Analysis of Financial Statements

Evaluating Financial Performance

Why? Evaluate the success of an ongoing business Determine weaknesses of an ongoing business Compare current performance with past performance Compare current performance with industry standards.

Ratio Analysis
Financial Ratios represent an attempt to standardize financial information in order to facilitate meaningful comparisons over time and between firms. The business is a storehouse of resources (i.e. assets on the balance sheet) which it converts to profit through production and then sales (reported on the income statement)

Terminology
Common Size Statements Liquidity Ratios
Current ratio Quick ratio Working Capital ratio Cash ratio

Leverage Ratios
Leverage ratio Debt ratio Debt / Equity ratio Equity multiplier

Coverage ratios
Times-interest-earned ratio Fixed-charge coverage ratio Cash flow coverage ratio

Asset Turnover Ratios

Receivables turnover ratio Days sales outstanding Aging schedule Inventory turnover ratio Days sales in Inventory Fixed asset turnover Total asset turnover

Profitability Ratios
Gross profit margin Net profit margin Return on Assets Earning Power Return on Equity

Benchmarking

Market Value Ratios Price / Earnings ratio (P/E) Earnings Yield Dividend Yield

Basic Financial Statements

Balance Sheet Assets = Liabilities + Owners Equity
Current Assets Cash Inventory A/R
Fixed Assets Land Plant Equipment Less:Depreciation

Current Liabilities Preferred Stock A/P Common Stock Accruals Par Value S-T Debt Paid-In Capital Retained Earnings L-T Liabilities Bonds L-T Bank Debt Mortgages
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Basic Financial Statements

The balance sheet for the Soni Tire Company is as follows:
Balance Sheet Soni Tire Company
Assets Cash $175 Accounts Receivable 430 Inventories 625 Current Assets $1,230 Plant & Equipment $2,500 Less:Acc. Depr. (1,200) Net Fixed Assets $1,300 Total Assets $2,530 Liabilities Accounts Payable $115 S-T Notes Payable 115 Current Liabilities $230 Bonds $600 Owners Equity Common Stock $300 Paid-in Capital 600 Retained Earnings 800 Total Owners Equity $1,700 Total Liabilities and Owners Equity $2,530
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Basic Financial Statements

Income Statement Revenues - Expenses = Net Income
Sales Investment Income Gains Interest Received Dividend Received COGS Salaries Depreciation Taxes Other Expenses Interest Paid
Dividends

Retained Earnings
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Basic Financial Statements

The income statement for the Soni Tire Company is as follows:
Income Statement Soni Tire Company

Sales $1,450 Cost of Goods Sold 875 Gross Profit $575 Operating Expenses 45 Depreciation 200 Net Operating Income (EBIT) $330 Interest Expense 60 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62
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Basic Financial Statements

Statement of Cash Flows Cash Inflow - Cash Outflow = Change in Cash
Cash Sales Collection of A/R Investment Income Sale of Securities Sale of Assets

Payments to Suppliers Salaries Taxes Dividends Interest Paid Repayment of Debt Purchase Assets

Basic Financial Statements

Balance Sheet Soni Tire Company Liabilities Per Share Data: (100 SharesAssets Outstanding) Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Net Income Inventories 625 Current Liabilities $230 Earnings Per Share (EPS) = Shares Outstanding Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Owners Equity $2,530 Cost of Goods Sold 875 Gross Profit $575 Operating Expenses 45 Depreciation 200 Net Operating Income $330 Interest Expense 60 EPS = $162 = $1.62 Earnings before Taxes $270 100 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 10

Basic Financial Statements

Balance Sheet Soni Tire Company Liabilities Per Share Data: (100 SharesAssets Outstanding) Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Total Dividends Paid Inventories 625 Current Liabilities $230 Dividends Per Share = Current Assets Outstanding $1,230 Bonds $600 Shares Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Owners Equity $2,530 Cost of Goods Sold 875 Gross Profit $575 Operating Expenses 45 Depreciation 200 Net Operating Income $330 Interest Expense 60 Dividends Per Share = $100 = $1.00 Earnings before Taxes $270 100 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 11

Ratio Analysis
Liquidity Ratios
Used to measure the ability of a firm to meet its short term financial obligations. Are there sufficient liquid assets to pay off current indebtedness?

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Ratio Analysis
Liquidity Ratios Measure the ability of the firm to meet its short-term financial obligations.
Current Assets Current Ratio = Current Liabilities

Is there a sufficient amount of current assets to pay off current liabilities? What is the cushion of safety?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Current Assets Current Ratio = Owners Equity $2,530 Cost of Goods Sold 875 Current Liabilities Gross Profit $575 Operating Expenses 45 Depreciation 200 Net Operating Income $330 Interest Expense 60 Current Ratio = $1,230 = 5.35x Earnings before Taxes $270 $230 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 14

Ratio Analysis
Liquidity Ratios Measure the ability of the firm to meet its short-term financial obligations.
Current Assets - Inventory Acid-Test Ratio = Current Liabilities

What happens to the firms ability to repay current liabilities after the least liquid of the current assets is subtracted?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Current Assets - Inventory Total Liabilities and Sales $1,450 Acid-Test Ratio = Owners Equity $2,530 Current Cost of Goods Sold 875 Liabilities Gross Profit $575 Operating Expenses 45 Depreciation 200 E.B.I.T. $330 $1,230 -$625 Interest Expense 60 Acid-Test Ratio = =2.63x $230 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 16

Ratio Analysis
Liquidity Ratios Measure the ability of the firm to meet its short-term financial obligations.
Cash Ratio = Cash and Equivalents Total Assets

What is the percentage of cash in the company?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Cash and Equivalents Cash Ratio = Owners Equity $2,530 Cost of Goods Sold 875 Assets Total Gross Profit $575 Operating Expenses 45 Depreciation 200 E.B.I.T. $330 175 Interest Expense 60 Cash Ratio = $2,530 =6.92% Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 18

Ratio Analysis
Efficiency Ratios Provide basis for assessing how effectively the firm is using its resources to generate sales
Annual Credit Sales Accounts Receivable

Receivables Turnover =

How many times a year does the company collect and reissue its receivables?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Receivables Annual CreditEquity Sales$1,700 Soni Tire Company Total Owners Turnover Accounts Receivable Total Liabilities and Sales $1,450 Owners Equity $2,530 Cost of Goods Sold 875 Gross Profit $575 Operating Expenses 45 Depreciation 200 E.B.I.T. $330 $1,450 Interest Expense 60 RTO = = 3.37x $430 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 20

Ratio Analysis
Efficiency Ratios Provide basis for assessing how effectively the firm is using its resources to generate sales
Accounts Receivable Daily Credit Sales

Average Collection Period =

How long does it take for the firm to collect its credit sales from customers?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets 800 Average $2,530 Retained Earnings Income Statement Accounts Receivable Soni Tire Company Total Owners Equity $1,700 Collection = TotalCredit Liabilities and Daily Sales Sales $1,450 Period Owners Equity $2,530 Cost of Goods Sold 875 Gross Profit $575 Operating Expenses 45 Depreciation 200 E.B.I.T. $330 $430 Interest Expense 60 ACP = = 108.24 days $1,450/360 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Days in a Dividends Paid 100 Addition to Retained Earnings $62 year 22

Ratio Analysis
Efficiency Ratios Provide basis for assessing how effectively the firm is using its resources to generate sales
Cost of Goods Sold Inventory

Inventory Turnover Ratio =

Is the level of inventory appropriate given the firms sales?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Inventory Cost of Goods Sold Sales $1,450 Turnover = Total Liabilities and Inventory Owners Equity $2,530 Cost of Goods Sold 875 Ratio Gross Profit $575 Operating Expenses 45 Depreciation 200 E.B.I.T. $330 Interest Expense 60 Inventory Turnover = $875 = 1.4x Earnings before Taxes (EBT) $270 $625 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 24

Ratio Analysis
Efficiency Ratios Provide basis for assessing how effectively the firm is using its resources to generate sales
Inventory Days Sales in Inventory = (Cost of Goods Sold / 360)

How many days of Sales can the current inventory support?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Equity $1,700 Days Sales Total Owners Inventory Total Liabilities and Sales $1,450 in (COGS / 360) Owners Equity $2,530 Cost of Goods Sold 875 Inventory Gross Profit $575 Operating Expenses 45 Depreciation 200 E.B.I.T. $330 $625 Interest Expense 60 DSI = = 260.71 days $875/360 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Days in a Dividends Paid 100 Addition to Retained Earnings $62 year 26

Ratio Analysis
Efficiency Ratios Provide basis for assessing how effectively the firm is using its resources to generate sales
Sales Net Fixed Assets

Fixed Asset Turnover Ratio =

How effective is the firm in using its fixed assets in generating sales?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Fixed Asset Total Owners Equity $1,700 Sales Total and Sales $1,450 Turnover = Liabilities Owners $2,530 Net Equity Fixed Assets Cost of Goods Sold 875 Ratio Gross Profit $575 Operating Expenses 45 Depreciation 200 E.B.I.T. $330 Interest Expense 60 Fixed Asset Turnover = $1,450 = 1.12x Earnings before Taxes (EBT) $270 $1,300 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 28

Ratio Analysis
Efficiency Ratios Provide basis for assessing how effectively the firm is using its resources to generate sales
Sales Total Assets

Total Asset Turnover Ratio =

How effective is the firm in using all assets to generate sales?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Total Asset Owners Equity $2,530 Sales Cost of Goods Sold 875 Turnover = Gross Profit $575 Total Assets Ratio Operating Expenses 45 Depreciation 200 E.B.I.T. $330 Interest Expense 60 Total Asset Turnover = $1,450 = 0.57x Earnings before Taxes (EBT) $270 $2,530 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 30

Ratio Analysis
Leverage Ratios
Used to measure the extent to which non-owner supplied funds have been used to finance the firms assets Two Types
Balance Sheet Leverage Ratios Coverage Ratios

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Ratio Analysis
Leverage Ratios
Balance Sheet Leverage Ratios
Measure the proportion of the firms assets financed with non-owner funds.
Debt Ratio = Total Debt Total Assets

What proportion of the firms assets are financed with debt?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Total Debt Owners Equity $2,530 Cost of Goods Sold 875 Debt Ratio = Gross Profit $575 Total Assets Operating Expenses 45 Depreciation 200 E.B.I.T. $330 Interest Expense 60 Debt Ratio = $230 + $600 = 33% Earnings before Taxes (EBT) $270 $2,530 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 33

Ratio Analysis
Leverage Ratios
Coverage Ratios
Measure the firms ability to cover (pay) the finance charges associated with its use of financial leverage.
Times Interest Earned Ratio =

E.B.I.T . Interest Expense

What is the margin of safety in the ability to repay interest payments?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Times EBIT $2,530 . Owners Equity Cost of Goods Sold 875 Interest = Interest Expense Gross Profit $575 Earned Ratio Operating Expenses 45 Depreciation 200 E.B.I.T. $330 $330 = 5.50x Interest Expense 60 TIE Ratio = $60 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 35

Ratio Analysis
Profitability Ratios
Measures the overall effectiveness of the firms management.

Two Types:
Profit in Relation to Sales Profit in Relation to Investment

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Ratio Analysis
Profitability Ratios
Profit in Relation to Sales measures the firms ability to convert sales volume into bottom-line profit.

Operating Income Operating Profit Margin = Sales

How effective is the firm in keeping costs of production low?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Sales $1,450 Operating Total Liabilities and E.B.I.T. Owners Equity $2,530 Cost of Goods Sold 875 Profit = Gross Profit $575 Sales Margin Operating Expenses 45 Depreciation 200 E.B.I.T. $330 Interest Expense 60 Oper. Profit Margin = $330 = 22.8% $1,450 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 38

Ratio Analysis
Profitability Ratios
Profit in Relation to Sales measures the firms ability to convert sales volume into bottom-line profit.

Net Profit Margin =

Net Income Sales

What is the amount of Net Profit for each dollar of sales?

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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Net Net Income Owners Equity $2,530 Cost of Goods Sold 875 Profit = Gross Profit $575 Sales Margin Operating Expenses 45 Depreciation 200 E.B.I.T. $330 Interest Expense 60 Net Profit Margin = $162 = 11.2% $1,450 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 40

Ratio Analysis
Profitability Ratios
Profit in Relation to Investment measures the firms ability to convert resources (investment) into bottom line profit.
Operating Income Operating Income = Total Assets Return on Investment What is the ability of the firm to generate operating income with its assets (before financing costs and taxes)?
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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Operating Inc. E.B.I.T. $2,530 Owners Equity Cost of Goods Sold 875 = Return on Total Assets Gross Profit $575 Investment Operating Expenses 45 Depreciation 200 E.B.I.T. $330 Interest Expense 60 OIROI = $330 = 13.04% $2,530 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 42

Ratio Analysis
Profitability Ratios
Profit in Relation to Investment measures the firms ability to convert resources (investment) into bottom line profit.
Net Income Total Assets

Return on Assets =

What is the relationship between the generated profits of the firm and the firms investment in assets?
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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities Cash $175 Accounts Payable $115 Accounts Receivable 430 S-T Notes Payable 115 Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Income Owners Net Equity $2,530 Cost of Goods Sold 875 Return on Assets = Total Assets Gross Profit $575 Operating Expenses 45 Depreciation 200 E.B.I.T. $330 Interest Expense 60 ROA = $162 = 6.40% $2,530 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 44

Ratio Analysis
Profitability Ratios
Profit in Relation to Investment measures the firms ability to convert resources (investment) into bottom line profit.
Net Income Return on Equity = Common Equity

What is the relationship between the generated profits of the firm and the owners investment in the firm?
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Ratio Analysis
Balance Sheet Soni Tire Company Assets Liabilities $175 Accounts Payable $115 Net Cash Income Return on Equity = Common Accounts Receivable 430 S-T Notes Payable 115 Equity Inventories 625 Current Liabilities $230 Current Assets $1,230 Bonds $600 Plant & Equipment $2,500 Owners Equity Less:Acc. Depr. (1,200) Common Stock $300 Net Fixed Assets $1,300 Paid-in Capital 600 Total Assets $2,530 Retained Earnings 800 Income Statement Soni Tire Company Total Owners Equity $1,700 Total Liabilities and Sales $1,450 Owners Equity $2,530 Cost of Goods Sold 875 Gross Profit $575 Operating Expenses 45 Depreciation 200 E.B.I.T. $330 Interest Expense 60 ROE = $162 = 9.53% $1,700 Earnings before Taxes (EBT) $270 Taxes (40%) 108 Net Income $162 Dividends Paid 100 Addition to Retained Earnings $62 46

Ratio Analysis
Summary of Soni Tire & Industry
Ratio
Liquidity Current Ratio Acid-Test Ratio

Industry
5.00x 3.00x

Soni
5.35x 2.63x

Looking at the current ratio it appears that Soni Tire is more liquid than the industry.... however when looking at Acid Test (a better measure) they are not as liquid indicating that inventory levels are probably too high.

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Ratio Analysis
Summary of Soni Tire & Industry
Ratio Industry Soni
108 days 1.40x 261 days 1.12x .57x Efficiency Avg. Collection Period 90 days Inventory Turnover 2.20x Days sales in inventory 166 days Fixed Asset Turnover 1.00x Total Asset Turnover 0.75x

Collection policies need examining, as Soni Tire is slower than average at collecting sales. Inventories are being sold more slowly than industry, again indicating too high inventories. Soni Tire is very efficient at converting Fixed Assets to Sales (fixed assets are productive). However, overall assets are not productive indicating Current Assets (inventories) are not as productive as the industry.

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Ratio Analysis
Summary of Soni Tire & Industry
Ratio Industry
33% 7.00x

Soni
33% 5.50x

Leverage Debt Ratio Times Interest Earned

While debt ratio is the same as the industry, Soni Tire is not as able to cover interest payments as the industry. This indicates Soni Tire may have too much debt as they cannot afford their level of debt.

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Ratio Analysis
Summary of Soni Tire & Industry
Ratio Industry Soni
22.8% 13.04% 11.2% 6.4% 9.53% Profitability Operating Profit Margin 20% Oper Income ROI 15% Net Profit Margin 12% Return on Assets 9.0% Return on Equity 13.43%

Soni Tire is good at keeping operating costs down, but not as good at total costs. The Operating Income ROI and ROA and ROE are all low mainly due to productivity problems.
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Ratio Analysis
Limitations of Ratio Analysis
Seasonality

Window Dressing
Differences in Accounting Practices

Industry Averages are NOT a Goal

Data from Balance Sheet
Market Values versus Book Values Older firms look better than newer firms Does not focus on cash flow

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