HOW HEALTHY IS C&C? C&C’s cash balance has fallen dramatically, and George Douglas wonders why. Cedric Renn, a potential employee, wonders if C&C will.
Jan 11, 2016
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HOW HEALTHY IS C&C?
C&C’s cash balance has fallen dramatically, and George Douglas wonders why.
Cedric Renn, a potential employee, wonders if C&C will be around for the long term.
Meredith Lincoln wonders if she should increase C&C’s credit limit.
Each can use C&C’s financial statements to help answer their question.
WHAT IS FINANCIAL STATEMENT ANALYSIS?
Analyzing a firm’s past financial performance
Finding out how a firm measures up against other firms in the industry
Forecasting future performance
WHY DO FINANCIAL STATEMENT ANALYSIS?
Managers
Stockholders (current AND potential)
Creditors
Customers
Bankers
Employees
Analysts
HORIZONTAL ANALYSIS
Shows the percentage increase or decrease in a particular line item on the financial statements; may also be expressed in dollars
Requires two years’ of information to calculate
The earliest year is considered the “base year”
HORIZONTAL ANALYSIS
Current Year Amount – Base Year Amount
Base Year Amount
HORIZONTAL ANALYSIS: SALES REVENUE
12/31/10 12/31/09 $ Change % Change
Sales revenue $5,237,000 $4,654,000 $583,000 12.5%
Cost of goods sold 3,876,432 3,464,440 411,992 11.9%
Gross margin 1,360,568 1,178,560 171,008 14.4%
Selling and administrative expenses 1,160,566 1,067,721 92,845 8.7%
Operating income 200,002 121,839 78,163 64.2%
Interest expense 41,715 43,210 (1,492) (3.5%)
Income before taxes 158,287 78,629 79,658 101.3%
Income tax expense 47,486 23,589 23,897 101.3%
Net income $ 110,801 $ 55,040 $ 55,761 101.3%
$5,237,000 - $4,654,000 = 12.5%
$4,654,000
C&C INCOME STATEMENT
12/31/10 12/31/09 $ Change % Change
Sales revenue $5,237,000 $4,654,000 $583,000 12.5%
Cost of goods sold 3,876,432 3,464,440 411,992 11.9%
Gross margin 1,360,568 1,178,560 171,008 14.4%
Selling and administrative expenses 1,160,566 1,067,721 92,845 8.7%
Operating income 200,002 121,839 78,163 64.2%
Interest expense 41,715 43,210 (1,492) (3.5%)
Income before taxes 158,287 78,629 79,658 101.3%
Income tax expense 47,486 23,589 23,897 101.3%
Net income $ 110,801 $ 55,040 $ 55,761 101.3%
Why don’t we add the % change column?
HORIZONTAL ANALYSIS ALLOWS US TO…
Identify trends and changes in account balances over time
Predict account balances based on the identified trend
TREND ANALYSIS
Shows account balances as a percentage of the base year
Can see how account balances are changing over time
TREND ANALYSIS CALCULATION FOR REVENUE
12/31/10 12/31/09 $ Change % Change
Sales revenue $5,237,000 $4,654,000 $583,000 112.5%
Cost of goods sold 3,876,432 3,464,440 411,992 111.9%
Gross margin 1,360,568 1,178,560 171,008 114.4%
Selling and administrative expenses 1,160,566 1,067,721 92,845 18.7%
Operating income 200,002 121,839 78,163 164.2%
Interest expense 41,715 43,210 (1,492) (13.5%)
Income before taxes 158,287 78,629 79,658 201.3%
Income tax expense 47,486 23,589 23,897 201.3%
Net income $ 110,801 $ 55,040 $ 55,761 201.3%
$5,237,000 = 112.5%
$4,654,000
COMMON-SIZE STATEMENTS
Every line item on the financial statement is presented as a percentage of a major statement component• Total assets for the balance sheet• Net sales for the income statement• Also known as vertical analysis
COMMON-SIZE BALANCE SHEET
Account BalanceTotal Assets
COMMON SIZE BALANCE SHEET
12/31/10 12/31/09
$ % $ %
Cash $ 7,752 0.42% $ 22,114 1.23%
Accounts receivable, net 623,713 33.34% 583,429 32.46%
Total inventory 640,372 34.23% 547,109 30.44%
Prepaid expenses 24,388 1.30% 8,164 0.46%
Total current assets 1,296,225 69.29% 1,160,816 64.59%
Property, plant & equipment 532,858 28.48% 600,647 33.42%
Other assets 41,704 2.23% 35,812 1.99%
Total assets $1,870,787 100.00% $1,797,275 100.00%
$7,752 = 0.42%
$1,870,787
12/31/10
Cash 0.42%
Accounts receivable, net 33.34%
Total inventory 34.23%
Prepaid expenses 1.30%
Total current assets 69.29%
Property, plant & equipment 28.48%
Other assets 2.23%
Total assets 100.00%
COMMON-SIZE BALANCE SHEET
12/31/10
Accounts payable 23.60%
Other accrued expenses 4.64%
Short-term debt 6.68%
Current maturities of LTD 1.07%
Total current liabilities 35.99%
Long-term debt 14.97%
Total liabilities 50.96%
Common stock 11.23%
Retained earnings 37.81%
Total stockholders’ equity 49.04%
Total liabilities & equity 100.00%
Notice that the Total Assets and Total Liabilities & Stockholders’ Equity lines must total to 100%
12/31/10
Cash 0.42%
Accounts receivable, net 33.34%
Total inventory 34.23%
Prepaid expenses 1.30%
Total current assets 69.29%
Property, plant & equipment 28.48%
Other assets 2.23%
Total assets 100.00%
12/31/10
Accounts payable 23.60%
Other accrued expenses 4.64%
Short-term debt 6.68%
Current maturities of LTD 1.07%
Total current liabilities 35.99%
Long-term debt 14.97%
Total liabilities 50.96%
Common stock 11.23%
Retained earnings 37.81%
Total stockholders’ equity 49.04%
Total liabilities & equity 100.00%
WHAT DOES THIS MEAN?
33.34% of C&C’s assets are in the form of
accounts receivable.
23.60% of C&C’s capitalization is provided by short-term creditors.
COMMON SIZE INCOME STATEMENT
Account BalanceNet Sales
COMMON SIZE INCOME STATEMENT
12/31/10 12/31/09Sales revenue $5,237,000 100.00% $4,654,000 100.00%Cost of goods sold 3,876,432 74.02% 3,464,440 74.44% Gross margin 1,360,568 25.98% 1,178,560 25.56%Selling and administrative expenses 1,160,566 22.16% 1,067,721 22.94%Operating income 200,002 3.82% 121,839 2.62%Interest expense 41,715 0.80% 43,210 0.93% Income before taxes 158,287 3.02% 78,629 1.69%Income tax expense 47,486 0.91% 23,589 0.51%
Net income $ 110,801 2.11% $ 55,040 1.18%
$3,876,432 = 74.02%
$5,237,000
COMMON SIZE INCOME STATEMENT
12/31/10 12/31/09Sales revenue 100.00% 100.00%Cost of goods sold 74.02% 74.44% Gross margin 25.98% 25.56%Selling and administrative expenses 22.16% 22.94%Operating income 3.82% 2.62%Interest expense 0.80% 0.93% Income before taxes 3.02% 1.69%Income tax expense 0.91% 0.51%
Net income 2.11% 1.18%
Notice that we start with Net Sales at 100%. If there had been Gross Sales and then Sales
Returns, Gross Sales would be greater than 100.
WHAT DOES THIS MEAN?
12/31/10 12/31/09Sales revenue 100.00% 100.00%Cost of goods sold 74.02% 74.44% Gross margin 25.98% 25.56%Selling and administrative expenses 22.16% 22.94%Operating income 3.82% 2.62%Interest expense 0.80% 0.93% Income before taxes 3.02% 1.69%Income tax expense 0.91% 0.51%
Net income 2.11% 1.18%
This means that for every $1.00 collected in sales revenue, 74.44¢
goes to make C&C’s goods for sale.
COMMON SIZE STATEMENTS ALLOW US TO…
Look at changes in the makeup of the base component• Has COGS as a percentage of net sales increased
this year?
Compare companies of different absolute sizes• Qualcomm vs. Ericsson
Compare a firm to industry averages
RATIO ANALYSIS
A comparison of the relationship between two or more financial statement items
Reveals symptoms of underlying strengths and weaknesses
Four major categories• Liquidity ratios• Leverage ratios• Profitability ratios• Market measure ratios
RATIO ANALYSIS ALLOWS US TO…
Compare a company with industry averages or norms (cross-sectional analysis)
Examine changes in a company’s ratios over time (longitudinal analysis)
Focus further investigations into a company’s performance (reveals symptoms, not answers)
LIQUIDITY RATIOS
What is liquidity?• Ability to convert assets into cash within a year or the
length of the business cycle
Why is it important?• Need to pay bills on time• Need to take advantage of opportunities
WORKING CAPITAL CALCULATION
Total Current Assets – Total Current Liabilities
Current Assets 12/31/10
Cash $ 7,752
Accounts receivable, net 623,713
Total inventory 640,372
Prepaid expenses 24,388
Total current assets $1,296,225
Current Liabilities 12/31/10
Accounts payable $441,602
Other accrued expenses 86,749
Short-term debt 125,000
Current maturities of LTD 20,000
Total current liabilities $673,351$1,296,225 – $673,351 = $622,874
CURRENT RATIO CALCULATION
Total Current Assets
Total Current Liabilities
Current Assets 12/31/10
Cash $ 7,752
Accounts receivable, net 623,713
Total inventory 640,372
Prepaid expenses 24,388
Total current assets $1,296,225
Current Liabilities 12/31/10
Accounts payable $441,602
Other accrued expenses 86,749
Short-term debt 125,000
Current maturities of LTD 20,000
Total current liabilities $673,351$1,296,225
$673,351= 1.93
CURRENT RATIO – WHAT DOES IT MEAN?
Literally, that C&C has 1.93 times more current assets than current liabilities
Measures the buffer to cover shrinkage in asset value in the event of forced liquidation
Measures ability to absorb random business shocks and uncertain cash flows
Rule of thumb 2:1, but don’t let it get too high; very industry-sensitive
ACID-TEST RATIO CALCULATION
Cash + Cash Equivalents + A/R
Total Current Liabilities
Current Assets 12/31/10
Cash $ 7,752
Accounts receivable, net 623,713
Total inventory 640,372
Prepaid expenses 24,388
Total current assets $1,296,225
Current Liabilities 12/31/10
Accounts payable $441,602
Other accrued expenses 86,749
Short-term debt 125,000
Current maturities of LTD 20,000
Total current liabilities $673,351= 0.94$7,752 + $623,713
$673,351
ACID-TEST RATIO – WHAT DOES IT MEAN?
Literally, C&C has 0.94 times “highly liquid” current assets as current liabilities
More stringent test than current ratio since it uses only the most liquid current assets
Rule of thumb is 1:1
CURRENT AND ACID-TEST RATIO LIMITATIONS
Static measures of liquidity
Not useful for predictions of cash flows
No insight into quality of the assets
No insight into timing of cash conversion
ACTIVITY RATIOS
What are they used for?• To measure how well a company is managing (using)
its assets• Provides some insight into the quality of the assets
underlying the liquidity ratios
Two areas we’ll study• Accounts Receivable• Inventory
A/R TURNOVER CALCULATION
Net Credit Sales
Average A/R
Current Assets 12/31/10 12/31/09
Cash $ 7,752 $22,114
Accounts receivable, net 623,713 583,429
Total inventory 640,372 547,109
Prepaid expenses 24,388 8,164
Total current assets $1,296,225 $1,797,275
Income Statement 12/31/10
Sales revenue $5,237,000
Cost of goods sold 3,876,432
Gross margin 1,360,568
$5,237,000
($623,713 + $583,429) / 2= 8.68 times
WHAT DOES IT MEAN?
A/R Turnover• Measures how many times receivables are generated
and collected within a year• Higher turnover means faster collection of cash
AVERAGE COLLECTION PERIOD
365 Days
A/R Turnover
365 days
8.68 times= 42 days
INVENTORY TURNOVER CALCULATION
Cost of Goods Sold
Average Inventory
Current Assets 12/31/10 12/31/09
Cash $ 7,752 $22,114
Accounts receivable, net 623,713 583,429
Total inventory 640,372 547,109
Prepaid expenses 24,388 8,164
Total current assets $1,296,225 $1,160,816
Income Statement 12/31/10
Sales revenue $5,237,000
Cost of goods sold 3,876,432
Gross margin 1,360,568
$3,876,432
($640,372 + $547,109) / 2= 6.53 times
WHAT DOES IT MEAN?
Inventory Turnover• Measures how many times inventory is sold within a
year• Higher turnover means faster sale of inventory and
less likely to have obsolete items, but too high may indicate stock-out problems
AVERAGE DAYS TO SELL INVENTORY CALCULATION
365 Days
Inventory Turnover
365 days
6.53 times= 55.9 days
DO YOU UNDERSTAND INVENTORY TURNOVER?
Who would you expect to have the highest inventory turnover? Why?
Ice cream manufacturer
Airplanemanufacturer
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LEVERAGE RATIOS
Longer time-frame of concern than short-term creditors
Interested in short-term position for payment of interest
Interested in long-term position for repayment of loan balance
DEBT RATIO CALCULATION
Total Liabilities
Total Assets
Assets 12/31/10
Total current assets $1,296,225
Property, plant & equipment, net 532,858
Other assets 41,704
Total assets $1,870,787
Liabilities 12/31/10
Total current liabilities $673,351
Long-term debt 280,000
Total liabilities $953,351
$953,351
$1,870,787= 50.9%
DEBT-TO-EQUITY RATIO CALCULATION
Total Liabilities
Total Stockholders’ EquityLiabilities 12/31/10
Total current liabilities $673,351
Long-term debt 280,000
Total liabilities 953,351
Common stock 210,000
Retained earnings 707,436
Total stockholders’ equity 917,436
Total liabilities & stockholders’ equity $1,807,787
$953,351
$917,436= 1.04
WHAT DOES IT MEAN?
Debt-to-Equity Ratio• At C&C there is $1.04 in debt for every $1 of
stockholder’s equity. Put another way, about 50% of the asset base is financed through debt, or borrowed money, while 50% is financed by stockholders’ capital
• The higher the ratio, the greater the risk assumed by the creditors
THE TIMES-INTEREST-EARNED CALCULATION
Earnings before Interest and Taxes
Interest ExpenseIncome Statement 12/31/10
Sales revenue $5,237,000
Cost of goods sold 3,876,432
Gross margin 1,360,568
Selling and administrative expenses 1,160,566
Operating income 200,002
Interest expense 41,715
Income before taxes 158,287
Income tax expense 47,486
Net income $ 110,801
$200,002
$41,715
= 4.79 times
PROFITABILITY RATIOS
Focuses on returns to the stockholder
GROSS MARGIN CALCULATION
Gross Margin
Net SalesIncome Statement 12/31/10
Sales revenue $5,237,000
Cost of goods sold 3,876,432
Gross margin 1,360,568
Selling and administrative expenses 1,160,566
Operating income 200,002
Interest expense 41,715
Income before taxes 158,287
Income tax expense 47,486
Net income $ 110,801
$1,360,568
$5,237,000
= 25.98%
RETURN ON ASSETS CALCULATION
NI + [ Interest Expense × (1 – tax rate) ]
Average Total AssetsIncome Statement 12/31/10
Operating income 200,002
Interest expense 41,715
Income before taxes 158,287
Income tax expense 47,486
Net income $ 110,801
Balance Sheet 12/31/10 12/31/09
Total assets $1,870,787 $1,797,275
$110,801 + [ 41,715× (1 – ) ]
($1,870,787 + $1,797,275) / 2
$41,715$158,287 =7.63%
RETURN ON COMMON STOCKHOLDER’S EQUITY CALCULATION
NI – Preferred Dividends
Average Common Stockholders’ EquityIncome Statement 12/31/10
Operating income 200,002
Interest expense 41,715
Income before taxes 158,287
Income tax expense 47,486
Net income $ 110,801
Balance Sheet 12/31/10 12/31/09
Common stock 210,000 210,000
Retained earnings 707,436 596,635
Total common equity $917,436 $806,635
$110,801 - $0
($917,436 + $806,635) / 2= 12.85%
MARKET MEASURE RATIOS
Only calculated for publicly traded stocks
EARNINGS PER SHARE CALCULATION
NI – Preferred Dividends
Average Number of Shares Outstanding
$1,486.7 - $0 = $3.07
484.9
PRICE/EARNINGS RATIO CALCULATION
Market Price per Share
Earnings per Share
$66.07
$3.07= 21.52 times
(Closing market price, 12/31/09)
DIVIDEND PAYOUT RATIO CALCULATION
Dividends per Share
Earnings per Share
$0.98
$3.07= 32%
SOME THINGS TO REMEMBER…
Ratios are a snapshot
The firm’s choice of accounting principles influences reported income
Read the footnotes to find unusual items
Contingent liabilities could influence future earnings
Discontinued operations or extraordinary items may influence future performance
INDUSTRY CLASSIFICATION
Standard Industrial Classification (SIC) code• 2329 for C&C
North American Industrial Classification System (NAICS) code• 315299 for C&C
SOURCES OF INDUSTRY DATA
Published Industry Analyses
Government Statistics
Industry trade groups
GOVERNMENT DATA EXAMPLE
Value of U.S. Men’s and Boys’ Team Sports Uniform Shipments
Sources: U.S. Census Bureau, Annual Survey of Manufactures Value of Product Shipments: 2001, 2004, 2006
TRADE ASSOCIATION DATA EXAMPLE
Sources: SMGA, Sports Participation Topline Report: 2006 Edition; 2007 Sports and Fitness Participation Report; 2008 Sports and Fitness Participation Report; 2009 Sports and Fitness Participation Report
U.S. Participants in Team Baseball, 6 Years of Age or Older, at Least Once per Year
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