Page 59 - Financial Statement Analysis

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36 Financial Statement Analysis

Illustration of Ratio Analysis. We can compute numerous ratios using a company’s
financial statements. Some ratios have general application in financial analysis, while
others are unique to specific circumstances or industries. This section presents ratio
analysis as applied to three important areas of financial statement analysis:
1. Credit (Risk) Analysis
a. Liquidity. To evaluate the ability to meet short-term obligations.
b. Capital structure and solvency. To assess the ability to meet long-term
obligations.
2. Profitability Analysis
a. Return on investment. To assess financial rewards to the suppliers of equity
and debt financing.
b. Operating performance. To evaluate profit margins from operating activities.
c. Asset utilization. To assess effectiveness and intensity of assets in generating
sales, also called turnover.
3. Valuation
a. To estimate the intrinsic value of a company (stock).
Exhibit 1.14 reports results for selected ratios having applicability to most compa-
nies. A more complete listing of ratios is located on the book’s inside cover. Data used
in this illustration are from Colgate’s annual report in Appendix A, although most ratios
can be computed from informations in the financial statements presented in Exhibits 1.5
through 1.8.

Exhibit 1.14 Financial Statement Ratios for Colgate (2006)

Liquidity
Current assets $3,301.0
Current ratio 0.95
Current liabilities $3,469.1
Cash and cash equivalents Marketable securities Accounts receivable
Acid-test ratio
Current liabilities
$489.5 $1,523.2
0.58
$3,469.1
Average accounts receivable ($1,523.2 $1,309.4)N2
Collection period 41.66 days
SalesN360 12,237.7N360
Average inventory ($1,008.4 $855.8)N2
Days to sell inventory 60.61 days
Cost of salesN360 $5,536.1N360

Capital Structure and Solvency
Total liabilities $7,727.1
Total debt to equity 5.48
Shareholder’s equity $1,410.9
Long-term liabilities $4,258.0
Long-term debt to equity 3.02
Shareholders’ equity $1,410.9
Income before income taxes and interest expense $2,001.8 $158.7
Times interest earned 13.61
Interest expense $158.7
(continued)