Author:CollinsQianRatioAnalysisAgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeawaysAnalyzingRatiosRatiosinisolationaremeaningless.Apany'sratiosmustbeexaminedovertimeand/oragainstitspetitors’ratios.Historicalparisonpetitiveparisonparepresentratioswithsamepany'shistoricalratiosInstablesituations,historicalratiosmaybeusedtoprojectfutureperformancepareapany’sratioswithsimilarfirms’ratiosorwithindustryaveragesatthesamepointintimeLookfortrendsLookatrelativeperformanceTheArtofRatioAnalysisWhichratiosaremostimportantinagivensituation?Whatitemsshouldbeincluded/excludedincalculatingtheratios?Howmuchinfluencedoesmanagementhaveovertheratios?Whatdotheratiossayaboutthefirm’sstrategy?Ratioanalysisisanartaswellasascience.TheNeedforJudgmentPotentialProblemManagementcansubstantiallyinfluencefinancialsintheshorttermImplicationsNeedtousejudgmenttounderstandfinancialsRatioanalysisrequireskeenjudgment.Financialstatementdataishistorical,notproformaCrosspanyparisonsaremeaninglessifadjustmentsarenotmadefordifferentaccountingconventionsThetimingofthereportingperiodinfluencesfundsflowsandrequirementsNeedtounderstandthathistorydoesNOTnecessarilypredictfutureNeedtobeverysensitiveaboutindustry-specificseasonalityandcyclicalityNeedtostandardizeacrosspaniestoadjustfordifferentaccountingmethodsAgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeawaysTypesofRatiosRatioshelpusunderstandhowwellapanyisperforming.Specifically,howmuchreturnisitgeneratingwithwhatlevelofrisk?Howwelldoesthepanymanagecostsrelativetorevenues?ReturnRiskCoverageInterestchargeFixedchargecoverageLiquidityCurrentratioQuickratioLeverageAssettoequityDebttoequityDebttototalcapitalTurnover

ReceivablesInventoryPayablesAssetProfitabilityOperatingmarginROSGrossmarginHoweffectiveisthepanyinmanagingitsresources?Whataretherespectiveclaimsofdebtandequityowners?Howriskyisthebusiness?Isthepanyabletomeetitsshort-termobligations?Isthepanyabletomeetitslong-termobligations?ProfitabilityRatios-DefinitionsProfitabilityratiosuselineitemsfromtheiestatement.RatiosDefinitionsGrossprofitmargin(orgrossmargin)Sales-costofgoodssoldSalesOperatingprofitmargin(oroperatingmargin)EarningsbeforeinterestandtaxesSalesReturnonsales(ROS)ProfitaftertaxSalesEffectivetaxrate*TaxesProfitbeforetaxProfitabilityRatios-DescriptionProfitability(ormargin)ratiosareafunctionofboththeindustryandapany'spositionwithintheindustryboundariesaresetbytheoperatingcharacteristicsoftheindustrywithintheseboundariesprofitabilityratiosaredeterminedbyaplayer’srelativepositionBaintypicallyusesgrossprofitandoperatingprofittomeasureprofitabilityROScanbealteredbynon-operatingactivities,suchassourcesoffinancingortaxratemanipulationsExtraordinaryitems,becausetheyareforunusualevents,suchasdiscontinueditemsorassetsales,areexcludedwhenweanalyzetheperformanceofthebasebusinessProfitabilityratiosmeasureafirm’sabilitytomanagecostsrelativetorevenues.ProfitabilityRatios-OverTimeGrossprofitmarginshouldstayconstantorincreasebecausecostofgoodssoldshouldbeaconstantpercentofsalesorshoulddecreaseaspanygetspriceincreasesand/orvolumediscountsOperatingmarginshouldincreaseasfixedadministrativeandsalescostsarespreadoveragreaternumberofunitsEffectivetaxrateshouldstayconstantordecreasesincealargerfirmisabletotakeadvantageofmoretaxsheltersAsapanygrows,itsreturnonsalesshouldincrease.HigherreturnonsalesProfitabilityRatios-MarketLeaderGrossprofitmarginshouldbehighersinceamarketleadercantypicallychargemoreforitsgoodsand/orreceivethegreatestvolumediscountsfromsuppliersOperatingprofitmarginshouldbesignificantlyhigher,becausehighervolumemeansfixedcostsarespreadovermoreunitsandbecausethegrossprofitmarginishigherThereshouldbenosignificantdifferenceintheeffectivetaxrateReturnonsalesshouldbesignificantlyhigherbecausetheoperatingmarginshouldbesignificantlyhigherThemarketleaderinanindustryshouldhavethebestprofitabilityratios.ThisisconsistentwiththeROS/RMSconceptwhichsaysthatpanieswithhighrelativemarketsharehavehighreturnsonsalesTurnoverRatios-DefinitionsTurnoverratiosuseabinationofiestatementandbalancesheetitems.RatiosDefinitionsReceivablesturnoverCreditsalesinperiod*AccountsreceivableaveragebalanceInventoryturnoverCostofgoodssoldinperiodAverageinventoryinperiodPayablesturnoverPurchasesonaccount**AccountspayableaveragebalanceAssetturnoverSalesinperiodAverageassetsAnyturnoverratiocanbeexpressedasaperiodratiowhichmeasuresthenumberofdaysinthecycleDaysinperiod***TurnoverratioPeriodratio=TurnoverRatios-TransactionCycleItiscriticalforafirmtomanageitspayables,inventory,andreceivables.*CashinflowCashcollectedforsalesmadeCashoutflowRawmaterialspurchasedCashdisbursedforrawmaterialspurchasedFinishedgoodsinventorySalesmadeAccountsreceivableperiodAccountspayableperiodXXXTurnoverRatios-DescriptionTurnoverratiosmeasureshowmanytimesperyearagivenresourceisconsumedPeriodratiosmeasurethenumberofdaysthatistakesforagivenresourceto“turnover”Management’sobjectiveistostretchouttheaccountspayableperiod(i.e.,havelowaccountspayableturnover)andshortentheperiodsforaccountsreceivableandinventory(i.e.,havehighaccountsreceivableandinventoryturnover)Turnoverratiosmeasurehowwellafirmismanagingitsresources.TurnoverRatios-TradeoffsRatioImprovementsDecreasethereceivablescollectionperiodi.e.,collecttheaccountsreceivablefasterDecreasetheinventoryholdingperiodi.e.,sellpletedproductsfasterIncreasetheaccountpayableperiodi.e.,takelongertopaysuppliersStrategicTradeoffIfthereceivablescollectionperiodistooshort,customersmaybuyatapetitorthathasmoregenerouscreditterms.(Oftenthisperiodisdictatedbyindustrynorms)Iftheinventoryholdingperiodistooshortthepanymaynothaveenoughinventorytofillabigorder.Also,thepanymaynotbeabletooutlastastrike,eitheratitsownfacilityoratoneofitsprimarysuppliers’facilitiesIftheaccountspayableperiodistoolong,supplierscouldraisetheirprices,chargeinterest(oftenatveryhighrates),orevenrefusetosupplythefirmoncredit.Also,workersmaygetrestlessiftheyhavetowaitlongertoreceivetheirpaychecks.Managingturnoverratiosmeansmanagingstrategictrade-offs.LeverageRatios-DefinitionsLeverageratiosuselineitemsfromthebalancesheet.Ratios*DefinitionsDuPontleverageratioAssetsEquityDebttoequityratioLong-termdebtEquityDebttototalcapitalordebttototalassetsratioTotalliabilitiesDebt+equityTotalliabilitiesAssets=LeverageRatios-DescriptionMoneycanberaisedfromdebtsources(banks,bondmarkets)orequitysources(stockholders)LeverageratiosreflectboththefinancingpoliciesofthefirmandtheriskinessofthebusinessInordertoanalyzeafirm’sleverageratios,oneneedstounderstandthedefinitionsofdebtandequityLeverageratiosmeasuretherespectiveclaimsofdebtandequityholders.DebtVersusEquityContractualpaymentsoverthelifeoftheloanInvestorlegallyguaranteedfullreturnofprincipleplusinterestnothingabovethatIncaseofliquidation,debtorhaspreferentialclaimonproceedsfromsaleofassetsNoguaranteedpaymentsfrommonstockInvestor“owns”partoffirmrighttoappreciationoffirm’svalueIncaseofliquidation,equityownertakeswhatisleft(maybenothing)Debtandequityhaveverydifferentcharacteristics.Debt=anythingthatcontractuallyrequirespaymentstobemadebeforetheequityholdershaveaccesstothefirm’searningsEquity=thevalueofthefirmleftoverafterallthedebtholdershavebeenpaidLowerrisktoinvestor;investordemandslowerreturnHigherrisktoinvestor;investordemandshigherreturnDebtQuestions-DebtandEquityDebtinLeverageRatiosBaintypicallylooksonlyatlong-termdebt(debtwithatermof1yearormore)Accountantsmeasuredebtasshort-termdebtpluslongtermdebtEquityinLeverageRatiosBaintypicallyusesthemarketvalueofequity(I.e.,thesharepricemultipliedbythenumberofshares).Othersmayusethebookvalueofequity,whichistheamountshownonthebalancesheetDebtQuestionsAccountspayable ?Short-termdebt ?Long-termdebt ?Cancelableleases ?Noncancelableleases ?Preferredstock ?monstock ?Deferredtax ?Wouldyoudefinethefollowingasdebt?DebtAnswersAccountspayable Short-termdebt Long-termdebt Cancelableleases Noncancelableleases Someitemsareclearlydebt,othersareclearlynotdebt,stillothersaredebatable.Notdebt.Itispartofworkingcapital,andis“secured”bytheinventoryandreceivablesthatitisusedtofinanceDebt,ifitusedtofinancecapitalexpansionsofthepanyNotdebt,ifitusedtofinanceworkingcapitalDebt.Notdebt.Becausetheyarecancelable,theyarenotcontractualobligationsDebt.Becausetheyarenon-cancelable,theyarecontractualobligations.(ForallpubliclytradedUSpanies,thepresentvalueofallthenoncancelableleasepaymentsmustbedisclosedinbalancesheetfootnotes.)Debatable

Argumentforequity-contractualobligationstopaydividendsonpreferredstockaremetafterdebtholders’claimsaremetArgumentfordebt-thereisacontractualobligationtopaydividendsonpreferredstockbeforemonstockdividendpaymentscanbemadeNotdebt.ItisequitymonstockPreferredstockLiquidityandCoverageRatios-DefinitionsLiquidityratiosuselineitemsfromthebalancesheet.Coverageratiosuselineitemsfromtheiestatement.RatiosDefinitionsCurrentratioCurrentassetsCurrentliabilitiesQuickratio(acidtest)Cash+marketablesecurities+receivablesCurrentliabilitiesInterestcoverageratioEarningsbeforeinterestandtaxesInterestexpenseFixedchargecoverageEarningsbeforeinterestandtaxesAllessentialpayments(includingleasepayments)Liquidity:Coverage:LiquidityandCoverageRatios-DescriptionAcceptablevaluesfortheseratiosdifferbyindustry.However,whenthecurrentratioorcoverageratiosfallbelow1thatmeansthefirmisunabletomeetitsobligationsItisausefulexercisetocalculatehowmuchrevenuecoulddrop(orcostsrise)beforecoveragewoulddropbelow1Liquidityratiosmeasurethefirm’sabilitytomeetitsshort-termobligations.Coverageratiosmeasurethefirm’sabilitytomeetitslong-termobligations.AgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeawaysReturnonEquityReturnonequityisdefinedasprofitaftertax(earnings)dividedbyequity.Itrelateseconomicoutputs(profit)toinputs(equity).Ittellsustheamountofprofitsthepanyearnedoneachdollarthestockholdersinvestedinthefirm.Itisimportanttonotethatnotalloftheearningsarepaidtothestockholderswhentheyareearned.Onlysomeportionoftheearningswillbereturnednowintheformofdividends.Theremainder(retainedearnings)willbere-investedinthepanytofinancegrowthThesizeofthedividedisdecidedbytheboardofdirectors;anindividualstockholderhasnoinfluenceoverwhenhe/sheactuallyreceivesthereturnthathe/shehasearnedItisabinationofprofitability,turnover,andleverageratiosReturnonequity,ROE,istheacidtestofsuccessforabusiness.DuPontFormulaByseparatingROEintoitsponents,onecangaininsightintohowtoimprovetheperformanceofabusiness.ROE=ProfitaftertaxEquityROE=ProfitaftertaxSalesSalesAssetsAssetsEquityXXReturnonAssetsLeverageROSAssetturnoverThisisknownastheDuPontformulaROE= ProfitabilityXTurnoverXLeverageAgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeawaysUnidentifiedIndustriesExerciseTheobjectiveofthisexerciseistotestyourunderstandingoffinancialratios.Exercise:Thebalancesheets(inpercentageform)andselectedratiosforsixindustriesaregivenonthefollowingpage.PleasematcheachofthesixindustriestothefinancialinformationCoalminingGrocerystoresHotelsandmotelsLegalservicesPackagedsoftwarePotatochipsandsnacksUnidentifiedIndustriesExercise-DataIndustryBalanceSheet(%)ABCDEF*Ratiosdonottietobalancesheetitemsbecausetheywerecalculatedusingaslightlydifferentdataset.**ThisisNOTinventoryturns.InventoryturnswouldbeCOGStoinventory.***SalestoassetsSource:"IndustryNormsKeyBusinessRatios,"Dun&BradstreetCashAccountsreceivableNotesreceivableInventoryOthercurrentTotalcurrentassetsFixedassetsOthernon-currentassetsTotalassetsAccountspayableBankloansNotespayableOthercurrentliabilitiesTotalcurrentliabilitiesOtherlong-termliabilitiesDeferredcreditsNetworthTotalliabilities&networthRatios*Quickratio(times)Currentratio(times)Totalliabilitiestonetworth(%)Collectionperiod(days)Salestoinventory(times)**Assetsturns***(times)Grossmargin(%)Returnonsales(%)Returnonassets(%)Returnonequity(%)

9.8%4.00.61.44.620.465.114.5

100.0%3.60.12.411.817.944.60.337.2

100.0%0.7x1.2x127%9.1days78.5x0.7x64%7%5%14%

9.3%21.20.22.02.735.451.712.9100.0%15.23.315.133.625.540.9

100.0%0.9x1.1x87%52.2days7.9x1.9x38%3%7%16%

4.8%28.614.64.552.535.112.4

100.0%15.40.40.414.030.217.51.750.6

100.0%1.6x2.5x62%30.9days23.7x2.9x29%2%5%7%

14.1%5.30.932.63.956.830.412.8

100.0%15.70.23.011.630.522.00.347.2100.0%0.6x1.9x93%2.6days19.0x5.0x22%1%6%13%

31.0%18.80.80.713.965.226.08.8

100.0%4.00.44.826.335.510.81.252.5

100.0%1.4x1.9x67%51.8days63.1x4.0x57%12%20%29%

22.1%32.20.54.78.568.018.613.4100.0%10.60.22.023.336.110.31.652.0

100.0%1.5x2.0x74%65.3days39.9x1.9x59%6%10%19%UnidentifiedIndustriesExercise-Answer

Characteristics:Financialratios:HotelsandMotelsVeryhighfixedassetsLowinventoryShortcollectionperiodLowassetturnoverHighgrossmarginHighleverageFixedassets=65%Inventory=1%Collectionperiod=9daysAssetturns=0.7xGrossmargin=64%Totalliabilitiestonetworth=127%CoalMiningVeryhighfixedassetsLowinventoryLongcollectionperiodFixedassets=52%Inventory=2%Collectionperiod= 52daysPotatoChips&SnacksLowpercentageofcashLongcollectioncycleCash=5%Collection=31daysGroceryStoresHighpercentageofcashLowaccountsreceivableShortcollectionperiodHighinventoryGoodliquidityratiosCash=14%Accountsreceivable=5%Collectionperiod=3daysInventory=33%Quickratio=0.6x;currentratio=1.9xLegalServicesHighpercentageofcashAlmostzeroinventoryHighassetturnoverHighprofitabilityLongcollectionperiodCash=31%Inventory=1%Assetsturns=4.0xGrossmargin=57%;ROS=12%;ROE=29%Collectionperiod=52daysPrepackagedSoftwareHighpercentageofcashHighaccountsreceivableLowinventoryHighgrossmarginLowfixedassetsSignificantintangibleassets(patents)Cash=22%Accountsreceivable=32%Inventory=5%Grossmargin=59%Fixedassets=19%Othernon-currentassets=13.4%GilletteExerciseExercise:PleasecalculateGillettepany’skeyfinancialratiosbasedonits1996annualreportProfitabilityTurnoverLeverageLiquidityandcoverageTheobjectiveofthisexerciseistotestyourabilitytocalculatekeyfinancialratios.Note:Forthisexercise,donotincludemerger-relatedcostsinthecalculations.GilletteExercise-ProfitabilityRatiosRatiosGilletteRatioCalculationsGrossprofitmargin(orgrossmargin)Sales-costofgoodssoldSalesOperatingprofitmargin(oroperatingmargin)Earningsbeforeinterestandtaxes**SalesReturnonsales(ROS)Profitaftertax**SalesEffectivetaxrate*TaxesProfitbeforetax6,016.09,697.7==62%2,049.39,697.7=

=21.1%1,231.79,697.7==12.7%576.31,525.0==37.8%(p.24)(p.24)(p.24,p.27)(p.24)PageNumberin1996AnnualReport1,636.3+413.09,697.7=948.7+283.09,697.7=GilletteExercise-TurnoverRatiosRatiosGilletteRatioCalculationsReceivablesturnoverCreditsalesinperiod*Accountsreceivableaveragebalance9,697.7(2,724.6+2,290.8)/2==3.87(p.24,p.25)or3653.87=94daysInventoryturnoverCostofgoodssoldinperiodAverageinventoryinperiod3,681.7(1,358.2+1,267.6)/2=2.80(p.24,p.25)or3652.80=130days=PayablesturnoverPurchasesonaccount**Accountspayableaveragebalance3,681.7(547.3+498.0)/2

=7.04(p.24,p.29)or3657.04=52days=AssetturnoverSalesinperiodAverageassets9,697.7(10,435.3+8,940.1)/2

=1.00=PageNumberin1996AnnualReportGilletteExercise-LeverageRatios

Ratios*GilletteRatioCalculationsDuPontleverageratioAssetsEquityDebttoequityratioLong-termdebt**EquityDebttototalcapitalordebttototalassetsratio10,435.34,490.9==2.32(p.25)14.5+1,490.4+298.94,490.9==0.40(p.25)5,944.410,435.3==0.57(p.25)PageNumberin1996AnnualReport1,803.84,490.9=TotalliabilitiesDebt+equityTotalliabilitiesAssets=GilletteExercise-LiquidityandCoverageRatiosRatiosGilletteRatioCalculationsCurrentratioCurrentassetsCurrentliabilitiesQuickratio(acidtest)Cash+marketablesecurities+receivablesCurrentliabilitiesInterestcoverageratioEarningsbeforeinterestandtaxes*InterestexpenseFixedchargecoverageEarningsbeforeinterestandtaxes*Allessentialpayments(includingleasepayments)Liquidity:Coverage:4,753.22,934.7==1.62(p.25)76.9+7.0+2,724.62,934.7==0.96(p.25)2,049.3-44.476.8-9.9==29.97(p.24)2,049.3-44.4(76.8-9.9)+93.0==12.54(p.24,p.31)PageNumberin1996AnnualReportAgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeawaysForecastingExercise-DataTheNewEnglandRazorpanyStatementofOperations($Millions)Revenues-COGS=Grossprofit-SG&A=EBIT-Taxes=NetieWorkingCapitalBalanceSheet(yearend)($Millions)Accountsreceivable+Inventory-Accountspayable=Networkingcapital**CashFlowStatement($Millions)EBIT+Depreciation-Increaseinworkingcapital-Taxespaid1995$8,834(6,769)2,065(266)1,799667$1,132$2,291269(1,610)$950$1,799266(96)(667)(593)$7091996$9,698(7,356)2,342(293)2,049(760)$1,289$2,725309(1,965)$1,069$2,049293(119)(760)(729)$7341997AssumptionsUsingabbreviatedfinancialstatementsforTheNewEnglandRazorpanyin1995and1996,forecastthestatementsfor1997.*ForecastingExercise-AnswerTheNewEnglandRazorpanyStatementofOperations($Millions)Revenues-COGS=Grossprofit-SG&A=EBIT-Taxes=NetieWorkingCapitalBalanceSheet(yearend)($Millions)Accountsreceivable+Inventory-Accountspayable=NetworkingcapitalCashFlowStatement($millions)EBIT+Depreciation-Increaseinworkingcapital-Taxespaid-Capitalexpenditure1995$8,834(6,769)2,065(266)1,799(667)$1,132$2,291269(1,610)$950$1,799266(96)(667)(593)1996$9,698(7,356)2,342(293)2,049(760)$1,289$2,725309(1,965)$1,069$2,049293(119)(760)(729)$7341997Assumptions$10,668(8,129)2,539(320)2,219(823)$1,396$2,891333(2,057)$1,167$2,219358(98)(823)(763)$89310%annualgrowth76.2%ofsales3.0%ofsales37.1%effectivetaxrate27.1%ofsales4.1%ofCOGS25.3%ofCOGS6.5%ofsalesin1998$11,73519987.4%ofcumulativeCAPEXForecastingExercise-Assumptions(p.1)Assumptionsshouldbemadebasedonthepany’shistoricalfinancialdata,aswellasyourjudgmentregardingfuturetrends.LineItemAssumptions(Rationale)AlternativemethodofmakingassumptionRevenuegrowthHistoricalgrowthrateof10%(Historicalratejudgedtobeagoodpredictoroffuturerate)IndustryforecastedgrowthrateCOGSAverageratioofCOGS/Salesin1995and1996(COGSisdirectlyrelatedtosales)EstimatefixedandvariableportionsofCOGSandthenapplyratioofvariablecosttosalestothesaleforecastPotentialimprovementofcoststructurecouldalsobeconsideredDepreciationAverageratioofdepreciationtocumulativeCAPEX(DepreciationisbasedoncumulativeCAPEX)EstimatetheaveragelifeofthePPEassetsandcalculatedepreciationbasedontheassetlivesForecastingExercise-Assumptions(p.2)AccountsreceivableAverageratioofA/Rtosales(A/Risdirectlyrelatedtosales)EstimatenumberofdaysofsalesInventoryAverageratioofinventorytoCOGS(InventoryismorerelatedtoCOGSthantosales)EstimatenumberofdaysofinventoryAccountspayableAverageratioofA/PtoCOGS(A/Pisthemoneypayabletosuppliers,thereforeitismorerelatedtoCOGSthantosales)EstimatenumberofdaysofCOGSCapitalexpenditureAverageratioofCAPEXtonextyear’ssales(Inagrowingbusiness,thepanyshouldkeepcapitalspendinginlinewithitssalesprojection)AssumenetPPEhasconstantrelationwithsalesgrowth,andthenplugCAPEXLineItemAssumptions(Rationale)AlternativemethodofmakingassumptionForecastingExercise-DetailedAnswerTheNewEnglandRazorpanyStatementofOperationsRevenue1997: Revenue1996x1.1=9,698x1.1=10,668Revenue1998: Revenue1997x1.1=10,668x1.1=11,735 (Revenue1998isneededtocalculateCAPEXlater)COGS1997: Revenue1997x0.762=10,668x0.762=8,129Grossprofit: 10,668-8,129=2,539SG&A: 10,668x0.03=320EBIT: Grossprofit-SG&A=2,539-320=2,219Taxes: EBITxeffectivetaxrate=2,219x37.1%=823NetIe: EBIT-taxes=2,219-823=1,396

1994 1995 1996 1997

CumulativeCAPEX(yearend) $3,139 $3,732 $4,461 $5,224AveragecumulativeCAPEX* $3,436 $4,097 $4,843Depreciationas%ofaveragecum.CAPEX 7.7% 7.2% 7.4%Depreciation: AveragecumulativeCAPEXin1997x7.4%=4,843x0.074=358 Accountreceivable: Salesx27.1%=10,668x0.271=2,891Inventory: COGSx4.1%=8,129x0.041=333Accountpayable: COGSx25.3%=8,129x0.253=2,057Networkingcapital: A/R+inventory-A/P=2,891+333-2,057=1,167WorkingCapitalBalanceSheetCashFlowStatementEBIT: 2,219Depreciation: 358Increaseinworkingcapital: (NWC)1997-(NWC)1996=1,167-1,069=98Taxespaid: 823Capitalexpenditure: Salesin1998x6.5%=11,735x0.065=763Cashflow: EBIT+depreciation-increaseinworkingcapital-taxespaid -CAPEX=893AgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeawaysAbbreviationsA/P = AccountspayableA/R = AccountsreceivableCAPEX = CapitalexpendituresCOGS = CostofgoodssoldEBIT = EarningsbeforeinterestandtaxesNWC = NetworkingcapitalPAT = ProfitaftertaxPBT = ProfitbeforetaxPPE = Property,plant,andequipmentROA = ReturnonassetsROE = ReturnonequityROS = ReturnonsalesSG&A = Selling,general,andadministrativeWC = WorkingcapitalAgendaUsingratiosTypesofkeyratiosprofitabilityturnoverleverageliquiditycoverageReturnonEquityRatioexercisesForecastingexerciseAbbreviationsKeytakeawaysKeyTakeawaysRatioshelponeunderstandhowwellapanyisperforming.Specifically,howmuchreturnisitgeneratingwithwhatlevelofrisk?Ratiosinisolationaremeaningless.Apany’sratiosmustbeexaminedovertimeand/oragainstpetitors’ratiosRatioanalysisisbothanartandascienceRatioanalysisrequireskeenjudgmentThefivemajorcategoriesofratiosandthequestionstheyanswerare:Type QuestionProfitability Howwelldoesthepanymanagecostsrelativetorevenues?Turnover Howeffectiveisthepanyinmanagingitsresources?Leverage Whataretherespectiveclaimsofdebtandequityowners? Howriskyisthebusiness?Liquidity Isthepanyabletomeetitsshort-termobligations?Coverage Isthepanyabletomeetitslong-termobligations?

ROEcanbewrittenas: Returnonequityistheacidtestofsuccessforabusiness.IttellustheamountofprofitsthepanyearnedoneachdollarthestockholdersinvestedROE=ProfitaftertaxSalesSalesAssetsAssetsEquityXX

=ProfitaftertaxEquityTakeawaySlides(1of3)TypesofRatiosProfitabilityRatiosTurnoverRatiosLeverageRatiosHowwelldoesthepanymanagecostsrelativetorevenues?ReturnRiskCoverageInterestchargeFixedchargecoverageLiquidityCurrentratioOutsideratioLeverageAssettoequityDebttoequityDebttototalcapitalTurnoverReceivablesInventoryPayablesAssetProfitabilityOperatingmarginROSGrossmarginHoweffectiveisthepanyinmanagingitsresources?Whataretherespectiveclaimsofdebtandequityowners?Howriskyisthebusiness?Isthepanyabletomeetitsshort-termobligations?Isthepanyabletomeetitslong-termobligations?RatiosDefinitionsReceivablesturnoverCreditsalesinperiodAccountsreceivableaveragebalanceInventoryturnoverCostofgoodssoldinperiodAverageinventoryinperiodPayablesturnoverPurchasesonaccountAccountspayableaveragebalanceAssetturnoverSalesinperiodAverageassetsAnyturnoverratiocanbeexpressedasaperiodratiowhichmeasuresthenumberofdaysinthecycleDaysinperiodTurnoverratioPeriodratio=RatiosDefinitionsDuPontleverageratioAssetsEquityDebttoequityratioLong-termdebtEquityDebttototalcapitalordebttototalassetsr