Purchase Solution

# Ratio Analysis Overview

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See attached Excel file.

This first part of this file is an overview of ratio analysis. The second part is specific instructions on how to do Discussion Board 2. Ratio analysis is a way to make the numbers given in financial statements come alive and tell you about the operations and risk of the company you are analyzing or to tell you about the similarities or differences in the operations and risk of companies which you are comparing (as in this discussion board).

When comparing two companies in a similar business, the first thing to do after calculating their respective ratios is to see if there are any major differences. For example if one company has a Return on Common Average Equity of 5% and a similar company has a return of 15%, this is a major difference that needs explaining.

The first thing to do is to recheck your calculations and make sure that you have done them correctly. Make sure you are comparing the same financial statements (annual etc) for the same point in time or period of time.

In checking for errors make sure that the calculations that are related to each other make sense. For example, the debt ratio is total liabilities (short and long term)/total assets. If your debt ratio is 59% then, by definition, your debt equity ratio must be 143% (or debt is 1.43 x equity). As a quick shortcut, always assume assets = \$100; if the debt ratio is 59%, then total liabilities = \$59; 100-59 = 41, which, by definition is total equity. 59/41 = 1.43. Check your own calculations against this.

If you have done your calculations correctly, then look behind the numbers. In the case of return on equity, look at the related ratios to get a clue as to the source of the difference (the DuPont System is helpful because it explains the link between operating profitability, asset utilization, the use of leverage (how much debt and equity are used) and return on equity.

Thus the difference might be that the company with a higher Return on Equity, has a better net operating profit margin. This in turn might be caused by a much better gross profit margin which means that the company with a higher return is able to buy or produce their inventory at much lower cost.

Another benefit of understanding the Dupont System it that is also gives insights into other relationships. For example better asset utilization will lead to better return on assets, all other things being equal.

Another place to look for reasons for differences in the notes to the financial statements. These will tell you whether there are any differences in accounting treatment ( not normally the case). More importantly they might give you clues as to important differences in the way of doing business. For example, one reason for large differences in receivables turnover may be that one of the companies sells its receivables thus increasing receivables turnover.

The key is when you have anomalies: go into them in detail to explain them. That is how you learn how one company may be doing something differently (the same is true for the same company over a number of different periods).

I have included as a separate file an Excel spreadsheet which lays out the template I would like you to follow in this assignment. Use this template in presenting all your background work. The analysis in the discussion board dialog box must be based on this template.

? The first part of the template is a listing of all the accounts and their values that are necessary for the required ratio calculations
? The second part is a listing of all the ratios and their definitions that are to be calculated and compared for this analysis. Make sure to carefully read the definitions. Some are a little different than the way they are presented in the book, but, in my opinion are more meaningful.
? To fill in the template, you may use Excel formulas to calculate the ratios using the first set of cells that contain necessary account values
? Make sure to indicate the periods (as of dates, year ended dates) on which your analysis is based
? Make sure to indicate the magnitude of the numbers used (000's, millions etc)
? Make sure to use the most recent annual statements and to indicate the URL of the company's financial statements and the pages on which the information is found. I should be able to click on this URL and go directly to the financial statements you used.
? You are required to get the financial statement from the SEC website. In addition, your numbers will not be reviewed.

To use SEC data, follow these instructions:
o Go to www.sec.gov
o Under "Filings and Forms" (EDGAR) click on "Search for Company Filings";
o This page will say: "You can search information collected by the SEC in several ways". Click on the line that starts :"Company or fund name"
o Put in your company name or ticker (stock symbol). Since getting the public company name can be difficult or choosing the right company from all of its subsidiaries can be difficult, I strongly recommend that you put in the company ticker. If you do not know the company ticker try Googling: "company name and stock symbol".
o I will assume I am looking for JP MorganChase and will type in its ticker : JPM
o The next page lists all the SEC filings for JPMorganChase (the public company). Since I only want the annual report, I need to filter these results. The official SEC document name for the annual report is the 10-K. Thus on the line where I can filter the results:
? Filing type: 10-K
? Prior to: Today's Date
? Ownership: Include
o Then hit the "Search" button (not "show all)
o Choose the 10-K with the most recent filing date. If the 10-K has an "interactive" button, then hit this button. This is where you will find the necessary information and this will also be the URL to be posted.
o If you want to see what a real annual report looks like, hit the "Document" button (instead of the "interactive" button) and then hit the "Document" number on the SEQ 1 line.

##### Solution Summary

A ratio analysis overview for operations is examined.

##### Solution Preview

Please see the attached file for the complete tutorial.

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