Horizontal Analysis

Balance Sheet
These changes suggest
that the company
expanded its asset base
during 2009 and
financed this expansion
primarily by retaining
income rather than
assuming additional
long-term debt.

Illustration 14-5
Horizontal analysis of
balance sheets

LO 3
 Vertical Analysis

Balance
Sheet
These results
reinforce the earlier
observations that
Quality is choosing to
finance its growth
through retention of
earnings rather than
through issuing
additional debt.

Illustration 14-8

LO 4
Consolidated Statements of
Cash Flows January January
(Amounts in millions) 2001 2000 Change Percent
Cash provided from operations
Net earnings $ 2,581 $ 2,320 $ 261
Reconciliation of net earnings to
net cash provided by operations
Depreciation and amortization 601 463 138
Increase in receivables (246) (85) (161)
Increase in merchandise inventories (1,075) (1,142) 67
Increase in accounts payable 754 820 (66)
Increase in income taxes payable 151 93 58
Other 30 (23) 53
--------- --------- ---------
Net cash provided by operations 2,796 2,446 350 14.31%
 TOOLS AND TECHNIQUES

KEY FINANCIAL RATIOS RELATIONSHIP AMONG FINANCIAL

STATEMENT ITEMS

CATEGORIES
PROFITABLITY MEASURES BUSINESS ABILITY TO GENERATE
RATIOS PROFITABLE SALES FROM ITS RESOURCES
MEASURES OPERTAING EFFICIENCY /EFFICIENT
ACTIVITY RATIOS UTILIZATION OF ASSETS
MEASURES BUSINESS ABILITY TO MEET SHORT
LIQUIDITY RATIOS
TERM OBLIGATIONS

SOLVENCY MEASURES BUSINESS ABILITY TO MEET LONG

RATIOS TERM OBLIGATIONS

VALUATION MEASURES QUANTITY OF EARNINGS ASSOCIATED

RATIOS WITH OWNERSHIP
 HOW EFFICIENTLY BUSINESS IS USING ASSETS
(ABILTY OF A FIRM TO CONVERT BALANCE SHEET
ACTIVITY RATIOS ITEMS INTO CASH OR SALES)
MANAGEMENT OF WORKING CAPITAL AND LTA
SOME RATIOS USEFUL IN ASSESING LIQUIDITY
NUMERATOR INCOME STATEMENT
RATIO DENOMINATOR = BALANCE SHEET

INVENTORY
TURNOVER
RECEIVABLES
LIQUIDITY
TURNOVER
PAYABLES
TURNOVER
FIXED ASSET
TURNOVER
SALES
TOTAL ASSET
TURNOVER
 INVENTORY TURNOVER RATIO

HOW MANY TIMES PER YEAR THE ENTIRE INVENTORY WAS THEORITICALLY SOLD
OR HOW MANY TIMES PER YEAR THE ENTIRE INVENTORY CONVERTED INTO SALES

INVENTORY TURNOVER COGS

AVG INV

INVENTORY TURNOVER IN DAYS

365 DAYS
DAYS OF INVENTORY ON HAND (DOH)
INVENTORY TURNOVER

HIGH INVENTORY TURNOVER RATIO LOW INVENTORY TURN OVER RATIO

RELATIVE TO INDUSTRY RELATIVE TO INDUSTRY

GOOD INVENTORY GROWTH IN REVENUE BAD INVENTORY

COMPARED
MANAGEMENT ABOVE INDUSTRY MANAGEMENT
WITH
SLOW GROWTH IN GROWTH IN
POTENTIAL LOSS OF TECHNOLOGICAL
REVENUE AS COMPARE SALES
REVENUE OBSOLESCENCE
TO INDUSTRY
 RECEIVABLE TURNOVER RATIO

HOW FAST COMPANY COLLECTS CASH FROM CREDIT CUSTOMERS

RECEIVABLE TURNOVER SALES

AVG RECEIVABLES

RECEIVABLE TURNOVER IN DAYS

DAYS TO COLLECT RECEIVABLESIN AN 365 DAYS

YEAR (DSO) RECEIVABLE TURNOVER

HIGH RECEIVABLE TURNOVER RATIO LOW RECEIVABLE TURN OVER RATIO

RELATIVE TO INDUSTRY RELATIVE TO INDUSTRY

GOOD RECEIVABLE GROWTH IN REVENUE BAD RECEIVABLE COMPARED

MANAGEMENT ABOVE INDUSTRY MANAGEMENT WITH
GROWTH IN
POTENTIAL LOSS OF BAD DEBTS(LENIENT SALES AND
COMPARED WITH
REVENUE(TIGHT CREIDT POLICY) AGING
AGING
CREDIT POLICY)
 PAYABLE TURNOVER RATIO

AVERAGE NUMBER OF DAYS THE COMPANY TAKES TO PAY ITS SUPPLIERS

PAYABLE TURNOVER PURCHASES

AVG PAYABLES

PAYABLES TURNOVER IN DAYS

DAYS TO PAY CREDITORS IN AN 365 DAYS

YEAR (DPO) A/C PAYABLES TURNOVER

HIGH PAYABLES TURNOVER RATIO RELATIVE LOW PAYABLES TURN OVER RATIO
TO INDUSTRY RELATIVE TO INDUSTRY

NOT GOOD USE OF GOOD USE OF

COMPARED
CREDIT POLICY CREDIT POLICY
COMPARED WITH WITH
LIQUIDITY RATIO LIQUIDITY
ADVANTAGE OF LOSS OF DISCOUNT RATIO
DISCOUNT
 FIXED ASSET TURN OVER RATIO

HOW EFFICIENTLY COMPANY GENERATES REVENUE FROM INVESTMENT IN

FIXED ASSETS

REVENUE
FIXED ASET TURNOVER RATIO =
AVG NET FIXED ASSETS
HIGH RATIO MORE EFFICIENT USE OF FIXED ASSETS

LOW RATIO INEFFICIENCY

HIGH RATIO DOES NOT MEAN HIGH

PROFITABILITY I.E DIFFERENCE BETWEEN ROA
AND ASSET TURNOVER
CARE CAPITAL INTENSIVE COMPANY

NEWLY STARTED COMPANY ASSET’S HAVE HIGH

CARRYING VALUE
 MEASURES COMPANY’S ABILITY TO MEET SHORT TERM
LIQUIDITY
OBLIGATIONS.
RATIOS
LEVEL OF LIQUIDITY DIFFERS FROM INDUSTRY TO INDUSTRY
COMPANY’S LIQUIDITY POSITION VARY ACCORDING TO
ANTICIPATED NEEDS FOR FUNDS AT ANY GIVEN TIME

RATIOS LIQUIDITY POSITION AT A PARTICULAR DATE, USE ENDING

BALANCES ROM BALANCE SHEET RATHER THAN AVGS

CURRENT RATIO

QUICK RATIO MEASURES COMPANY’S ABILITY TO PAY CURRENT LIAB

CASH RATIO

DEFNSIVE
INTERVAL RATIO
ADDITIONAL LIQUIDITY MEASURES
CASH CONVERSION
CYCLE
 EXPRESSES CURRENT ASSETS IN RELATION TO CURRENT
CURRENT RATIO
LIABILITIES

CURRENT ASSETS
CURRENT RATIO =
CURRENT LIABILITIES

HIGH RATIO GREATER ABILITY TO MEET SHORT TERM OBLIGATIONS

LESS LIQUIDITY, MORE RELIANCE ON OPERATING CASH

LOW RATIO FLOWS AND OUTSIDE FINANCING TO MEET SHORT TERM
OBLIGATIONS

CURRENT ASSETS INCLUDES INVENTORY AND

CARE RECEIVABLES WHICH MIGHT HAVE LOW TURNOVER
RATIO
 QUICK RATIO MORE COSERVATIVE AS COMPARE TO CURRENT RATIO
EXPRESSES QUICK ASSETS IN RELATION TO CURRENT LIABILITIES

QUICK ASSETS
QUICK RATIO =
CURRENT LIABILITIES

QUICK ASSETS CURRENT ASSETS MINUS INVENTORY,PREPAIDS, ADVANCES

HIGH RATIO GREATER ABILITY TO MEET SHORT TERM OBLIGATIONS

LESS LIQUIDITY, MORE RELIANCE ON OPERATING CASH

LOW RATIO FLOWS AND OUTSIDE FINANCING TO MEET SHORT TERM
OBLIGATIONS

CARE MARKET CRISIS THE FAIR VALUE OF SECURITIES ARE SIGINIFICANTLY

DOWN
 CASH RATIO MORE CONSERVATIVE AS COMPARE TO QUICK RATIO
RELIABLE MEASURE OF LIQUIDITY IN CRISIS SITUATION

CASH +MARKETABLE SECURITIES

CASH RATIO =
CURRENT LIABILITIES

HIGH RATIO GREATER ABILITY TO MEET SHORT TERM OBLIGATIONS

LESS LIQUIDITY, MORE RELIANCE ON OPERATING CASH

LOW RATIO FLOWS AND OUTSIDE FINANCING TO MEET SHORT TERM
OBLIGATIONS

BETTER INDICATOR OF LIQUIDITY IN SITUATION WHERE INVENTORY TURNOVER

RATIO IS LOW
 DEFENSIVE
MEASURES HOW LONG COMPANY CAN CONTINUE TO PAY ITS
INTERVAL RATIO
EXPENSES FROM ITS EXISTING LIQUID ASSETS

DEFENSIVE QUICK ASSETS

INTERVAL RATIO =
DAILY CASH EXPENDITURES

Daily cash expenditures =( Annual operating expenses -- non cash charges)/365

HIGH RATIO GREATER LIQUIDITY

LOW LIQUIDITY,
LOW RATIO

INCASE RATIO IS LOW, ASCERTAIN SUFFICIENCY OF EXPECTED CASH INFLOWS

CASH CONVERSION
TIME BETWEEN OUTLAY AND COLLECTION OF CASH
CYCLE

CASH CONVERSION
= DOH + DSO MINUS NUMBER OF DAYS OF PAYABLES
CYCLE

GREATER LIQUIDITY, INVENTORY & RECEIVABLES FINANCE

(INVESTMENT IN OPERATIONS )FOR A SHORTER PERIOD OF
SHORTER CYCLE
TIME

LOW LIQUIDITY, INVENTORY & RECEIVABLES FINANCE

LONGER CYCLE (INVESTMENT IN OPERATIONS )FOR A LONGER PERIOD OF
TIME

FINANCING THROUGH EQUITY OR DEBT

 COMPANY Z
EXAMPLE

2005 2004 2003

CURRENT RATIO 2.1 1.9 1.6

QUICK RATIO 0.8 0.9 1.0

DOH 55 45 30

DSO 24 28 30

EVALUATE THE LIQUIIDTY

 COMPANY Z
EXAMPLE

2005 2004 2003

DSO 32 31 28

DOH 4 3 3

NUMBER OF DAYS PAYABLES 73 70 68

CASH CONVERSION CYCLE (37) (36) (37)

COMPETITOERS CASH
CONVERSION CYCLE

A 27 37 61

B (7) (9) (3)

C (40) (41) (40)

 SOLVENCY RATIO MEASURES COMPANYS ‘ ABILITY TO PAY LONGTERM
DEBTS(RISK FACTOR)

TWO TYPES DEBT RATIOS COVERAGE RAIOS

BALANCE SHEET INCOME STATEMENT

MEASURE ABILTY TO COVER

MEASURE DEBT TO EQUITY
DEBT

DEBT TO ASSET RATIO/TOTAL

INTEREST COVERAGER RATIO
DEBT RATIO
FIXED CHARGE COVERAGE
DEBT TO EQUITY RATIO
RATIO
FINANCIAL LEVERAGE RATIO

DEBT = INTEREST BEARING SHORT AND LONGTERM DEBTS

(EXCLUDE ACCRUED EXENSES AND A/PAYABLE)
DEBT TO ASSET RATIO MEASURES %GE OF TOTAL ASSETS FINANCED WITH DEBT

TOTAL DEBT
DEBT TO ASSET RATIO =
TOTAL ASSETS

HIGH RATIO MEANS HIGHER FINANCIAL RISK WEAK

INTERPRETATION
SOLVENCY
DEBT TO EQUITY MEASURES THE AMOUNT OF DEBT CAPITAL RELATIVE TO
RATIO/GEARING EQUITY

TOTAL DEBT
DEBT TO EQUITY RATIO =
SHS’EQUITY

HIGH RATIO MEANS HIGHER FINANCIAL RISK WEAK

INTERPRETATION
SOLVENCY

CARE SOME DEBTS MIGHT NOT BE THE PART OF BALANCE SHEET

FINANCIAL LEVERAGE
MEASURES THE AMOUNT OF ASSET RELATIVE TO EQUITY
RATIO

FINANCIAL LEVERAGE AVG TOTAL ASSETS

RATIO =
AVG TOTAL EQUITY

INTERPRETATION

DUPONT ANALYSIS
 ROE = ROA * LEVG FACTOR

2005 5.92% = 3.70% *1.60

2004 1.66% = 1.05% *1.58
2003 1.62 = 1.05 *1.54
2002 -0.62 = -0.39% *1.60

ROE = Net profit Margin * Asset turnover* levg factor

2005 5.92% = 3.30% *1.11 *1.60

2004 1.66% = 1.11% *0.95 *1.58
2003 1.62 = 1.13% *0.93 *1.54
2002 -0.62 = -0.47% *0.84 *1.60
AN ANALYST WISHES TO UNDERSTAND THE FACTORS DRIVING
THE TREND IN ROE OVER A RECENT THREE YEAR PERIOD, THE
ANALYST OBTAINS THE FOLLOWING DATA

2004 2003 2002

ROE 20.62% 14.42% 10.17%

TAX BURDON 64.88% 62.52% 60.67%

INTEREST BURDON 130.54% 112.60% 130.50%

EBIT MARGIN 6.51% 6.40% 4.84%

ASSET TURN OVER 1.55 1.38 1.19

LEVERAGE 2.42 2.32 2.24

WHAT MIGHT ANALYST MAY CONCLUDE ?

INTEREST COVERAGE MEASURES NUMBER OF TIMES EBIT COULD COVER INTEREST
RATIO PAYMENTS

INTEREST COVERAGE EBIT

RATIO =
INTEREST EXPENSE

HIGH RATIO INDICATES STRONGER SOLVENCY,

INTERPRETATION
ASSURANCE OF DEBT SERVICES
VALUATION RATIOS/MARKET RATIOS MEASURE RETURNS TO STOCKHOLDERS
AND THE VALUE THE MARKET PLACE PUTS
ON A COMPANY’S STOCK.

EARNING PER SHARE RATIO

(EPS)

PRICE EARNING RATIO

DIVIDEND PAYOUT RATIO

 EARNING PER SHARE RATIO (EPS)

PROVIDES THE INVESTOR WITH A COMMON DENOMINATOR TO GAUGE

INVESTMENT RETURNS

INVESTORS IN COMMON STOCK HOPE TO EARN A RETURN ON THEIR

INVESTMENT THROUGH DIVIDENDS OR INCREASES IN THE STOCK PRICE

EARNINGS AVAILABLE TO COMMON STOCK HOLDER

EPS =
WEIGH AVG COMMON SHARES OUTSTANDING

EARNINGS AVAILABLE TO COMMON STOCK HOLDER

DEPS =
WEIGHTED-AVERAGE NUMBER OF SHARES OF
COMMON STOCK OUTSTANDING, ASSUMING FULL
CONVERSION OF ALL CONVERTIBLE SECURITIES
PRICE EARNING RATIO RELATES EARNINGS PER COMMON SHARE TO THE
MARKET PRICE AT WHICH THE STOCK TRADES,
EXPRESSING THE “MULTIPLE” THAT THE STOCK
MARKET PLACES ON A FIRM’S EARNINGS

P/E RATIO = Market price of common stock

Earnings per share

NOTE: EPS IS CALCULATED ON THE BASIS OF NET INCOME CALCULTED BY

MANAGEMENT
DIVIDEND PAYOUT RATIO THE DIVIDEND PAYOUT RATIO SHOWS THE
PROPORTION OF EARNINGS PER SHARE THAT IS
PAID TO THE COMMON STOCKHOLDERS IN THE
FORM OF DIVIDENDS

DIVID PAYOUT RATIO = Cash Dividends per share

Earnings per share
CASH FLOW RATIOS

Free Cash Flow = Net Cash Flow from Operting minus Capital
Expenditure minus dividends