Target & Walmart’s Profitability
Ratios
Target
2002
2001
2000
1999
Net profit margin
3.8%
3.4%
3.4%
3.4%
Operating profit margin
5.1%
4.6%
4.6%
4.6%
Return on assets
8.5%
8.4%
9.2%
9.4%
Return on equity
19.1%
19.0%
20.4%
20.4%
Payout ratio
13.2%
14.8%
15.3%
16.7%
Plowback ratio
86.8%
85.2%
84.7%
83.3%
Growth in equity from plowback
16.6%
16.2%
17.3%
17.0%
Walmart
2002
2001
2000
1999
Net profit margin
3.3%
3.0%
3.3%
3.2%
Operating profit margin
3.6%
3.6%
3.9%
3.8%
Return on assets
10.1%
9.7%
10.1%
10.6%
Return on equity
21.6%
20.1%
22.0%
22.9%
Payout ratio
16.5%
18.7%
17.0%
16.6%
Plowback ratio
83.5%
81.3%
83.0%
83.4%
Growth in equity from plowback
18.0%
16.3%
18.3%
19.1%
12
Best Profitability Management?
The DuPont System
o A breakdown of ROE and ROA into
component ratios
ROA =
Net Income + interest
assets
ROE =
earnings available for commonstock
equity
13
The DuPont System
ROA =
sales Net Income + interest
x
assets
sales
asset
turnover
Operating profit
margin
The DuPont System
ROE =
assets sales Net Income + interest
Net Income
x
x
x
equity assets
sales
Net Income + interest
leverage asset
ratio turnover
Operating
profit
margin
debt
burden
14
The DuPont System:
Simplification of ROE
o The last two terms of the 4-part DuPont equation for
ROE, operating profit margin and debt burden, can be
simplified to one term, net profit margin.
o Net profit margin = Net Income/Sales
o Also assets/equity can be written in terms of the total
debt ratio.
ROE =
assets sales Net Income
x
x
equity assets
sales
assets
1
1
total liabilitie s
=
=
= 1+
equity 1 − total debt ratio 1 − total liabilitie s
equity
total assets
Target vs. Walmart Du Pont
System
Target
2002
2001
2000
1999
Asset turnover
1.665
1.825
2.012
2.054
Operating profit margin
5.1%
4.6%
4.6%
4.6%
ROA
8.5%
8.4%
9.2%
9.4%
Leverage ratio
3.049
3.035
2.959
2.930
Asset turnover
1.665
1.825
2.012
2.054
Operating profit margin
5.1%
4.6%
4.6%
4.6%
Debt burden
0.738
0.743
0.748
0.744
ROE
19.1%
19.0%
20.4%
20.4%
2002
2001
2000
1999
2.767
2.718
2.601
2.772
Walmart
Asset turnover
Operating profit margin
3.6%
3.6%
3.9%
3.8%
ROA
10.1%
9.7%
10.1%
10.6%
Leverage ratio
2.394
2.433
2.597
2.563
Asset turnover
2.767
2.718
2.601
2.772
Operating profit margin
3.6%
3.6%
3.9%
3.8%
Debt burden
0.897
0.849
0.840
0.840
ROE
21.6%
20.1%
22.0%
22.9%
15
Final Du Pont System
comments
o When a firm uses no debt financing,
the leverage term = 1 and ROE =
ROA.
o Using more financial leverage will
increase ROE when the return on new
assets (investment) exceeds the
interest rate on the new debt.
MVA & Economic Profit
Market Value Added = The difference
between the market value of common stock
and its book value
A gauge of how much value management
added for the year. Depends upon
managerial decisions and stock market
forces.
16
MVA for Target and Wal-Mart
Target 2002
2001
2000
WalMart
2002
28.05 42.83
36.31
Stock
Price
47.56 59.37 55.90
# of
909.8 905.2
Shares
897.8
# of
4395
Shares
4453
4470
Stock
Price
2001
1999
MV of
Equity
25520 38770 32599
MV of
Equity
209,026
264,375
249,873
Total
BV Eq
9443
6519
Total
BV Eq
39337
35102
31343
MVA
16,077 30,910
26,080
MVA
169,689
229,273
218,530
5.00
MV/BV
5.31
7.53
7.97
MV/BV 2.70
7860
3.93
Residual Income & EVA
Economic Profit = capital invested multiplied by the
spread between return on investment and the cost of
capital.
EP = Economic Profit
= ( ROI − r ) × Capital Invested
Residual Income or EVA = Net Dollar return after
deducting the cost of capital
EVA = Residual Income
= Income Earned - income required
= Income Earned - [Cost of Capital × Investment ]
© EVA is copyrighted by Stern-Stewart Consulting Firm and used with permission.
17
EVA for Target and Wal-Mart
o From Stern-Stewart
(www.sternstewart.com) EVA/MVA
ranking in millions of dollars.
o Target
n 2002 EVA: 341 2002 MVA rank: 44
n 1999 EVA: 710 1999 MVA rank: 92
o Wal-Mart
n 2002 EVA: 2,928
n 1999 EVA: 2,233
2002 MVA rank: 3
1999 MVA rank: 6
18