Discussion 3

  

Go to

Http://finance.yahoo.com/

, and locate current financial information for Starbucks Corp (SBUX) and McDonald’s Corp (MCD), including each company’s current financial statements and stock market prices. With this information:

1.     Compute the financial ratios for both firms for the most recent year, and evaluate the relative performance of the two firms in the following areas: (10 points)

·        Liquidity

·        Asset management efficiency

·        Financing practices (Capital structure)

·        Profitability

2.     What is each firm’s current price-earnings ratio and market-to-book ratio? What do these ratios tell you about how investors value these two firm’s future prospects? (5 points)

3.     Based on your analysis, what is your personal assessment of the two firms’ past performance?

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Ch. 3 – Financial Statements

1

The Annual Report

Balance sheet – provides a snapshot of a firm’s financial position at one point in time.

Income statement – summarizes a firm’s revenues and expenses over a given period of time.

Statement of cash flows – reports the impact of a firm’s activities on cash flows over a given period of time.

Statement of stockholders’ equity – shows how much of the firm’s earnings were retained, rather than paid out as dividends.

How presentation will benefit audience: Adult learners are more interested in a subject if they know how or why it is important to them.
Presenter’s level of expertise in the subject: Briefly state your credentials in this area, or explain why participants should listen to you.
2

Balance Sheet
What are the resources of the company?
What are the company’s existing obligations?
What are the company’s net assets?

Lesson descriptions should be brief.
3

Balance Sheet
Summary of the financial position of a company at a particular date
Assets: cash, accounts receivable, inventory, land, buildings, equipment and intangible items
Liabilities: accounts payable, notes payable and mortgages payable
Owners’ Equity: net assets after all obligations have been satisfied

Lesson descriptions should be brief.
4

Accounting Equation
Assets = Liabilities + Owners’ Equity
Sources of Funding
Creditors’
claims
against
resources
=
+
Owners’
claims
against
resources
Resources

Resources
to use to
generate
revenues

Example objectives
At the end of this lesson, you will be able to:
Save files to the team Web server.
Move files to different locations on the team Web server.
Share files on the team Web server.

5

Current Assets
Cash
Marketable Securities
Accounts Receivable
Inventories
Prepaid Expenses
Fixed Assets
Machinery & Equipment
Buildings and Land
Other Assets
Investments & patents
Assets
Liabilities (Debt) & Equity

Current Liabilities
Accounts Payable
Accrued Expenses
Short-term notes
Long-Term Liabilities
Long-term notes
Mortgages
Equity
Preferred Stock
Common Stock (Par value)
Paid in Capital
Retained Earnings

Shows the results of a company’s operations over a period of time.
What goods were sold or services performed that provided revenue for the company?
What costs were incurred in normal operations to generate these revenues?
What are the earnings or company profit?
Income Statement

Income Statement
SALES
– EXPENSES
= PROFIT
Revenue

Income Statement
SALES
– EXPENSES
= PROFIT
Cost of Goods Sold
Operating Expenses
(marketing, administrative)
Financing Costs
(Interest Expense)
Taxes

Income Statement
SALES
– Cost of Goods Sold
GROSS PROFIT
– Operating Expenses
OPERATING INCOME (EBIT)
– Interest Expense
EARNINGS BEFORE TAXES (EBT)
– Income Taxes
NET INCOME
– Stock Dividends
– NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

SALES
– Cost of Goods Sold
GROSS PROFIT
– Operating Expenses
OPERATING INCOME (EBIT)
– Interest Expense
EARNINGS BEFORE TAXES (EBT)
– Income Taxes
NET INCOME
– Stock Dividends
– NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
Operating
Activities

SALES
– Cost of Goods Sold
GROSS PROFIT
– Operating Expenses
OPERATING INCOME (EBIT)
– Interest Expense
EARNINGS BEFORE TAXES (EBT)
– Income Taxes
NET INCOME
– Stock Dividends
– NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
Financing
Activities

Statement of Cash Flows
Reports the amount of cash collected and paid out by a company in operating, investing and financing activities for a period of time.
How did the company receive cash?
How did the company use its cash?
Complementary to the income statement.

14

Statement of Cash Flows
Cash inflows
Sell goods or services
Sell other assets or by borrowing
Receive cash from investments by owners
Cash outflows
Pay operating expenses
Expand operations, repay loans
Pay owners a return on investment

15

Match Classification of Cash Flows
Operating activities – Transactions and events that enter into the determination of net income.
Investing activities – Transactions and events that involve the purchase and sale of securities, property, plant, equipment, and other assets not generally held for resale, and the making and collecting of loans.
Financing activities – Transactions and events whereby resources and obtained from, or repaid to, owners and creditors.

16

Operating Activities
Cash Inflow
Sale of goods or services
Sale of investments in trading securities
Interest revenue
Dividend revenue
Cash Outflow
Inventory payments
Interest payments
Wages
Utilities, rent
Taxes

17
14

Investing Activities
Cash Inflow
Sale of plant assets
Sale of securities, other than trading securities
Collection of principal on loans
Cash Outflow
Purchase of plant assets
Purchase of securities, other than trading securities
Making of loans to other entities

18
16

Financing Activities
Cash Inflow
Issuance of own stock
Borrowing
Cash Outflow
Dividend payments
Repaying principal on borrowing
Treasury stock purchase

19
18

CASH OUTFLOWS

Operating
Activities
Financing
Activities
Investing
Activities
CASH INFLOWS
Financing
Activities
Operating
Activities
Investing
Activities
Statement of Cash Flows

20

Statement of Stockholder’s Equity
Beginning retained earnings
+ Net income
– Dividends paid
= Ending retained earnings
An additional financial statement that identifies changes in a firm’s equity from one accounting period to the next.

Ch. 4: Financial Statement Analysis

1

Know how to standardize financial statements for comparison purposes

Know how to compute and interpret important financial ratios

Know the limitations of ratio analysis

Objectives

Financial Statement Analysis
Involves
Benchmark (peer)Analysis:
Comparing firm’s performance with others in the same industry
Trend Analysis:
Evaluating trends in the firm’s financial position over-time

3
3

Financial Statement Analysis
Tools
1. Standardized statements
Common size balance sheet
Divide by total assets
Common size income statement
Divide by sales
2. Ratios

4
4
– Differences in size create problems (time-series and cross-sectional)
– Currency
-We standardize by using percentages
– Ratios: problem–> people compute and use differently
– how computed, intended measure, unit, high/low values, improved?
– What can the company do to affect ratios and how might this affect other ratios?

Common Size Balance Sheet

5
5
– Differences in size create problems (time-series and cross-sectional)
– Currency
-We standardize by using percentages
– Ratios: problem–> people compute and use differently
– how computed, intended measure, unit, high/low values, improved?
– What can the company do to affect ratios and how might this affect other ratios?

Common Size Income Statement

6
6

Ratios also allow for better comparison through time or between companies
As we look at each ratio, ask yourself:
How is the ratio computed?
What is the ratio trying to measure and why?
What is the unit of measurement?
What does the value indicate?
How can we improve the company’s ratio?
Ratio Analysis

7

Ratio Categories
Short-term solvency or liquidity ratios
Long-term solvency, or financial leverage ratios (capital structure ratios)
Asset management or turnover ratios
Profitability ratios
Market value ratios

8
8
Liquidity ratios- firms ability to pay bills over the short run
Long-term solvency – financial leverage
Asset management (turnover) ratios – how efficient is firms use of assets to generate sales
Profit- how efficient does firm use assets to generate profits
Market value ratios – use market price of stock
Not just computing ratios… trying to make better decisions!

Liquidity Ratios

9
9
First…liquidity (house selling for $1)
Current ratio: usually think higher the better (current assets and liabilities should be converted to cash within next year)
– could mean inefficient use of cash
– long term things have an effect (long term debt increases current cash)
– liquid assets generally less profitable
– think back to WSJ article
Quick ratio: inventory usually least liquid current asset and quality may not be known
Suppose CR stays the same and QR goes down
– Not increasing current assets…if liabilities come due could be an issue
– Large levels of inventory have accumulated (should look into inventory)

Inventory turnover ratio measures how many times the company turns over its inventory during the year.

Days’ Sales Outstanding

Asset Management Ratio

Fixed Asset Turnover Ratio measures how effectively the firm uses its plant and equipment.

Total Asset Turnover Ratio represents the amount of sales generated per dollar invested in the firm’s assets.
Asset Management Ratio

Debt ratio measures the proportion of the firm’s assets that were financed using current plus long-term liabilities.

Times Interest Earned Ratio measures the ability of the firm to service its debt or repay the interest on debt.

Capital Structure Ratios

Debt/Equity ratio is calculated by dividing Total Debt by Total Equity.

Equity Multiplier

Capital Structure Ratios

Profit Margin measures operating income, or EBIT, per dollar of sales

Basic Earning Power (BEP) Ratio indicates the ability of the firm’s assets to generate operating income.

Profitability Ratios

Return on Total Assets (ROA)

Return on Equity (ROE)

Profitability Ratios

Price/Earning Ratio(P/E) shows how much investors are willing to pay per dollar of earning

Market to Book Ratio (M/B)

Market Value Ratios

DuPont Equation
ROE = NI / TE
Multiply by 1 and then rearrange:
ROE = (NI / TE) (TA / TA)
ROE = (NI / TA) (TA / TE) = ROA * EM
Multiply by 1 again and then rearrange:
ROE = (NI / TA) (TA / TE) (Sales / Sales)
ROE = (NI / Sales) (Sales / TA) (TA / TE)
ROE = PM * TAT * EM
= Profit Margin * Total Asset Turnover * Equity Multiplier

17
17
Popularized by Du Pont Corporation
ROE is affected by 3 things:
1) operating efficiency (profit margin)
2) asset use efficiency (total asset turnover)
3) financial leverage (equity multiplier)

DuPont Identity
ROE = PM * TAT * EM
Profit margin
Operating efficiency
How well it controls costs
Total asset turnover
Asset use efficiency
How well it manages its assets.
Equity multiplier
Financial leverage

18
18

Benchmark
Trend Analysis
Peer Group Comparisons
Standard Industrial Classification (SIC) Codes
North American Industry Classification System (NAICS)

19

19

Sample ratios: Molson Coors
From Reuters
Management Effectiveness
Company Industry Sector S&P 500
Return on Assets (TTM) 3.89 1.13 1.19 6.89
Return on Assets – 5 Yr. Avg. 3.66 3.87 4.13 8.12
Return on Investment (TTM) 4.35 1.45 1.76 9.65
Return on Investment – 5 Yr. Avg. 4.40 5.74 6.06 11.00
Return on Equity (TTM) 6.61 2.16 3.65 20.90
Return on Equity – 5 Yr. Avg. 7.30 8.22 8.88 19.96
From Hoovers
Profitability Company Industry Market
Gross Profit Margin 40.50% 54.88% 28.77%
Pre-Tax Profit Margin 10.79% 18.51% 8.48%
Net Profit Margin 8.13% 12.51% 5.53%
Return on Equity 5.9% 16.7% 10.1%
Return on Assets 3.3% 6.5% 1.5%
Ret on Invested Capital 4.5% 9.1% 4.4%

20
20

Potential Problems with Ratio Analysis
No underlying theory
No way to know which ratios are most relevant
Benchmarking is difficult
Especially for diversified firms
Globalization and international competition makes comparison more difficult
Differences in accounting regulations
Firms use varying accounting procedures
Firms have different fiscal years
Extraordinary, or one-time, events
Mixed signals
Relies on historical data

21
21
Conglomerates
Trump case: Marvin Roffman sued when he questions Trump Taj Majal (1990)
New issues: Internet and information
s
liabilitie
Current
assets
Current

Ratio
Current
=
s
Liabilitie
Current
Inventory

–
Asset
Current

Ratio

(Quick)
Test
–
Acid
=
=
Cost of Goods Sold
Inventory Turnover
Inventories
Sales/365

Annual
s
Receivable
day
per

Sales

Average
s
Receivable
g
outstandin

sales

Days
=
=
Assets

Total
Sales
Ratio
Turnover

Assets

Total
=
Assets

Fixed
Net
Sales
Ratio
Turnover

Assets

Fixed
=
=
Total Liabilities
Debt Ratio
Total Assets
=
Times Interest
Net Operating Income or EBIT
EarnedInterest Expense
TE
TD

Ratio
Equity

Debt to
=
E
D
+
=
=
1
TE
TA

Multiplier
Equity
Sales
EBIT
Margin

Operating
=
Assets

Total
EBIT
BEP
=
Assets

Total
Income
Net
ROA
=
Equity

Total
Income
Net
ROE
=
share
per

Earning
share
per

Price
P/E
=
share
per

Book value
share
per

price
Market
M/B
=

Financial Statement Analysis

Ratio Analysis Example

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

$3,588

Prufrock Corporation Balance Sheet as of December 31,2008 ($ in millions)
Assets																																																Liabilities and Owners’ Equity
Current assets	Current liabilities
Cash	$98	Accounts payable	$344
Accounts receivable	$188	Notes payable	$196
Inventory	$422			Total	$540
$708	Long-term debt	$457
Fixed assets	Owners’ equity
Net plant and equipment	$2,880	Common stock and paid-in surplus	$ 550
Total assets		$3,588	Retained earnings	$2,041
$2,591
Total liabilities and owners’ equity

 

 

 

 

 

 

 

 

 

 

Prufrock Corporation 2008 Income Statement ($ in millions)
Sales	2311
Cost of goods sold	1344
Depreciation	276
Earnings before interest and taxes	691
Interest paid	141
Taxable income	550
Taxes (34%)	187
Net income	363
Dividends	121
Addition to retained earnings	242

*Create common size balance sheet and common size income statement.

*Calculate ratios for Prufrock Corporation

Short-term solvency or liquidity ratios

Liquidity ratio measures the firm’s ability to pay its bills over the short run without undue stress.

Current ratio=

*Do we have enough short-term liquid assets to cover our short-term debts?

Quick ratio (acid test ratio) =

*Do we have enough really liquid short-term assets to cover our short-term debts?

Long-term solvency, or financial leverage, ratios

Leverage ratio measures the form’s long-run ability to meet its obligations.

Total debt ratio=

What percentage of total assets is financed with either short- or long-term debt?

Debt-equity ratio=

Times interest earned=

* It measures how well a company has its interest obligations covered. Are we generating enough income to make out interest payments?

Asset management or turnover ratios

Turnover ratios measure asset use efficiency.

Inventory turnover=

*On average, how many times per year do we go through our inventory? (Excess inventory is expensive!)

Day’s sales Outstanding=

Fixed Assets Turnover Ratio=

Total Assets Turnover Ratio=

Profitability ratios

Operating margin=

Profit margin=

Return on assets (ROA) =

*What is profit per dollar of asset?

Return on equity (ROE) =

*What is the rate of return for stockholders?

Return on equity (ROE) = Profit margin * Total asset turnover * Equity multiplier

Market value ratios

(We assume that Prufrock has 33 million shares outstanding and stock sold for $88 per share at the end of the year.)

EPS=

Price-earnings ratio=

Market-to-book ratio=

4-1