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Analysis of Financial Statements: Chapter No.07
Analysis of Financial Statements: Chapter No.07
07
Analysis of Financial
Statements
What major financial ratios help analysts in the
following areas: stock valuation, estimating and
evaluating systematic risk, predicting the credit
ratings on bonds, and predicting bankruptcy?
4. Risk analysis
a. Business risk
b. Financial risk
Current Assets
Current Ratio
Current Liabilitie s
365
Average Invetory Processing Period
Annual Turnover
SAIF ULLAH, [email protected],
+923216633271
Evaluating Internal Liquidity
Cash conversion cycle combines information from
the receivables turnover, inventory turnover, and
accounts payable turnover
Receivable Days
+Inventory Processing Days
-Payables Payment Period
Cash Conversion Cycle
SAIF ULLAH, [email protected],
+923216633271
Evaluating Operating Performance
Ratios that measure how well management is
operating a business
(1) Operating efficiency ratios
Examine how the management uses its assets and capital,
measured in terms of sales dollars generated by asset or
capital categories
(2) Operating profitability ratios
Analyze profits as a percentage of sales and as a percentage of
the assets and capital employed
Net Sales
Total Asset Turnover
Average Total Net Assets
Net Sales
Fixed Asset Turnover
Average Net Fixed Assets
Gross Profit
Gross Profit Margin
Net Sales
Operating Profit
Operating Profit Margin
Net Sales
Net Income
Net Profit Margin
Net Sales
Net Income
Return on Total Equity
Average Total Equity
Operating leverage
Production has fixed and variable costs
Fixed production costs cause profit volatility with changes in
sales
Fixed production costs are operating leverage
= RR x ROE
g Percentage of Earnings Retained Return on Equity
where:
g = potential growth rate
RR = the retention rate of earnings
ROE = the firm’s return on equity Safdar
iqbal
Problem No.01
The Shamrock Vegetable Company has the following results:
Net sales $6,000,000
Net total assets 4,000,000
Depreciation 160,000
Net income 400,000
Long-term debt 2,000,000
Equity 1,160,000
Dividends 160,000
Required:
a. Compute Shamrock’s ROE directly. Confirm this using the three Du Pont
components.
b. Using the ROE computed in Part a, what is the expected sustainable growth
rate for Shamrock?
c. Assuming the firm’s net profit margin went to 0.04, what would happen to
Shamrock’s ROE?
d. Using the ROE in Part c, what is the expected sustainable growth rate? What
if dividends were only $40,000?