Ratio: Balance Sheet and Financial Results

UVA-C-2332 Rev. Oct. 17, 2012 RATIOS TELL A STORY—2011 Financial results and conditions vary among companies for a number of reasons. One reason for the variation can be traced to the characteristics of the industries in which companies operate. For example, some industries require large investments in property, plant, and equipment (PP&E), while others require very little. In some industries, the competitive productpricing structure permits companies to earn significant profits per sales dollar, while in other industries the product-pricing structure imposes a much lower profit margin.In most low-margin industries, however, companies often experience a relatively high rate of product throughput. A second reason for some of the variation in financial results and conditions among companies is the result of management philosophy and policy. Some companies reduce their manufacturing capacity to match more closely their immediate sales prospects, while others carry excess capacity to be prepared for future sales growth. Also, some companies finance their assets with borrowed funds, while others avoid that leverage and choose instead to finance their assets with owners’ equity.And some corporate management teams choose to not pay dividends to their owners, preferring to reinvest those funds in the company. Of course, another reason for some of the variation in reported financial results among companies is the differing competencies of management. Given the same industry characteristics and the same management policies, different companies may report different financial results simply because their managements perform differently. And last, one other reason is that some industries are more susceptible to macroeconomic conditions than others.This can be true when macroeconomic conditions (e. g. , foreign exchange rates, interest rates, and taxes) are weak and deteriorating as well as when they are strong and improving. Or this can also be true when such conditions are stable versus volatile. Those differences in industry characteristics, in company policies, in management performance, and in responsiveness to the macroeconomic environment are reflected in the financial statements published by publicly held companies. Furthermore, they can be highlighted through the use of financial ratios.Exhibit 1 presents balance sheets, in percentage form, and This case was prepared by Professor Mark E. Haskins, Darden Graduate School of Business Administration, and has benefited from collaborations with various colleagues over the years on earlier versions. It was written as a basis for discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright ? 2012 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved.To order copies, send an e-mail to [email  protected] com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. ? -2- UVA-C-2332 selected financial ratios computed from fiscal year 2011 balance sheets and income statements for 13 companies from the following industries: ? ? ? ? ? ? ? ? ? ? ? ? ? irline railroad pharmaceuticals commercial banking photographic equipment, printing, and sales discount general-merchandise retail electric utility fast-food restaurant chain wholesale food distribution supermarket (grocery) chain Internet retailing advertising agency services computer software development Study the balance sheet profiles and the financial ratios listed for each of the 13 companies as presented in Exhibit 1. 1 Your assignment is to use your intuition, common sense, and basic understanding of the unique attributes of each industry listed above to match each column in the exhibit with one of the indus tries.Be prepared to give the reasons for your pairings, citing the data that seems to be consistent with the characteristics of the industry you selected. Ours is not a perfect world, however, and for our class discussion, it will be helpful if you will also identify those pieces of data that seem to contradict the pairings you have made. Please note that using the data available here, you will find it difficult to identify those companies whose financial results differ because of management policy and competence.Please note in Exhibit 1: OCI = Other Comprehensive Income, CFFO = Cash Flow From Operations, ST = Short Term, and LT = Long Term. 1 -3The ratios in Exhibit 1 are based on the following formulas: 1. ROS (return on sales) = Net income Net sales Net sales Average total assets Net income Average total assets ROS ? Asset turnover Average total assets Average total owners’ equity Net income Average total owners’ equity ROA ? Financial leverage Total current assets Total current liabilities Cost of goods sold Average ending inventory Average accounts receivable Net sales/365 days UVA-C-2332 . Asset turnover = 3. ROA (return on assets) or = = 4. Financial leverage = 5. ROE (return on equity) or = = 6. Current ratio = 7. Inventory turnover = 8. Receivables collection = 9. Revenue growth = This year’s net sales—Last year’s net sales Last year’s net sales Net sales—Cost of goods sold Net sales Cash dividends Net income Research and development expense Net sales 10. Gross margin = 11. Dividend payout 12. R&D ratio = = -4Exhibit 1 RATIOS TE ELL A STORY Y—2011 Selected Financ Data for 13 C S cial Companies (b balance sheet amou are percentage of total assets) unts UVA-C-2332 V