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3 Chapter 3. Model for Analysis of Financial Statements
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5 Financial statements are analyzed by calculating certain key ratios and then comparing them with the ratios of
6 other firms and by examining the trends in ratios over time. We can also combine ratios to make the analysis
7 more revealing, as is done with the DuPont analysis, and graphs can be used to facilitate trend analysis.
8 Spreadsheet models such as the one below are exceptionally useful for this type of analysis.
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10 Note that financial analysis is generally the starting point for a forecast of future performance. We analyze
11 historical data, then plan changes in operations, and then forecast what results will be under the new operating
12 plan. This is where spreadsheets become REALLY useful, as we can make changes in assumptions and instantly
13 see the results of those changes. Thus, the Chapter 3 model is really a lead-in to the one for Chapter 4, where we
14 get into forecasting.
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16 INPUT DATA
17 2001 2000
18 Year-end common stock price $23.00 $26.00
19 Year-end shares outstanding (in millions) 50 50
20 Tax rate 40% 40%
21 After-tax cost of capital 11.0% 10.3%
22 Lease payments $28 N/A
23 Principal payments $20 N/A
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25 Balance Sheets
26 (in millions of dollars)
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28 Assets 2001 2000
29 Cash and marketable securities $10 $80
30 Accounts receivable $375 $315
31 Inventories $615 $415
32 Total current assets $1,000 $810
33 Net plant and equipment $1,000 $870
34 Total assets $2,000 $1,680
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36 Liabilities and equity
37 Accounts payable $60 $30
38 Notes payable $110 $60
39 Accruals $140 $130
40 Total current liabilities $310 $220
41 Long-term bonds $754 $580
42 Total debt $1,064 $800
43 Preferred stock (400,000 shares) $40 $40
44 Common stock (50,000,000 shares) $130 $130
45 Retained earnings $766 $710
46 Total common equity $896 $840
47 Total liabilities and equity $2,000 $1,680
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49 Income Statements
50 (in millions of dollars)
51 2001 2000
52 Net sales $3,000.0 $2,850.0
53 Operating costs $2,616.2 $2,497.0
54 Earnings before interest, taxes, & deprn (EBITDA) $383.8 $353.0
55 Depreciation $100.0 $90.0
56 Earnings before interest and taxes (EBIT) $283.8 $263.0
57 Less interest $88.0 $60.0
58 Earnings before taxes (EBT) $195.8 $203.0
59 Taxes (40%) $78.3 $81.2
60 Net Income before preferred dividends $117.5 $121.8
61 Preferred dividends $4.0 $4.0
62 Net Income available to common stockholders $113.5 $117.8
63 Common dividends $57.5 $53.0
64 Addition to retained earnings $56.0 $64.8
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66
67 Calculated Data: Operating Performance & Cash Flows 2001 2000
68 Net operating working capital (NOWC) $800.0 $650.0
69 Total operating capital $1,800.0 $1,520.0
70 Net Operating Profit After Taxes (NOPAT) $170.3 $157.8
71 Net Cash Flow (Net income + Depreciation) $213.5 $207.8
72 Operating Cash Flow (OCF) $270.3 $247.8
73 Free Cash Flow (FCF) ($109.7) N/A
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75
76 Calculated Data: Per-share Information 2001 2000
77 Earnings per share (EPS) $2.27 $2.36
78 Dividends per share (DPS) $1.15 $1.06
79 Book value per share (BVPS) $17.92 $16.80
80 Cash flow per share (CFPS) $4.27 $4.16
81 Free cash flow per share (FCFPS) ($2.19) N/A
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83
84 At this point, we can use the previously determined data to calculate the ratios outlined throughout Chapter 3.
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86 Calculated Data: Ratios Industry
87 2001 2000 Average
88 Liquidity ratios
89 Current Ratio 3.2 3.7 4.2
90 Quick Ratio 1.2 1.8 2.1
91 Asset Management ratios
92 Inventory Turnover 4.9 6.9 9.0
93 Days Sales Outstanding 45.6 40.3 36.0
94 Fixed Asset Turnover 3.0 3.3 3.0
95 Total Asset Turnover 1.5 1.7 1.8
96 Debt Management ratios
97 Debt Ratio 53.2% 47.6% 40.0%
98 Times Interest Earned 3.2 4.4 6.0
99 EBITDA Coverage Ratio 3.0 N/A 4.3
100 Profitability ratios
101 Profit Margin 3.8% 4.1% 5.0%
102 Basic Earning Power 14.2% 15.7% 17.2%
103 Return on Assets 5.7% 7.0% 9.0%
104 Return on Equity 12.7% 14.0% 15.0%
105 Market Value ratios
106 Price-to Earnings Ratio 10.1 11.0 12.5
107 Price-to-Cash Flow Ratio 5.4 6.3 6.8

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108 Market-to-Book Ratio 1.3 1.5 1.7
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110
111 Trend Analysis--Graphing
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113 A picture is said to be worth a thousand words, and a graph provides a picture of a set of data. We illustrate
114 graphing techniques here with a trend analysis of Allied's ROE. We also assume that the industry average ROE is
115 a constant. In a more realistic problem, we would have more years of data, and historical data on the industry
116 average, but our purpose here is just to illustrate the technique.
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118 We will make a "scatter diagram," with years on the horizontal axis and ROE on the vertical axis. First, we need
119 the data arranged in the proper order, with years in the first column and ROE's in the second one. This is shown
120 below:
121
122 ROE
123 Years Allied Industry
124 2000 14.02% 15.00%
125 2001 12.67% 15.00%
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127 The graph below shows that Allied's ROE is below that of the average firm in its industry, and is trending down.
128 This is bad, and management should take corrective actions. We discuss this in Chapter 4.
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130
131
Allied's ROE Vs. Industry
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133
15.50%
134
15.00%
135
14.50%
136
14.00%
137 Allied
13.50% Industry
138
ROE

13.00%
139
12.50%
140
12.00%
141
11.50%
142
11.00%
143 2000 2001
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145
146
147 DuPont Analysis
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149 The DuPont Analysis is a decomposition of the ROE ratio, that is designed to identify the value drivers of ROE.
150 Firm's can look at the components of ROE and see where there is need for improvement.
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152 ROE = PM X TATO X Equity Multiplier
153 Allied (2001) 12.67% 3.78% 1.50 2.23
154 Allied (2000) 14.02% 4.13% 1.70 2.00
155 Industry Average 15.00% 5.00% 1.80 1.67
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157 Here, we can see that Allied's ROE has been below that of the industry average and trending downward. Allied's
158 use of debt has created greater leverage for the firm, but that has failed to compensate for shortcomings in asset
159 management (reflected by the TATO) and operating efficiency (reflected by PM).
160

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