MANAGERIAL FINANCE 410
STUDENT LECTURE NOTE 5 (Rev Fa15)
I. Ratio Analysis Overview
A. A Summary of the most important financial ratios is
shown in the list below.
KEY FINANCIAL RATIOS
Liquidity Ratios
Liquidity ratios address questions about whether or not
the firm is able to pay its bills on time and how quickly
the firm is able to convert (non-cash) short-term assets
into cash in order to pay off trade payables or other
maturing short-term liabilities.
 CAs 
CR = 
.
 CLs 
The Current Ratio is a general indicator of the firm's
ability to service its current debts as they come due.
The higher this ratio is, the greater the cushion between
current expected outflows and current inflows.
 (CAs - Inv) 
QR = 
 .
 CLs
The Quick Ratio is often called the Acid-test Ratio
and it is a refinement of the current ratio. It excludes
the (less liquid) inventory and measures those assets
which are either cash or easily convertible to cash in
comparison to current liabilities. Again, the higher the
ratio, the more liquid the firm is. Generally any value
less than 1 indicates dependency on inventory to
liquidate short-term debt.
 Sales 
Sales/Recs = 
.
 ARs 
The Sales/Receivables ratio measures how often AR's
turn over during the year. The higher the ratio, the
shorter the time between the average credit sale and its
cash collection.
 COS 
COS/Inv = 
.
 Inv 
The Cost-of-Sales/Inventory ratio describes how
frequently an average unit of inventory turns over
during the year. Or, equivalently, Inventory TO
(implicitly) describes what percentage of COS is
represented by Inventory. As this ratio increases it
indicates that a smaller proportion of COS is accounted
for by raw materials, goods-in-process, and finished
goods compared to other operating expenses.
1
 COS 
COS/Payables = 
.
 APs 
Efficiency Ratios
The Cost-of-Sales/Payables ratio shows how often
trade payables turn over during the year. As this ratio
increases it indicates a shorter time period between
credit purchases and cash payment.
These ratios describe how effectively the firm utilizes its
assets and employs its net working capital.
 Sales  Total Asset Turnover is a very general measure of a
TATO = 
.
 TAs  firm's ability to generate sales in relation to total assets.
TATO should be used only to compare firms within
industry groups and in conjunction with other efficiency
ratios in developing specific conclusions.
 Sales 
FATO = 
.
 FAs 
Fixed Asset Turnover is a more specific measure of
asset efficiency than TATO in that it focuses explicitly
on fixed assets. Highly depreciated fixed assets (net of
accumulated depreciation) or a very labor-intensive
operation may cause distortion of this ratio.
 365 
ACP = 
.
 Sales/ARs 
Average Collection Period tells how long it takes the
firm on average to collect a credit sale. ACP, described
in RMA Reports as Days’ Receivables can be found
from the Sales/Recs. ratio. It is printed in bold type
directly to the left of the Sales/Recs. ratio.
 365  Inventory Conversion Period tells how long it takes the
ICP = 
.
 COS/Inv  firm on average to produce a unit of production, and how
long before the inventory is sold. ICP, described in the
RMA Reports as Days' Inventory is printed in bold type
directly to the left of the COS/Inv. ratio.
 365 
APP = 
.
 COS/APs 
Average Payment Period tells how long in days it
takes the firm on average to pay for its credit
purchases. APP is shown in RMA Reports as Days'
Payables. It can be found from the COS/AP ratio.
Days' Payables are shown in bold type directly to the
left of the COS/AP ratio.
CCC = ACP + ICP – APP.
Cash Conversion Cycle is an aggregate measure of
net working capital efficiency. It measures the time in
days between when productive inputs are paid for and
when the cash inflow from a sale is actually received.
The longer the CCC is, the more the firm has tied up in
working capital.
2
Coverage/Leverage Ratios
These ratios show the firm's ability to service its debt and
the extent to which the firm relies on debt vs. stock
financing.
 EBIT 
TIE = 
.
 LT Debt Int 
Times Interest Earned indicates how many times the
firm is able to pay its long-term debt interest out of
earnings from operations. A high ratio generally
indicates that the firm has little difficulty in meeting
debt service obligations and may show that the firm has
additional ability to take on more debt.
 FAs 
FA/NW = 
.
 TE 
The Fixed Asset/Net Worth ratio is a leverage
measure indicating the extent to which owner's equity
has been invested in plant and equipment (fixed
assets). A lower ratio indicates a relatively smaller
investment in fixed assets relative to net worth, and
that there's a greater "cushion" for creditors in case of
bankruptcy. Thus, a higher ratio indicates greater risk
for the creditors.
 TLs 
Debt/NW = 
.
 TE 
The Debt/Net Worth ratio shows the relationship
between capital contributed by creditors and that
provided by owners of the firm. It is an indication of
the degree of protection afforded the creditors by
stockholders' investment. Obviously, as this number
grows it shows an increasing proportion of total
investment by creditors relative to owners. Firms with
a low Debt/NW ratio will generally have greater access
to future borrowing.
 TLs 
Debt Ratio = 
.
 TAs 
The Debt Ratio describes the proportion of capital
provided by creditors versus owners. It is closely
related to the Debt/NW ratio. Although the Debt Ratio
can not be directly found from the RMA Studies it can
be found using the common-size equity ratio.
Profitability Ratios
 EBIT 
OPM = 
.
 Sales 
The ratios express a given type of earnings as a
percentage of either output or return on investment.
Operating Profit Margin relates earnings from
operations to the sales generating those earnings.
Since this measure includes interest costs it provides a
measure of return in relation to financial risk. This
measure is shown in RMA Studies in the CommonSize ratios under "Operating Profit".
3
 EBT 
B-T PM = 
.
 Sales 
Before-Tax Profit Margin describes the amount of
earnings before taxes generated by sales. This measure
is shown in RMA Studies in the Common-Size ratios
under "Profit-before Taxes" as a percentage of Sales.
 EAC 
A-T PM = 
.
 Sales 
Due to major differences in Tax Liability for firms with
similar before-tax earnings caused by tax rules, the
RMA Studies utilize only Earnings Before Taxes in
calculating profitability ratios. Thus, all industry profit
ratios are determined before taxes. The three after-tax
(A-T) versions are provided here because although
these numbers may be less comparable to other firms,
they are more relevant for stockholders. The after-tax
measures use Earnings Available to Common
Stockholders (EAC) in place of EBT.
The
Before-Tax (A-T) Return on Asset ratio measures
 EBT 
B-T ROA = 
.
 TAs  the pre-tax (after-tax) return on total assets and measures
the effectiveness of management in employing the
resources provided to it by total investment in the firm. A
 EAC  heavily depreciated plant and/or a large amount of
A-T ROA = 
.
 TAs  intangible assets may distort ROA.
 EBT 
B-T ROE = 
.
 TE 
 EAC 
A-T ROE = 
.
 TE 
Return on Equity measures the before-tax (after-tax)
return on the funds provided by the owners of the firm.
This ratio is THE one best indicator of shareholder
welfare maximization. However, ROE needs to be
viewed with caution since a relatively high ROE is
usually a positive indicator, but may also show that the
firm uses high levels of debt. Whereas, a low ROE
may be due to a largely equity-financed, conservative
firm.
II. The After-Tax DuPont Formula and Its Uses
A. The Effect of Leverage: Developed by an analyst at
DuPont (big shock), the approach shows how a given
ROA is translated into a relatively ______ ROE
through use of leverage (gearing) by the firm.
1. Consider first the calculation of ROA:
4
 EAC   EAC  Sales  .
ROA = 

*
 TA's  Sales   TA's 
(5.1)
= Profit Margin  TATO.
This formulation makes sense because a company's
ROA is determined by a combination of profit and
volume. They either make money on mark-up or
sales volume.
2. How is ROA translated into ROE?

EAC
  EAC  
TA' s

ROE = 

*
  TA' s   Common Equity  . (5.2)
Common
Equity




= ROA  Equity Multiplier.
3. Call the quantity [1/Equity Multiplier] the Equity
Ratio. It can be found from knowledge of the debt
ratio. Recall that the debt ratio was given above as
follows:
 Total Liabilities 
Debt Ratio = 
.

Total
Assets


The Equity Ratio can then be determined as follows
since TAs = TLs + TEs:
5
Equity  Total Assets   Total Liabilities   Total Equity 
=

  
 ;
TA' s
TA' s
Ratio
 Total Assets  
= 1 -  Debt Ratio .
Similarly the Equity Ratio can also be re-expressed
in terms of the Equity Multiplier (EM) as its
reciprocal. Thus, the linkage is as follows.
 Total Equity 
Equity Ratio = 
 ;
TA's



TA' s
Equity Multiplier = 
.

 Total Equity 

ROA

 TA 
ROE = 

ROA
*
  ROA * EM .



Equity
Ratio
TE




(5.3)
Notice, that the lower the amount of equity
employed by the firm, the lower the divisor (in the
equity multiplier), the higher the resulting ROE.
Thus, if two firms have _____ ROA's, the firm
which uses the ______ degree of leverage will have
the ______ ROE.
4. An Example on the Use of Leverage
Ex. 5.1 – Leverage and Returns
Rasmus Astrand (F381 Fa’09, F382 Sp’10) is demonstrating the effect of leverage on firm ROAs vs. ROEs. He
6
has developed the following example.
Assume there are two firms, Firm L and Firm U which
are identical in terms of their operating incomes (i.e. EBITL
= EBITU = $200k). However, their capital structures are
quite different as is shown in the figure below.
Firm L
Debt @ 8%
Equity
Total Assets
Amt
$500k
$500k
$1000k
Firm U
Debt
Equity
Total Assets
Amt
$0k
$1000k
$1000k
Assume that both firms have sales of $2,500k and a flat
tax rate of 40%. Calculate:
a) Earnings after taxes (EAT) for both firms, and
b) Use the DuPont formula to find both ROA and ROE
for the two firms.
c) What can you conclude about the effect of leverage
on returns to stockholders?
A5.1
Firm L(evered)
EBIT
$200k
-Interest
$40k
EBT
$160k
-Taxes
$64k
$96k
a) EAT
Firm U(unlevered)
EBIT
$200k
-Interest
$0k
EBT
$200k
-Taxes
$80k
EAT
$120k
A5.1b) Use the DuPont formulas to find ROA and ROE.
 $2,500k   $96k 
*
ROAL = 
= 2.5 * 0.0384 = _____ =


 $1,000k   $2,500k 
7
.
 $2,500k   $120k 
ROAU = 
= 2.5 * 0.048 = _____ =
*


 $1,000k   $2,500k 
.
 $1,000k 
ROEL = 0.096 * 
= 0.096 * 2 = _____ =
 $500k 
 $1,000k 
ROEU = 0.12 * 
= 0.12 * 1 = _____ =

 $1,000k 
.
.
A5.1c) The ROAL < ROAU, but ROEL > ROEU. This
illustrates the fact that the presence of debt in the levered
firm’s capital _________ the return to its shareholders.
Note also that for the unlevered firm that ROA = ROE,
since stockholders are providing 100% of the financing.
III. Financial Statement Analysis
A. Cross Sectional Analysis compares a firm's financial
data at a point in time to the same numbers from the
relevant industry
B. Time-Series Analysis examines a firm's operating
results over time, eg. a five-year period.
C. The best source of comparative industry data for U.S.
companies is the Annual Statement Studies published
by Robert Morris Associates.
D. The Industries, SIC (Standard Industrial Classification) and NAICS (North American Industry
Classification System) numbers covered in the RMA
Annual Statement Studies are detailed in pages 1946, and 16-18, respectively, of the (2001-02) report.
8
E. The SEC 10-K forms currently provide the firm’s 4digit SIC code, however, the RMA Reports are now
(since 2005) coded solely on the basis of the 6-digit
NAICS.
F. A website link to the U.S. Census Department’s
“Correspondence Tables: 2002 NAICS Matched to
1987 SIC” is given below:
http://www.census.gov/epcd/naics02/N02TOS87.HTM
G. The breakdown by industry is as follows:
Part I - Manufacturing Industries;
Part II - Wholesaling Industries;
Part III - Retailing, Services and Not Elsewhere
Classified Industries;
Part IV - Contractor Industries;
Part V - Finance Industry Supplement.
The comparative numbers provided by the RMA Reports
cover both the common-size balance sheet and the income
statement data, as well as (more than) the 21 key financial
ratios in Figure 5.1 below.
FIGURE 5.1
Liquidity Ratios:
Coverage/Leverage Ratios:
 Current Ratio
 Times Interest Earned
 Quick Ratio
 Fixed Assets/Net Worth
 Sales/Receivables
 Debt/Net Worth
 Cost of Sales/Inventory
 Debt/Total Assets
 Cost of Sales/Payables
Profitability Ratios:
Efficiency Ratios:
 Operating Profit Margin
 Total Asset Turnover
 Before-Tax Profit Margin
9





Fixed Asset Turnover
Average Collection Period
Inventory Conversion Period
Average Payment Period
Cash Conversion Cycle





After-Tax Profit Margin
Before-Tax ROA
After-Tax ROA
Before-Tax ROE
After-Tax ROE
H. 2008 10-K Financial Statements for Lance, Inc.
Item 8. Financial Statements and Supplementary Data
Consolidated Statements of Income
LANCE, INC. AND SUBSIDIARIES
For the Fiscal Years Ended December 27, 2008, December 29, 2007, and December 30, 2006
(in thousands, except share and per share data)
2008
2007
2006
852,468 $
531,528
320,940
762,736 $
444,487
318,249
730,116
415,576
314,540
Selling, general and administrative
Other (income)/expense, net
290,826
Income from continuing operations before interest and income taxes
291,680
(854)
30,114
277,317
2,390
38,542
283,006
191
31,343
Interest expense, net
Income from continuing operations before income taxes
3,041
27,073
2,222
36,320
3,156
28,187
Income tax expense
Net income from continuing operations
9,367
17,706
12,511
23,809
9,809
18,378
—
—
—
44
15
29
153
53
100
Net sales and other operating revenue
Cost of sales
Gross margin
$
Income from discontinued operations, before income taxes
Income tax expense
Net income from discontinued operations
Net income
$
Basic earnings per share:
From continuing operations
From discontinued operations
Basic earnings per share
Weighted average shares outstanding — basic
Diluted earnings per share:
From continuing operations
From discontinued operations
Diluted earnings per share
Weighted average shares outstanding — diluted
See Notes to Consolidated Financial Statements.
10
17,706 $
23,838 $
18,478
0.77 $
0.61
0.57 $
—
—
—
0.77 $
0.61
$
0.57 $
31,202,000 30,961,000 30,467,000
$
0.76 $
0.60
0.56 $
—
—
—
0.76 $
0.60
$
0.56 $
31,803,000 31,373,000 30,844,000
$
Consolidated Balance Sheets
LANCE, INC. AND SUBSIDIARIES
December 27, 2008 and December 29, 2007
(in thousands, except share data)
2007
2008
Assets
Current assets
Cash and cash equivalents
Accounts receivable
Inventories
Deferred income taxes
Prepaid expenses and other current assets
Total current assets
Fixed assets, net
Goodwill, net
Other intangible assets, net
Other assets
Total assets
22,711
28,915
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable
Accrued compensation
Accrued profit-sharing retirement plan
Accrual for casualty insurance claims
58,630
Accrued selling costs
Other payables and accrued liabilities
Short-term debt
Total current liabilities
Long-term debt
Deferred income taxes
Accrual for casualty insurance claims
48,070
Other long-term liabilities
Total liabilities
Commitments and contingencies
Stockholders’ equity
Common stock, 31,522,953 and 31,214,743 shares outstanding, respectively
Preferred stock, no shares outstanding
Retained earnings
Additional paid-in capital
Accumulated other comprehensive income
48,301
Total stockholders’ equity
Total liabilities and stockholders’ equity
See Notes to Consolidated Financial Statements.
$
807
74,406
43,112
9,778
12,933
141,036
216,085
80,110
23,966
4,949
$466,146
$
8,647
64,081
38,659
9,335
12,367
133,089
205,075
55,956
13,171
5,712
$413,003
$ 25,939
26,312
5,592
5,581
5,162
15,983
7,000
91,569
91,000
31,241
8,459
8,370
230,639
$ 21,169
20,564
5,383
8,163
4,511
14,847
—
74,637
50,000
26,874
7,428
6,967
165,906
26,268
—
160,938
49,138
(837)
235,507
$466,146
26,011
—
163,356
41,430
16,300
247,097
$413,003
I. RMA Report for NAICS Industry 311821: Cookie and
Cracker Manufacturing, 4/1/08 – 3/31/09
11
Comparative Historical Data
5
6
6
2
8
4/1/06-3/31/07
ALL
27
%
7.1
18.7
14.2
1.9
41.9
38.9
11.6
7.5
100.0
5
4
3
9
4/1/07-3/31/08
ALL
21
%
6.6
19.8
17.3
1.1
44.8
38.4
12.3
4.5
100.0
13.2
4.3
12.7
0.1
7.8
38.0
24.8
0.6
5.5
31.0
100.0
10.8
2.8
13.7
0.1
7.9
35.4
18.9
0.8
10.7
34.2
100.0
MANUFACTURING – Cookie and Cracker Manufacturing NAICS 311821
Type of Statement
Current Data Sorted by Sales
8
1
6
3
12
4/1/08-3/31/09
ALL
30
%
13.6
18.5
18.9
3.5
54.6
36.5
4.2
4.6
100.0
Unqualified
Reviewed
Compiled
Tax Returns
Other
1
1
1
1
2
NUMBER OF
STATEMENTS
0-1MM
3
%
ASSETS
3(4/1-9/30/08)
1-3MM
1
%
3-5MM
2
%
2
1
3
5-10MM
6
%
Cash & Equivalents
Trade Receivables (net)
Inventory
All Other Current
Total Current
Fixed Assets (net)
Intangibles (net)
All Other Non-Current
Total
3
1
2
5
4
3
27 (10/1/08-3/31/09)
10-25MM
25MM & OVER
10
8
%
%
12.4
17.3
21.8
4.3
55.8
38.7
2.9
2.6
100.0
LIABILITIES
3.7
5.6
16.3
0.0
10.7
36.3
22.0
0.8
4.1
37.0
100.0
Notes Payable-Short Term
Cur.Mat. - L/T/D
Trade Payables
Income Taxes Payable
All Other Current
Total Current
Long Term Debt
Deferred Taxes
All Other Non-Current
Net Worth
Total Liabilities & Net Worth
2.3
3.8
14.3
0.0
9.2
29.6
21.2
0.8
3.9
44.5
100.0
INCOME DATA
22
28
41
19
36
51
22
28
43
(23)
(21)
100.0
32.7
27.8
5.0
1.6
3.4
1.9
1.3
0.7
1.2
0.8
0.4
16.7
13.0
9.0
18.8
10.2
7.2
16.9
12.9
8.5
6.2
1.4
0.5
0.7
1.2
4.1
0.8
2.3
327.3
49.8
10.4
-2.1
16.3
2.8
-1.3
12.2
5.6
3.4
3.0
2.1
1.5
1433029M
757365M
24
29
38
23
42
55
17
30
38
(20)
(18)
100.0
28.6
22.3
6.2
0.9
5.4
1.8
1.3
0.9
1.2
0.7
0.4
14.9
12.4
9.6
16.2
8.6
6.6
21.8
12.3
9.5
14.3
4.0
1.4
0.5
1.1
2.0
0.8
1.4
NM
47.2
25.5
7.0
15.8
9.5
2.0
12.3
6.7
3.0
3.0
2.4
1.4
1517108M
681787M
100.0
33.5
27.1
6.5
1.0
5.5
3.8
1.9
0.9
2.1
1.2
0.4
18
20.4
25
14.6
33
11.2
18
20.0
30
12.0
59
6.2
17
22.0
22
16.7
37
9.8
17.3
(23)
4.4
2.0
0.4
0.7
3.7
0.5
1.1
5.0
62.0
(24)
29.1
8.6
27.0
14.8
1.7
23.8
7.5
3.9
4.0
2.8
1.8
1311106M
443329M
Net Sales
Gross Profit
Operating Expenses
Operating Profit
All Other Expenses (net)
Profit Before Taxes
RATIOS
Current
Quick
17
29
43
36
52
69
13
35
47
Sales/Receivables
Cost of Sales/Inventory
Cost of Sales/Payables
100.0
32.8
23.9
8.9
1.0
7.9
3.8
1.5
1.2
1.9
1.0
0.4
21.4
12.7
8.5
10.0
7.1
5.3
27.9
10.3
7.8
EBIT/Interest
0.3
0.7
3.0
0.6
1.2
3.5
Fixed/Worth
Debt/Worth
% Profit Before Taxes/
Tangible Net Worth
% Profit Before Taxes/ Total
Assets
Sales/Net Fixed Assets
Sales/Total Assets
Net Sales ($)
Total Assets ($)
M = $ thousand MM $ million
12
782M
300M
1274M
297M
7563M
5244M
46797M
16518M
25.5
14.2
1.7
27.3
4.8
1.9
3.5
1.9
1.1
166845M
95183M
1087845M
325787M
J. Conducting Cross-Sectional Analysis
1. Common-size Statements
a. Income Statement: take _____ as 100%, replace each
dollar amount with its relative proportion of Sales.
b. Balance Sheet: take _____ ______ (or Total Liabs. +
Total Equities) as 100% and find proportion which
each asset or liability account represents.
2. An Example using the Datasets for Lance, Inc.
provided above is next.
Ex. 5.2
1. Brody Howes (F382 Fa’07) is going to help you in
developing a spreadsheet which will perform the
following calculations for Lance, Inc. for the fiscal year
ended December 27, 2008.
a) Calculate the Common-Size Balance Sheet Ratios;
b) Calculate Common-Size Income Statement Ratios;
c) Determine the specific financial ratios given above in
FIGURE 5.1.
d) Determine the appropriate industry numbers from the
RMA Annual Statement Studies and incorporate
them, insofar as possible, into the spreadsheet.
The specific format for certain of the cell locations are as
follows:
ASSETS
LIABILITIES
Total CA's: C10
Total CL's:H8
Total FA's:C16
Total Liabs.: H12
Total Assets: C17 Total Equity: H21
TL's + TE: H22
13
INC STMT
Net Sales: G25
COS:G26
EBIT: G32
EBT: G34
EAT=EAC: G36
2. Conduct Cross-Sectional Analysis for Lance, Inc.
versus the Industry for the most recent year. For the 18
ratios which correspond between the firm and RMA
discuss whether each ratio is a positive or negative
indicator for Lance.
Explain carefully how each negative ratio is influenced,
or influences, other ratios. In one or two sentences each,
summarize how the four ratio groups (i.e., Liquidity,
Efficiency, Leverage and Profitability) compare, as a
whole, to the industry.
A5.2. See the spreadsheet at the end of this lecture note:
“COMPARATIVE ANALYSIS OF FINANCIAL
POSITION”. Note: The RMA Studies Industry judged
to most closely represent Lance, Inc. is “Cookies and
Crackers”; SIC# = 2052.
A5.2.2. Liquidity Ratios:
Industry
 CAs   $141,036 
Current Ratio: 
=
= _____ vs. 1.90.
 CLs   $91,569 
Lance's Current Ratio is (18.9%)1 _____ than that of
the industry suggesting that either CAs are relatively
low or that CLs are high. The Quick Ratio and
leverage ratios need to be examined to decide if this
presents a potential problem before making a more
1
Calculated as (1.54 -1.90)/1.90 = -0.189, or generally (Firm Ratio minus
Industry Ratio)/Industry Ratio.
14
specific conclusion-although Lance's lower ratio is a
slightly ________ indicator.
 $97,924 
 CAs  Inv 
Quick Ratio: 
=
 $91,569  =
 CLs 


____.
Industry
vs. 1.20.
The Quick Ratio for Lance is slightly _____ than the
industry's ratio which is also a ________ indicator for
the firm. Given that Lance’s QR dropped less
(compared to the CR) than the Industry’s did this
indicates that Lance's inventory is lower than that of
the Industry. This conclusion is verified by comparing
the firm's common-size Inventory ratio (=9.25%) to
the industry's ratio (=18.9%).
 Sales 
Sales/Recs: 
=

 ARs 
______
 $852,468 
 $74,406  =


Industry
Vs. 14.6
The Lance Sales/Receivables Ratio is a ________
indicator of liquidity since it is _____ than that of the
Industry. This ratio shows Lance has more
uncollected sales compared to all sales than the
Industry. (Note: this result seems counterintuitive
given the comparison of common-size AR ratios.
How can this be explained?)
Industry
15
vs. 12.0
 COS   $531,528 
COS/Inv: 
=
=
______
 Inv   $43,112 
The COS/Inventory ratio for Lance is a slightly
_______ indicator for the firm. Compared to all costs
of production, Lance’s inventory is a bit lower than
the Industry’s, although the difference is marginal.
 COS   $531,528 
COS/Payables: 
=
=


APs
$
25
,
939

 

______
Industry
vs. 16.70
The COS/Payables Ratio for Lance is a ________
indicator for the firm. It suggests that Lance’s trade
credit (unpaid credit purchases) is smaller compared
to the costs of production than that for the Industry.
Efficiency Ratios:
 Sales   $852,468 
Total Asset TO: 
=
=______.
 TAs   $466,146 
Industry
vs. 2.80
TATO for Lance is a ________ measure compared to
the Industry suggesting that the firm generates fewer
dollars in sales per dollar of TAs.
Industry
 Sales   $852,468 
Fixed Asset TO: 
=
= ______. vs. 7.50


FAs
$
325
,
110

 

16
Compared to the Industry's ratio, Lance's FATO is
also a _______ figure indicating that the firm utilizes
its FAs less efficiently. Or, equivalently that the firm
requires proportionately more FA's to generate the
same amount of sales. This conclusion is not
surprising in view of the firm's comparatively lower
current ratio (less CAs means more FAs). The same
finding is shown by comparing Lance's common-size
FA ratio (=69.7%) to the Industry's FA ratio
(=45.4%).
Industry

 

365
365
ACP: 
=
=
_____.
 

vs. 25 days
 (Sales/ARs )   ($852,468 / $74,406) 
Lance's ACP is a ________ efficiency measure for
the firm indicating that, on average, it takes almost six
days longer, on average, to collect its ARs as does the
industry.
Industry
 365  

365
ICP: 
 =  ($531,528 / $43,112)  = ______. vs. 30 days
(COS/Inv)

 

The Inventory Conversion Period for Lance shows
that the firm converts its production inputs into
finished inventory marginally ______ than does the
industry. This slightly positive efficiency measure is
not surprising given the firm's relatively lower
inventory level.
Industry
17
vs. 22 days

 

365
365
APP: 
=
=
______.
 

 (COS/APs)   ($531,528 / $25,939) 
The Average Payables Period for Lance is ____
(19.04% lower) than that for the Industry. This shows
that the firm pays for its credit purchases about four
days more quickly (on average) than does the
Industry.
CCC: =
= ______ days
= 31.858 + 29.605 – 17.812
Industry
vs. 33 days
The Cash Conversion Cycle which describes the time
(in days) between when the production inputs are paid
for and the cash from a sale is received. The CCC for
Lance is 10.65 days ______ than that for the Industry.
This ________ indicator shows that Lance does not
manage cash as well as the average Industry firm.
Coverage/Leverage Ratios:
Industry
 EBIT   $30,114 
TIE: 
=
=
_____x
vs. 4.4x
 LT Debt Int   $3,041 
The TIE measure is a very ________ indicator for
Lance showing that the firm is more than twice
(2.25)2 as capable of affording its interest costs from
operating profits. This comparison shows the firm is
2
Based on the wording used here, the comparison is calculated as
Firm/Industry = 9.9027/4.4 = 2.2506.
18
either more profitable than the Industry, has less debt,
or both. Since the firm’s common-size EBIT (its
OPM) of 3.53% is less than the Industry’s (6.50%) it
must be the case that Lance uses less debt.
Industry
 FAs   $325,110 
Fixed/Worth: 
=
= ______ vs. 0.70


TE
$
235
,
507

 

Comparison of the FA/NW ratio for Lance and the
Industry shows the firm’s ratio to be almost two
(1.972) times ______. This indicator would technically be negative for the firm. However, it may be
showing relatively more FAs, (we knew that), or more
equity/less debt (shown next), or both (true for Lance)
which are not negative when considered in
combination.
 TLs   $230,639 
Debt/NW: 
=
= ______


 TE   $235,507 
Industry
vs. 1.1
Lance’s D/E ratio indicates that the firm uses ____
debt than does the Industry. Lance’s Debt/NW ratio
is 11.25% lower than the Industry’s. This lower debt
level for the firm is also shown using the Debt Ratio,
below.
 TLs   $230,639 
Debt Ratio: 
=
= ______


 TAs   $466,146 
Industry
vs. 63.0%
Note: Industry Debt Ratio = 1- RMA Common-Size Equity Ratio
19
= 1- 0.370 = 0.630 = 63.0%.
As is further emphasized by the Debt Ratio, Lance
utilizes ____ debt (about 21.5% less) than the
Industry. This ratio and the Debt/Worth ratio will also
show one reason why Lance’s ROE is markedly
lower in comparison to the Industry.
Profitability Ratios:
 EBIT   $30,114 
OPM: 
=
= ______


Sales
$
852
,
468

 

Industry
vs. 6.50%
The Operating Profit Margin for the Industry is 1.84
times3 that of Lance. This ___________ comparison
indicates that the firm keeps a smaller share of each
dollar from operations. This ratio is given for both
Lance and the Industry in the common-size Income
Statement ratios.
Industry
 EBT   $27,073 
Before-Tax PM: 
=
= ______. vs. 5.50%


Sales
$
852
,
468

 

Lance's Before-Tax Profit Margin is exceeded by the
Industry’s B-T PM by a slightly smaller amount than
was its OPM (1.73 times). This is consistent with
Lance having ____ debt and therefore less debt
interest.
3
This comparison, as worded here is calculated as Industry/Firm, i.e., 0.065/0.0353 = 1.8414 times.
20
Industry
 EAC   $17,706 
After-Tax PM: 
=
=
______.
vs. NC
 Sales   $852,468 
Although the Industry A-T PM is not available
because RMA provides no after-tax ratios it seems
probable that Lance's A-T PM would be _____ than
the Industry's average.
 EBT   $27,073 
Before-Tax ROA: 
=
= _____.


TAs
$
466
,
146

 

Industry
vs. 14.80%
 EAC   $17,706 
After-Tax ROA: 
=
= _____.
 TAs   $466,146 
Industry
vs. NC
Lance's B-T ROA is markedly _____ (60.74%) than
that of the Industry. Again this is not surprising given
the firm's much lower profit margins. Lance's A-T
ROA is not directly comparable to a similar Industry
ratio but most assuredly must be at least somewhat
lower.
Industry
 EBT   $27,073 
Before-Tax ROE: 
=
= ______. vs. 29.10%


TE
$
235
,
507

 

Industry
 EAC   $17,706 
After-Tax ROE: 
=
= _____. vs. NC


TE
$
235
,
507

 

As was true with the B-T ROA, B-T ROE for the
Industry is seriously ______ (2.53 times) than that of
21
Lance. It is also clear that A-T ROE must be much
lower for Lance than for the Industry as well.
Overall Conclusions:
Liquidity Ratios: Lance is generally ____ liquid than
its Industry. The main reason that working capital is
relatively low is that Lance’s cash level is very low.
On the positive side, inventory and accounts payable
are found to be somewhat lower than the Industry.
Efficiency Ratios: Lance seems to utilize its total and
fixed assets somewhat ____ effectively than its
Industry based on its turnover ratios. Generally the
firm's management of short-term assets is inferior to
the Industry. However, Lance’s default risk is
probably viewed as relatively lower than average
since it pays its trade payables more quickly.
Coverage/Leverage Ratios: Lance’s TIE ratio is very
________ because of the firm's relatively lower debt
interest. The three leverage ratios also clearly show
that the firm employs less debt than the Industry.
Thus, Lance’s lower default risk is further reinforced.
Profitability Ratios: Lance's (B-T) profit margins are
all relatively _____ than those for the Industry. Both
Before-Tax return on investment measures (ROA and
ROE) suggest Lance is relatively less profitable than
the average firm in the Industry.
IV. Financial Statements & Free Cash Flow
22
FIN 410: Comparative Analysis of Financial Position
Lance, Inc.
ASSETS:
27-Dec-08
ComSize
Industry
LIABILITIES:
27_Dec-08 ComSize Industry
Current Assets
Current Liabilities
Cash
$807
0.17%
13.6%
Accounts Payable
$25,939 5.56%
16.3%
MarketableSecs
$0
0.00%
Accrued and other
$58,630 12.58%
20.0%
Accounts Rec'ble
$74,406
15.96%
18.5% Short-term debt
$7,000 1.50%
Total CL's
Inventories
$43,112
9.25%
18.9%
$91,569 19.64%
36.3%
Long-Term Liabilities
Other
$22,711
4.87%
Total CA's
$141,036
30.26%
54.6%
L-T Debt
$91,000 19.52%
22.0%
Other Liabilities
$48,070 10.31%
4.9%
Fixed Assets
Total Liabs.
$230,639 49.48%
63.0%
Fixed Assets, net
$216,085
46.36%
36.5% Stockholder's Equity
Goodwill, net
$80,110
17.19%
4.2%
Preferred Stock
$0 0.00%
Other Assets
$28,915
6.20%
4.6%
Common Stock
$26,268 5.64%
Total FA's
$325,110
69.74%
45.4%
Treasury Stock
$0 0.00%
Total Assets
$466,146
100.00%
100.0% Retained Earnings
$160,938 34.53%
Add’l Paid-In Cap
$49,138 10.54%
Prefd. Shs. Out:
0
Other
($837) -0.18%
Total Equity
Com Shs. Out:
31522.953
$235,507 50.52% 37.0%
TLiabs + TEquity
Earnings/Share
$0.56
$466,146 100.00% 100.0%
INCOME STATEMENT
27-Dec-08 ComSize Industry
Net Sales
$852,468 100.00% 100.0%
Cost of Sales
$531,528 62.35%
66.5%
Gross Margin
$320,940 37.65%
33.5%
Administrative & Selling Expenses
$291,680 34.22%
Research & Development Expenses
$0 0.00%
Other (income)/expense, net
($854)
($854) -0.10%
Total Operating Expenses
$290,826 $290,826 34.12%
27.1%
Operating Income (EBIT)
$30,114 $30,114 3.53%
6.5%
Debt Interest and other income (loss)
$3,041 0.36%
Earnings Before Taxes (EBT)
$27,073 3.18%
5.5%
Provision for Income Taxes
$9,367
$9,367 1.10%
Net Income (EAC)
$17,706 $17,706 2.08%
CALCULATION OF FINANCIAL RATIOS
Liquidity Ratios:
Lance
Industry
Coverage/Leverage
Lance
Industry
Current Ratio
Times Int. Earned
1.54
1.90
9.90
4.4
Quick Ratio
Fixed/Worth
1.07
1.20
1.38
0.70
Sales/Recs.
TLiab/Worth
11.46
14.60
0.98
1.1
COS/Inventory
TLiab/TA's
12.33
12
49.5%
63.0%
COS/Payables
Profitability Ratios (%):
20.49
16.70
Efficiency Ratios:
Oper.Profit Margin
3.53%
6.50%
Total Asset TO
BT-Profit Margin
1.83
2.80
3.18%
5.50%
Fixed Asset TO
AT-Profit Margin
2.62
7.50
2.08%
Avg. Coll. Period
BT-Retrn on Assets
31.86
25.00
5.81%
14.80%
Inv. Conv. Period
AT-Retrn on Assets
29.60
30.00
3.80%
Avg. Pmt. Period
BT-Retrn on Equity
17.81
22.00
11.50%
29.10%
Cash Conv. Cycle
AT-Retrn on Equity
43.65
33.00
7.52%
23
A. Traditional Accounting Statements and Measures of
Profitability are designed primarily for creditors and
tax collectors.
B. Alternative Measures make the data more useful for
financial analysis.
C. Modifications for Managers and Equity Analysts
1. Operating Current Assets (OperCA) are the assets
necessary to operate the business.
OperCA = Cash + ARs + Inventory.
(5.4)
2. Operating Current Liabilities (OperCL) are the
funds obtained from non-investors, like suppliers
(APs), employees (accrued wages) and the taxman
(accrued taxes).
OperCL = APs + Accruals.
(5.5)
3. Net Operating Working Capital (NOWC)
represents the working capital acquired with investorsupplied funds.
NOWC = (Cash + ARs + Inv) – (APs + Accruals). (5.6)
4. Operating Capital (OperCap) represents all assets
(both short- and long-term) required to operate the
business.
OperCap = NOWC + Net FA (Fixed Assets).
24
(5.7)
• Note: These measures exclude nonoperating items
such as marketable securities and notes payable, and
fixed assets not directly tied to production
5. Net Operating Profit after Taxes (NOPAT) is the
amount of profit a company would generate if it had
no debt and held (owned) no financial (nonproductive) assets. It is considered to be a better
measure of management performance than net
income.
NOPAT = EBIT * (1- t).
(5.8)
6. Free Cash Flow (FCF) is the cash flow available to
investors after investments (in fixed assets and
working capital) needed to sustain operations have
been made.
FCF = NOPAT - OperCap,
(5.9)
where: OperCap is based on Net FA.
• If the OperCap were found using FAGross, then
FCF would be:
FCF = NOPAT + Dep - OperCap(Gross).
(5.9a)
Note: (5.9) and (5.9a) yield the same result because
the difference between Gross and Net Fixed Assets is
Depreciation.
Question: Is negative FCF always a bad sign?
25
Answer: Not if NOPAT is positive  FCF < 0 could
be due to large investments in operating assets.
7. Return on Invested Capital (ROIC) is a measure that
can be used to assess whether a firm’s growth is
profitable.


NOPAT
ROIC = 
.

 Operating Capital 
(5.10)
If a firm’s ROIC is greater than the rate of return
investors require, i.e., WACC, then the firm is
adding value.
8. Market Value Added (MVA) is calculated as the
difference between the market value of equity and the
book value of equity (i.e., the total amount of investorsupplied equity).
MVA = MV of Equity – BV of Equity.
(5.11)
9. Economic Value Added (EVA) is a measure of how
much value (true economic profit) has been added to
the firm over the course of a particular year. It differs
from accounting profit because it represents residual
income after all costs of capital (debt and equity) have
been deducted.
EVA = NOPAT – kWACC*(OperCap)
(5.12)
EVA = (OperCap)*(ROIC – WACC).
(5.12a)
26
Notes to Consolidated Financial Statements.
NOTE 5. FIXED ASSETS
Fixed assets at December 27, 2008 and December 29, 2007 consisted of the following:
(in thousands)
2008
Land and land improvements
Buildings and building improvements
Machinery, equipment and computer systems
Trucks and automobiles
Furniture and fixtures
Construction in progress
2007
$ 14,670
15,209
84,118
87,067
287,821
305,007
59,490
61,967
2,304
2,334
10,909
12,341
459,312
483,925
Accumulated depreciation and amortization
(253,732)
(267,456)
$ 205,580
$ 216,469
Assets held for sale
(505)
(384)
Fixed assets, net
$
205,075
$ 216,085
The increase in fixed assets during 2008 was primarily due to purchases of fixed assets for existing
facilities and $11.0 million from business acquisitions.
Depreciation expense related to fixed assets was $32.0 million during 2008, $29.3 million during 2007, and
$26.8 million during 2006.
During 2008, we capitalized $0.3 million of interest expense into fixed assets as part of our ERP system
implementation.
There are two facilities in Canada that accounted for $17.5 million and $24.2 million of the total net fixed
assets in 2008 and 2007, respectively.
At December 27, 2008, and December 29, 2007, assets held for sale consisted of land and buildings related
to certain properties in Columbus, Georgia.
$
Addendum: See page 28 for WACC (presumably).
Including the effects of the interest rate swap agreements, the weighted average interest
rate for 2008 and 2007 was 3.6% and 5.3%, respectively.
Ex. 5.3
Danielle Baker (F382 Sp’06) has provided you with the
supplemental information from Lance’s 10-K report on
fixed assets and depreciation. Danielle has also supplied
the Balance Sheet and Income Statement data for Lance
for 2007 and 2008. Use the Income Statement information
to determine the firm’s average tax rate for both 2007 and
2008 (use round function and round tax rate to four
decimal places in SS).
Use the Lance_FCF Worksheet in Spreadsheet 3 to
calculate all of the relevant values given in equations (5.4)
27
through (5.12). Skip equations (5.9a) and (5.12a) in this
analysis.
From Bloomberg the firm’s WACC = 10.5143% in 2007
and 7.9466% in 2008.
a) Was the firm able to fund expansion needs internally?
b) Based on ROIC was the firm adding value in 2007 or
2008?
c) Determine MVA in 2007 and 2008 using the
information provided previously in the firm’s 10-K
reports.
LANCE Inc.
Cash & equiv.
S-Term Inv.
Accts Rec
Inventories
Other Current
Total Curr As
Net Fixed As
Goodwill
Other Assets
Total FAs
Total Assets
2008
$807
$0
$74,406
$43,112
$22,711
$141,036
$216,085
$80,110
$28,915
$325,110
$466,146
2007
$8,647
$0
$64,081
$38,659
$21,702
$133,089
$205,075
$55,956
$18,883
$279,914
$413,003
Sales
COS
Gross Margin
Selling, general and admin exp
Other (income)/expense
Total Oper. Costs
EBIT
Interest exp.
EBT
Avg. Rate
Taxes
?
Net Inc fr. Cont Opers.
EBT fr. Discnt'd Opers.
Tax Expense
Net Income
28
Accts payable
Accruals & Other
S-T Debt & Other
Total Curr Liabs
Long-term debt
Other L-T Liabs
Total Liabs
2008
$25,939
$58,630
$7,000
$91,569
$91,000
$48,070
$230,639
2007
$21,169
$53,468
$0
$74,637
$50,000
$41,269
$165,906
Preferred Stock
Common stock
Retained earnings
Add’l Paid-In & Other
Total equity
Total L&E
$0
$26,268
$160,938
$48,301
$235,507
$466,146
$0
$26,011
$163,356
$57,730
$247,097
$413,003
2008
$852,468
$531,528
$320,940
$291,680
($854)
$290,826
$30,114
$3,041
$27,073
$9367
$17,706
$0
$0
$17,706
Avg. Rate
?
2007
$762,736
$444,487
$318,249
$277,317
$2,390
$279,707
$38,542
$2,222
$36,320
$12,511
$23,809
$44
($15)
$23,838
A5.3.
Avg Tax Rate = Tax Liab/Taxable Income.
Avg Tax Rate08 = $9,367/$27,073 = ______.
Avg Tax Rate07 = $12,511/$36,320 = ______.
OperCA = (Cash + AR + Inv + Other CAs).
OperCA08 = ($807 + $74,406 + $43,112 + $22,711)
= _____ ___.
OperCA07 = _____ ___.
OperCL = (AP + Accruals & Other CLs).
OperCL08 = ($25,939 + $58,630) = ____ ___.
OperCL07 = ____ ___.
NOWC = OperCA – OperCL.
NOWC08 = $141,036 – $84,569 = ___ ____.
NOWC07 = _____ __.
OperCap = NOWC + Net FA + Other LT Assets.
OperCap08 = $56,467 + $216,085 + $109,025
= _____ ___.
OperCap07 = ___ _____.
NOPAT = EBIT * (1 – t).
NOPAT08 = $30,114 * (1 – 0.346) = __ _____.
NOPAT07 = $38,542 * (1 – 0.3445) = _ ______.
FCF08 = NOPAT - Net capital investment
= NOPAT – (OperCap08 – OperCap07)
= $19,695 – ($381,577 – $338,366)
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= $19,695 – $43,211
= _____ ___.
A5.3a) Since NOPAT is less than the change in OperCap
and FCF is negative the firm is not able to fund its
expansion needs internally.
ROIC = NOPAT/OperCap.
ROIC08 = $19,695/$381,577 = __ ___.
ROIC07 = $25,264/$338,366 = __ ___.
A5.3b) ROIC08 (=5.16%) < WACC08 (=7.9466%), and
ROIC07 (=7.47%) < WACC07 (=10.5143%), so the
firm was losing value in both 2007 and 2008.
EVA08 = NOPAT- (WACC * OperCap08)
= $19,695 - (0.079466)*($381,577)
= $19,695 - $30,322 = -$10,627.
EVA07 = $25,264 - (0.105143)*($338,366)
= $25,264 - $35,577 = -$10,313.
A5.3c) Using “Close” prices (12/29/08 & 12/27/07)
MVA = MVEquity – BVEquity.
MVA08 = (31522.953)*($22.02) – $235,507
= $458,628.
MVA07 = (31214.743)*($21.03) – $247,097
= $409,349.
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Strangely even though EVA was negative in both 2007
and 2008, the firm’s performance was positive and the
stock price (and MVA) increased from 2007 to 2008.
Note: Retained Earnings and Add’l Paid-In decreased,
(management draining the reserves?) so BVE declined.
This would account for the increase in MVA. Further,
the share price increasing suggests the market did not
perceive possible management duplicity.
10. MVA vs. EVA
a. MVA measures the effect of managerial actions
on shareholder wealth since the firm’s inception.
b. EVA measures managerial effectiveness in a
given year.
c. The relationship between MVA and EVA is not
necessarily direct, although firms with a history of
positive (negative) EVA’s will probably have a
positive (negative) MVA. However, MVA
reflects expected future prospects, so MVA could
still be positive in the face of a series of negative
EVAs if investors expect a turnaround.
d. In choosing MVA vs. EVA to evaluate management performance for incentive-based compensation, firms typically use EVA. Why?
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