After reading this chapter, you should be able to answer the following questions: Why are financial statement ratios important? How is return on investment calculated and why is it important? What is the DuPont model and what do margin and turnover mean? What is the significance of return on equity and how is it calculated?...
Trang 2Learning Objectives
1 Why are financial statement ratios Important?
2 How Is return on investment
calculated and why Is it important?
3 What is the DuPont model and
what do margin and turnover
mean?
4 What is the significance of return on equity and how Is It calculated?
Trang 3Learning Objectives
5 What does liquidity mean and why is It Important?
6 How are working capital, current ratio, and acid-test ratio calculated and why are they significant?
Trang 5Financial Ratios and Trend
Analysis
Trang 6Learning Objective 2
- How Is return on investment
calculated and why Is It
important?
Trang 7Return on Investment
Calculations
¢ Rate of return =
Amount of return / Amount of investment Return on investment is a measure of
profitability
Derived from the interest calculation of:
Trang 8Return on Investment
and Risk
- In evaluating Investments, risk must also be considered
- Risk relates to the range of outcomes from an activity; wider range = greater risk
- In general, higher risk = higher return
Trang 9Financial Statements and
Return on Investment
¢ Also called Return on Assets
- The amount of return = Net Income
- The amount of the Investment = Average Total
Assets
- Describes the rate of return management was able to earn on the assets available to use during the year
Trang 10Learning Objective 3
¢ What is the DuPont model and what
Trang 11The DuPont Model
An expansion of the basic return on investment calculation
Return on Investment =
Net Income Sales
Sales Average Total Assets
Net Income / Sales = Margin
Trang 12Margin and Asset Turnover
- Margin indicates that some sales
revenues must result in net income if the firm Is to be profitable
- Turnover indicates how efficiently the firm IS uSing Its assets to generate revenue
Trang 13Learning Objective 4
Trang 14Return on Equity
- Return on Equity is a special case
application of the rate of return concept - Return on Equity =
Net Income
Average Owners’ Equity
Trang 15Learning Objective 5
Trang 16Working Capital and Measures of Liquidity
* Liquidity is the firm’s ability to meet Its current obligations
* Working capital is the excess of a firm’s
current assets over Its current liabilities
— Current assets are cash and other assets
likely to be converted to cash within a year — Current liabilities are those obligations
expected to be paid within a year
Trang 18Learning Objective 6
* How are working capital,
current ratio, and acid-test ratio
calculated and why are they significant?
Trang 19Current Ratio
- The trend in the current ratio is the most
Trang 20Acid-Test Ratio
- Also known as the Quick Ratio
° The Acid-Test Ratio is a more conservative
measure of liquidity since Inventory Is not
included tn its calculation
- As ageneral rule, an Acid-Test Ratio of 1.0 Is considered adequate
Trang 21Learning Objective 7
Trang 22Trend Analysis
- Graph return against the year, with the years listed on the horizontal axis
- The more compressed the graph, the more pronounced the peaks and
valleys
- See following graph of margin and turnover for Intel Corporation