Learning Objectives
• Accurately interpret financial, market,
and other data to assess performance
– Financial data used in simulation, cases, &
team project
• Understand a business firm as a system
of decisions concerned with creating
value
– Use rehearsal and tournament simulations
to understand interrelationships among
decisions and performance
Review - some key financial measures
Balance Sheet
Assets
Liabilities
Equity
Liabilities and equity = sources of funds.
Assets = uses of funds (good & bad).
Liabilities = debt claim.
Equity = ownership claim.
Financial Measures
ST Assets
ST Liabilities
LT Assets
LT Liabilities
Equity
Capital Budgeting
 Deals with the firm’s investment
in long-term assets
 e.g., in what capabilities/capacities
should you invest?
Financial Measures
ST Assets
ST Liabilities
LT Assets
LT Liabilities
Equity
Capital Structure
 Deals with long-term financing of the
firm’s activities
 e.g., what mix of long term debt and
equity will you use?
Financial Measures
ST Assets
ST Liabilities
LT Assets
LT Liabilities
Equity
Working Capital Management
 Deals with management of short-term
(current) assets.
 e.g., will you delay payables, speed up
collections, manage inventory to
expected, best, or worst case sales, etc.
Financial Measures
Liquidity Ratios
Current Ratio:
Current Assets / Current Liabilities
Quick Ratio:
(Current Assets - Inventories) / Current
Liabilities
High values - company will not default on
short-term obligations (if too high, profitable
opportunities may be lost).
Financial Measures
Leverage Ratios
Debt to Equity Ratio = Tot Debt / Tot Equity
(degree of reliance on debt for financing).
Low ratios suggest more conservative (safe
from bankruptcy) company
But - if not using debt, you are foregoing
investment and growth opportunities.
Financial Measures
Some common profit ratios
Return on Sales ROS = Profit after taxes/Sales
Return on Assets ROA = Profit after taxes/Total Assets
Return on Equity ROE = Profit after taxes /
Shareholders’ Equity (book value)
Earnings per Common share (EPS) = (Profits after
taxes - Preferred Dividend) / (# of common shares
outstanding)
Payout Ratio = Cash Dividends / Net Income
But these ignore the cost of capital (interest, dividends)
Financial Measures
DuPont formula
points to interrelatedness of performance measures
Profit margin X asset turnover X equity multiplier = ROE
Net income/sales X sales/assets X assets/equity = ROE
Net income/sales X sales/assets X assets/equity = ROE
Net income/sales X sales/assets = ROA
Net income/sales X sales/assets = ROA
ROE is positively related to the efficiency of the firm in
managing its shareholders’ equity (generally).
A firm can increase ROE by any of the ratios in the
DuPont formula. Increases in net profit margin will
improve ROE. If a firm can get more sales out of its
existing assets, ROE will improve. If a firm increases
leverage or debt load, ROE increases (all other things
equal).
Caution - if a firm’s ROE increases or is trending up, it
may be that a firm is increasing leverage without
strategic use of assets. Improvement in ROE may
artificial, possibly fatal in the long-term.
If a company is consistently increasing profit margin,
find out why - if margins are achieved through cost
cutting, an uptrend in ROE may not continue.
Market to Book Ratio M/B
M - investors’ assessment of the present value
of the expected cash flows from assets in
place, and cash flows from investments the
firm would have an opportunity to make some
time in the future.
B - accountant’s perspective - historical
measure of equity resources contributed by
shareholders.
The value of a firm is determined by what people are
willing to pay for it.
Value depends on future expectations of earnings &
growth.
Financial Measures
Source: A. Hax, MIT OCR