Financial Ratio Analysis of two companies Essay Sample
on

Abstraction

This research paper will measure Sample Company utilizing reexamine standard fiscal ratio analysis techniques and measure its possible as a good investing. This is written in the signifier of a memo to the CEO of an Alabama-based house. looking for sound fiscal advice with respects to whether of non purchasing stock in Sample Company is a sound investing.

Introduction

This research paper will uncover the fiscal analysis techniques used to measure the fiscal public presentation of the Sample Company. and measure the company’s worthiness as an investing. The paper is divided into three subdivisions. The first subdivision is the memo. which is the chief organic structure of the paper. The 2nd subdivision. Appendix A. includes as a mention contains each of the sets of the four fiscal statements that show Sample Company’s public presentation from 1999 to 2001. The 3rd subdivision. Appendix B. contains the existent fiscal ratio analysis techniques. demoing the company’s public presentation in 2000 and 2001. the per centum alteration in public presentation between these old ages. a short description of the significance of each ratio. every bit good as a short appraisal of the company’s alteration in public presentation between 2000 and 2001. Using these appendices to back up the fiscal analysis thoughts expressed in the memo. the reader should experience that they have a complete set of facts to confirm these thoughts and supply a mention for them.

Memo

Date: July 1. 2003

To: Randall K. Black. Chief executive officer

Absolutely Alabama Investments

From: William F. Slater. III. Adviser

Slater Technologies

Subject: Fiscal Analysis Using Ratio Analysis and Recommendation

Beloved Randall:

Thank you for the chance to reexamine Sample Company’s fiscal statements and do this ratio analysis. every bit good as some recommendations about possible investing in this company.

Using fiscal statements from 1999. 2000. and 2001. along with standard fiscal ratio analysis. I have been able to develop what I believe is a clear image of this company’s fiscal public presentation. Note that the fiscal analysis was done utilizing the fiscal study informations from publically available fiscal statements for the old ages 2000 and 2001. I have included these statements for your reappraisal in Appendix A

Appendix B contains other steps of Sample Company’s fiscal public presentation. as expressed in standard fiscal ratio analysis techniques utilizing figures from the fiscal studies in Appendix A.

Profitableness of Sample Company

First. let’s expression at the Return on Investment ( ROI ) for 2000 and 2001. utilizing the Dupont Model. which is margin times turnover. Margin is net income divided by the gross revenues. and turnover is gross revenues / mean entire assets ( Marshall. 2002 ) .

Sample Company ROI for 2000

ROI = MARGIN x TURNOVER

OPERATING INCOME =Operating IncomexSales

Average TOTAL ASSETSSalesAverage Total Assetss

Input signal: 498 =498 x8. 251

7. 196 8. 251 7. 196

Consequence: 6. 9 % =6. 0 % x1. 15

Sample Company ROI for 2001

ROI = MARGIN x TURNOVER

OPERATING INCOME =Operating IncomexSales

Average TOTAL ASSETSSalesAverage Total Assetss

Input signal: 924 =924 x10. 359

8. 659 10. 359 8. 659

Consequence: 10. 7 % =8. 9 % x1. 20

At over 55. 1 % . the addition in ROI between 2000 and 2001 is singular and shows that Sample Company increased its gross revenues while increasing the use of its assets used to bring forth these gross revenues. And to accomplish these consequences. the gross revenues. runing income and mean entire assets had to all addition proportionally. In the short term. this would be a good tendency. but if it continues. it could be a mark that Sample Company is non maintaining a large investing in assets. because non that as the denominator in this ROI computation. a low plus figure can be used to assist drive up the overall consequence. Meaning that if this tendency continues. it may be an indicant of increased operations instead than betterment in plus efficiency.

Stock Performance

The common stock value increased 54. 8 % . from $ 42/share to $ 65/share. between 2000 and 2001. This is an indicate that the market likes what it sees in the public presentation and the direction of Sample Company. In add-on. it paid 1. 2 % in dividends for the past two old ages. Another cardinal index. the Price to Earnings Ratio. fell from 12. 0 to 10. 7. This is non adequate to be dismaying. In fact. some investors. myself included. experience that lower Price to Gain Ratios are non needfully a good thing. The ground being that if a company is fighting to pay out big net incomes per portion. to do the denominator in the P/E equation big plenty to maintain the P/E ratio depression. so frequently such fiscal force per unit areas can take the attending of the direction off from the company’s operations and other of import issues. wish lasting as a traveling concern in a tough concern clime.

Activity of Sample Company

The activity ratios step the company’s direction of plus degrees and gross revenues ( Marshall. 2002 ) . Between 2000 and 2001. Sample Company showed positive public presentation with its mean yearss gross revenues by over 25 % and decreased its figure of twenty-four hours gross revenues in histories receivable over 2 % . Together. these ratios show the efficiency of aggregation relation to the mean age of receivables. The stock list turnover fell by 5. 9 % and the fixed plus turnover increased by 18. 8 % . These turnover figures overall would propose that assets are being used expeditiously to bring forth gross revenues.

Leverage of Sample Company

Leverage is the usage of debt to finance company assets ( Marshall. 2002 ) . When a company uses purchase. it incurs an extra constituent in its
operations. set it besides increases the ROE relation to the ROI. Between 2000 and 2001. Sample Company’s debt ratio increased 32. 3 % and its debt / equity ratio increased 21. 5 % . An premise of greater debt in order to bring forth the overall addition in public presentation that Sample Company delivered in 2001 could about be expected. A really encouraging mark is the 31 % addition in the ratio of the times involvement earned ratio. because it indicates that Sample Company has an progressively strong capableness to pay the involvement on its debts with the income it is bring forthing. This is a positive mark for investors and could assist in portion to account for the overall addition in stock monetary value.

Liquid of Sample Company

The liquidness of a company is the ability to run into its loan duties as it relates to its current assets and its current liabilities ( Marshall. 2002 ) . Appendix B shows that we have analyzed three of import liquidness ratios: 1 ) Current Ration. 2 ) Acid Test. and 3 ) Working Capital. Of these three. the best indexs of liquidness. when seeking to demo tendencies. are the Acid trial and the Current Ratio. A current ratio of 2 and an acerb trial of 1. 0 are considered “adequate liquidity” ( Marshall. 2002 ) . Sample Company’s Acid Test Numberss for 2000 and 2001 were. 84 and. 79. and its Current Ratio Numberss for 2000 and 2001 were 1. 45 and 1. 54. Each sets of these ratio figures indicate that Sample Company could possibility hold some troubles in run intoing its fiscal duties. so these Numberss will be of import to watch closely in the hereafter.

What Is Necessary to Measure the Company?

Besides making this elaborate fiscal ratio analysis. it would critical to research the one-year studies for 1999 – 2001 and read the explanatory notes and other fiscal information. There we would happen an inside expression at organisation beyond the Numberss. and the bases for how these fiscal studies were assembled. These notes contain indispensable information about its important accounting policies. These policies can and should include information about the depreciation methods that was used. employee benefits. amortisation of intangible benefits. net incomes per portion. stock option and purchase programs. Other types of information that should be disclosed are inside informations of other fiscal statement sums ( such as elaborate accounts of long-run debt ) . other revelations such as any possible accounting rule alteration. concern combinations ( amalgamations. acquisitions. temperaments ) . eventualities and committednesss ( i. e. revelations of possible pending cases ) . events subsequent to the balance sheet day of the month. impacts of rising prices. concern section information ( i. e. geographic sections ) . and a possible management’s statement of duty.

Other fiscal information that can establish in these studies: a statement demoing management’s treatment and analysis. a sum-up of past fiscal information. an independent auditor’s study. and a digest study.

Without the explanatory notes and other fiscal information. the true image of an organization’s fiscal fortunes can non be known.

Finally. we would desire to take extra clip to run a Dun and Bradstreet study on the company. to I would desire to cognize how the company pays its measures and treats its creditors. Specifically. I would wish to see these Dun and Bradstreet studies on the company: D & A ; B Rating. PAYDEX® . and Score Tables. The US D & A ; B ( 5A to HH ) evaluations reflect company size based on net worth or equity as computed by D & A ; B. These evaluations are assigned to concerns that have supplied D & A ; B with current fiscal information ( Dun & A ; Bradstreet. 2003 ) .

There is besides a Financial Stress Score. The Financial Stress theoretical account predicts the likeliness of a steadfast ceasing concern without paying all creditors in full. or reorganising or obtaining alleviation from creditors under state/federal jurisprudence over the following 12 months. Tonss were calculated utilizing a statistically valid theoretical account derived from D & A ; B’s extensive informations files ( Dun & A ; Bradstreet. 2003 ) .

There is besides a Commercial Credit Score. The US Commercial Credit Score predicts the likeliness of a house paying in a delinquent mode ( 90 + yearss past footings ) during the following 12 months. based on the information in D & A ; B’s file. The mark was calculated utilizing statistically valid theoretical accounts derived from D & A ; B’s extensive informations files ( Dun & A ; Bradstreet. 2003 ) .

Dun and Bradstreet studies are among the most respected in the universe. Besides. if I know how a company treats its creditors. so I will hold some thought of how serious the company is about its repute and about being in concern. These studies would give us a greater sense confidence cognizing that we now have obtained nonsubjective information from one of the world’s most well-thought-of beginnings of fiscal analysis. To obtain these studies easy. we can travel to Dun and Bradstreet at hypertext transfer protocol: //dunandbradstreet. com/us/ and order a study on the company utilizing a recognition card dealing over the web.

What Ratios Have the Most Value?

Which ratio has the most value. truly depends on what facet of the company you are trying to step. For the aggressive investor. that ration will probably be the ROI. For a individual who is measuring the hazards associated with the ability of the company to stay solvent. a ratio like the acerb trial. or the debt ratio will hold considerable importance. So the reply to the inquiry of which ratio has the most value is truly who is inquiring and what do they trust to happen. To rephrase a common epigram on criterions. the nice thing about ratios is that you have so many to take from.

What Other Factors. Beyond Ratios. Necessitate To Be Considered?

As mentioned above in the subdivision on what is necessary to measure the company. we would desire to obtain one-year studies and besides Dun and Bradstreet studies. In add-on to all this. we would desire measure such things as the public presentation of the company’s rivals. the standard mean fiscal ratios for the industry this company is in. and step Sample Company’s public presentation against these norms. Other factors would be the company’s image in the community. any possible judicial proceeding the company is involved in either as complainant or suspect. client testimonies ( good and bad ) . the market behaviour of the market the company is in. any offshore menaces to competition. work force demographics and handiness. and a elaborate reappraisal of the company leading. including the executive staff ( president and vide presidents ) . and the board of managers.

What Type of Industry Do You Think The Organization Is and Why?

I think this is likely a fabrication company because the undermentioned indexs are within the scope of what would be a fabrication concern ( Marshall. 2002 ) :

RatioSample Company 2001 ValueManufacturing Typical Value

ROI10. 7 % 10 % to 15 %

ROE16 % 10 % – 15 %

Margin8. 9 % 10 % – 15 %

Asset Turnover1. 21. 0 to 3. 0

How Would Your Assessment Criteria Change If The Company In a Different Industry

The tabular array below shows how my appraisal would alter if the industry of this company were different.

Changes in Assessment Method

IndustryChange in AssessmentComments

Retail? No alteration. but closer attending to activity ratios and stock list turnoverInventory turnover and activity ratios are cardinal indexs of efficiency in gross revenues and in pull offing receivables.

Trading? No alteration. but closer attending to activity ratios and stock list turnoverInventory turnover and activity ratios are cardinal indexs
of efficiency in gross revenues and in pull offing receivables.

Service? No alteration. but closer attending to activity ratios and fixed plus turnoverFixed plus turnover and activity ratio are cardinal indexs of efficiency in gross revenues and in pull offing receivables.

e-commerce? Similar analysis but closer attending to activity ratios. liquidness. and purchase. in add-on to serious scruitiny on ROI projections. And a batch of accent on other standards such as the worthiness of the concern theoretical account. the mark market. who the investors are and why they think the company has a opportunity. etc. Before the flop. the point coms had a serious job with seeking to recognize gross excessively rapidly. and overstated gross from reselling ( Marshall. 2002 )

Decision

So we have seen that a batch of ways to analyse a company’s fiscal public presentation. It’s non “rocket scientific discipline. ” but it does take a batch of clip and a willingness to scranch the Numberss utilizing a spreadsheet. some good organized fiscal studies. and a good set of ratio guidelines. It besides takes a dedication to the truth and being willing to delve deeper than what the mean individual reads in a 500-word column in the concern subdivision of the newspaper.

Finally. would I urge the purchase of Sample Company’s stock as an investing? The reply is a qualified “Yes” . After more careful research. if my findings were consistent with the fiscal analysis in this study. so I perfectly would be in favour of purchasing this company’s stock.

Appendix A – Sample Company’s Financial Statements from 1999 – 2001

STATEMENT 1

SAMPLE CO.

Amalgamate Results of Operations

For the Years Ended December 31

( dollars in 1000000s except per portion informations )

2001 2000 1999

Gross saless $ 10. 359 $ 8. 251 $ 7. 362

Operating costs:

Cost of goods sold8. 011 6. 523 6. 064

Selling. general. and administrative expenses1. 242 1. 071 980

Research and development expenses182 159 178

$ 9. 435 $ 7. 753 $ 7. 222

Operating net income $ 924 $ 498 $ 140

Interest expense264 209 197

$ 660 $ 289 $ ( 57 )

Other income 182 170 160

$ 842 $ 459 $ 103

Provision for income taxes262 118 21

Net income of amalgamate companies $ 580 $ 341 $ 82

Equity in net income ( loss ) of affiliated companies36 ( 22 ) ( 6 )

Profit–before extraordinary revenue enhancement benefit $ 616 $ 319 $ 76

Extraordinary revenue enhancement benefit from foreign revenue enhancement recognition carryforwards – 31 –

Net income $ 616 $ 350 $ 76

Net income per portion of common stock before extraordinary revenue enhancement benefit $ 6. 07 $ 3. 20 $ 0. 77

Net income per portion of common stock after extraordinary revenue enhancement benefit $ 6. 07 $ 3. 51 $ 0. 77

Dividends paid per portion of common stock $ 0. 75 $ 0. 50 $ 0. 50

STATEMENT 2

SAMPLE CO.

Changes in Consolidated Ownership

For the Years Ended December 31

( dollars in 1000000s )

2001 2000 1999

Common stock:

Balance at beginning of twelvemonth $ 827 $ 714 $ 696

Common portions issued. including exchequer portions reissued:

2001–1. 317. 485 ; 2000–2. 601. 322 ; 1999–452. 95983 113 18

Treasury portions purchased: 2001–1. 326. 058 ( 86 ) – –

Balance at year-end $ 824 $ 827 $ 714

Net income employed in the concern:

Balance at beginning of twelvemonth $ 2. 656 $ 2. 363 $ 2. 349

Attention deficit disorder: Profit616 350 76

Deduct: Dividends paid and collectible 88 57 62

Balance at year-end $ 3. 184 $ 2. 656 $ 2. 363

Foreign currency interlingual rendition accommodation:

Balance at beginning of twelvemonth $ 82 $ 72 $ 23

Aggregate accommodation for the twelvemonth 23 10 49

Balance at year-end $ 105 $ 82 $ 72

Ownership at year-end $ 4. 113 $ 3. 565 $ 3. 149

SAMPLE CO.

Amalgamate Financial Position

At December 31

( dollars in 1000000s except per portion informations )

2001 2000 1999

Current assets:

Cash and short-run investings $ 74 $ 155 $ 166

Receivables2. 669 2. 174 1. 808

Refundable income taxes114 130 92

Deferred income revenue enhancements and postpaid disbursal allocable to

the undermentioned year474 224 208

Inventories1. 986 1. 323 1. 211

$ 5. 317 $ 4. 006 $ 3. 485

Current liabilities:

Short-run adoptions $ 1. 072 $ 623 $ 696

Collectible to material providers and others1. 495 1. 351 1. 182

Wagess. wages. and parts for employee benefits485 431 450

Dividends payable30 19 12

Income taxes118 48 10

Long-run debt due within one twelvemonth 235 286 122

$ 3. 435 $ 2. 758 $ 2. 472

Net current assets $ 1. 882 $ 1. 248 $ 1. 013

Buildings. machinery. and equipment–net2. 802 2. 467 2. 431

Land–at original cost107 96 97

Patents. hallmarks. and other intangibles71 47 60

Investings in and progresss to attached companies288 227 185

Long-run receivables902 665 413

Other assets199 123 90

Entire assets less current liabilities $ 6. 251 $ 4. 873 $ 4. 289

Long-run debt due after one year1. 953 1. 287 1. 134

Deferred income revenue enhancements 185 21 6

Net assets $ 4. 113 $ 3. 565 $ 3. 149

Ownership ( Statement 2 ) :

Common stock of $ 1. 00 par value:

Authorized portions: 200. 000. 000

Outstanding portions ( 2001–101. 414. 138 ; 2000–101. 422. 711

[ after subtracting 23. 470 and 2. 961 exchequer portions. severally ] ;

1999–98. 832. 079 ) at paid-in sum $ 824 $ 827 $ 714

Net income employed in the business3. 184 2. 656 2. 363

Foreign currency interlingual rendition adjustment105 82 72

$ 4. 113 $ 3. 565 $ 3. 149

STATEMENT 4

SAMPLE CO.

Amalgamate Statement of Cash Flows

For the Years Ended December 31

( dollars in 1000000s )

2001 2000 1999

Cash flows from runing activities:

Net income $ 616 $ 350 $ 76

Adjustments for non-cash points:

Depreciation and amortization434 425 453

Other ( 74 ) 144 86

Changes in assets and liabilities:

Receivables ( 777 ) ( 699 ) ( 765 )

Refundable income taxes15 ( 34 ) 1

Inventories ( 598 ) ( 124 ) ( 68 )

Collectible to material providers and others348 252 ( 14 )

Other–net ( 39 ) ( 80 ) ( 4 )

Net hard currency provided by runing activities $ ( 75 ) $ 234 $ ( 235 )

Cash flows from puting activities:

Outgos for land. edifices. machinery. and equipment $ ( 793 ) $ ( 493 ) $ ( 331 )

Returns from disposals of land. edifices. machinery. and equipment30 32 16

Investings in and progresss to attached companies ( 24 ) ( 65 ) ( 52 )

Other–net ( 50 ) ( 25 ) 41

Net hard currency used for puting activities $ ( 837 ) $ ( 551 ) $ ( 326 )

Cash flows from funding activities:

Dividends paid $ ( 77 ) $ ( 50 ) $ ( 49 )

Common portions issued. including exchequer portions reissued4 6 3

Treasury portions purchased ( 86 ) – –

Returns from long-run debt issued371 503 156

Payments on long-run debt ( 298 ) ( 102 ) ( 307 )

Short-run borrowings–net965 ( 91 ) 578

Net hard currency provided by funding activities $ 879 $ 266 $ 381

Effect of exchange rate alterations on hard currency $ ( 48 ) $ 40 $ 41

Decrease in hard currency and short-run investings $ ( 81 ) $ ( 11 ) $ ( 139 )

Appendix B – Financial Ratio Analysis of Sample Company

Standard Financial Ratio Analysisfor Sample Company

Percentage

Assessment20002001Change Description

Profitableness

ROI ( % ) Great6. 910. 755. 1 Rate of Return on assets invested

ROE ( % ) Great10. 41653. 8 Rate of return of Assetss provided by proprietors equity

Margin ( % ) Great68. 948. 3 Net income ensuing from each dollar of gross revenues

Net incomes Per Share ( $ ) Great $ 3. 51 $ 6. 0772. 9 Net income earned on each portion of common stock

Monetary value to Earnings ( Ratio ) Good1210. 7-10. 8 Market monetary value of portion / net incomes per portion. measures how expensive

Dividend Payout ( % ) Good14. 212. 4-12. 7 Proportion of net incomes that were paid as dividends to common stockholders

Dividend Yield ( % ) Good1. 21. 20. 0 Part of stockholders’ ROI: rate of return from one-year hard currency dividend

Market Price per portion ( $ ) Good $ 42. 00 $ 65. 0054. 8 Change in Market Price of stock during the twelvemonth

Percentage

Assessment20002001Change Description

Activity

Inventory Turnover ( Times ) OK5. 14. 8-5. 9 Efficiency of the firm’s stock list direction patterns

Fixed Asset Turnover ( Times ) Good3. 23. 818. 8 Efficiency with which assets are used to bring forth gross revenues

No. of Days in Accounts Receivable ( yearss ) Good96. 294-2. 3 Average age of histories receivable and

Average Dayss Gross saless ( $ ) OK $ 22. 61 $ 28. 3825. 5 Relative efficiency of the firm’s aggregation policies relative to recognition trems

Leverage

Debt RatioNot so good35. 947. 532. 3 Entire Liabilitiess / ( Entire Liabilities + Owners’ Equity )

Debt/Equity RatioNot so good26. 532. 221. 5 Entire Liabilities / Total Owners’ Equity

Timess Interest Earned ( Times ) Good3. 194. 1831. 0 Net incomes before involvement and revenue enhancements / Interest disbursal ( Ability to pay its involvement )

Liquid

Current Ratio ( Ratio ) Marginal1. 451. 546. 2 Liquidity more comparable over clip

Acid Test ( Ratio ) Marginal0. 840. 79-6. 0 Conservative appraisal

Working Capital ( $ ) Great $ 1. 248 $ 1. 88250. 8 Firm’s ability to run into its duties when they come due


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