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Monforte Case in-class discussion Wed
Oct 8
Look at ratio analysis for Monforte
Implications for discount rate and project feasibility evaluation; risk

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Financial Ratio Analysis
Capital Budgeting including
Payback, Rate of Return,
Profitability Index and Net
Present Value
Economic Feasibility

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Purpose is to illustrate proper capital budgeting analysis.
We will look at:
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-Financial Ratio Analysis
-Payback
-Net Present Value
-Rate of Return
-Profitability Index

FINANCIAL STATEMENT
ANALYSIS
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Analysis of Consolidated Financial
Statements
Basically these are corporate Report
Cards
Shows how well the firm is Performing
Important that statements be prepared consistently over time for comparison purposes

Green Mountain Coffee Stock Prices –
10 Years
Source: Fidelity Investment Research, 2014

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Sometimes it’s common to report financial statements as “ Common
Size“ meaning that the statements show their components as a percent of some base (such as Percent of sales)
See Monforte financials
For our analyses we’ll be using standard consolidated financial statements

Why Evaluate Financial
Statements?
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Internal Uses
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Performance evaluation for firm
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Performance evaluation among divisions
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Planning for the future (Pro
Forma statements)

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External Uses
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Useful for investors and business partners
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Suppliers evaluate whether to grant credit to the firm?
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Important to help evaluate firm financial health

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A systematic listing of Assets and Liabilities
A snapshot of the business showing everything Owned and Owed
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Assets are items of value Owned
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Liabilities are items of value
Owed

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Owners Equity shows what percent of the firm is owned by the Owners/
Investors
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An accounting equation
Total Assets -Total Liabilities
= Owners Equity

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A summary of revenues and expenses over the accounting period
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Revenues (sales) = Price X Quantity
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Gross Margin (GM) = Sales
- Cost of Goods Sold
Gross Margin

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When combined with a cash flow statement, shows financial progress (or lack there of) over time
Can analyze activity and profitability when combined with balance sheet information

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Represents the cash revenues and cash expenditures for a specified time period
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Three activities impacting cash flow include:
Operating
Investing
Financing

OPERATING CASH FLOW
(Starts With Net Income and Adds
Back Non-Cash Items)
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Net Income After Taxes Adjusted for:
-Depreciation
-Changes in A/R
-Changes in Inventory
-Changes in Other Current Assets
-Changes in any Accrued Expenses
-Change in any other Current Liabilities

Investing Cash Flow
(Determine all Changes in Long Term
Assets Employed in the Business_
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Changes in Fixed Assets
Changes in Notes Receivable
Changes in securities or investments
Changes in intangible non-current assets

Financing Cash Flow
(Examines all Changes in Loans, Equity
Accounts, but doesn’t Include Net Income
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Change in Borrowings
Changes in Capital Stock
Minus Dividends Paid

+/- Operating Cash Flow
+/- Investing Cash Flow
+/- Financing Cash Flow
= Total Cash Flow
+ Cash Flow at Beginning of Period
= Cash Flow at End of Period

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Can be used to determine Sources and
Uses of cash for the level and timing of borrowing and investing/financing activities
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Provides a source of Cash Receipts shown in the income statement
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Uniquely adapted for evaluating the affect of adding, deleting or expanding enterprises
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Can help identify periods of cash Surpluses

Ways to Track Financial
Performance Over Time
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One is time trend analysis, i.e. a
History
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Second, comparative financial analyses compared to the firm’s “peers”
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Often use both approaches to track performance over time

Problems with Comparative
Financial Analyses
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Conglomerate firms statements hard to compare to “peers”—Too unique
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Peer firms may be scattered around the globe making Comparisons difficult
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Firms often use different accounting standards, particularly for valuing Inventory

Problems with Comparative
Financial Analysis
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Different Fiscal years
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Unusual or transient events cloud these statements (such as a one time business expense write-off or a one time sale of a portion of the business).

Financial Statement Analysis
Using Ratios
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Why Use Ratios?
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Easy to Calculate
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Allows easy Comparisons with the firm’s past performance
Allows comparison with like firms or
“peers”
Relatively easy to Understand
Helps communicate firm’s financial position to others such as Creditors,
Investors and Suppliers.

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Merely Indicators—deteriorating ratios may sound the “alarm” but not tell you the Source of the problem
Inter firm comparisons Difficult
Data using balance sheet can be misleading in that it is a Snapshot at one point in time
Need to know industry well before jumping to too many Conclusions .

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Measure of the firm’s ability to meet financial obligations in the Short-Term.
Theoretically a firm could be strong in owners equity as a share of assets, for example, yet be starved for funds in the short term to pay current bills.
Two ratios are recommended:
Current Ratio and
Quick Ratio

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Defined as those assets that can be converted into cash quickly to meet current obligations
Current Ratio =
Current Assets
Current Liabilities

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Another measure of how assets can be converted into cash quickly, but removing the effects of Inventory.
Why?
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Inventory is often the least Liquid current asset
Book values of inventory are often not very reliable as some inventory may turn out to be damaged or obsolete or even missing

Quick Ratio
Quick Ratio =
Current Assets – Inventory
Current Liabilities

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Sometimes called “Leverage“ratios
Represents state of the firm’s total financial resources showing that, if sold, the firm could meet all its Financial
Obligations
More of a Long run indicator
Lenders tend to look at these closely to see if they could recover Loaned funds

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Remember that a firm may not only be solvent, but so solvent that additional borrowing may be in order!
Three ratios are recommended:
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Debt to Assets
Equity to Assets
3. Debt to Equity

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Defined as a measure of the firm’s Total
Liabilities to Total Assets.
Debt to Assets =
Total Liabilities
Total Assets

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Similar to Debt to Assets only we’re looking at Owners Equity instead of debt
Equity to Assets =
Owners Equity
Total Assets

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Shows the amount of debt owed to the owners position in the firm (equity)
Debt to Equity =
Total Liabilities
Total O. Equity

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A means of measuring the intensity with which the assets of the firm are being used. Some call these “Efficiency“ ratios
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Three ratios are particularly useful:

Asset Turnover
Fixed Asset Turnover
Inventory Turns

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Defined as how fast the assets employed in the firm are turning over relative to sales. Varies widely by industry
Asset Turnover =
Total Sales
Total Assets

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Shows the how many sales are being generated for the fixed assets employed in the firm.
Fixed Asset Turnover =
Total Sales
Fixed Assets

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Inventory Turns defined as the rate at which inventory is turning over relative to sales (normally calculated as an annual figure
Inventory Turns =
Cost of Goods Sold
Average Annual Invent.

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They are what they say they are—measures of profits relative to assets and profits.
Four ratios are commonly calculated:
Gross Profit Margin
Net Profit Margin
Return on Assets
Return on Investment

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Gross Margin relative to sales is one indicator of how well the firm is being managed with respect to prices received, combination of products handled, net prices paid for products before processing
Gross Margin is sometimes referred to as
Markup”
Gross Margin or Sales – Cost Goods Sold
Total Sales Total Sales

Gross Product Margin
GMCR 8 quarters ending 6/30/11

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Defined as net income to Total Sales.
Net Profit Margin =
Net Income
Total Sales

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Defined as how much net income is being generated for all the Assets employed by the firm.
Return on Assets =
Net Income
Total Assets
Note this can also be calculated by multiplying net profit margin X Asset turns

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Shows how much the owners are receiving for their investment in the firm
Return on Investment =
Net Income
Owners Equity

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Provides a measure of capital or financial market of an individual firm
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Three common measures:
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Price Earnings Ratio
Beta
Market Capitalization

Price Earnings Ratio relates price of stock to the Price per Share
Called the “Multiple“ because it shows how much investors are willing to pay per $ of
Earnings
P/E Ratio = Market Price Per Share
Earnings Per Share