Ratio Analysis Helpful for making comparisons over time and among companies, highlighting: * Similarities * Differences * Trendsee eg Activity Ratios (Operational Efficiency Ratios) + Measures of effective utilisation of various assets, such as inventory or accounts receivable “> Greater the turnover, the more effectively the business enterprise is at producing a benefit from its investment in assets. The most common turnover ratios are the following:ahs Cer) Inventory Turnover ratio + Inventory turnover = Cost of goods sold/ Average inventory “+ Ratio represents how many times inventory is created and sold during the period “* Good signal of production and purchasing efficiency “+ High ratio shows that inventory is selling quickly, good demand and low inventory carrying cost “> Low ratio warns overstocking, obsolete inventory or selling issueseh er) oH a) aD R0.) Accounts Payable Turnover ratio + Accounts Payable Turnover =Cost of sales / Average accounts payable ¢* Number of times trade payables turn over during the year + Low turnover beneficial. * Higher the turnover, the shorter the period between purchases and payment “> High ratio reflects unfavourable supplier repayment termsae gemarerce Payment Period > Payment Period o inmonths =12/ Accounts Payable Turnover © Indays = 365 / Accounts Payable Turnover o Inweeks = 52 / Accounts Payable TurnoverWorking Capital Turnover Ratio Working Capital Turnover Ratio = Net Sales (Revenue from Operations) / Net Working Capital “ Ratio represents the ability of the business to put the working capital to work to generate the sales * It is the indicator of the effective utilisation of the working capital of the business aWorking Capital Turnover Ratio * Working Capital Turnover Ratio = Net Sales (Revenue from Operations) / Net Working Capital + Ratio represents the ability of the business to put the working capital to work to generate the sales % It is the indicator of the effective utilisation of the working capital of the businessa Analysis of Financial Statements + From the following data, calculate: (a) inventory turnover and (b} working capital turnover: Sales 2,400,000 Other CurrentAssets 660,000 Cost of sale: 1,800,000 Fixed Assets 1,540,000 Net profit 300,000 Net'Worth 1,500,00 Inventory 800,000 Debt 900,000 Current Liabilities 600,000Sales 2.400,000 ther Current Assets, 660.000 Cost of sale 1,800,000 Fixed Assets 1,540,000 Net profit 300,000 = Net'Worth 1,800,00 Inventory 800,000 = Debr 900,000 ‘Current Liabilities 600,000 Inventory Tumover Ratio _ __Costof Sates Average Inventory = 2800000 & 2.25 Times S000Sales 2,400,000 ‘Cost of sale 1,800,000 Net profit 300,000 Inventory 800,000 ‘Current Liabilities 600,000 Working Capital Turnover Ratio = Working Capital = Current Assets — Current Liabilities ‘Other Current Assets Fixed Assets NecWorth Debt 660,000 1,540,000 1,500,00 700,000 Gast of sales Working Capital _ 1,800,000 Feogor = 209 Times = 00,0001 660,000 — 600,000 = 860,000Inventory Turnover ratio “ Inventory turnover = Cost of goods sold/ Average inventory. TRUE / FALSE “ Low Inventory Turnover ratio shows that inventory is selling quickly, good demand and low inventory carrying cost. TRUE / FALSE “+ Low Inventory Turnover ratio warns averstocking, obsolete inventory or selling issues. TRUE / FALSEThumbr Accounts Payable Turnover ratio «+ Accounts Payable Turnover =Cost of sales / Average accounts receivables. TRUE / FALSE payable “ Low Accounts Payable Turnover is beneficial. TRUE f FALSE + Lower the Accounts Payable Turnover, the shorter the period between purchases and payment. TRUE / FALSE Lower/ longer; Higher/ shorter “+ High ratio reflects unfavourable supplier repayment terms. TRUE / FALSELiquidity Ratios Measure of ability to meet its short-term obligations using assets that are most readily converted into cash Greater the coverage of liquid assets to short-term liabilities, the better as it is Ability to pay near future debts and still have the funding for its ongoing operating activities.Current Ratio Current Ratio = Current Assets / Current Liabilities * Indicates ability to satisfy current liabilities with current assets. “* A common rule of thumb: current ratio as 2:1 is ‘good’; and ratio less that 1 may indicate liquidity issues * Very high current ratio may mean there is either excess cash lying idle with the firm or the funds are blocked in inventory or debtorsQuick Ratio + Quick Ratio = Quick Assets / Current Liabilities % Quick Assets = Current Assets — Inventory — Prepaid expenses + Measurement of the ability of the firm to convert its current assets quickly into cash in order to meet its current liabilities. “> Indicates a company's ability to satisfy current liabilities with its most liquid assets “+ Also known as acid test ratioNet working capital to sales ratio + Net working capital to sales ratio = Working Capital/ Net Sales + Measure of cashflow. Should always be +ve figure “ Measures the amount of capital invested in resources that are subject to quick turnover + Lenders often use this number to evaluate ability to weather hard timeB oT WU obe x? &, AYs aye] A Paragraph = Insert. = (Oraning Liquidity Ratios are measure of ability to meet long-term debt obligations using assets that are most readily converted into cash. TRUE / FALSE “ Liquidity Ratios indicate the ability to pay near future debts and still have the funding for its ongoing operating activities. TRUE / FALSEArjar fy) Se WW: Ly Hy AYs ay+|| A Parageaph — Insert. = Draning “ Liquidity Ratios are measure of ability to meet long-term debt obligations using assets that are most readily converted into cash. TRUE / FALSE. Short-term. > Liquidity Ratios indicate the ability to pay near future debts and still have the funding for its ongoing operating activities. TRUE / FALSE+ Current Ratio = Current Liabilities / Current Assets. TRUE / FALSE * Current Ratio indicates ability to satisfy current liabilities with fixed assets. TRUE / FALSE Very high current ratio may mean there Is possibility of: o excess cash lying idle with the firm. TRUE / FALSE o funds are blocked in Inventory or debtors. TRUE / FALSE+ Current Ratio = Current Liabilities / Current Assets. TRUE / FALSE. Current Assets / Current Liabilities Current Ratio indicates ability to satisfy current liabilities with fixed assets. TRUE / FALSE. Current + Very high current ratio may mean there is possibility of: o excess cash lying idle with the firm. TRUE / FALSE o funds are blocked in inventory or debtors. TRUE J FALSE h