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RATIO ANALYSIS Handout

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14 views29 pages

RATIO ANALYSIS Handout

Uploaded by

Too Cashewyfied
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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RATIO ANALYSIS

Financial Ratios
• Are percentages, turnovers, or ratios expressing the
relationship between selected items derived from the
balance sheet or from the income statement.
Approaches in Financial Ratios
Cross-Sectional Analysis
• Comparison of different firms’ financial ratios at the same point in
time; involves comparing the firm’s ratios to those of other firms in
its industry or to the industry average.
• Benchmarking
• A type of cross-sectional analysis in which the firms’ ratio
values are compared to those of a key competitor or group
of competitors that it wishes to emulate.
Approaches in Financial
Ratios(cont’d)
Time-Series Analysis
• Evaluation of the firm’s financial performance over time
using financial ratio analysis.
Combined Analysis
• Combination of both cross-sectional and time-series
approach.
Types of Financial Ratios
• Liquidity ratios
• are the financial statement ratios which measure the ability of a
business to meet its short-term financial obligations on time.
• Efficiency ratios
• Profitability ratios
• Debt ratios
Types of Financial Ratios
• Liquidity ratios
• Efficiency ratios
• Efficiency ratios are the financial statement ratios that measure
how effectively a business uses and controls its assets
• Profitability ratios
• Debt ratios
Types of Financial Ratios
• Liquidity ratios
• Efficiency ratios
• Profitability ratios
• Profitability ratios are the financial statement ratios which focus
on how well a business is performing in terms of profit
• Debt ratios
Types of Financial Ratios
• Liquidity ratios
• Efficiency ratios
• Profitability ratios
• Debt ratios
• financial statement ratios which show the degree to which the
business is leveraging itself through its use of borrowed money.
Additional Information
• All sales are on credit.
• Purchases is 90% of cost of goods sold.
• All purchases are on credit.
• Common stock outstanding is 20,000 shares
NOTE:
• If problem is silent assume purchases is 100% of cost of
goods sold.
• If the problem is silent, always assume that all sales are on
credit.
Types of Financial Ratios
Liquidity Ratios

• Current ratio = current assets / current


liabilities.

• The generally acceptable current ratio


is 2:1
• The minimum acceptable current
ratio is 1:1
Types of Financial Ratios
Liquidity Ratios
• Acid test/Quick ratio = (quick assets)/ current
liabilities.
• Quick assets are cash and other current
assets that can be easily converted to
cash.
• Quick assets include cash, temporary
investments, and receivables but exclude
inventories and prepaid assets.
Types of Financial Ratios
Efficiency Ratios
• Average Collection Period = Accounts
Receivable / Average credit sales per
day

• The collection period or average


collection period must be compared
to competitors to see whether the
credit given, and customer risk, is in
line with the industry.
Types of Financial Ratios
Efficiency Ratios
• Average Payment Period = accounts
payable / average purchases per day
• The average amount of time needed to
pay accounts payable.
Types of Financial Ratios
Efficiency Ratios
• Inventory Turnover = cost of goods
sold / inventory
•
• A high inventory turnover ratio
indicates that the product is selling
well.
Types of Financial Ratios
Efficiency Ratios
Types of Financial Ratios
Efficiency Ratios

• Total Asset Turnover = Sales / total


assets
• = indicates the efficiency with which
the firm uses its assets to generate sales.

• Inventory Turnover = 2.99 times


Types of Financial Ratios
Profitability ratios

• Gross Profit Margin = Gross Profit /


Sales
• measures the percentage of each
sales peso remaining after the firm
has paid for its goods.

• Inventory Turnover = 2.99 times


Types of Financial Ratios
Profitability ratios

• Operating Profit Margin =


Operating Profits/ Sales
• measures the percentage of each
sales peso remaining after all costs
and expenses other than interest,
taxes, and preferred stock dividends
are deducted.
Types of Financial Ratios
Profitability ratios

• Net profit margin = Net income/sales


•=
• Measures the proportion of the revenue that
finds its way into profits.
• A low profit margin indicates a low margin
of safety: higher risk that a decline in sales
will erase profits and result in a net loss.
Types of Financial Ratios
Profitability ratios

Earnings per share = Earnings available


for stockholders/ number of shares
outstanding
=
Earnings available for stockholders =
Net Profit after taxes – Preferred Stock
dividends
Represents the amount earned on
behalf of each share
Types of Financial Ratios
Profitability ratios

Return on Assets = Net Income / Total


Assets
=
measures the overall effectiveness of
management in generating profits with
its available assets.
A low return on assets ratio indicates
that the earnings are low for assets.
Types of Financial Ratios
Profitability ratios

Return on Equity = Net Income /


Stockholders Equity
=
The return on equity is like the “return on
assets”. Assets come from two sources:
debt and equity. The ROE focuses on
the latter. Return on equity measures
profitability using resources provided by
investors and company earnings.
Types of Financial Ratios
Debt Ratios

Debt to Total Assets = Total


Liabilities / Total Assets
=
measures the proportion of total assets
financed by the firm’s creditors.
If the ratio is less than one, most of the
company's assets are financed through
equity. If the ratio is greater than one, most
of the company's assets are financed
through debt.
Types of Financial Ratios
Debt Ratios

Times Interest Earned = EBIT/(Interest +


Interest charges)
=

Used to determine how easily a


company can pay interest on
outstanding debt
The lower the ratio, the more the
company is burdened by debt
expense.
Industry Average
Ratio INDUSTRY EENER GOOD/BAD
Current 2.35
Quick 0.87
ACP 35.3 days
APP 40 days
Inventory Turnover 4.55
Total Assets Turnover 1.09
Debt Ratio 0.3
Times Interest Earned 12.3
Gross Profit Margin 0.202
Net Profit Margin 0.091
Earnings per share 3.10

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