Financial Management
Dr. Andrea Rigamonti
andrea.rigamonti@econ.muni.cz
Lecture 2
Content:
• Financial statement analysis
Financial statement analysis – Profitability ratios
The gross (profit) margin measures the ability to sell a
product for more than the cost of producing it:
Gross margin =
Gross profit
Sales
The operating margin uses instead the operating
income, i.e., the earnings before interests and taxes:
Operating margin =
Operating income
Sales
The EBIT margin is given by:
EBIT margin =
EBIT
Sales
Financial statement analysis – Profitability ratios
Sometimes Operating income and EBIT are used
interchangeably (and therefore also Operating margin
and EBIT margin), but it is imprecise because the former
does not include non-operating incomes and expenses.
The Net profit margin shows the fraction of each dollar
in revenues that is available to equity holders after the
firm pays interest and taxes:
Net profit margin =
Net income
Sales
Financial statement analysis – Profitability ratios
The Return on assets (ROA) shows, in percentage, how
profitable a company's assets are in generating revenue:
ROA =
Net income
Total assets
The Return on equity (ROE) provides a measure of the
return that the firm has earned on its past investments :
ROE =
Net income
Average shareholders′equity
Financial statement analysis – Profitability ratios
The return on invested capital (ROIC) measures the aftertax
profit generated by the business itself, excluding any
interest expenses (or income), and compares it to the
capital raised from equity and debt holders that has
already been deployed (i.e., not held as cash):
ROIC =
EBIT(1 − Tax rate)
Book value of equity + Debt
As EBIT(1 − Tax rate) gives the net operating profit after
tax (NOPAT), and Book value of equity + Debt is a typical
way to measure invested capital, we can also write:
ROIC =
NOPAT
Invested capital
Financial statement analysis – Liquidity ratios
Liquidity measures are used to measure the firm’s ability
to pay the short term obligations. From the list to the
most stringent we have:
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐫𝐚𝐭𝐢𝐨 =
Current assets
Current liabilities
𝐐𝐮𝐢𝐜𝐤 𝐫𝐚𝐭𝐢𝐨 =
Current assets − Inventories
Current liabilities
𝐂𝐚𝐬𝐡 𝐫𝐚𝐭𝐢𝐨 =
Cash
Current liabilities
Financial statement analysis – Leverage ratios
Leverage ratios are also called debt management ratios,
and they help estimate the likelihood of default.
Leverage is the extent to which a firm relies on debt as a
source of financing.
Debt to assets ratio, or debt ratio, is:
Debt ratio =
Total debt
Total assets
Debt to equity ratio is:
Debt to equity ratio =
Total debt
Total equity
Financial statement analysis – Leverage ratios
The Liabilities to assets ratio measures the extent to
which a firm’s assets are not supported by equity.
Liabilities to assets ratio =
Total liabilities
Total assets
The Equity multiplier measures how much of a company's
assets are financed through stockholders' equity, i.e., the
amplification of the firm’s accounting returns that results
from leverage.
Equity multiplier =
Return on equity
Return on assets
=
1
1 − Liabilities to assets ratio
Financial statement analysis – Efficiency ratios
Also called Asset management ratios or Working capital
ratios, they measure how effectively a firm manages assets.
The total assets turnover ratio measures the dollars in
sales generated for each dollar that is tied up in assets:
Total assets turnover ratio =
Sales
Total assets
The fixed assets turnover ratio measures how effectively
the firm uses its plant and equipment (can be sensitive to
inflation, as fixed assets are reported using historical costs).
Fixed assets turnover ratio =
Sales
Net fixed assets
Financial statement analysis – Efficiency ratios
Days sales outstanding (DSO), also called Average
collection period (ACP), or also Accounts receivable days
(A/R Days) is the average length of time that the firm must
wait after making a sale before receiving cash.
DSO =
Receivables
Average sales per day
Turnover ratios are an alternative way to measure working
capital. Higher turnover corresponds to shorter days, and
thus a more efficient use of working capital.
Financial statement analysis – Efficiency ratios
For example, the Inventory turnover measures how many
times a company's inventory is sold and replaced in a year.
Inventory turnover =
Annual cost of sales
Inventory
The Accounts receivable turnover measures how frequently
a company collects its accounts receivable in a year.
Accounts receivable turnover =
Sales
Accounts receivable
Financial statement analysis – DuPont equation
The DuPont equation (or identity) expresses the ROE as:
ROE =
Net income
Sales
×
Sales
Total assets
×
Total assets
Sales
= Profit margin × Asset turnover × Equity multiplier
This formulation is useful for identifying the drivers of
ROE, and for benchmarking.
With benchmarking we mean comparison with other
companies in the same field, typically the leaders in that
field, to identify strengths and weaknesses.