III. Traditional Performance Analysis
A. What is Traditional Performance Analysis?
B. Applying Traditional Performance Analysis Historically
1. Examine Historical Income Statements
2. Examine Historical Balance Sheets
3. Create and Analyze Common Size Financial
Statements
4. Create and Analyze Cash Flow Statements
5. Create and Analyze Ratios
6. Apply the DuPont Analysis
7. Examine Market Performance
A. What is Traditional Performance Analysis?
Traditional performance analysis examines the firm’s ability to:
1. Generate revenue (sales):
 annual growth in sales
 asset turnover
2. Generate profits (net income):
 annual growth in net income
 earnings per share
 gross, operating and profit margins
 ROA
 ROE
3. Manage assets:
 cash & equiv./assets
 working capital/assets (or sales)
 days sales outstanding
 inventory turnover or inv./asset
 fixed asset turnover
 asset turnover
4. Manage debt:
 current debt
o current and quick ratios
o days payable outstanding
 long-term debt
o LT debt/assets
o total debt/assets
 ability to pay interest expense
o coverage ratios or times interest earned
5. Manage cash flows:
 cash flow from operations = net income + depr. expense +
changes in working capital
 free cash flow = cash flow from operations – cash flow from
investments
 free cash flow less dividends = free cash flow – dividends
Alternative Definition of Free Cash Flow
 Free Cash flow =
Net Operating Profit after Taxes
+ Depreciation Expense
- Change in Operating working capital
- Capital Expenditures
6. Manage other measures of performance:
A. Economic Value Added (EVA)
EVA equals net operating profit after taxes (NOPAT) minus the total cost
of capital.
EVA = NOPAT - $ Cost of Capital
EVA = NOPAT - WACC x I
If we multiply the RHS by I/I then:
EVA = (NOPAT - WACC x I) x I/I
EVA = (NOPAT/I - WACC) x I
or
EVA = (ROIC - WACC) X I
where:
o NOPAT is net operating profit after taxes
o ROIC is the return on invested capital
o (NOPAT/Invested Capital)
o WACC is the weighted average cost of capital
o I is the total amount of capital invested in the operations of
the firm that requires an explicit return.
Two Definitions of Invested Capital (I):
Asset Side:
Invested Capital = Operating Assets - Non-Interest Bearing Liabilities
Liab. & Equity Side:
Inv. Capital = Int. Bearing Liab. + Equity - Non-Operating Assets
What is the advantage of EVA over other definitions of profits/cash
flow?
B. Cash flow return on investment (CFROI)
CFROI T 
CashFlowt
CashInvested in Operations t
Where
Cash Flow = NOPAT + Depreciation Expense
Cash Invested in Operation is the same as Invested Capital used to
calculate EVA
C. Applying Traditional Performance Analysis to a Company’s
Historical Performance
1. Examine Historical Income Statements
2. Examine Historical Balance Sheets
3. Analyze Common Size Financial Statements
4. Analyze Cash Flow Statements
5. Analyze Ratios
6. Examine Other Performance Measures
7. Apply the DuPont Analysis
8. Examine Market Performance
Performance Benchmark:
All of a company’s performance measures must be compared to:
 Its own measure over time
 Other peer firms, industry, and market
DuPont Analysis
DuPont analysis is a short form of ratio analysis that focuses on the
components of ROE and ROA. The question being addressed is what
are the factors affecting the firm's profitability?
DuPont Analysis
ROE
ROA
Profit Margin
ROE =
Equity Multiplier
Asset Turnover
Net Income
= ROA x Equity Multiplier
Total Equity
 Net Income   Total Assets 
= 

x
 Total Assets   Total Equity 
ROA =
Net Income
= Profit Margin x Asset Turnover
Total Assets
 Net Income   Sales 
= 
x

 Sales   Total Assets 
Example: DuPont Analysis applied to Performance:
WEYERHAEUSER, 2000
Profit Margins %
Gross Margin
Pre-Tax Margin
Net Profit Margin
S&P
Company Industry 500
24.4
23.9
47.5
8.3
5.2
11.3
5.3
3.4
7.2
Financial Condition
Debt/Equity Ratio
Current Ratio
Quick Ratio
Interest Coverage
Leverage Ratio
S&P
Company Industry 500
0.75
1.38
1.08
1.2
1.2
1.3
0.5
0.5
0.9
4.8
2.9
2.6
2.7
3.6
5.7
Investment Returns %
Return On Equity
Return On Assets
Return On Capital
S&P
Company Industry 500
12.3
10.0
16.1
4.6
2.8
2.8
7.0
4.2
7.7
Management Efficiency
Receivable Turnover
Inventory Turnover
Asset Turnover
S&P
Company Industry 500
11.8
9.5
6.3
8.5
7.1
7.8
0.9
0.9
0.4
Market Performance
A. Stock Returns
 Holding period returns
 Average Annual Returns
o Compounded
o Arithmetic Average
 Value of a Dollar invested
B. Dividends
 Dividends per share
 Dividend Yield
 Dividend Payout
C. Analysts
 Analyst Earnings Estimates/Surprises
 Analyst Ratings/Recommendations
D. Market Value Ratios
 Price-Earnings ratio
 Market-to-Book ratio
Growth and External Financing
How much can a company grow without any external financing?
Internal Growth Rate
Internal Growth Rate 
Re tained Earnings
Total Assets
Where Net Assets = Fixed Assets + Net Working Capital
Internal Growth Rate 
Re tained Earnings Net Income
Equity


Net Income
Equity
Total Assets
Internal Growth Rate  plowback ratio  return on equity 
Equity
Total Assets
How much can a firm grow without any external equity?
Sustainable Growth Rate  plowback ratio  return on equity
If a firm can raise enough debt, any growth rate can be financed
However, most firms do not increase leverage beyond a certain point
Sustainable growth rate shows the highest growth rate that a firm can
maintain without increasing its leverage
Definitions of Ratios Used in Traditional Performance Analysis:
1. Generate revenue (sales):
asset turnover ratio equals sales divided by total assets
2. Generate profits (net income):
earnings per share equals net income divided by number of
shares outstanding
gross margin equals gross profit divided by sales
operating margin equals operating profit divided by sales
profit margin equals net income divided by sales
return on assets equals net income divided by total assets
return on equity equals net income divided by total equity
3. Manage assets:
cash & equiv. to assets ratio equals cash plus marketable
securities divided by total assets
working capital to assets ratio equals working capital (ca-cl)
divided by assets
days sales outstanding ratio equals accounts receivables divided
by
sales per day (365 days in a year)
inventory turnover ratio equals sales divided by inventory
inventory to asset ratio equals inventory divided by total assets
net fixed asset turnover ratio equals sales divided by net fixed
assets (or net plant and equipment)
asset turnover ratio equals sales divided by total assets
4. Manage debt
current ratio equals current assets divided by current liabilities
quick ratio equals current assets minus inventory, divided by
current
liabilities
days payable outstanding ratio equals accounts payable divided
by
sales per day (365 days in a year)
lt debt to asset ratio equals long-term debt divided by total assets
total debt to asset ratio equals total liabilities divided by total
assets
times interest earned ratio equals EBIT divided by interest
expense