Financial Statement Analysis
Ratio Analysis Example
| Prufrock Corporation Balance Sheet as of December 31,2008 ($ in millions) | ||||||
| Assets | Liabilities and Owners’ Equity | |||||
| Current assets | Current liabilities | |||||
| Cash | $98 | Accounts payable | $344 | |||
| Accounts receivable | $188 | Notes payable | $196 | |||
| Inventory | $422 | Total | $540 | |||
| Total | $708 | Long-term debt | $457 | |||
| Fixed assets | Owners’ equity | |||||
| Net plant and equipment | $2,880 | Common stock and paid-in surplus | $550 | |||
| Total assets | $3,588 | Retained earnings | $2,041 | |||
| Total | $2,591 | |||||
| Total liabilities and owners’ equity | $3,588 |
| Prufrock Corporation 2008 Income Statement ($ in millions) | ||
| Sales | 2311 | |
| Cost of goods sold | 1344 | |
| Depreciation | 276 | |
| Earnings before interest and taxes | 691 | |
| Interest paid | 141 | |
| Taxable income | 550 | |
| Taxes (34%) | 187 | |
| Net income | 363 | |
| Dividends | 121 | |
| Addition to retained earnings | 242 |
*Create common size balance sheet and common size income statement.
*Calculate ratios for Prufrock Corporation
Short-term solvency or liquidity ratios
Liquidity ratio measures the firm’s ability to pay its bills over the short run without undue stress.
Current ratio=
*Do we have enough short-term liquid assets to cover our short-term debts?
Quick ratio (acid test ratio) =
*Do we have enough really liquid short-term assets to cover our short-term debts?
Long-term solvency, or financial leverage, ratios
Leverage ratio measures the form’s long-run ability to meet its obligations.
Total debt ratio=
What percentage of total assets is financed with either short- or long-term debt?
Debt-equity ratio=
Times interest earned=
* It measures how well a company has its interest obligations covered. Are we generating enough income to make out interest payments?
Asset management or turnover ratios
Turnover ratios measure asset use efficiency.
Inventory turnover=
*On average, how many times per year do we go through our inventory? (Excess inventory is expensive!)
Day’s sales Outstanding=
Fixed Assets Turnover Ratio=
Total Assets Turnover Ratio=
Profitability ratios
Operating margin=
Profit margin=
Return on assets (ROA) =
*What is profit per dollar of asset?
Return on equity (ROE) =
*What is the rate of return for stockholders?
Return on equity (ROE) = Profit margin * Total asset turnover * Equity multiplier
Market value ratios
(We assume that Prufrock has 33 million shares outstanding and stock sold for $88 per share at the end of the year.)
EPS=
Price-earnings ratio=
Market-to-book ratio=
4-1