Financial Statement AnalysisCase 13-2

Financial StatementsBalance SheetIncome StatementStatement of Cash Flows

Balance SheetA Financial Picture of what a company is worth as of a particular date.

ASSETSHow much a company owns

LIABILITIES OWNERS EQUITYHow much the company owesHow much the company is worth

Income StatementA financial report which tells how well a company is performing during a specific period of time. (its profitability or net profit)

SERVICE BUSINESSREVENUES OPERATING EXPENSE = NET INCOME

RETAIL BUSINESSREVENUES COST OF GOODS SOLD = GROSS PROFIT OPERATING EXPENSE = NET PROFIT

Cash Flows StatementProvides information about a companys investing and financing activities during the accounting period.

Business ObjectiveCreate value for its shareholders, while maintaining a sound financial position.Profitability.Return on investment

Financial Ratios

ClassificationOverall measuresProfitabilityInvestment utilizationFinancial condition

Overall MeasuresReturn On InvestmentsReturn on AssetsReturn on Invested CapitalReturn on Equity

Return On Investments

RETURN ON ASSETS- measures success in using assets to earn profit.ROA = Net Income + Interest (1- Tax rate) Total Assets

RETURN ON INVESTED CAPITAL-how effective the company uses the money invested in its operations.ROIC= Net Income + Interest (1- Tax rate) Long-term liabilities + Shareholders Equity

RETURN ON EQUITY-shows relationship between net income and common stockholders equity. ROE= Net Income . Shareholders Equity

Profitability Gross Margin PercentageProfit Margin (ROS)

Profitability

GROSS MARGIN PERCENTAGE-measures the percentage of each sales dollar a company earns before considering period costs.Gross Margin Percentage= Gross Margin . Net Sales Revenues

PROFIT MARGIN- shows the percentage of each sale earned as net income. ROS = Net Income . Net Sales Revenues

Investment UtilizationAsset TurnoverDays CashDays ReceivablesDays InventoriesInventory TurnoverCurrent RatioAcid test Ratio

Investment Utilization

ASSET TURNOVER- a measure of how efficiently a company's assets generate revenue.Asset Turnover = Sales Revenues . Total Assets

Days CashDays Cash = Cash . Cash Expense / 365

Investment Utilization

Days InventoryDays Inventory = Inventory . Cost of Sales / 365

Days Receivables- measures the ability to collect receivables. Days Receivables = Account Receivables . Sales / 365

Investment Utilization

INVENTORY TURNOVER- indicates how rapidly inventory is sold.Asset Turnover = Cost of Sales . Inventory

CURRENT RATIO - measures ability to pay current liabilities with current assets.Current Ratio = Current Assets . Current Liabilities

ACID-TEST RATIO- tells whether the entity can pay all its current liabilities if they come due immediately.Acid Test Ratio = Monetary Current Assets . Current Liabilities

Financial ConditionDebt/Capitalization RatioTimes Interest Earned Ratio

Financial Condition

DEBT/ CAPITALIZATION RATIO- this ratio computes the proportion of a company's long-term debt relative to its available capital.Debt / Capitalization = Long-Term Liabilities . Long-Term Liabilities + Shareholders Equity

TIMES INTEREST EARNED RATIO- measures the number of times that operating income can cover interest expense.Times Interest Earned = Pretax Operating Profit + Interest Interest

CASE 13-2Amerbran Company (B)

CASE 13-2 AMERBRAN COMPANY (B)BACKGROUNDAmerbran Company was a diversified company that sold various consumer products, including food, tobacco, distilled products and personal care products and financial services.

Statement of the ProblemCalculate the ratios listed using the year end amounts for ratios that involve balance sheet data.

Comment on Amerbrans treatment of excise taxes as part of the calculation for gross margin

As an outside analyst, what questions would you want to ask Amerbrans management based on the ratios you have calculated?

Analysis

Questions Comment on Amerbrans treatment of excise taxes as part of the calculation for gross margin.Excise tax should not be included in the calculation of gross margin as excise tax is a tax on the sale or production for sale of specific goods. Therefore, excise tax is a selling expense which shall be included in the selling, general & administrative expenses.

QuestionsAs an outside analyst, what questions would you want to ask Amerbrans management based on the ratios you have calculated?

1. Return on Assets What is the reason for the decrease in ROA from 20x0 to 20x1?

a. Lower Net Income in 20x1 and Higher Assets in 20x1 due to acquisition of additional PPE

b. Recommendation is to maximize the use of assets in generating revenue for the next years of the operation

2. Return on Equity What is the action plan to increase your ROE so as to attract more investors in your company?a. Increase net income by reducing unnecessary expenses, take advantage of discounts and reduce cost purchases.

3. Gross Profit What is the action plan to maintain the profitability of the company?a. Maintain the profitability of the company by taking advantage of discounts and reducing unnecessary expenses.

4. Return on Sales What is the action plan to increase the return on sales for the next years to come?a. Decrease in unnecessary operating expenses so as to increase the net income generated by the company.

5. Asset Turnover What is the action plan to maintain/ increase the asset turnover of the company?a. Maximize the sales of the products through price strategies while maximizing the use of the companys assets.

6. Days Cash What is the action plan of the company to increase the days cash? a. Decrease unnecessary expenses to be liquid.

7. Days Receivables How will the company maintain/ shorten the time that the receivables be collected?a. The company can either maintain their days receivable or shorten the collection period by providing a shorter date of receivables from their clients.

8. Days Inventory How can the company shorten their days inventory?a. The company can shorten their days inventory by maximizing the use of their fixed assets in hastening the production of their products.

9. Inventory Turnover How can the company maintain/ increase their inventory turnover?a. The company can maintain/ increase their inventory turnover by maximizing their assets by decreasing the decrease the amount of inventory through production while maintaining a low cost of sales.

10. Current Ratio How can the company increase their liquidity?a. The company can increase their liquidity by decreasing their current liabilities such as short term loans and decreasing their accounts payables

11. Acid Test Ratio How can the company increase their liquidity?The company can increase their liquidity by decreasing their current liabilities such as short term loans and decreasing their accounts payables and at the same time increase their cash on hand and other cash equivalents.

12. Debt to Capitalization Ratio How can the company decrease their long term liabilities?a. The company can decrease their long term liabilities by attracting more investors to invest in the company instead of borrowing money.

13. Times Interest Earned How can the company decrease the interest expense?a. The company can decrease their interest expenses by attracting more investors to invest in the company instead of borrowing money.

Alternative ActionWe can use the Dupont Model in order to determine the profitability, and return on investments for the company.

ConclusionBased on the numbers and ratios of the financial statements of Amerbran Company, it can be concluded that Amerbran Company is liquid and solvent to continue its operating process. It has a high profitability based on the gross margin percentage from 20x0 to 20x1 (60.87% to 63.22%). Its investment utilization has improved from 20x0 to 20x1. Based on the numbers given, they have improved their days receivable from 38 days to 36 days. They have also increased their inventory turnover by 0.15 (from 20.10 to 2.25) while decreasing their days inventory hold of 162 days from 174 days.

THANK YOU

*)*Return on assets measures the amount of profit the company generates as a percentage of the value of its total assets.The profit percentage of assets varies by industry. For this reason it is often more effective to compare a company's ROA to that of other companies in the same industry or against its own ROA figures from previous periods. Investors and analysts should bear in mind that the ROA does not account for outstanding liabilities and may indicate a higher profit level than actually derived.

Return on invested capital (ROIC) is a profitability ratio. It measures the return that an investment generates for those who have provided capital, i.e. bondholders and stockholders. ROIC tells us how good a company is at turning capital into profits.A firm's ROIC can be an excellent indicator of the size and strength of its moat. If a company is able to generate ROIC of 15-20% year after year, it has developed a great method for turning investor capital into profits.ROIC is especially useful for companies that invest a large amount of capital, like oil and gas firms, computer hardware companies, and even big box stores. As an investor, it's important to know that if a company takes your money, you'll get an adequate return on your investment.

Return on equity (ROE) is a measure of profitability that calculates how many dollars of profit a company generates with each dollar of shareholders' equity. ROE is more than a measure of profit; it's a measure of efficiency. A rising ROE suggests that a company is increasing its ability to generate profit without needing as much capital. It also indicates how well a company's management is deploying the shareholders' capital.

*Gross margin is important because it reflects the core profitability of a company before overhead costs, and it illustrates the financial success of a product or service. Gross margin is used to calculate gross profit margin, which is calculated by simply dividing gross margin by total revenue (gross margin / total revenue). Calculating gross profit margin allows you to compare similar companies to each other and to the industry as a whole to determine relative profitability.Companies with higher gross profit margins have a competitive edge over rivals, whether because they can charge a higher price for good/services (as reflected in higher revenues) or because they pay less for direct costs (as reflected in lower costs of goods sold).

*The asset turnover ratio is a measure of how efficiently a company's assets generate revenue. It measures the number of dollars of revenue generated by one dollar of the company's assets.

In general, a low asset turnover ratio suggests problems with excess production capacity, poor inventory management, or lax collection methods. Increases in the asset turnover ratio over time may indicate a company is "growing into" its capacity (while a decreasing ratio may indicate the opposite), but remember that asset purchases made in anticipation of coming growth (or the sale of unnecessary assets in anticipation of declining growth) can suddenly and somewhat artificially change a company's asset turnover ratio.Low-margin industries tend to have higher asset turnover ratios than high-margin industries because low-margin industries must offset lower per-unit profits with higher unit-sales volume. Additionally, capital-intensive companies will typically have lower asset turnover ratios than companies using fewer assets. This is why comparison of asset turnover ratios is generally most meaningful among companies within the same industry, and the definition of a "high" or "low" ratio should be made within this context.

*Days Receivable) is important because the speed at which a company collects cash is important to its efficiency and overall profitability. The faster a company collects cash, the faster it can reinvest that cash to make more sales.

*The inventory turnover ratio measures the rate at which a company purchases and resells products to customers. In general, low inventory turnover ratios indicate a company is carrying too much inventory, which could suggest poor inventory management or low sales. Excess inventory ties up a company's cash and makes the company vulnerable to drops in market prices. Conversely, high inventory turnover ratios may indicate a company is enjoying strong sales or practicing just-in-time inventory methods. High inventory turnover also means a company is replenishing cash quickly and has a lower risk of becoming stuck with obsolete inventory. However, higher is not always better, and exceptionally high inventory turnover may indicate a company is running out of items frequently or making ineffective purchases and therefore losing sales to competitors.It is important to understand that the timing of inventory purchases, particularly those made in preparation for special promotions or new-product introductions, can suddenly and somewhat artificially change the ratio.

The current ratio is the ratio of current assets to current liabilities.Tracking the current ratio and other liquidity ratios helps an investor assess the health of a company.A high current ratio indicates that a company is able to meet its short-term obligations. In the example above, if all of XYZ's current liabilities came due on January 1, 2010, XYZ would be able to meet those obligations with cash.

The acid-test ratiois a measure of how well a company can meet its short-term financial liabilities.

Obviously, it is vital that a company have enough cash on hand to meet accounts payable, interest expenses, and other bills when they become due. The higher the ratio, the more financially secure a company is in the short term. A common rule of thumb is that companies with a Acid-Test orquick ratio of greater than 1.0 are sufficiently able to meet their short-term liabilities.*Long-Term Debt to Capitalization Ratio A variation of the traditional debt-to-equity ratio, this ratio computes the proportion of a company's long-term debt relative to its available capital. By using this ratio, investors can identify the amount of leverage utilized by a specific company and compare it with others to help analyze the company's risk exposure. Generally, companies that finance a greater portion of their capital through debt are considered riskier than those with lower leverage ratios.

The interest coverage ratio, also known as times interest earned, is a measure of how well a company can meet its interest-payment obligations.In general, a high coverage ratio may suggest a company is "too safe" and is neglecting opportunities to magnify earnings through leverage. An interest coverage ratio below 1.0 indicates that a company is not able to meet its interest obligations. Because a company's failure to meet interest payments usually results in default, the interest coverage ratio is of particular interest to lenders and bondholders and acts as a margin of safety. However, because the interest coverage ratio is based on current earnings and current expenses, it primarily focuses a company's short-term ability to meet interest obligations.**