Ch 5.Financial Analysis.ppt

* * * * * * * * * * * * * * * * * * Financial Leverage Analysis Borrowing allows a firm to access to capital, but increases the risk of ownership for equity holders. Analysis of leverage can be performed on both short- and long-term debts: Liquidity analysis relates to evaluating current liabilities Solvency analysis relates to longer term liabilities Liquidity Analysis There are several ratios useful to evaluate a firm’s liquidity, including: Current ratio Quick ratio Cash ratio Operating cash flow ratio Each of these ratios attempts to measure the ability of a firm to pay its current obligations. Liquidity Analysis Knowing how the liquidity ratios are calculated allows the user to understand how to interpret them: Current ratio = Current assets / Current liabilities Current liabilities Quick ratio = Cash + Short-term investments + Accts. receivable Current liabilities Cash ratio = Cash + Marketable securities Current liabilities Operating cash flow ratio = Cash flows from operations Current liabilities Copyright (c) 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Chapter 5: Financial Analysis Palepu Healy Comparison of Wal-Mart and TargetLiquidity Ratios Debt and Coverage Ratios Beyond short-term survival, solvency measures the ability of a firm to meet long-term obligations. Several useful ratios are used to analyze solvency. Three using only shareholders’ equity as a denominator are: Liabilities-to-equity ratio = Total liabilities Shareholders’ equity Debt-to-equity ratio = Short-term debt + Long-term debt Shareholders’ equity Net-debt-to-equity ratio = Short-term debt + Long-term debt – Cash and marketable securities Shareholders’ equity More Debt and Coverage Ratios Two ratios that use debt as a proportion of total capital are: Debt-to-capital ratio = Short-term debt + Long-term debt