Chapter 4
Analysis of Financial
Statements
 Ratio Analysis
 DuPont System
4-1
Why are ratios useful?
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Ratios standardize numbers and facilitate
comparisons.
Ratio comparisons should be made through
time and with competitors.
 Trend analysis.
 Peer (or industry) analysis.
4-2
Five Major Categories of Ratios and the
Questions They Answer
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Liquidity: Can we make required payments?
Current ratio, Quick ratio.
Asset management: right amount of assets
vs. sales? Inventory Turnover
Debt management: Right mix of debt and
equity? Debt ratio, Times-Interest-Earned
Profitability: Gross Margin, Operating Margin
and Net Profit Margin.
Market value: Do investors like what they see
as reflected in P/E and M/B ratios?
4-3
Analysis of Income Statement
 Margin /Common Size
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Analysis
Gross Margin
Operating Margin
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Research and Development
Sales and Administrative
Tax rate
Profit Margin
Income Statement
 Trend analysis
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Margin comparison: are we becoming more
profitable?
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Growth rate: has the company been growing its
sales, Earnings? What is driving the growth? Is the
growth sustainable?
 Peer analysis
The Du Pont System
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Objective: A set of manageable ratios leading
to maximize ROE
ROE=NI/Equity
Why ROE: reward/investment; comparable
across industry
To increase ROE, lower Equity, higher NI,
Invest less(equity) but make more(NI)
However, lower equity is related to higher debt
and hence higher interest burden
NI—(from)Sales—(generated by)Assets—
(funded by) Equity
The Du Pont system
Du Pond Analysis can be expressed as:
ROE = (NI/Sales) x (Sales/TA) x (TA/Equity)
ROE = (Profit margin) x (TA turnover) x (Equity
multiplier)
Focuses on:
 Expense control (PM)
 Asset utilization (TATO)
 Debt utilization (Eq. Mult.)
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Shows how these factors combine to determine ROE.
Some examples applying Du Pond system
 GE: 50% financed, TATO is 2, NI=1B, S=10B
what is ROE?
 Ford:
PM=5%, TATO=0.5 ROE=10%, what is
its capital structure?
DuPont equation: a real life example
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Resource: http://finance.yahoo.com/
Decompose ROE of Ford
Compare with Microsoft