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Financial Analysis - Chapter 3
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TCU Ira Silver Financial Planning
Terms in this set (23)
Ratio Analysis and its importance
Financial ratios:
- used to weight and evaluate the operating performance of a firm
- numerical calculations and analyzing ratios
- used to compare performance record as against similar firms in the industry
Return on equity (ROE) =
profit/equity
DuPont analysis looks at the ________ asset turnover and uses it.
total
Profitability ratios: (3)
1. profit margin
2. return on assets (investment)
3. return on equity
Asset utilization ratios (5):
1. Receivable turnover
2. Average collection period
3. Inventory turnover
4. Fixed asset turnover
5. Total asset turnover
Liquidity ratios: (2)
tells how quickly a company can get money to pay bills
1. current ratio
2. quick ratio
Debt utilization ratios: (3)
tells about capital structure and ability to pay interest
1. debt to total assets
2. times interest earned
3. fixed charge coverage
Types of ratios: (4)
1. Profitability ratios
2. Asset utilization ratios
3. Liquidity ratios
4. Debt utilization ratios
Profitability ratios
Measure the firm's ability to earn adequate return on: sales, assets, invested capital
Asset utilization ratios
Measure the speed at which the firm is turning over: accounts receivable, inventory, LT assets
Liquidity ratios
Ability to pay off ratios
Emphasized the firm's ability to pay off ST obligations as they come due
Debt utilization ratios
Estimates the overall debt position of the firm
Evaluates in the light of asset base and earning power
For potential investors/security analysts, there are two considerations of importance of ratios
Primary: profitability ratios
Secondary: liquidity and debt utilization
For banker or trade creditor
Liquidity ratios
(if they lend the money, they want to make sure they get it paid back)
For LT creditors
Debt utilization ratios and profitability ratios
Profitability ratios equations
Profit margin = Net Income / Sales
Assets turnover = sales / assets
Return on assets (investment) = net income / assets
OR
ROA = Profit margin * assets turnover
DuPont System of Analysis - return on assets
A satisfactory ROA might be derived through:
- a high profit margin
or
- a rapid assets turnover (generating more sales per dollar of its assets)
or
- a combo of both!
ROA (investment) = profit margin * asset turnover
DuPont System of Analysis - return on equity
A satisfactory return on equity might be derived through:
- a high return on total assets
- a generous utilization of debt
or
- a combo of both
ROE = (ROA) / (1 - debt/assets)
*** the more debt you have, any money you make will be magnified... so the ROE is the ROA times the FLM
Asset utilization ratios relate the balance sheet (assets) to the income statement (sales)
Total asset turnover = sales / assets
Liquidity ratios determine if the firm can meet each maturing obligation as it comes due
current ratio = current assets/current liabilities
quick ratio = current assets - inventory / current liabilities
*** you want the current ratio to be high!
Debt utilization ratios measure the prudence of the debt management policies of the firm
Debt to total assets = total debt/total assets
Times interest earned = income before interest and taxes / interest
Fixed charge coverage = income before fixed charges and taxes / fixed charges
an analysis that gives a picture of performance over a number of years against industry averages
trend analysis
Impact of inflation on financial analysis... inflation:
- revenue is stated in current dollars
- plant, equipment, or inventory may have been purchased at lower price levels
- profits may be more a function of increasing prices than of satisfactory performance
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