GRAEME RANKINE IDENTIFY THE INDUSTRYANALYSIS OF FINANCIAL STATEMENT DATA Since companies in the same industry face similar opportunities and constraints, they tend to make similar invest- ment, dividend, and financing decisions. Thus, the financial characteristics of firms in the same industry tend to cluster together. For example, old economy businesses with large amounts of tangible assets may have higher leverage ratios because such assets provide good collateral for lenders. Service or trading firms may have large amounts of intangible assets such as knowledge assets or a large and loyal customer base, and, hence, have low leverage ratios because growth options can devalue quickly. On the other hand, companies in different industries tend to exhibit different financial characteristics, as measured by financial ratios, because of cross-sectional dif- ferences in operating and financing decisions. With some knowledge of the different operating, investing, and financing decisions across industries, financial ratios may be used to identify an industry (see Exhibit 1 for the definition of ratios used). Common-sized balance sheets (all items scaled by total assets), common-sized income statements (all items scaled by net sales), and selected financial ratios for the nine companies are provided. Since unusual deviation from target values may occur in any given year, the values for the items were averaged over three years. The three- year average common-sized balance sheet, common-sized income statement, and financial ratios are reported in Exhibits 2, 3, and 4, respectively. The 9 companies are drawn from the following 9 different industries Liquor producer and distributor Discount airline Commercial bank (items fitted into the same categories as the non-financial firms) Computer software company Large integrated oil and gas company Mobile phone service operator R&D-based pharmaceutical manufacturer Retail grocery company R&D-based semiconductor manufacturer Assignment Using the financial statement data provided in Exhibits 2, 3, and 4, match the companies with their industry. NOTE: #DIV/! or #Value! indicates that the item was not separately disclosed. . Exhibit 1. Definitions of Some Key Financial Ratios LIQUIDITY RATIOS Cash & Marketable Securities to Total Assets = (Cash + Market Securities) / Total Assets Acid Test Ratio = (Cash + Market Securities + Receivables) / Current Liabilities Current ratio = Current Assets / Current Liabilities ASSET MANAGEMENT Day's Receivable = 365 / (Sales / Receivables) Day's Inventory = 365 / (Cost of Sales / Inventory) Asset Turnover = Sales / Total Assets FINANCIAL LEVERAGE Debt to Total Assets = (Total Current Debt + Long-term Debt) / Total Assets Debt to Stockholders' Equity = (Total Current Debt + Long-term Debt ) / Stockholders' Equity Coverage Ratio Operating Profit + Interest Expense) / Interest Expense PROFITABILITY Gross Margin Ratio = Gross Profit / Sales Return on Sales = Net Income / Sales Return on Assets Net Income / Total Assets Return on Equity - Net Income / Stockholders' Equity DUPONT ANALYSIS Return on Equity = Return on Sales * Asset Turnover * Leverage (Net Income / Sales) x (Sales / Assets) * (Assets / Stockholders Equity) Exhibit 2. Common-Sized Income Statement (all items scaled by sales) Company 1 2 3 4 5 6 7 8 9 Sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Cost of Goods Sold 42.9% 30.3% 25.2% 15.6% 22.7% 77.3% 12.6% 73.6% 80.7% Gross Profit 57.1% 69.7% 74.8% 84.4% 77.3% 22.7% 87.4% 26.4% 19.3% Selling, General, & Administrative Exp. 27.1% 37.2% 33.1% 54.8% 38.0% 11.9% 38.1% 19.1% 3.8% Operating Income before Depreciation 30.1% 32.5% 41.7% 29.6% 39.3% 10.7% 49.3% 7.3% 15.5% Depreciation, Depletion & Amortization 14.3% 1.8% 13.5% 5.5% 4.3% 4.8% 3.1% 1.8% 3.9% Operating Profit 15.7% 30.8% 28.1% 24.1% 35.0% 5.9% 46.2% 5.5% 11.6% Interest Expense 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Non-Operating Income/Expense 1.0% 0.3% 1.1% 0.5% 1.0% 0.1% -13.4% 0.5% 4.9% Special Items -2.2% -0.1% -0.39% 0.1% -3.0% -0.8% -1.0% 0.0% 0.5% Pretax Income 11.7% 30.0% 28.2% 23.8% 32.4% 4.3% 31.8% 5.4% 16.8% Total Income Taxes 3.8% 9.4% 7.3% 5.1% 6.8% 1.7% 10.1% 1.7% 6.9% Income Before Extraordinary Items & Non-controlling Interest 7.9% 20.5% 21.09 18.8% 25.5% 2.6% 21.7% 3.7% 9.9% Net Income 7.7% 20.5% 21.0% 18,8% 25.5% 2.6% 20.2% 3.5% 9.5% Source: Standard & Poar's Capital IQ Net Advantage. Exhibit 3. Common-Sized Balance Sheet (all items scaled by total assets) ASSETS 1 2 3 4 5 6 7 8 9 Cash & Short-Term Investments 1.4% 8.79 21.496 17.4% 51.99 16.6% 10.49 3.6% 2.896 Net Receivables 4.8% 14.2% 4.7% 11.8% 12.2% 1.9% 55.1% 3.2% 10.6% Inventories 0.4% 21.6% 5.396 7.6% 1.3% 2.4% 3.09% 21.5% 4.5% Prepaid Expenses 0.6% 3.7% 0.0% VALUE 0.0% VALUE! 0.0% VALUE! 0.0% Other Current Assets 1.6% 3.0% 4.8% 2.3% 3.8% 2.5% VALUE 1.096 1.6% Total Current Assets 8.6% 51.296 36.1% 39.1% 69.29 23.3% 68.5% 29.3% 19.5% Gross Plant, Property & Equipment 98.2% 25.796 79.8% 43.7% 15.9% 104.8% #VALUE! 85.0% 122.3% Accumulated Depreciation -58.3% -13.5% -16.3% -21.0% -8.8% -36.5% #VALUE! -27-3% -54.6% Net Plant, Property & Equipment 40.0% 12.2% 33.5% 22.7% 7.19 68.3% 0.8% 57.7% 67.7% Investments at Equity 1.5% #VALUE! 1.5% VALUE VALUE! 0.0% 0.7% VALUE! 8.4% Other Investments WVALUE! #VALUE! 7.8% 17.3% 8.0% 0.3% 22.2% 0.096 2.0% Intangibles 47.6% 34.7% 19.2% 13.8% 14.0% 6.0% 3.3% 10.1% VALUE Deferred Charges 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% #VALUE! OVALUE! 0.0% Other Assets 2.696 1.9% 1.9% 7.0% 1.6% 2.1% VALUE! 2.996 2.496 TOTAL ASSETS 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% LIABILITIES Accounts Payable Notes Payable & Other ST Borrowings Current Portion of LT Debt Total Current Debt Income Taxes l'ayable Accrued Expenses Other Current Liabilities Total Other Current Liabilities Total Current Liabilities Long Term Debt Deferred Taxes & Investment Tax Credit Other Liabilities TOTAL LIABILITIES Redeemable Non-controlling Interest EQUITY Preferred Stock - Redeemable Preferred Stock - Nonredeemable Total Preferred Stock Common Stock Capital Surplus Retained Earning Less: Treasury Stock Common Equity Shareholders Equity Parent Nonredeemable Non-controlling Interest STOCKHOLDERS EQUITY TOTAL TOTAL LIABILITIES & EQUITY 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.09% 0.0% 0.0% 3.9% 3.5% 3.7% 3.3% 3.7% 5.3% 70.4% 18.7% 11.6% 0.0% 0.1% 0.3% 0.0% 0.4% 0.0% 3.8% 3.1% 2.1% 1.5% 0.0% 0.0% 2.5% 1.0% 2.8% 1.1% 2.1% 0.5% 1.5% 0.2% 0.3% 2.5% 1.4% 2.8% 4.9% 5.1% 2.7% 0.5% 0.8% 0.0% 0.6% 0.5% 0.5% #VALUE! 0.7% 3.0% 3.5% 8.29% 9.2% VALUE 3.0% 5.4% VALUE! 8.9% VALUE! 2.5% 0.1% 2.4% 19.0% 18.0% 12.5% VALUE! 0.4% 3.9% 6.0% 8.4% 11.6% 19.0% 20.99 18.0% VALUE! 9.3% 3.9% 11.99 12.8% 15.6% 25.6% 26.6% 26.5% 75.3% 33.8% 21.1% 24.0% 22.1% 13.3% 14.7% 9.9% 14.7% 8.4% 22.2% 2.4% 11.0% 4.0% 4.2% VALUE 1.4% 15.0% 0.49% 2.3% 11.3% 17.7% 9.8% 4.2% 15.5% 8.09 6.096 5.3% 1.6% 14.5% 64.696 48.7% 37296 55.6% 45.9% 62.1% 88.9% 59.996 49.396 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.4% 0.096 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.096 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.99% 0.0% 0.0% WVALUE! #VALUE! VALUE! VALUE #VALUE! #VALUE! 0.9% VALUE! WVALUE! 2.6% 0.8% 0.0% 2.1% 0.0% 4.3% 0.6% 0.2% 2.99 33.3% 1.8% 23.4% 14.4% 47.0% 6.5% 4.1% 1.6% 0.0% 11.6% 69.9% 39.3% 37.0% 7.0% 30.7% 5.7% 35.5% 103.9% - 12.1% -21.29% VALUE! -9.1% VALUE! -3.8% -0.4% VALUE!-58,0% 35.296 51.3% 62.896 54.1% 37.9% 10.1% 37296 48.8% 35.2% 51.3% 62.8% 44.4% 54.1% 37.9% 11.0% 37.296 48.8% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.1% 2.5% 1.896 35.4% 51.3% 62.8% 54.1% 37.9% 11.1% 39.7% 50.7% 100.0% 100.0% 100.0% 100.0% 100.00 100.0% 100.0% 100.0% 100.0% N Exhibit 4. Selected Financial Ratios (three-year average of values for 2011-2013) Company 1 3 4 5 6 7 8 9 LIQUIDITY RATIOS Cash & Market Sec to Total Assets 0.01 0.09 0.21 0.17 0.52 0.17 0.10 0.04 0.03 Acid Test Ratio 0.52 1.80 1.67 1.15 2.41 0.70 0.87 0.20 0.63 Current Ratio 0.71 4.02 2.32 1.54 2.61 0.88 0.91 0.87 0.92 ASSET MANAGEMENT Day's Receivable 37.35 67.77 26.01 63.34 80.88 7.57 3,208.07 5.10 31.30 Day's Inventory 7.52 341.92 117.78 264.40 37.57 12.50 1,342.81 46.27 16.66 Asset Turnover 0.47 0.77 0.65 0.68 0.55 0.90 0.06 2.31 1.23 FINANCIAL LEVERAGE Long-term Debt to Total Assets 0.26 0.22 0.14 0.17 0.11 0.17 0.13 0.27 0.05 Long-term Debt to Stockholders' Equity 0.04 0.00 0.01 0.06 0.03 0.07 0.44 0.13 0.05 Coverage Ratio #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! PROFITABILITY Gross Margin Ratio 0.57 0.70 0.75 0.84 0.77 0.23 0.87 0.26 0.19 Return on Sales 0.08 0.21 0.21 0.19 0.26 0.03 0.20 0.04 0.09 Return on Assets 0.04 0.16 0.14 0.13 0.14 0.02 0.01 0.08 0.12 Return on Equity 0.11 0.31 0.22 0.29 0.26 0.06 0.11 0.20 0.23 DUPONT ANALYSIS Return on Equity = 0.11 0.31 0.22 0.29 0.26 0.06 0.11 0.20 0.23 Return on Sales 0.08 0.21 0.19 0.26 0.03 0.20 0.04 0.09 * Asset Turnover 0.47 0.77 0.65 0.68 0.55 0.06 2.31 1.23 * Leverage 2.84 1.98 1.59 1.85 9.05 2.52 1.98 Source: Standard & Poor's Capital IQ Net Advantage. 0.21 0.90 2.64 2.27