Financial Statement Analysis: Basis for Management Advice

• Chapter 0 - Overview
  • Course Goals
  • Introduction
  • Organization
• Chapter 1 - Firm Valuation
  • Learning Objectives
  • Introduction
  • Why Use a Valuation Technique?
  • Who Uses Valuation Techniques?
    • Owners
    • Potential Owners
    • Bankers
    • Security Analysts
  • Wells Fargo "Dividend Capitalization" Model
  • Dividend Computation for Privately-Held Corporation
  • Questions
• Chapter 2 - The Effect Ratios
  • Learning Objectives
  • Introduction
  • Effect Ratios
    • Liquidity Measures
    • Leverage Measures
    • Profitability Measures
  • Liquidity
    • Quantity of Liquidity Measures
    • Timing of Liquidity Measures
  • Inventory to Working Capital
  • Trade Receivables to Working Capital Ratio
  • Net Sales to Working Capital (Working Capital Turnover)
  • Operating Cash Flow to Current Liabilities
  • Debt Ratios
    • Tangible Debt Ratios
  • Current Liabilities to Net Worth
  • Times Interest Earned
  • Net Profit to Net Worth (Return on Equity)
  • Effect Ratio Summary
  • Questions
• Chapter 3 - Analysis of Profitability
  • Learning Objectives
  • Introduction
  • DuPont System
  • DuPont System
  • Total DuPont System
  • EBITDA Analysis
  • Earnings Quality
    • Continuation of Earnings
    • Relationship to Cash Flow
  • Questions
• Chapter 4 - Causal Ratios
  • Learning Objectives
  • Introduction
  • Causal Ratios
  • Fixed Assets to Net Worth
  • How Fixed Assets Affect Profit
  • Ratios That Could Be Changed by the Fixed Assets to Net Worth Ratio
  • Correction Procedures
    • Excessive Fixed Assets
  • Collection Period
  • Collection Period - Example
  • Ratios That Could Be Changed by the Collection Period
  • Correction Procedures
    • Abnormal Collection Period Ratio
  • Net Sales to Inventory (Inventory Turnover)
  • Net Sales to Inventory - Example
  • Ratios That Could Be Changed by Net Sales to Inventory
  • Correction Procedures
    • Sluggish Movement of Stock
  • Net Sales to Net Worth
    • The Trading Ratio
  • Trading Ratio - Example
  • Trading Ratio - Example
  • Ratios That Could Be Changed by the Trading Ratio
  • Overtrading Characteristics
  • Correction Procedures
    • Overtrading or Undertrading
  • The Profit Margin
  • The Profit Margin - Example
  • Correction Procedures
    • Low or Negative Profit Margin
  • Miscellaneous Assets to Net Worth
    • Miscellaneous Assets Include
  • Correction Procedures
    • Investment in Miscellaneous Assets
  • Causal Ratio Summary
  • Questions
• Chapter 5 - How to Conduct a Financial Statement Analysis
  • Learning Objectives
  • Introduction
  • How to Conduct an Analysis of Financial Statements
  • Industry and Time Series Analysis
  • Sources of Industry Averages
    • Primary Sources
    • Other Sources
  • Problems with Using Industry Data
  • An Example of Computing Industry Statistics from Robert Morris Data
  • An Example of Computing Industry Statistics from Dun and Bradstreet Data
  • Guidelines to Use in Applying Ratio Analysis
  • Questions
• Chapter 6 - Case Studies
  • Case Study 1
    • Case Study 1 - Causal Ratio Summary
  • Case Study 2
    • National West Airline
  • Case Study 3
  • Case Study 4
  • Discussion Case 1
  • Discussion Case 2
• Chapter 7 - Users of Financial Statements
  • Learning Objectives
  • Introduction
  • Ratios Examined by Banks for Short-Term Loans
  • Ratios Examined by Banks for Long-Term Loans
  • Commercial Loan Departments' Most Significant Ratios and Their Primary Measures
    • Gibson's Study
  • Commercial Loan Departments' Ratios Appearing Most Frequently in Loan Agreements
  • Corporate Controllers' Most Significant Ratios and Their Primary Measures
  • Ratios Appearing in Corporate Objectives and Their Primary Measures
  • Questions
• Chapter 8 - Forecasting Sustainable Growth
  • Learning Objectives
  • Introduction
  • Definitions
  • Derivation of the Sustainable Growth Model
  • The Alabama Door Company
    • Assumptions
    • Class Exercise
  • Calculation of Alabama Door Growth Rate
  • Improving Sustainable Growth
  • Sustainable Growth - Available External Equity
• Chapter 9 - Case Problem
  • Learning Objectives
  • Introduction
  • Marine Supply Company Balance Sheet
  • Marine Supply Company Selected Income Figures
  • Marine Supply Company Selected Financial Ratios
  • Case Problem Requirements
• Chapter 10 - Forecasting Bankruptcy
  • Learning Objectives
  • Introduction
  • Altman's Bankruptcy Prediction Formula
    • Altman's Suggested Z-score Cutoff
    • Computational Note
    • Usage Notes
  • Bankruptcy Prediction Example
  • Altman's Second Model
  • Questions
• Chapter 11 - Latest Developments

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Chapter 2 - The Effect Ratios

Learning Objectives

Upon completion of this chapter you will be able to

• Understand why these ratios are "effect" ratios and not causal ratios.

• Know why you should not focus on the effect but on the cause.

• Determine what each of these ratios measures.

• Calculate each ratio.

• Determine how a change in any one of the causal ratios will affect each ratio.

Introduction

The effect ratios are used to determine the extent of a company's problems. Liquidity, leverage, and profitability measures are included.

The purpose of this chapter is to introduce you to the effect ratios. These ratios do not show the reason for a change; they only show that a change has occurred. The ratios show the magnitude of a change but do not record the reason for that change. The chapter does show how a change in any of the causal ratios can change each of the effect ratios. The nine effect ratios are the current ratio, inventory to working capital, receivables to working capital, net sales to working capital, debt to net worth, debt to assets, short-term debt to net worth, times interest earned, and return on equity.

Effect Ratios

Liquidity Measures

• Current Ratio

• Quick Ratio

• Defensive Interval

• Cash Conversion Cycle

• Inventory/Working Capital

• Receivables/Working Capital

• Net Sales/Working Capital

• Operating Cash Flow to Current Liabilities

Leverage Measures

• Debt to Net Worth

• Debt to Assets

• Tangible Debt Ratios

• Short-term Debt to Net Worth

• Times Interest Earned

• Cash Times Interest Earned

• Fixed Charge Coverage

Profitability Measures

• Return on Equity – Net Income/Net Worth

There are three areas of concern that are measured by financial statement characteristics. Liquidity is the measurement of how well the firm can meet its obligations in the short run. The second area is leverage. Leverage ratios measure the firm's debt usage and how well it can afford its debt. The third area is profitability. Profitability ratios are a measure of how profitable a firm is relative to its size.

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