Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

II. Financial Statements

and Long−Term Financial

Planning

3. Working with Financial
   Statements

© The McGraw−Hill^111

Companies, 2002

Associates, one of many sources of such information. Table 3.11 contains selected ratios
from the same source.
There is a large amount of information here, most of which is self-explanatory. On
the right in Table 3.10, we have current information reported for different groups based
on sales. Within each sales group, common-size information is reported. For example,
firms with sales in the $10 million to $25 million range have cash and equivalents equal
to 8.7 percent of total assets. There are 96 companies in this group, out of 582 in all.
On the left, we have three years’ worth of summary historical information for the en-
tire group. For example, operating expenses rose from 36.4 percent of sales to 37.5 per-
cent over that time.
Table 3.11 contains some selected ratios, again reported by sales groups on the right
and time period on the left. To see how we might use this information, suppose our firm
has a current ratio of 2. Based on these ratios, is this value unusual?
Looking at the current ratio for the overall group for the most recent year (third col-
umn from the left in Table 3.11), we see that three numbers are reported. The one in the
middle, 1.5, is the median, meaning that half of the 582 firms had current ratios that
were lower and half had bigger current ratios. The other two numbers are the upper and
lower quartiles. So, 25 percent of the firms had a current ratio larger than 2.4 and 25
percent had a current ratio smaller than 1.1. Our value of 2 falls comfortably within
these bounds, so it doesn’t appear too unusual. This comparison illustrates how knowl-
edge of the range of ratios is important in addition to knowledge of the average. Notice
how stable the current ratio has been for the last three years.

There are many sources of ratio information in addition to the one we examine here.
Our nearby Work the Webbox shows how to get this information for just about any com-
pany, along with some very useful benchmarking information. Be sure to look it over
and then benchmark your favorite company.

Problems with Financial Statement Analysis

We close out our chapter on financial statements by discussing some additional prob-
lems that can arise in using financial statements. In one way or another, the basic prob-
lem with financial statement analysis is that there is no underlying theory to help us
identify which quantities to look at and to guide us in establishing benchmarks.
As we discuss in other chapters, there are many cases in which financial theory and
economic logic provide guidance in making judgments about value and risk. Very little
such help exists with financial statements. This is why we can’t say which ratios matter
the most and what a high or low value might be.

CHAPTER 3 Working with Financial Statements 79

More Ratios

Take a look at the most recent numbers reported for Sales/Receivables and EBIT/Interest in

Table 3.11. What are the overall median values? What are these ratios?

If you look back at our discussion, you will see that these are the receivables turnover and the

times interest earned, or TIE, ratios. The median value for receivables turnover for the entire

group is 42.2 times. So, the days in receivables would be 365/42.2 9, which is the bold-faced

number reported. The median for the TIE is 3.6 times. The number in parentheses indicates that

the calculation is meaningful for, and therefore based on, only 507 of the 582 companies. In this

case, the reason is probably that only 507 companies paid any significant amount of interest.

EXAMPLE 3.5