Financial Statement Analysis

Transcription

1 Financial Statement Analysis Lakehead University September 2003 Overview of the Lecture 3.1 Using Financial Ratios 3.2 Analyzing Liquidity 3.4 Analyzing Leverage 3.3 Analyzing Activity 3.5 Analyzing Profitability 3.6 A Complete Ratio Analysis 2

2 3.1 Using Financial Ratios How to compare balance sheets from different companies? Calculating ratios is a good way to do so. A ratio standardizes an item on a statement, i.e. it makes it comparable to the same item on a different statement. Ratios put absolute numbers in perspective Using Financial Ratios A ratio is a numerator divided by a denominator. The units of a ratio can be of three types: 1. A percent (35%, for example); 2. A times (1.5 times, for example); 3. A number of days (67 days, for example). 4

3 3.1 Using Financial Ratios What can we do with ratios? Cross-Sectional Analysis: Analyze different companies in a given year. Times-Series Analysis: Analyze the same company over different years. Combined Analysis: Do both Using Financial Ratios The ratios of a company should be compared to those of its nearest competitors or to the average ratios of firms in the same industry. There are different categories of ratios, some ratios are more important than others depending on the industry a firm operates in. 6

4 3.1 Using Financial Ratios What is important to know about a ratio is 1. How it is computed. 2. What it is intended to measure. 3. What does mean a high or low value? 4. What are the problems with this measure? Using Financial Ratios Financial ratios are grouped in four categories: 1. Short-term, or liquidity, ratios; 2. Long-term solvency, or financial leverage, ratios; 3. Asset management, or turnover, ratios (activity); 4. Profitability and market value ratios. 8

5 Unibroue, Inc and 2001 Balance Sheets (in thousands of $) Assets Cash & marketable securities 2,300 2,114 Accounts receivable 3,891 4,435 Inventories 4,128 3,417 Other Total current assets 10,903 10,600 Net fixed assets 23,085 22,426 Total assets 33,988 33,086 Liabilities and Stockholders Equity Accounts payables and accrued liabilities 3,199 2,257 Instalments on long-term debt Total current liabilities 4,136 3,209 Long-term debt 5,125 5,992 Total equity 22,154 21,637 Total liabilities and equity 33,988 33,086 9 Unibroue, Inc and 2001 Income Statements (in thousands of $) Sales 23,622 21,580 Cost of goods sold (11,824) (11,540) Selling and administrative expenses (SGA) (7,669) (6,543) Amortization (2,073) (1,833) Earnings before interest and taxes 2,056 1,664 Interest expense (675) (731) Foreign exchange gain Pretax income 1, Taxes (434) (338) Net income Number of shares outstanding 6,111,875 6,235,451 Earnings per share $0.16 $0.10 Stock price (December of that year) $2.43 $

6 3.2 Analyzing Liquidity Computation: Most often used are item/current liabilities, but there are other types of liquidity ratios. Intention: These ratios measure the firm s ability to meet its short-term obligations. High/Low: A high value indicates that short-term liquidity is not a problem. A value too high may indicate that management is too conservative. Problems: These measures are not perfect, as we will see shortly Analyzing Liquidity The Current Ratio Current ratio = Current assets Current liabilities Unibroue s current ratio was 10,903 4,136 = 2.64 in ,600 3,209 = 3.30 in

7 3.2 Analyzing Liquidity A current ratio above 2 is often considered a good sign, but this depends on the industry the firm operates in. One problem with the current ratio is that it considers assets that may never convert to cash, such as inventories. The quick, or acid-test ratio is a solution to this problem Analyzing Liquidity The Quick, or Acid-Test Ratio Acid-test ratio = Cash and Marketable Securities + Accounts Receivable Current liabilities Unibroue s quick ratio was 2,300+3,891 4,136 = 1.50 in ,114+4,435 3,209 = 2.04 in

8 3.2 Analyzing Liquidity The Quick, or Acid-Test Ratio Note that this ratio is sometimes calculated as Acid-test ratio = which gives, for Unibroue, Current assets Inventories, Current liabilities 10,903 4,128 4,136 = 1.64 in ,600 3,417 3,209 = 2.24 in Analyzing Liquidity One must compare a firm s acid-test ratio with those of its competitors. Like the current ratio, the acid-test ratio also considers assets that are not 100% liquid. The cash ratio is a solution to this problem. 16

9 3.2 Analyzing Liquidity The Cash Ratio Cash ratio = Cash (and Marketable Securities) Current liabilities Unibroue s cash ratio was 2,300 4,136 2,114 3,209 = 0.56 in 2002 = 0.66 in Analyzing Liquidity One must compare a firm s cash ratio with those of its competitors. The cash ratio is a very conservative measure of liquidity. Other liquidity ratios: NWC to total assets = Interval measure = NWC Total assets Current assets Average daily operating costs, where Average daily operating costs = (COGS + SGA)/

10 3.4 Analyzing Leverage Computation: Depends on the ratio. Intention: These ratios measure the firm s ability to meet its long-term obligations, i.e. its financial leverage. High/Low: A high value for debt ratio increases the probability of financial distress. A too low value may indicate that management does not sufficiently take advantage of leverage. Problems: These measures are not perfect, as we will see shortly Analyzing Leverage The Total Debt Ratio Total debt ratio = Total assets Total equity Total assets Unibroue s total debt ratio was 33,988 22,154 33,988 = 0.35 in ,086 21,637 33,086 = 0.35 in

11 3.4 Analyzing Leverage Note the relationship between these ratios: Debt/equity ratio = Financial leverage multiplier = Total debt Total equity Total assets Total equity Financial leverage multiplier = Total debt + Total equity Total equity = 1 + Debt/equity ratio The financial leverage multiplier (FLM) is often referred to as the equity multiplier Analyzing Leverage Investors might be more interested in long-term debt, since short-term debt (accounts payable and bank borrowing, for instance) are constantly changing. The long-term debt ratio ignores short-term liabilities: Long-term debt ratio = Long-term debt Long-term debt + Total equity 22

12 3.4 Analyzing Leverage Times Interest Earned Times interest earned ratio = EBIT Interest Cash Coverage Cash coverage ratio = EBIT + Depreciation Interest Analyzing Activity Computation: Usually related to total sales and/or total assets. Intention: These ratios measure how efficiently a firm utilizes its assets to generate sales. High/Low: A high turnover ratio is usually a sign of efficiency. Problems: Each measure looks at a specific item, need more than one measure to make a decision. 24

13 3.3 Analyzing Activity Inventory Turnover Inventory turnover = COGS Inventory Average Age of Inventory Days Sales in Inventory = 365 Inventory Turnover Analyzing Activity What value of inventory do we use? Can use either the value for inventory that appears on the balance sheet or the average inventory over the year. Unibroue s inventory turnover in 2002 was 11,824 4,128 = 2.86 using Dec. 31, 2002, inventories 11,824 (4,128+3,417)/2 = 3.13 using average inventories in

14 3.3 Analyzing Activity Unibroue s average age of inventory was, in 2002, = 127 days using Dec. 31, 2002, inventories = 116 days using average inventories in 2002 A high inventory turnover ratio (i.e. small average age of inventory) is a sign of efficiency Analyzing Activity Receivables Turnover Receivables turnover = Sales Accounts receivable Average Collection Period Days Sales in Receivables = 365 Receivables Turnover 28

15 3.3 Analyzing Activity What is accounts receivable? As with inventories, we can use either the value for accounts receivable that appears on the balance sheet or the average value of accounts receivable during the year. Unibroue s receivables turnover in 2002 was 23,622 3,891 = 6.07 using 2002 A/R 23,622 (3,891+4,435)/2 = 5.67 using average A/R in Analyzing Activity Unibroue s average collection period was, in 2002, = 60 days using Dec. 31, 2002, A/R = 64 days using average A/R in 2002 A high receivables turnover ratio (i.e. small average collection period) is a sign that the firm has no difficulty collecting cash. 30

16 3.3 Analyzing Activity Payable Turnover Payables turnover = COGS Accounts payable Average Payment Period Average Payment period = 365 Payables Turnover Analyzing Activity Again, we can use either the value for accounts payable that appears on the balance sheet or the average value of accounts payable during the year. Unibroue s payables turnover in 2002 was 11,824 3,199 = 3.70 using 2002 A/P 11,824 (3,199+2,257)/2 = 4.33 using average A/P in

17 3.3 Analyzing Activity Unibroue s average payment period was, in 2002, = 99 days using Dec. 31, 2002, A/P = 85 days using average A/P in 2002 A low payables turnover ratio (i.e. large average payment period) is a sign that the firm gets favourable credit from its suppliers Analyzing Activity Note that it is important to consider average collection period with average payment period. Note also that a long average payment period may be problematic if suppliers are expected to tighten their credit policies. 34

18 3.3 Analyzing Activity Other Activity Ratios NWC turnover = Sales/NWC Fixed asset turnover = Sales/Net fixed assets Total asset turnover = Sales/Total assets Analyzing Profitability Computation: Usually Net income/item. Intention: These ratios measure how efficiently assets are used to generate bottom line, net income. High/Low: A high profitability ratio is usually a good sign. Problems: Each measure looks at a specific item, cannot rely on only one measure. 36

19 3.4 Analyzing Profitability Profit Margin Profit Margin = Net Income/Sales Unibroue s profit margin was , ,580 = 4.07% in 2002 = 2.82% in Analyzing Profitability Gross Profit Margin Gross Profit Margin = Gross Income/Sales Unibroue s gross profit margin was 11,798 23,622 11,540 21,580 = 49.9% in 2002 = 46.5% in

20 3.4 Analyzing Profitability Operating Profit Margin Operating Profit Margin = EBIT/Sales Unibroue s operating profit margin was 2,056 23,622 1,664 21,580 = 8.7% in 2002 = 7.7% in Analyzing Profitability Return on Assets (ROA) ROA = Net income/total assets Unibroue s return on assets was , ,086 = 2.83% in 2002 = 1.84% in

21 3.4 Analyzing Profitability Return on Equity (ROE) ROE = Net income/total equity Unibroue s return on equity was , ,637 = 4.34% in 2002 = 2.81% in Analyzing Profitability Return on assets should preferably be greater than the firm s borrowing rate. A benchmark for return on equity is often around 15%. 42

22 Market Value Ratios Computation: Usually stock price/item. Intention: These ratios measure how shareholders value different items pertaining to the firm. High/Low: A high ratio may or may not be a good sign. Problems: Again, need more than one measure. 43 Market Value Ratios The Price/Earnings (P/E) Ratio P/E ratio = Stock price/earnings per share This ratio usuall involves expected future earnings. Nevertheless, we could say that Unibroue s P/E ratio was = in 2002 = in

23 Market Value Ratios A stock may be considered cheap when its P/E ratio is below 15. Rule of 19: Over the past 40 years, the average P/E ratio in the U.S. has been 19 minus the inflation rate. Hence, if the inflation rate is 3%, the right P/E ratio is 19 3 = Market Value Ratios The Market-to-Book Ratio (ME/BE) ME/BE ratio = Stock price/book equity per share, where book equity per share means total equity, as it appears on the balance sheet, divided by the number of shares outstanding. For Unibroue, this ratio was ,154/6, ,637/6,235 = 0.67 in 2002 = 0.58 in

24 Market Value Ratios Since the book value of assets is usually below its market value, a stock with a market-to-book ratio below one may be considered a good buy. On the other hand, a market-to-book ratio below one is the sign that management has not been very successful at creating value and thus might not be able to create value in the future either The DuPont System ROE = = Net income Total equity Net income Total equity Sales Total assets Sales Total assets = Net income Sales Sales Total assets Total assets Total equity = Profit margin Total asset turnover }{{} ROA FLM 48

25 3.6 The DuPont System In the case of Unibroue in 2002, we have ROE = 4.34% = NI Sales Sales TA TA TE = ,622 23,622 33,988 33,988 22, 154 = 4.07% Ratio Sleeman Unibroue Profitability ratios (%) Gross Profit margin Operating Profit margin Net Profit margin Return on assets Return on equity Financial leverage ratios Total debt ratio Debt/equity ratio Long-term debt ratio Times interest earned

26 Ratio Sleeman Unibroue Liquidity ratios Current ratio Acid-test ratio Market value ratios P/E ratio Market-to-book ratio Asset management ratios Average age of inventory (days) Average collection period (days) Average payment period (days) Total asset turnover The Case of Unibroue Unibroue s long-term debt level is low compared to Sleeman and brewers in general. Long-term debt ratios in this industry are usually around 40-50%. Unibroue s profits margin is also low compared to other brewers: Anheuser-Busch: 13.2% in 2001 Coors: 5.1% in Return on equity: Anheuser-Busch: 41.6% in 2001 Coors: 13.1% in

27 U.S. Number for Brewers in 2002 Ratio Industry Average ROE 53.3% ROA 11.2% Oper Profit Margin 18.9% Net Profit Margin 12.1% Interest Coverage 7.9 times 53 Some U.S. Distillers and Vintners in 2001 Ratio Brown-Forman Constellation Brands ROE 18.3% 17.6% ROA 11.5% 4.9% Net Profit Margin 11.6% 4.9% 54