UNIT 2.1.

Financial Statement Analysis

Ratio Analyses

Ratio analyses are conducted to understand relationships among various

items reported in one or more of the financial statements.

Receivable
Net Sales Revenue
Turnover =
Average Net Receivables
Ratio

It is essential to understand that no analysis is complete unless it leads

to an interpretation that helps financial statement users understand and
evaluate a company’s financial results
Ratio Computations
Ratio analysis compares the amounts for one or more line items
to the amounts for other line items in the same year.

Ratios are classified into three categories . . .

Solvency ratios
Profitability ratios examine a
examine a company’s company’s
ability to generate ability to pay
income. interest and repay
debt when due.
Liquidity ratios
help us determine if a
company has
sufficient
current assets to repay
liabilities when due.
Common Profitability Ratios
Common Liquidity Ratios
Common Solvency Ratios
Ratio Calculations
Ratio Calculations
Profitability Ratios
Net Profit Margin – The slowly improving economy helped boost
Lowe’s profits in 2010 as shown by the increase in Net Profit
Margin.

Gross Profit Percentage – Lowe’s gross profit percentage indicates

how much profit was made on each Peso of sales after deducting
the Cost of Goods Sold.
 Profitability Ratios
Asset Turnover Ratio – indicates the amount of sales revenue
generated for each Peso invested in assets during the period.

Fixed Asset Turnover – indicates how much revenue the company

generates in sales for each Peso invested in fixed assets,
Home Depot 2010 fixed asset turnover ratio was 2.69
Profitability Ratios
Return on Equity (ROE) – Compares the amount of net income to
average stockholders’ equity. ROE reports the net amount earned
during the period as a percentage of each Peso contributed by
stockholders and retained in the business.

Earnings Per Share (EPS) – Shows the amount of earnings

generated for each share of outstanding common stock.
Profitability Ratios
Price /Earnings (P/E) Ratio – Shows the relationship between EPS
and the market price of one share of the company’s stock.
Liquidity Ratios
Let’s change our attention to an examination of liquidity
ratios. The analyses in this section focus on the
company’s ability to survive in the short term, by
converting assets to cash that can be used to pay current
liabilities as they come due.

Receivable Turnover Ratio – Most retail home improvement companies

have low levels of accounts receivable relative to sales revenue because
they collect the majority of their sales immediately in cash.

Receivable
Net Sales Revenue
Turnover =
Average Net Receivables
Ratio
 Liquidity Ratios
Inventory Turnover Ratio – The inventory turnover ratio indicates how
frequently inventory is bought and sold. The “days to sell” indicates the average
number of days needed to sell each purchase of inventory.
Home Depot sells its inventory in an average of 85 days in 2010.

Current Ratio – The current ratio measures the company’s ability to pay
its current liabilities
Liquidity Ratios
Quick Ratio – The quick ratio is a much more stringent test of short-
term liquidity than is the current ratio. Lowe’s quick ratio increased
slightly in 2010, just as its current ratio did.

Referred to as “quick assets.”

Let’s examine some Solvency Ratios

Solvency ratios focus on a company’s ability to survive over the long
term, that is, its ability to repay debt at maturity and pay interest prior to
that time.
Solvency Ratios
Debt to Assets Ratio – indicates the proportion of total assets that
creditors finance.

In 2010, The Home Depot had a debt-to-assets ratio of 53 percent.

Times Interest Earned – indicates how many times the company’s interest
expense was covered by its operating results.
End of Presentation