financial ratio analysis case study

INTRODUCTION

Financial ratio analysis is an important topic and is covered in all mainstream corporate finance textbooks. It is also a popular agenda item in investment club meetings. It is widely used to summarize the information in a company's financial statements in assessing its financial health. In today's information technology world, real time financial data are readily available via the Internet. Performing financial ratio analysis using publications, such as Robert Morris Associates’ Annual Statement Studies, Dun & Bradstreet’s Key Business Ratios, Moody’s Manuals, Standard & Poor’s Corporation Records, Value Line Investment Survey, etc., is no longer efficient. Since students and investors now have easy access to on-line databases, the assignments on financial ratio analysis can be modified accordingly to enhance learning. Based upon my experience as a finance professor and as a member of a local investment club, I have prepared this  teaching note to help students and investors in performing financial ratio analysis via an on-line database, Dow Jones Interactive. This database is a Web based, enterprise wide business news and research solution supported by Dow Jones & Company, the parent company of The Wall Street Journal.  The class assignment presented herein is designed to demonstrate how to assess a company's overall operations over time and its current financial standing in the industry.

THE FINANCIAL RATIO ANALYSIS ASSIGNMENT

Students will work on the assignment collaboratively in groups of three or four students. Each group will select an industry of interest to the group, and each student will select a company within that industry. Students will download the relevant financial data from the Internet and perform ratio analysis for the selected companies. Since successful financial ratio analysis is as much an art as it is a science, students must use common sense and sound judgment throughout the analysis. The purpose of this assignment is to provide students with the opportunity to:

• retrieve real time financial data via the Web;
• analyze the financial performance of selected companies;
• practice communication skills, both in writing (through word processing) and in speaking (through giving a Power Point presentation);
• enhance teamwork skills.

TREND ANALYSIS

To evaluate how the selected company is performing over time, more than one year's financial ratios are required. Students are instructed to follow the path shown below to retrieve the financial profile for the selected company via Dow Jones Interactive. (The initial steps may differ depending on how your library's site is organized.)

• Go to the University Library home page
• Click on Research Resources
• Click on Dow Jones Interactive (DJI)
• On DJI page, click on Company and Industry Center
• Click on Financial Profile
• Select Region: Worldwide
• Enter Company Symbol: ____________
• Display as: Formatted report
• Click on Get Report
• Download the report including Key Financial Ratios, Balance Sheets, Income Statements and Key Competitors (see APPENDIX 1 for an excerpt Financial Profile of Intel)

Trend analysis provides signals as to whether the company's financial health is likely to improve or deteriorate. Each student will perform the trend analysis based upon the following financial ratios:

• Leverage Ratios: to measure the extent to which the company's assets are financed with debt;
• Liquidity Ratios: to measure the company's ability to pay its bills;
• Profitability Ratios: to measure the company's ability to generate earnings;
• Efficiency Ratios: to measure the company's ability to utilize its assets;
• Market Value Ratios: to measure the market perception about the company's future prospects.

The downloaded four years' balance sheets and income statements are to be used to calculate the financial ratios not reported in the DJI. For example, four leverage ratios (Debt/Equity, LT Debt/ Cap, LT Debt/Tot Debt, and LT Debt/Tot Assets) are reported, but the interest coverage ratio (= earnings available for interest/interest expenses) is missing in the DJI. Students are required to obtain the earnings and interest expenses information from the income statements and calculate this ratio to measure the company's ability to service the debt. In the area of liquidity, current ratio (= current assets/current liabilities) and quick ratio (= quick assets/ current liabilities) are reported, but the interval measure (= quick assets/daily operating expenditures) is not. Students are required to obtain quick assets (= cash & equivalent + receivables) from the balance sheets and operating expenditures from the income statements, and calculate this ratio to measure how long the company can keep up with its bills using only existing quick assets. As the financial ratios in each of the five performance areas are compiled, they are analyzed across time. A sample trend analysis for Intel is presented (below) in Table 1.