Analyzing Profitability – From the textbook – Financial Analysis with Microsoft Excel Read Chapter 3 Review PPT Chapter 3. ***ATTACHED Usin
Analyzing Profitability –
From the textbook – Financial Analysis with Microsoft Excel
Read Chapter 3
Review PPT Chapter 3. ***ATTACHED
Using your financial statements from Southwest Airlines in Week 2, calculate the following ratios : ***ATTACHED (Professor comments to fix it: For your internet exercise, you need to follow the rules for Common Sized statements – also referred to as a vertical analysis. You need to make the sales = to 100% and it will be the denominator to everything on the income statement. Total Assets will be the denominator on the balance sheet.)
Gross Profit Margin, Operating Profit Margin, Current Ratio,
From the Red Company Software Materials –
Drilling down into the Dupont Analysis
Read Red Company Chapter 4 pages 35-57. ***ATTACHED
Watch the videos at the Red Company website on the Dupont Analysis (04A, 04B, 04C)
URL: https://www.youtube.com/watch?v=qRBHfpyTDU8
Complete Homework EX 4-1 through 4-10
Chapter 3
Financial Statement Analysis Tools
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Analysis Tools Covered in this Chapter
In this chapter will see:
How to calculate many financial ratios
How to use financial ratios to make predictions about potential bankruptcy
How to calculate the economic profit (as opposed to net income) that a firm earned in a period
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Financial Ratios
Financial ratios are simply comparisons of two financial statement items
These comparisons help us to draw conclusions about the financial health of the firm that aren’t immediately obvious by looking at the raw values (e.g., net income may be positive, but what matters is how large it is relative to sales, assets, or equity)
We will calculate five categories of ratios:
Liquidity ratios
Efficiency ratios
Leverage ratios
Coverage ratios
Profitability ratios
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Liquidity Ratios
Liquidity ratios describe the ability of a firm to meets its short-term obligations by comparing current assets to current liabilities
Current assets will be converted to cash which will then be used to retire current liabilities
For both ratios, higher values are indicative of a higher probability of being able to pay off short-term debts
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Efficiency Ratios
Efficiency ratios, also called asset management ratios, provide information about how well the company is using its assets to generate sales
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Leverage Ratios (1 of 2)
Leverage ratios describe the degree to which the firm uses debt in its capital structure
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Leverage Ratios (2 of 2)
Generally, lower leverage ratios are preferred though a reasonable amount of debt is usually considered to be a good thing
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Coverage Ratios
Coverage ratios describe the quantity of funds available to “cover” certain expenses, particularly interest expense (though this is not the only one)
We generally prefer higher coverage ratios as that indicates a level of debt that is easy for the firm to service
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Profitability Ratios (1 of 2)
Profitability ratios measure how profitable a firm is relative to sales, total assets, or equity
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Profitability Ratios (2 of 2)
Without exception, higher profitability ratios are preferred over lower ones
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
10
E P I’s Financial Ratios
The image to the right shows the calculations of all financial ratios that we discussed
These values were calculated using the financial statements given in Chapter 2
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
DuPont Analysis
DuPont analysis refers to a method of decomposing the return on equity into its components to better understand the R O E and why it may have changed (or why it is different than that of some other firm)
There are two versions of DuPont analysis:
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Using Financial Ratios
Financial ratios can be analyzed in three ways:
Trend Analysis
Comparing to Industry Averages
Compared to Company Goals and Debt Covenants
Additionally, ratios can be used in valuation analysis and for financial distress prediction
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Financial Distress Prediction (Z-Scores)
In 19 68, Edward Altman first used discriminant analysis to classify firms into one of three categories: bankruptcy predicted, possible bankruptcy, and no financial distress
Today, this model would be considered to be a “machine learning” model alongside other classification methods (e.g., k-means or support vector machines)
We covered two Z-Score models:
The Original Z-Score Model
The Z-Score Model for Private Firms
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Original Z-Score Model
The original Z-Score model was for publicly traded firms:
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + X5
where
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Z-Score Model for Private Firms
Altman also estimated a model for privately held firms to allow for the fact that you cannot calculate the market value of equity for a private firm
This model is very similar, but the coefficients changed (note that X4 has been redefined):
Z = 0.717X1 + 0.847X2 + 3.107X3 + 0.420X4 + 0.998X5
where
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Economic Profit Measures of Performance
Economic profit is the profit earned in excess of the firm’s costs, including its implicit opportunity costs (primarily its cost of equity, which is ignored by accounting profit)
Definition of Economic Profit:
Note that economic profit is often referred to as Economic Value Added (E V A), which is a trademark of Stern Stewart and Company
Timothy R. Mayes, Financial Analysis with Microsoft Excel, 9th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Current Assets
Current Ratio
Current Liabilities
=
Current AssetsInventories
Quick Ratio
Current Liabilities
–
=
Cost of Goods Sold
Inventory Turnover
Inventory
=
Credit Sales
Accounts Receivable Turnover
Accounts Receivable
=
Accounts Receivable
Average Collection Period
Credit Sales
360
=
Sales
Fixed Asset Turnover
Net Fixed Assets
=
Sales
Total Asset Turnover
Total Assets
=
Total Liabilities
Total Debt Ratio
Total Assets
=
Long-term Debt
Long-term Debt Ratio
Total Assets
=
Long-term Debt
LTD to Total Capitalization
Long-term DebtTotal Equity
=
+
Total Liabilities
Debt to Equity
Total Equity
=
Long-term Debt
LTD to Equity
Total Equity
=
EBIT
Times Interest Earned
Interest Expense
=
EBITNoncash Expenses
Cash Coverage Ratio
Interest Expense
+
=
Gross Profit
Gross Profit Margin
Sales
=
Net Operating Profit
Operating Profit Margin
Sales
=
Net Income
Net Profit Margin
Sales
=
Net Income
Return on Assets (ROA)
Total Assets
=
Net Income
Return on Equity (ROE)
Total Equity
=
Net Income
Return on Common Equity
Common Equity
=
Net IncomeSalesTotal Assets
DuPont ROE
SalesTotal AssetsTotal Equity
=´´
EBITEBTNet IncomeSalesTotal Assets
Extended DuPont ROE
SalesEBITEBTTotal AssetsTotal Equity
=´´´´
1
2
3
4
5
Total Assets
Retained EarningsTotal Assets
EBITTotal Assets
Market Value of EquityBook Value of Liab
ilities
SalesTotal Assets
Net WorkingCapital
X
X
X
X
X
=
=
=
=
=
1.8102.675
Bankruptcy
Predicted
Gray ZoneNo Financial
Distress
1
2
3
4
5
Total Assets
Retained EarningsTotal Assets
EBITTotal Assets
Book Value of EquityBook Value of Liabil
ities
SalesTotal Assets
Net WorkingCapital
X
X
X
X
X
=
=
=
=
=
1.212.90
Bankruptcy
Predicted
Gray ZoneNo Financial
Distress
Economic ProfitNOPATAfter-tax Cost of Op
erating Capital
NOPAT(Total Net Operating CapitalWACC)
=-
=-´
,
Red Company Homework
| Enter your answers below – numbers only with | ||||
| 2017 | 2016 | |||
| EX2-1 | % of net sales | % of net sales | ||
| 1 | Cost of Sales | 63.20% | 63.40% | |
| 2 | Gross profit | 36.70% | 36.50% | |
| 3 | selling, general, and admin expense | 22.50% | 22.50% | |
| 4 | operating earnings | 14.17% | 13.97% | |
| 5 | net earnings | 10.60% | 9.65% | |
| B. | Discuss which line item (Cost of sales or selling, general and administrative expense) helped to increase the operating earnings and net earnings as a % of Net Sales from 2016 to 2017 | This helped operating earnings and net earnings as a percent of sales go up from 2016 to 2017, because the cost of sales was a little less in 2017. This helped. | ||
| 2017 | 2016 | |||
| EX 2-2 | % of net sales | % of net sales | ||
| 1 | Total receivables, net | 12.25% | 11.79% | |
| 2 | Inventories, net | 22% | 22.17% | |
| 3 | Accounts payable | 14.17% | 13.61% | |
| 4 | Retained earnings | 7.50% | 7.88% | |
| 5 | Total stockholders' equity | 41.31% | 39.72% | |
| B. | Did liabilities or equity finance more of Toro's Total assets in 2017? | liabilities | ||
| 2017 | 2016 | |||
| EX-2-3 | % of net sales | % of net sales | ||
| 1 | Net sales | 4.72% | 0.05% | |
| 2 | Cost of sales | 4.21% | 2.40% | |
| 3 | Gross profit | 5.28% | 4.69% | |
| 4 | selling, general, and admin expense | 4.72% | 0.62% | |
| 5 | net earnings | 18.89% | 14.58% | |
| B. | Coment on the percent change in gross profit from 2016 to 2017 compared to the percent change in net sales from 2016 to 2017 | It is the percentage change in net sales from 2016 to 2017. Even though net sales have gone up a lot from last year compared to gross profit. | ||
| 2017 | 2016 | |||
| EX2-4 | % of net sales | % of net sales | ||
| 1 | Total receivables, net | $19,808 | 12.13% | |
| 2 | Inventories, net | $21,958 | 7.15% | |
| 3 | Accounts payable | $37,084 | 21.23% | |
| 4 | Retained Earnings | $54,285 | 11.30% | |
| B. | Comment on the percent change in inventory from 2016 to 2017 compared to the percent change in cost of sales from 2016 to 2017 | When you compare the percentage changes in inventory from 2016 to 2017 to the percentage changes in cost of sales from 2016 to 2017, you see that inventory changed more than cost of sales changed. | ||
Internet Exercise
| Big RockCandy Mountain Mining Co. | ||||
| Income Statement | ||||
| For the Year Ended Dec. 31,2020 | ||||
| 2020 | 2019 | |||
| Sales | 412,500 | 398,600 | ||
| Cost of Goods Sold | 318,786 | 315,300 | ||
| Gross Profit | 93,714 | 83,300 | =B5-B6 | |
| Selling and G&A Expenses | 26,250 | 24,550 | ||
| Other Expenses | 1,210 | 1,245 | ||
| Depreciation Expense | 29,800 | 29,652 | ||
| EBIT | 36,454 | 27,853 | =B7-SUM(B8:B10) | |
| Interest Expense | 8,582 | 8,457 | ||
| Earnings Before Taxes | 27,872 | 19,396 | =B11-B12 | |
| Taxes | 6,968 | 4,849 | =B13*B18 | |
| Netlncome | 20,904 | 14,547 | =B13-B14 | |
| Notes: | ||||
| Tax Rate | 0.25 | 0.25 | ||
| Shares | 52,100 | 52,100 | ||
| EPS | $0.40 | $0.40 | ||
| Big Rock Candy Mountain Mining Co. | ||||
| Balance Sheet | ||||
| As of Dec. 31,2020 | ||||
| Assets | 2020 | 2019 | ||
| Cash | 16,435 | 11,596 | ||
| Accounts Receivable | 45,896 | 47,404 | ||
| Marketable Securities | 3,656 | 619 | ||
| Inventory | 52,397 | 54,599 | ||
| Total Current Assets | 118,384 | 114,218 | =SUM(B5:B8) | |
| Gross Fixed Assets | 436,573 | 397,023 | ||
| Accumulated Depreciation | 87,450 | 57,650 | ||
| Net Plant & Equipment | 349,123 | 339,373 | =B10-B11 | |
| Total Assets | 467,507 | 453,591 | =B9+B12 | |
| Liabilities and Owner's Equity | ||||
| Accounts Payable | 37,752 | 36,819 | ||
| Accured Expenses | 3,183 | 3,085 | ||
| Total Current Liabilities | 40,935 | 39,904 | =SUM(B15:B16) | |
| Long-term Debt | 170,562 | 178,581 | ||
| Total Liabilities | 211,497 | 218,485 | =B17+B18 | |
| Common Stock | 58,664 | 58,664 | ||
| Additional Paid-In-Capital | 136,807 | 136,807 | ||
| Retained Earnings | 60,539 | 39,635 | ||
| Total Shareholder's Equity | 256,010 | 235,106 | =SUM(B20:B22) | |
| Total Liabilities and Owner's Equity | 467,507 | 453,591 | =B19+B23 | |
| Big Rock Candy Mountain Mining Co. | ||||
| Common Size Income Statement | ||||
| For the years 2019 and 2020 | ||||
| Income Statement | Common Size Income Statement | |||
| 2020 | 2019 | 2020 | 2019 | |
| Sales | 412,500.00 | 398,600.00 | 100.00% | 100.00% |
| Cost of Goods | 318,786.00 | 315,300.00 | 77.28% | 79.10% |
| Gross Profit | 93,714.00 | 83,300.00 | 22.72% | 20.90% |
| Depreciation | 29,800.00 | 29,652.00 | 7.22% | 7.44% |
| Selling & Admin. Expense | 26,250.00 | 24,550.00 | 6.36% | 6.16% |
| Other Operating Expense ___ | 1,210.00 | 1,245.00 | 0.29% | 0.31% |
| Net Operating Income | 36,454.00 | 27,853.00 | 8.84% | 6.99% |
| Interest Expense | 8,582.00 | 8,457.00 | 2.08% | 2.12% |
| Earnings Before Taxes | 27,872.00 | 19,396.00 | 6.76% | 4.87% |
| Taxes | 6,968.00 | 4,849.00 | 1.69% | 1.22% |
| Net Income | 20,904.00 | 14,547.00 | 5.07% | 3.65% |
| New Smyrna Surf Shop | ||||
| Statement of Cash Flows | ||||
| For the Year 2020 | ||||
| Cash Flows from Operations | ||||
| Net Income | 120.540.00 | |||
| Depreciation Expense | 7,148 | |||
| Change in Accounts Receivable | (11,248) | |||
| Change in Inventories | (8,276) | |||
| Change in Accounts Payable | 1,589 | |||
| Total Cash Flows from Operations | 109,753.00 | |||
| Cash Flows from Investing | ||||
| Change in fixed assets | (41,704) | |||
| Total Cash Flows from Investing | S (41,704) | |||
| Cash Flows from Financing | ||||
| Change in Notes Payable | (3,025) | |||
| Change in Long-Term Debt | 755 | |||
| Change in Common Stock | – | |||
| Change in Paid-In Capital | – | |||
| Cash Dividends | (60,000) | |||
| Total Cash Flows from Financing | (62,270.00) | |||
| Net Change in Cash Balance | 5,779.00 | |||
| Check answer against Balance Sheet | ||||
| Beginning Cash From Balance Sheet | 15,187 | |||
| Ending Cash From Balance Sheet | 20,966 | |||
| Net Change in Cash Balance | 5,779.00 | |||
