Financial Management

Master of Management Program

References:
Parrino, R., Bates, T. W., Gillan, S. L., & Kidwell, D. S. (2018).
Fundamentals of Corporate Finance. John Wiley & Sons, Inc.

Dr. Kurnadi Gularso

 SESSION 3
Analyzing
Financial Statement

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 The interrelations among the Financial Statements

Account BS10 CF11 BS11 Bal.

Cash 16.6 271.9 288.5
Current assets (less cash) 671.4 79.9 751.3
Fixed assets 805.8 43.6 849.4 126.7
-83.1
Current liabilities (less notes) 341.8 25.5 367.3 54.4
Long-term debt and notes 309.8 274.7 584.5 251.4
Capital stock 892.9 -23.3 869.6
Retained earnings -50.7 118.5 67.8

Notes:
CFO
CFI
CFF

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Financial Statements Analysis
• Standardizing Statements:
• Common-size Balance Sheets
• Common-size Income Statements
• Ratio Analysis:
• Short-term solvency or liquidity measures: current ratio, quick (acid-test) ratio, cash ratio
• Long-term solvency measures: total debt ratio, times interest earned, cash coverage
• Asset management or turnover measures: inventory turnover and days’ sales in inventory,
receivables turnover and days’ sales in receivables, total asset turnover
• Profitability measures: profit margin, EBITDA margin, return on assets, return on equity
• Market value measures: price-earnings ratio, market-to-book ratio, market capitalization,
enterprise value, enterprise value multiples

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 Common-size Balance Sheets

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 Common-size Income Statements

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Selecting a Benchmark
• Trend Analysis
• Industry Analysis
• Peer Group Analysis

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Ratios for
Time-trend
Analysis

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 Two Basic Strategies to Earn a Higher ROA

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 The DuPont Equation

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 Applying the DuPont System

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 The DuPont
Identity

The DuPont identity tells us that ROE is affected by

three things:
1. Operating efficiency (as measured by profit
margin).
2. Asset use efficiency (as measured by total asset
turnover).
3. Financial leverage (as measured by the equity
multiplier).
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Peer Group
Ratios

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Peer Group
Analysis

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 Common Financial Ratios

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Summary of
Key Equations

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Summary of
Key Equations
(Cont’d)

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1. DuPont Identity
• If Wilkinson, Inc., has an equity multiplier of 1.35, total asset turnover
of 2.10, and a profit margin of 5.2 percent, what is its ROE?

ROE = 5.2% 2.10 1.35

ROE = 14.74%

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2. Equity Multiplier and Return on Equity
• Synovec Company has a debt–equity ratio of .70. Return on assets is
8.4 percent, and total equity is $840,000. What is the equity
multiplier? Return on equity? Net income?
Equity multiplier = Assets/Total equity
D/E = 0.70
D = 0.70 E
TA = D + E = 0.70 E + E = 1.70 E
Equity multiplier = TA/E = 1.70
ROE = NI/E
NI = ROE x E
NI = 14.28% 840,000
NI = 119,952

ROE = ROA x EM
ROE = 8.4% 1.70
ROE = 14.28%

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3. Efficiency ratio
• Sorenson Inc. has sales of $3,112,489, a gross profit margin of 23.1
percent, and inventory of $833,145. What are the company's
inventory turnover ratio and days' sales in inventory?
Sales 3,112,489
COGS -2,393,504
Gross profit 718,985 23.1%

Inventory = 833,145
Inventory turnover ratio = COGS / Inventory
2.87 times

Days sales in inventory = 365 / Inventory turnover ratio

127 days

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4. Leverage ratios
• Norton Company has a DER =
ROA =
1.65
11.3%
debt-to-equity ratio of E= 1,322,796

1.65, ROA of 11.3 Equity multiplier (EM) = 1 + DER

percent, and total 2.65

equity of $1,322,796. EM = TA / E
• What are the TA = EM * E 3,505,409

company's equity ROA = NI / TA

multiplier, debt ratio, NI = ROA * TA 396,111

and ROE? ROE = NI / E 29.9%

Debt ratio = 1 - E / TA
0.62
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5. Benchmark analysis
• Trademark Corp.'s financial manager collected the following information
for its peer group to compare its performance against that of its peers.

a. Explain how Trademark is performing relative to its peers.

b. How do the industry ratios help Trademark's management?

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5. Benchmark analysis (cont’d)

Ratios Trademark Peer Group

DSO (days) 33.5 L 27.9 J
Total assets turnover 2.3 L 3.7 J
Inventory turnover 1.8 L 2.8 J
Quick ratio 0.6 L 1.3 J

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6. Market-value ratios
• Rockwell Jewelers management announced that the company had net
earnings of $6,481,778 for this year. The company has 2,543,800
shares outstanding, and the year-end stock price is $54.21. What are
Rockwell’s earnings per share and P/E ratio?
NI 6,481,778
Shares 2,543,800
Price 54.21

EPS = NI / Shares 2.55 USD

PER = Price / Earning 21.27 times

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 HW 1: Liquidity ratios
• Laurel Electronics has a quick ratio of 1.15, current liabilities of
$5,311,020, and inventories of $7,121,599. What is the firm's current
ratio?

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HW 2: Efficiency ratio
• Norwood Corp. currently has accounts receivable of $1,223,675 on
net sales of $6,216,900. What are its accounts receivable turnover
and days' sales outstanding (DSO)?

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HW 3 Efficiency ratio
• If Norwood Corp.'s management wants to reduce the DSO from that
calculated in HW (2) to an industry average of 56.3 days and its net
sales are expected to decline by about 12 percent, what would the
new level of receivables be?

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HW 4: Coverage ratios
• Nimitz Rental Company had depreciation expenses of $108,905,
interest expenses of $78,112, and an EBIT of $1,254,338 for the year
ended June 30, 2017. What are the times-interest-earned and cash
coverage ratios for this company?

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HW 5: Leverage ratios
• Conseco, Inc., has a debt ratio of 0.56. What are the company's debt-
to-equity ratio and equity multiplier?

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HW 6: Profitability ratios
• Cisco Systems has total assets of $35.594 billion, total debt of $9.678
billion, and net sales of $22.045 billion. Its net profit margin for the
year is 20 percent, while the operating profit margin is 30 percent.
What are Cisco’s net income, EBIT ROA, ROA, and ROE?

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 HW 7: Return on Equity
• Firm A and Firm B have debt–total asset ratios of 25 percent and 40
percent and returns on total assets of 8 percent and 7 percent,
respectively. Which firm has a greater return on equity?

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HW 8: Days’ Sales in Receivables
• A company has net income of $314,000 a profit margin of 8.9 percent,
and an accounts receivable balance of $152,800. Assuming 80 percent
of sales are on credit, what is the company’s days’ sales in
receivables?

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HW 9: Ratios and Fixed Assets
• The Whisenhunt Company has a ratio of long-term debt to long-term
debt and equity of .29 and a current ratio of 1.20. Current liabilities
are $1,280, sales are $6,140, profit margin is 8.9 percent, and ROE is
17.6 percent. What is the amount of the firm’s net fixed assets?

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HW 10: DuPont Identity
• The DuPont identity presented in the chapter is commonly referred to
as the three-factor DuPont identity. Another common way that the
DuPont identity is expressed is the five-factor model, which is:

• Derive the five-factor DuPont identity (EBT is earnings before tax, but
after interest). What does each term measure?

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 HW 11: Common-Size and Common–Base
Year Financial Statements
• In addition to common-size
financial statements, common–base
year financial statements are often
used. Common–base year financial
statements are constructed by
dividing the current year account
value by the base year account
value. Thus, the result shows the
growth rate in the account. Using
the following financial statements,
construct the common-size balance
sheet and common–base year
balance sheet for the company. Use
2014 as the base year.

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HW 12: Balance Sheet
• Complete the balance sheet of Flying Roos Corporation.

• You have the following information:

• Debt ratio = 40%; DSO = 39 days
• Current ratio = 1.5; Inventory turnover ratio = 3.375
• Sales = $2.25 million; Cost of goods sold = $1.6875 million

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 HW 13: Balance Sheet
• Blackwell Automotive’s balance sheet at the end of its most recent fiscal year shows the
following information:

• In addition, it was reported that the firm had a net income of $156,042 on sales of
$4,063,589.
a. What are the firm’s current ratio and quick ratio?
b. Calculate the firm’s days’ sales outstanding, total asset turnover ratio, and fixed
asset turnover ratio.
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 Financial Statement Analysis
Greenfern Corporation recently filed the following financial statements with the SEC.

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 Financial Statement Analysis (Cont’d)

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HW 14: Greenfern Corporation (1)
• Refer to the preceding balance sheet and income statement for
Greenfern Corporation for the fiscal year ended July 31, 2017. What
are the company's current ratio and quick ratio? What do these ratios
tell us about Greenfern?

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HW 15: Greenfern Corporation (2)
• Refer to the preceding balance sheet and income statement for Greenfern
Corporation for the fiscal year ended July 31, 2017. Calculate the following ratios:
a. Inventory turnover
b. Days' sales outstanding.
c. Total asset turnover.
d. Fixed asset turnover.
e. Total debt ratio.
f. Debt-to-equity ratio.
g. Times interest earned ratio.
h. Cash coverage ratio.

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HW 16: Greenfern Corporation (3)
• Refer to the preceding balance sheet and income statement for
Greenfern Corporation for the fiscal year ended July 31, 2017. Use the
DuPont identity to calculate the return on equity (ROE). In the
process, calculate the following ratios:
• net profit margin, total asset turnover, equity multiplier, EBIT
return on assets (EROA), and return on assets.

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The End of Session 3

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