anal is is ratio

8/3/2019 Anal is is Ratio

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The Use Of Financial RatiosAnalyzing LiquidityAnalyzing ActivityAnalyzing Debt

Analyzing ProfitabilityA Complete Ratio Analysis


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THE USE OF FINANCIAL RATIOSFinancial Ratio are used as a relative

measure that facilitates the evaluation ofefficiency or condition of a particular aspectof a firm's operations and statusRatio Analysis involves methods ofcalculating and interpreting financial ratiosin order to assess a firm's performance andstatus

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(1) (2) (1)/(2)

Year End Current Assets/Current Liab. Current Ratio1994 $550,000 /$500,000 1.10

1995 $550,000 /$600,000 .92

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1994, HarperCollins PublishersCopyright


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Three sets of parties areinterested in ratio analysis:

Shareholders

CreditorsManagement

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5/19

There are two types of ratiocomparisons that can be made:

Cross-Sectional AnalysisTime-Series Analysis

Combined Analysis uses both types ofanalysis to assess a firm's trends versusits competitors or the industry

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LiquidityActivityDebtProfitability

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8/19

Liquidity refers to the solvency ofthe firm's overall financial position,

i.e. a "liquid firm" is one that caneasily meet its short-term obligationsas they come due.

A second meaning includes theconcept of converting an asset intocash with little or no loss in value.

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9/19

Net Working Capital (NWC)NWC = Current Assets - Current Liabilities

Current Ratio (CR)Current AssetsCR = Current Liabilities

Quick (Acid-Test) Ratio (QR)Current Assets - Inventory

QR = Current Liabilities

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10/19

Activity is a more sophisticatedanalysis of a firm's liquidity,evaluating the speed withwhich certain accounts are

converted into sales or cash;also measures a firm's efficiency

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11/19

Inventory Turnover (IT)

Average Collection Period (ACP)

Average Payment Period (APP)

Fixed Asset Turnover (FAT)

Total Asset Turnover (TAT)

Cost of Goods SoldIT =Inventory

Accounts Receivable ACP =

Annual Sales/360

Accounts Payable APP=

Annual Purchases/360

SalesFAT =

Net Fixed Assets

SalesTAT =

Total Assets

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12/19

Debt is a true "double-edged" sword as it allowsfor the generation of profits with the use of otherpeople's (creditors) money, but creates claims on

earnings with a higher priority than those of thefirm's owners.Financial Leverage is a term used to describe themagnification of risk and return resulting fromthe use of fixed-cost financing such as debt andpreferred stock.

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Prof. Kuhle


13/19

Debt Ratio(DR)

Debt-Equity Ratio

(DER)

Times Interest Earned

Ratio (TIE)Fixed Payment Coverage Ratio

(FPC)

Total LiabilitiesDR=Total Assets

Long-Term Debt DER=

Stockholders Equity

Earnings Before Interest & Taxes (EBIT)

TIE=Interest

Earnings Before Interest &Taxes + Lease Payments

FPC=Interest + Lease Payments+{(Principal Payments +Preferred Stock Dividends)X [1 / (1 -T)]}

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14/19

Profitability Measures assess the firm'sability to operate efficiently and are ofconcern to owners, creditors, andmanagementA Common-Size Income Statement,which expresses each income statementitem as a percentage of sales, allows foreasy evaluation of the firms profitabilityrelative to sales.

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Gross Profit Margin (GPM)Operating Profit Margin

(OPM)Net Profit Margin (NPM)

Return on Total Assets(ROA)Return On Equity (ROE)Earnings Per Share (EPS)Price/Earnings (P/E) Ratio

Gross ProfitsGPM= Sales

Operating Profits (EBIT)OPM =

Sales

Net Profit After Taxes

NPM= Sales

Net Profit After TaxesROA=

Total AssetsNet Profit After Taxes

ROE= Stockholders Equity

Earnings Available for Common Stockholders EPS =

Number of Shares of Common Stock Outstanding

Market Price Per Share of Common Stock

P/E =Earnings Per Share

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16/19

DuPont System of AnalysisDuPont System of Analysis is anintegrative approach used to dissect afirm's financial statements and assess itsfinancial conditionIt ties together the income statement andbalance sheet to determine two summarymeasures of profitability, namely ROAand ROE

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17/19

DuPont analysisNet Income

Sales

Total Assets

Profit Margin

AssetTurnover

Total Debt

Total Assets

Return onAssets

FinancingPlan

Return onEquityReturn on Assets

(1 - Debt/Assets)=


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The firm's return is broken into threecomponents:

A profitability measure (net profit margin)An efficiency measure (total asset turnover)

A leverage measure (financial leveragemultiplier)

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