Statement
Analysis
K R Subramanyam
John J Wild
McGraw-Hill/Irwin
10-2
Credit Analysis
10
CHAPTER
10-3
10-4
10-5
Denominator Considerations
Payables vary with sales.
Current liabilities do not include prospective cash outlays.
10-6
10-7
Note of caution
Quality of current assets and the composition of current liabilities are
more important in evaluating the current ratio.
Working capital requirements vary with industry conditions and the
length of a companys net trade cycle.
10-8
10-9
10-10
10-11
10-12
10-13
Inventory management
Effective inventory management increases inventory
turnover.
10-14
10-15
10-16
10-17
10-18
10-19
10-20
10-21
$ 70,000
150,000
65,000
130,000
35,000
18,000
200,000
43,000
200,000
$750,000
520,000
350,000
25,000
20,000
10-22
$ 70,000
$ 150,000
825,000
$ 975,000
( 206,250)(a)
768,750
$ 838,750
$ 543,000
(15,000)
18,000
203,500
749,500
$ 89,250
50,000
$ 39,250
(continued)
10-23
572,000
150,000
722,000
(65,000)
657,000
10-24
Basics of Solvency
Solvency long-run financial viability and its ability to
cover long-term obligations
Capital structure financing sources and their attributes
Earning power recurring ability to generate cash from
operations
Loan covenants protection against insolvency and
financial distress; they define default (and the legal
remedies available when it occurs) to allow the
opportunity to collect on a loan before severe distress
10-25
Basics of Solvency
Capital Structure
Equity financing
Debt financing
10-26
Basics of Solvency
Motivation for Debt
10-27
Basics of Solvency
Financial Leverage- Illustrating Tax Deductibility of Interest
10-28
Basics of Solvency
Adjustments for Capital Structure - Liabilities
Potential
Potentialaccounts
accountsneeding
needingadjustments
adjustments Chapter
Chapterreference
reference
Deferred
DeferredIncome
IncomeTaxes
Taxes--IsIsititaaliability,
liability,
equity,
equity,or
orsome
someofofboth?
both?
Operating
OperatingLeases
Leases--capitalize
capitalizenonnoncancelable
cancelableoperating
operatingleases?
leases?
Off
OffBalance
BalanceSheet
SheetFinancing
Financing
Contingent
ContingentLiabilities
Liabilities
Minority
MinorityInterests
Interests
Convertible
ConvertibleDebt
Debt
Preferred
PreferredStock
Stock
33&&66
33
33
33&&66
55
33
33
10-29
10-30
10-31
10-32
10-33
Earnings Coverage
Earnings to Fixed Charges
Limitation of capital structure measures - inability to
focus on availability of cash flows to service debt.
Role of earnings coverage, or earning power, as the
source of interest and principal repayments.
Earnings to fixed charges ratio
10-34
Earnings Coverage
Earnings to Fixed Charges
10-35
10-36
Earnings Coverage
Times Interest Earned
10-37
Earnings Coverage
Relation of Cash Flow to Fixed Charges
10-38
Earnings Coverage
Earnings Coverage of Preferred Dividends
10-39
Earnings Coverage
Interpreting Earnings Coverage
Earnings coverage measures provide insight into the
ability of a company to meet its fixed charges
High correlation between earnings-coverage
measures and default rate on debt
Earnings variability and persistence is important
Use earnings before discontinued operations,
extraordinary items, and cumulative effects of
accounting changes for single year analysis but,
include them in computing the average coverage
ratio over several years
10-40
Earnings Coverage
Capital Structure Risk and Return
A company can increase risks (and potential returns) of
equity holders by increasing leverage
Substitution of debt for equity yields a riskier capital
structure
Relation between risk and return in a capital structure
exists
Only personal analysis can reflect ones
unique risk and return expectations
Return
$
Risk
?