Ratio 2

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Releasing Financial Information
McGraw-Hill/Irwin
Preliminary
Press
Releases
Quarterly
and Annual
Reports
Securities
and Exchange
Commission
(SEC) Filings
Investor
Information
Websites
Slide 1
Horizontal (Trend) Analysis
Horizontal analysis compares a
company’s financial condition
and performance over time.
A year-over-year percentage change expresses
the current year’s dollar change as a percentage
of the prior year’s total using this formula.
Percent
Change
McGraw-Hill/Irwin
=
Current Year’s Total
̶ Prior Year’s Total
×
100%
Prior Year’s Total
Slide 2
Horizontal Analysis of Lowe’s
Summarized Balance Sheets
LOWE'S
Comparative Balance Sheets (in millions)
Dollar
Percent
2006
2005
Change Change*
Assets
Current assets:
Cash
$
364 $
423 $
(59)
(13.9)
Short-term investments
432
453
(21)
(4.6)
Accounts receivable
Inventories
7,144
6,635
509
7.7
Other current assets
374
277
97
35.0
Total current assets
8,314
7,788
526
6.8
Property and equipment, net
18,971
16,354
2,617
16.0
Long-term investments
482
497
(15)
(3.0)
Total assets
$ 27,767 $ 24,639 $ 3,128
12.7
* Percent rounded to first decimal point.
McGraw-Hill/Irwin
Slide 3
Horizontal Analysis of Lowe’s
Summarized Balance Sheets
LOWE'S
Comparative Balance Sheets (in millions)
2006
2005
Dollar
Change
Liabilities and Stockholders' Equity
Current liabilities
$ 6,539 $ 5,832 $
Long-term liabilities
5,503
4,511
Total liabilities
12,042
10,343
Stockholders' equity
15,725
14,296
Total liabilities and stockholders' equity $ 27,767 $ 24,639 $
* Percent rounded to first decimal point.
McGraw-Hill/Irwin
707
992
1,699
1,429
3,128
Percent
Change*
12.1
22.0
16.4
10.0
12.7
Slide 4
Horizontal Analysis of Lowe’s
Summarized Income Statements
LOWE'S
Comparative Income Statements (in millions)
Net sales revenue
Cost of revenues
Gross profit
Operating and other expenses
Interest expense
Income tax expense
Net income
2006
2005
$ 46,927 $ 43,243
30,729
28,453
16,198
14,790
11,046
10,136
154
158
1,893
1,731
$ 3,105 $ 2,765
Earnings per share
$
* Percent rounded to first decimal point.
McGraw-Hill/Irwin
2.02 $
1.78
Dollar
Percent
Change Change*
$ 3,684
8.5
2,276
8.0
1,408
9.5
910
9.0
(4)
(2.5)
162
9.4
$
340
12.3
0.24
13.5
Slide 5
Changes Revealed in Trend Analysis
Lowe’s grew significantly in 2006.
Total
assets
rose by
12.7
percent
Net sales
revenues
rose by
8.5
percent.
Gross
profit
rose by
9.5
percent
Net
income
rose by
12.3
percent.
The growth in net sales revenues more than offset the
growth in expenses resulting in net income growth in 2006
that was greater than the net sales revenues growth.
McGraw-Hill/Irwin
Slide 6
Vertical (Common Size) Analysis
Vertical analysis focuses on important relationships
within financial statements by expressing each
financial statement amount as a percentage of
another amount on that statement.
Common-size percentages for financial
statements are calculated using this formula.
Common-size
Percent
=
Analysis Amount
Base Amount
× 100%
The base amount is total assets for the balance sheet
and sales revenue for the income statement.
McGraw-Hill/Irwin
Slide 7
Vertical Analysis of Lowe’s
Summarized Balance Sheets
LOWE'S
Comparative Balance Sheets (in millions)
2006
Amount Percent*
Assets
Current assets:
Cash
Short-term investments
Inventories
Other current assets
Property and equipment, net
Long-term investments
Total assets
$
$
Liabilities and Stockholders' Equity
Current liabilities
$
Long-term liailities
Stockholders' equity
Total liabilities and stockholders' equity $
* Percent rounded to first decimal point.
McGraw-Hill/Irwin
2005
2005
Percent*
364
432
7,144
374
18,971
482
27,767
1.3% $
1.6%
25.7%
1.3%
68.3%
1.7%
100.0% $
423
453
6,635
277
16,354
497
24,639
1.7%
1.8%
26.9%
1.1%
66.4%
2.0%
100.0%
6,539
5,503
15,725
27,767
23.5% $
19.8%
56.6%
100.0% $
5,832
4,511
14,296
24,639
23.7%
18.3%
58.0%
100.0%
Slide 8
Vertical Analysis of Lowe’s
Summarized Income Statements
LOWE'S
Comparative Income Statements (in millions)
2006
2005
Amount
Percent
Amount
Percent
Net sales revenue
$ 46,927
100.0% $ 43,243
100.0%
Cost of revenues
30,729
65.5%
28,453
65.8%
Gross profit
16,198
34.5%
14,790
34.2%
Operating and other expenses
11,046
23.5%
10,136
23.4%
Interest expense
154
0.3%
158
0.4%
Income tax expense
1,893
4.0%
1,731
4.0%
Net income
$
3,105
6.6% $ 2,765
6.4%
* Percent rounded to first decimal point.
McGraw-Hill/Irwin
Slide 9
Interpreting Common Size Statements
Lowe’s total assets grew in 2006 by more than
$3,000,000,000. Most of the growth was in
property and equipment which increased from
66.4 percent of total assets in 2005 to 68.3 of total
assets in 2006.
The growth in total assets was accompanied by
increases in all major categories of liabilities and
equities. However, only long-term liabilities
increased as a percent of total assets, from 18.3
percent of total assets in 2005 to 19.8 percent of
total assets in 2006.
McGraw-Hill/Irwin
Slide 10
Interpreting Common Size Statements
Lowe’s was able to increase its net income as a
percent of sales from 6.4 percent to 6.6 percent
by reducing cost of goods sold as a percent of
sales by 0.3 percent.
The percentage decrease in cost of goods
sold was partially offset by small increase in
operating and other expenses.
McGraw-Hill/Irwin
Slide 11
Financial Ratios
Financial ratio analysis compares amounts
for one or more financial statement items
to amounts for other financial statement
items in the same year.
McGraw-Hill/Irwin
Slide 12
Profitability Ratios
Profitability ratios provide us with measures
of a company’s ability to generate
income in the current period.
Net profit
margin
Gross profit
percentage
Asset
turnover
Return on
equity (ROE)
McGraw-Hill/Irwin
Fixed asset
turnover
Earnings per
share (EPS)
Price/earnings
(P/E)
Return on
assets (ROA)
Slide 13
Profitability Ratios ̶ Net Profit
Margin
Net profit
margin
=
Net income
Net sales revenue
× 100%
Lowe’s 2006: ($3,105 ÷ $46,927) × 100% = 6.6%
Lowe’s 2005: ($2,765 ÷ $43,243) × 100% = 6.4%
Net profit margin represents the percentage of sales
revenue that remains in net income after expenses
have been deducted.
McGraw-Hill/Irwin
Slide 14
Profitability Ratios ̶ Gross Profit
Percentage
Gross profit
=
percentage
Net sales ‒ Cost of goods sold
Net sales
× 100%
Lowe’s 2006: (($46,927 ‒ $30,729) ÷ $46,927) × 100% = 34.5%
Lowe’s 2005: (($43,243 ‒ $28,453) ÷ $43,243) × 100% = 34.2%
Gross profit percentage indicates how much profit was
made, on average, on each dollar of sales, after
deduction of cost of goods sold.
McGraw-Hill/Irwin
Slide 15
Profitability Ratios ̶ Asset Turnover
Asset
turnover
=
Net sales revenue
Average total assets
Lowe’s 2006: $46,927 ÷ (($27,767 + $24,639) ÷ 2) = 1.79
Lowe’s 2005: (Given)
= 1.89
The asset turnover ratio indicates the amount of sales
revenue generated for each dollar invested in assets.
McGraw-Hill/Irwin
Slide 16
Profitability Ratios ̶ Fixed Asset
Turnover
Fixed asset
turnover
=
Net sales revenue
Average net fixed assets
Lowe’s 2006: $46,927 ÷ (($18,971 + $16,354) ÷ 2) = 2.66
Lowe’s 2005: (Given)
= 2.86
The fixed asset turnover ratio indicates the amount of sales
revenue generated for each dollar invested in fixed assets
such as store buildings and land used in the business.
McGraw-Hill/Irwin
Slide 17
Profitability Ratios ̶ Return on
Assets (ROA)
Net income
ROA =
Average total assets
× 100%
Lowe’s 2006:
$3,105 ÷ ($27,767 + $24,639) ÷ 2) × 100% = 11.8%
Lowe’s 2005: (Given)
= 12.1%
The return on assets ratio measures how much a
company earns for each dollar of investment in assets.
McGraw-Hill/Irwin
Slide 18
Profitability Ratios ̶ Return on
Equity (ROE)
ROE =
Net income
Average stockholders’ equity
× 100%
Lowe’s 2006: $3,105 ÷ (($15,725 + $14,296) ÷ 2) × 100% = 20.7%
Lowe’s 2005: (Given)
= 21.4%
The return on equity ratio measures the amount earned
as a percentage of each dollar invested by stockholders.
McGraw-Hill/Irwin
Slide 19
Profitability Ratios ̶ Earnings per
Share (EPS)
EPS =
Net income
Average number of common shares
EPS is reported in the income statement.
Lowe’s 2006: EPS = $2.02
Lowe’s 2005: EPS = $1.78
Earnings per share indicates the amount of earnings
for each share of outstanding common stock.
McGraw-Hill/Irwin
Slide 20
Profitability Ratios ̶ Price/Earnings
(P/E) Ratio
P/E Ratio =
Stock price
EPS
The stock price was $31 per share at the
time 2006 earnings were announced.
Lowe’s 2006: $31 ÷ $2.02 = 15.3
Lowe’s 2005: (Given)
= 16.3
The P/E ratio measures the relationship between the current
market price of the stock and its earnings per share.
McGraw-Hill/Irwin
Slide 21
Liquidity Ratios
Liquidity ratios focus on a company’s ability
to convert its assets into cash in order to
pay current liabilities as they come due.
Receivables
turnover
Inventory
turnover
Current
ratio
Quick
ratio
McGraw-Hill/Irwin
Slide 22
Liquidity Ratios ̶ Receivables
Turnover
Receivables
turnover
=
Net sales revenue
Average net receivables
Lowe’s receivables balance from
customers is insignificant
because most sales are cash
or credit card sales.
The receivables turnover ratio is a measure of
how fast a company collects its receivables.
McGraw-Hill/Irwin
Slide 23
Liquidity Ratios ̶ Inventory Turnover
Inventory
turnover
=
Cost of sales
Average inventory
Lowe’s 2006: $30,729 ÷ (($7,144 + $6,635) ÷ 2) = 4.5
Lowe’s 2005: (Given)
= 4.5
The inventory turnover ratio indicates how many times
inventory is bought and sold during the period.
McGraw-Hill/Irwin
Slide 24
Liquidity Ratios ̶ Days to Sell
Days to sell
=
365
Inventory turnover ratio
Lowe’s 2006: 365 ÷ 4.5 = 81.1 days
Lowe’s 2005: 365 ÷ 4.5 = 81.1 days
The days to sell ratio converts inventory turnover
into the number of days need to sell inventory.
McGraw-Hill/Irwin
Slide 25
Liquidity Ratios ̶ Current Ratio
Current
ratio
=
Current assets
Current liabilities
Lowe’s 2006: $8,314 ÷ $6,539 = 1.27
Lowe’s 2005: $7,788 ÷ $5,832 = 1.34
The current ratio measures the ability of a company
to pay its current debts as they become due.
McGraw-Hill/Irwin
Slide 26
Liquidity Ratios ̶ Quick Ratio
Quick
ratio
=
Quick assets
Current liabilities
Cash
Short-term Investments
Accounts receivable
Quick Assets
2006
2005
$
364 $ 423
432
453
$
796 $ 876
Lowe’s 2006: $796 ÷ $6,539 = 0.12
Lowe’s 2005: $876 ÷ $5,832 = 0.15
The quick ratio is similar to the current ratio,
but measures the company’s immediate
ability to pay it current debts.
McGraw-Hill/Irwin
Slide 27
Solvency Ratios
Solvency ratios focus on a company’s ability to
repay debt, pay interest, and finance replacement
and/or expansion of long-term assets.
Times
interest
earned
Debt-toassets
McGraw-Hill/Irwin
Free cash
flow
Slide 28
Solvency Ratios ̶ Debt-to-assets
Ratio
Debt-to assets
=
Total liabilities
Total assets
Lowe’s 2006: $12,042 ÷ $27,767 = 0.43
Lowe’s 2005: $10,343 ÷ $24,639 = 0.42
The debt-to-assets ratio indicates the proportion
of total assets that is financed by creditors.
McGraw-Hill/Irwin
Slide 29
Solvency Ratios ̶ Times Interest
Earned Ratio
Times
interest
earned
=
Net
Interest
Income tax
+
+
income
expense
expense
Interest expense
Lowe’s 2006: ($3,105 + $154 + $1,893) ÷ $154 = 33.5
Lowe’s 2005: ($2,765 + $158 + $1,731) ÷ $158 = 29.5
The times interest earned ratio indicates the
number of times a company’s interest expense
was covered by its operating results.
McGraw-Hill/Irwin
Slide 30
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