Principles of

Chapter 8 Corporate Finance

Tenth Edition

Financial Analysis

Slides by
Matthew Will

Copyright © 2011 by the McGraw-Hill Companies,

Inc. All rights reserved.
McGraw-Hill/Irwin
 12-2

Financial Analysis
shareholders,
bondholders,
bankers,
suppliers,
Strategy
employees,
management

Speaking numbers

Finance Human Resource

 12-3

Topics Covered
➢Financial Statements
➢Measuring Profitability
➢Measuring Efficiency
➢Measuring Leverage
➢Measuring Liquidity
➢Interpreting Financial Ratios
 12-4

Financial Statements
Which one is Asset (A),
Liabilities (L), Equity (E)?

Item Categories
Cash balances
Inventories
Net plant and
equipment
Accounts payable
Long-term debt
Retained earnings
Contributed Capital
Accounts receivable
 12-5

Financial Statements
Which one is Asset (A),
Liabilities (L), Equity (E)?

Item Categories
Cash balances A
Inventories A
Net plant and A
equipment
Accounts payable L
Long-term debt L
Retained earnings E
Contributed Capital E
Accounts receivable A
 12-6

Financial Statements
Which one is Revenue (R),
Expense (E)?

Item Categories
Cost of goods sold
Depreciation
Sales
Selling expense
Interest expense
Income tax expense
 12-7

Financial Statements
Which one is Revenue (R),
Expense (E)?

Item Categories
Cost of goods sold E
Depreciation E
Sales R
Selling expense E
Interest expense E
Income tax expense E
 12-8

Financial Statements
Which one is CF from
operating (CFO), investing
(CFI), financing (CFF)?

Item Categories

Cash collected from

customers
Cash to purchase
plant equipment
Cash paid for
dividends
 12-9

Financial Statements
Which one is CF from
operating (CFO), investing
(CFI), financing (CFF)?

Item Categories
Cash collected from CFO
customers
Cash to purchase plant CFI
equipment
Cash paid for dividends CFF
 12-10

Financial Statements
 12-11

Relationships Among the Statements

 12-12

Financial Analysis

Stakeholders Financial Ratio

Shareholders Performance
Bondholders Liquidity, Profitability
Bankers Liquidity, Leverage
Suppliers Efficiency
Employees Profitability
Management Efficiency, Profitability
Lowe’s Companies
12-13
Lowe’s Companies
12-14
 Lowe’s Companies
12-15

Balance sheet ($mil)

2008 2007
Assets
Current assets
Cash and marketable securities 661 530
Accounts receivable 166 247
Inventories 8,209 7,611
Other current assets 215 298
Total current assets 9,251 8,686

Fixed assets
Tangible fixed assets
property plant and equipment 31,477 28,836
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361

Long -term investments 253 509

Other long-term assets 460 313
Total assets 32,686 30,869
Lowe’s Companies
12-16

Balance sheet ($ mil)

2008 2007
Liabilities and Shareholders’ Equity
Current liabilities
Debt due for repayment 1,021 1,104
Accounts payable 4,543 4,137
Other current liabilities 2,458 2,510
Total current liabilities 8,022 7,751

Long-term debt 5,039 5,576

Deferred income taxes 660 670
Other long-term liabilities 910 774
Total liabilities 14,631 14,771

Common stock and other paid-in capital 735 729

Retained earnings and capital surplus 17,320 15,369
Total shareholders' equity 18,055 16,098

Total liabilities and shareholders’ equity 32,686 30,869

 Lowe’s Companies
12-17

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable 166 247 Accounts payable 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
TangiNet working
ble fixed assets capital = Current Asset
Other long-term liabilities– Current Liabilities
910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
 Lowe’s Companies
12-18

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable 166 247 Accounts payable 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
TangibleNet
fixed assets working capital = Current Asset
Other long-term liabilities – Current910Liabilities
774
property plant and equipment 31,477NWC28,836
(2008) Total= 1,229 ($mil) 14,631
liabilities 14,771
Less accumulated depreciation 8,755 NWC7,475(2007) = 935 ($mil)
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
 Lowe’s Companies
12-19

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable Total capital
166 =247 Long-term
Accounts payable debt + Equity 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475 Book value of equity
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
 Lowe’s Companies
12-20

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Total capital = Long-term
Current liabilitiesdebt + Equity
Cash and marketable securities Total661Capital530 (2007)
Debt due= 21,674 ($mil) 1,021
for repayment 1,104
Accounts receivable Total166Capital Accounts=
247 (2008) payable
23,094 ($mil) 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
 Lowe’s Companies
12-21

Net Income = ( EBIT – Interest ) x (1 – Tax rate)

Income ($ mil)
2008
Net sales 48,230
Cost of goods sold 31,729
Selling, general, and administrative expenses 11,158
Depreciation 1,539
Earnings before interest and taxes (EBIT) 3,804
Interest expense 298
Taxable income 3,506
Tax 1,311
Net income 2,195

Dividends 491
Addition to retained earnings 1,704
 Lowe’s Companies
12-22

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable Total capital
166 =247 Long-term
Accounts payable debt + Equity 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475 Book value of equity
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
 12-23

Measuring Profitability
Lowe’s Profitability Measurements
 Lowe’s Companies
12-24

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable 166 247 Accounts payable 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
 Lowe’s Profitability Summary
12-25

Item Measure % Description

ROC

Effective
Financial
ROE Leverage

ROA

Efficiency in
Asset
Management
 12-26

Measuring Efficiency
Income Statement

Sales
Asset turnover ratio =
Average total assets

Balance Sheet
 Lowe’s Companies
12-27

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable 166 247 Accounts payable 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
 12-28

Asset Turnover Example

Lowe’s Company has following information of 2008:
• Net sales: 48,230 ($ mil)
• Total asset at the end of 2008: 32,686 ($ mil)
• Total asset at the end of 2007: 30,869 ($ mil)
Calculate Asset turnover of Lowe’s

=> Asset Turnover = 48,230  (30,869 + 32,686)/2 = 1.52

For Lowe’s, each 1$ of assets => produced 1.52$ of sales
 12-29

Measuring Efficiency
Balance sheet ($mil) Balance sheet ($ mil)
2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable 166 247 Accounts payable 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
 12-30

Measuring Efficiency
 12-31

Measuring Efficiency
 12-32

Measuring Efficiency
Balance sheet ($mil) Balance sheet ($ mil)
2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable 166 247 Accounts payable 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
 Lowe’s Efficiency Summary
12-33

Item Measure times Description

Asset
turnover

Inventory
turnover

Receivables
turnover

Payables
turnover
 Lowe’s Efficiency Summary
12-34

Item Measure days Description

Days in
Inventory

Average
Collection
period
Average
Payment
period
Operating
cycle
Cash cycle
 12-35

Measuring Leverage
long term debt
Long term debt ratio =
long term debt + equity
Balance long term debt
Debt equity ratio =
Sheet equity

Income
Statement
 12-36

Leverage Example
Balance sheet ($ mil) Calculate Long-term debt ratio,
2008 2007
Liabilities and Shareholders’ Equity
Debt equity ratio, Total debt ratio at
Current liabilities the end of 2008.
Debt due for repayment 1,021 1,104
Accounts payable 4,543 4,137
Other current liabilities 2,458 2,510 • Long-term debt ratio =
Total current liabilities 8,022 7,751

Long-term debt 5,039 5,576

Deferred income taxes 660 670 • Debt equity ratio =
Other long-term liabilities 910 774
Total liabilities 14,631 14,771

Common stock and other paid-in capital 735 729 • Total debt ratio =
Retained earnings and capital surplus 17,320 15,369
Total shareholders' equity 18,055 16,098

Total liabilities and shareholders’ equity 32,686 30,869

 12-37

Leverage Example
Income ($ mil) Calculate Times-interest-
2008
Net sales 48,230
earned ratio for 2008.
Cost of goods sold 31,729
Selling, general, and administrative expenses 11,158
Depreciation 1,539 • Times-interest-earned ratio =
Earnings before interest and taxes (EBIT) 3,804
Interest expense 298 (3,804+1,539) / 298 = 17.93
Taxable income 3,506 times
Tax 1,311
Net income 2,195

Dividends 491
Addition to retained earnings 1,704
 12-38

The DuPont System

Net income
ROE =
Equity

Assets Sales NOPAT Net income

ROE = X X X
Equity Assets Sales NOPAT

ROE = Leverage Asset Operating Debt

ratio turnover profit burden
margin
 12-39

Measuring Liquidity
Balance sheet ($mil) Balance sheet ($ mil)
2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable 166 247 Accounts payable 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
 12-40

Measuring Liquidity

Net working capital Net working capital

=
to total assets ratio Total assets

Cash & Marketable securities

Receivables
Inventory
Other current assets
current assets
Current ratio =
current liabilities
 12-41

Measuring Liquidity
Balance Sheet

Net working capital Net working capital

=
to total assets ratio Total assets

current assets
Current ratio =
current liabilities
Liquidity Net-working-capital-to-total assets ?
Current ratio ?
12-42

example Quick ratio ?

Cash ratio ?
 12-43

Interpret financial ratios

Performance Leverage measures
measures

FINANCIAL RATIOS

Efficiency measures Liquidity measures