Financial Ratio Analysis
How can published financial
statements be used to assess
financial performance?
Financial Ratio Types
• Market Value
• Profitability
• Asset Activity
• Leverage
• Liquidity
Market Value Ratios
• Examples: Marketto-Book; PriceEarnings
• Questions: How do
securities markets
value the company’s
assets? Earnings?
Profitability Ratios
• Examples: Return on
assets, equity, invested
capital; gross, net profit
margin
• Questions: How profitable
is the company per dollar
invested in the business;
per dollar of sales?
Asset Activity Ratios
• Examples: asset turnover,
average collection period,
inventory conversion period,
payables deferral period
• Questions: How efficiently
does the company use its
assets? How long does it take
assets or liabilities to turn into
cash?
Leverage Ratios
• Examples: Debt/assets;
Debt/equity; Interest
coverage
• Questions: How much of
a burden does debt pose
relative to assets, equity
or cash flow? How risky
is the company?
Liquidity Ratios
• Examples: Current ratio,
quick ratio, interval
measure
• Questions: How easily
can the company meet its
immediate cash
requirements? How risky
is the company?
Financial Ratios Relative to What?
• By themselves, financial ratios have no
meaning. We need to compare to:
– Past data for the same company
– Data for similar companies (e.g., same
industry)
– Other ratios (i.e., DuPont ratios, Cash
Conversion Cycle)
A Good Source of Company Ratios
www.investor.reuters.com
Dell and Gateway: Margin Trends
2005
2004
2003
2002
2001
2000
1999
1998
1997
18.6
18.2
17.9
17.7
20.2
20.7
22.5
22.1
21.5
6.6
6.4
6
4
6.8
6.6
8
7.7
6.7
Gross Margin
9.1
13.6
13.6
14.1
21.4
20.5
18.3
17.1
18.6
Net margin
0.5
-15.1
-7.1
-17.4
2.5
4.8
4.5
1.7
5
Dell
Gross Margin
Net Margin
Gateway
Dell, Gateway and Computer Hardware
Dell
Gateway
Industry
18.6
9.1
31.1
Net Margin
6.6
0.5
7.2
Asset Turnover
2.4
2.1
1.5
Inventory Turnover
91.6
16.4
45
Rec. Turnover
12.6
11.9
8.6
ROIC
40.8
3.2
19.6
ROE
58.4
44.4
31.9
0.9
0.8
1.3
13.6
3.7
6.9
Gross Margin
Quick Ratio
Mkt/Book
DuPont Ratios
Net Income x Sales x Assets = Net Income
Sales
Assets Equity
Equity
Net profit
margin
X
Asset x Equity =
turnover multiplier
ROE
DuPont Analysis: Selected Companies
ROE
S/A
NI/S
A/E
Burlington Northern Santa Fe
0.138
0.128
0.337
3.219
Citicorp
0.165
0.102
0.114
14.121
Consolidated Edison
0.113
0.495
0.098
2.340
Merck
0.375
0.943
0.195
2.038
Safeway
0.334
3.203
0.025
4.209
Wal-Mart Stores
0.198
2.776
0.030
2.384
THE CASH CONVERSION CYCLE
DAYS SALES IN INVENTORY
INVENTORY/(COGS/DAY)
INVENTORIES
PURCHASED
DAYS SALES IN RECEIVABLES
RECEIVABLES/(SALES/DAY)
SALES
BOOKED
SUPPLIERS PAID
IN CASH
CASH RECEIVED
FOR SALES
PAYABLES/((COGS+SG&A)/DAY)
DAYS SALES IN PAYABLES
CASH CONVERSION
CYCLE
Cash Conversion Cycle: Selected Companies
Company
Inv. Conv.
Ave.
Coll.
Op. Cycle
Pay.
Def.
Cash
Conv.
HewlettPackard
89.8
65.1
154.9
65.9
89
Merck
70
42.7
112.7
66
46.7
Boeing
74.1
22
96.1
54.4
41.7
Wal-Mart
Stores
64.4
2.8
67.2
37.4
29.8
Safeway
33.9
2.8
36.7
35.3
1.4
American
Airlines
15.1
24.7
39.8
70.9
-31.1
McDonald's
3.9
7.1
11
62.2
-51.2