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Performance
Objectives
■ Why Financial Ratio Analysis
■ What are the Five Categories
■ How to compute
■ Limitations
Why?
■ 1. Liquidity
■ 2. Efficient use of Assets
■ 3. Leverage (financing)
■ 4. Profitability/Returns
■ 5. Shareholder Wealth
Example:
CyberDragon Corporation
CyberDragon’s
Balance Sheet ($000)
Assets: Liabilities & Equity:
Cash $2,540 Accounts payable 9,721
Marketable securities 1,800 Notes payable 8,500
Accounts receivable 18,320 Accrued taxes payable 3,200
Inventories 27,530 Other current liabilities 4,102
Total current assets 50,190 Total current liabilities 25,523
Plant and equipment 43,100 Long-term debt (bonds) 22,000
less accum deprec. 11,400 Total liabilities 47,523
Net plant & equip. 31,700 Common stock ($10 par) 13,000
Total assets 81,890 Paid in capital 10,000
Retained earnings 11,367
Total stockholders' equity 34,367
Total liabilities & equity 81,890
Sales (all credit) $112,760
Cost of Goods Sold CyberDragon’s Income
(85,300)
Gross Profit Statement
27,460
Operating Expenses:
Selling (6,540)
General & Administrative (9,400)
Total Operating Expenses (15,940)
Earnings before interest and taxes (EBIT) 11,520
Interest charges:
Interest on bank notes: (850)
Interest on bonds: (2,310)
Total Interest charges (3,160)
Earnings before taxes (EBT) 8,600
Taxes (3,344)
Net Income 5,016
CyberDragon
Other Information
Current Assets
Current Ratio =
Current Liabilities
What is CyberDragon’s Current
Ratio?
50,190
25,523 = 1.97
Inventory Turnover
Cost of Goods Sold
=
Inventory
What is the firm’s Inventory
Turnover?
85,300
27,530 = 3.10 times
Operating Income
OIROI =
Total Assets
What is the firm’s Operating Income
Return on Investment (OIROI)?
11,520 = 14.07%
81,890
•Slightly below the industry
average of 15%.
•The OIROI reflects product
pricing and the firm’s ability to
keep costs down.
Operating Profit Margin
11,520 = 10.22%
112,760
CONTACT:
0322-3385752
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,
KARACHI, PAKISTAN.
What is their Total Asset Turnover?
Sales
Fixed Asset Turnover =
Net Fixed Assets
What is the firm’s Fixed Asset
Turnover?
112,760
31,700 = 3.56 times
A/R Ratios
Inventory Ratios
3. Leverage Ratios/How
Financing Assets?
■ Measure the impact of using debt
capital to finance assets.
■ Firms use debt to lever (increase)
returns on common equity.
How does Leverage work?
■ Suppose we have an all equity-
financed firm worth $100,000. Its
earnings this year total $15,000.
ROE =
15,000
ROE = = 15%
100,000
How does Leverage work?
■ Suppose the same $100,000 firm is
financed with half equity, and half
8% debt (bonds). Earnings are still
$15,000 … less interest.
ROE =
How does Leverage work?
■ Suppose the same $100,000 firm is
financed with half equity, and half
8% debt (bonds). Earnings are still
$15,000.
Total Debt
Debt Ratio =
Total Assets
What is CyberDragon’s Debt Ratio?
47,523 = 58%
81,890
If the industry average is 47%, what
does this tell us?
11,520
3,160 = 3.65 times
Net Income
ROE =
Common Equity
What is CyberDragon’s
Return on Equity (ROE)?
5,016
34,367 = 14.6%
5,016
34,367 = 14.6%
20
3.86 = 5.18
What is CyberDragon’s
Price/Book Ratio?
20
26.44 = .76
5. Is Management Creating
Shareholder Value? … Cont.
where:
r = Operating return on assets
k = Total cost of capital
A = Amount of capital (or Total Assets)
EVA Example
■ A firm has total assets of $5,000 and has raised money
from both debt and equity in equal proportion. Further,
assume that cost of debt is 8% and the cost of equity is
16%. Assume the firm earns 17% operating income on its
investments.