Financial Ratios

Financial ratios are a valuable and easy way to interpret the numbers found in statements. It can
help to answer critical questions such as whether the business is carrying excess debt or
inventory, whether customers are paying according to terms, whether the operating expenses are
too high and whether the company assets are being used properly to generate income.

When computing financial relationships, a good indication of the company's financial strengths
and weaknesses becomes clear. Examining these ratios over time provides some insight as to
how effectively the business is being operated.

Liquidity ratios
Current Ratio:
The current ratio is an excellent diagnostic tool as it measures whether or not your business has
enough resources to pay its bills over the next 12 months. The formula is:

Current ratio = Current assets/Current liabilities

2006= 3373 / 2532= 1.33 times

2005= 2929 / 1899 = 1.54 times

The current ratio of the company is good it shows that the company has the more current assets
in order to meet its short term bills. It shows the positive impact on the company but if we
compare it with the previous year then we have found the decline of 0.21 times in the company
current asset which is not good for the company.

Quick Ratio:
The quick ratio, sometimes called the acid-test, is a more stringent test of liquidity than the
current ratio. This is because it removes inventory from the equation. Inventory is the least liquid
of all the current assets. A business has to find a buyer if it wants to liquidate inventory, or turn it
into cash.

Quick ratio = Current Assets - Inventory/Current Liabilities

2006= 3373 - 877 / 2532= 0.99 times

2005= 2929 - 566 / 1899 = 1.24 times

The quick ratio of the company is decreasing in 2006 as compared to 2005. The decrease in the
quick ratio is not good for the company it shows bad impact on the company. But in 2006 we
have seen from the ratio that the company does not need to rely on their inventory to meet their
short term liabilities. And this shows a positive impact on the company if it does not lose more.

Cash Ratio:
Thecash ratio is an indication of the firm’s ability to pay off its current liabilities if some
immediate payment is demanded.

Cash ratio = cash / current liabilities

2006= 1022 / 2532 = 0.40 times

2005= 1013 / 1899 = 0.53 times

The cash ratio also decreases in 2006 as compared to 2005 which means that the company does
not have much cash to meet their short term obligations. So, the company has to rely on the other
current assets in order to meet their short term obligations. This will affect the company
negatively. Because if some immediate payment is demanded then the company does not have
the cash to meet this.

Net Working Capital Ratio:

A measure of both a company's efficiency and its short-term financial health. The working
capital ratio is calculated as:

2006= 3373 - 2532 = 841

2005= 2929 - 1899 = 1030

As in both years the working capital is positive which shows that the company has the ability to
pay off its short term liabilities. As we have seen that the working capital decreases in 2006
which affect the company negatively. On other hand the positive working capital shows that the
company will continue its operations and has sufficient balance to meet upcoming operational
expenses. And this affects the company positively. 

Leverage ratios
Debt to total asset ratio:
It is the percentage of total funds provided by creditors.

Debt to total asset ratio = Total debt / total asset

2006 = 3779 / 4363 = 0.87 times

2005 = 3379 / 3696 = 0.91 times

If it is between 0.5 to 0.6 then it is efficient and best for the company but if it is more than the 0.6
then it is risky and if it is below the 0.5 then it is inefficient. So in this company the result in
2006 is 0.87 and in 2005 the result is 0.91 then we can say that the company’s performance is
better.

Debt to equity ratio:

It is percentage of total funds provided by creditors versus by owners.

Debt to equity ratio = total debt / total stock holders equity

2006 =3779 / 431 = 8.76 times

2005 = 3379 / 246 = 13.74 times

Long term debt to equity ratio:

Long term debt to equity ratio = long term debt / total stockholders equity

2006 = 1247 / 431 = 2.89 times

2005 = 1480 / 246 = 6.02 times

Equity Multiplier:
It is the ratio of the total assets to the total equity. It tells us about how much the company has
assets for the equity. It can be calculated as:

Equity multiplier = Total Assets / Total Equity

2006= 4363 / 431 = 10.12 times

2005 = 3696 / 246 = 15.02 times

Times Interest Earned Ratio:

Time interest earned ratio (TIE), also known as interest coverage ratio, indicates how well a
company can cover its interest payments on a pretax basis. The larger the time interest earned,
the more capable the company is at paying the interest on its debt.
Times interest earned = EBIT / Interest
2006= 389 / 19 = 20.47 times
2005= 432 / 48 = 9 times
As we see that there is the increase in the times interest earned ratio which means that the
company has higher earning available to meet its interest payments. Which affect positively on
the financial position of the company?

Activity ratios

Inventory turnover:
It tells about weather a firm holds excessive stocks of inventories and weather a firm are slowly
selling its inventories compared the industry average.

Inventory turnover = CGS / Inventory

2006 = 8255 / 877 = 9.41 times

2005 = 6451 / 566 = 11.40 times

If it is above the previous year then it is best for the company so in this company the ratio is
below the previous year so we can say the company is not going well.

Days Sales in Inventory ratio:

The days’ sales in inventory tells you the average number of days that it took to sell the average
inventory held during the specified one-year period

Days Sales in Inventory = 365 days / Inventory turnover

2006= 365 / 9.41 = 39 days

2005= 365 / 11.40 = 32 days

This shows that the company takes 32 days to sell the average inventory in 2005 and it increases
to 39 days in 2006 to sell the average inventory held during the specified one year period. This
increase in the average number of days shows that company is not doing its operations well.
Accounts Receivable Turnover Ratio:
Accounts Receivable Turnover = Credit Sales / Accounts Receivable

2006= 10711 /399 = 26.84 times

2005= 8490 / 274 = 30.99 times

As we have seen the declining in the accounts receivable turnover ratio which indicates the
collection problem. This shows that the company is not going well.

Average collection period:

Average collection period = 365 days / Accounts Receivable turnover

2006= 365 / 26.84 = 14 days

2005= 365 / 30.99 = 12 days

There is an increase in the average collection period of the company in 2006 as compared to
2005. This shows that the company takes 2 more days in 2006 to recover its receivable. It will
impact the company collection period negatively because company has to wait more to collect
the amounts of its credit sales.

Accounts Payable Turnover Ratio:

A short-term liquidity measure used to quantify the rate at which a company pays off its
suppliers. 

Accounts Payable Turnover = Credit Purchases / Accounts payable

2006= 8255 / 1816 = 4.55 times

2005= 6451 / 1366 = 4.72times

Average Payable Period:

Average Payable Period = 365 days / Accounts Payable Turnover

2006= 365 / 4.55 = 80 days

2005= 365 / 4.72 = 77 days

Fixed Assets Turnover:
A financial ratio of net sales to fixed assets. The fixed-asset turnover ratio measures a company's
ability to generate net sales from fixed-asset investments

Fixed assets turnover = Net sale / Net Fixed Assets

2006= 10711 / 990= 10.82 times

2005= 8490 / 767 = 11.07 times
Total Asset Turnover:
It tells about the sales productive and plan and equipment utilization.

Total fixed asset = sales / total asset

2006 = 10711 / 4363 = 2.45 times

2005 = 8490 / 3696 = 2.30 times

So if the result is more than 1 then it is healthy for the company and if the result is below the 1
then the company is weak and inefficient so in this company the result is more than 1 in both
years so we can say the company is efficient and healthy.

Profitability ratios
Gross Profit Margin:
It tells about the total margin available to cover operating expenses and yield a profit.

Gross profit margin = Gross Profit / sales

2006 = 2456 / 10711 = 22.93 %

2005 = 2039 / 8490 = 24.02 %

If it more than the previous year then it is best and healthy for the company. But for this
company we have seen that it is decreasing in 2006 as compared to 2005 which means that the
company is not performing well. And the impact of decrease in the Gross profit margin will
negatively affect the company. But if we ignore the decrease in the gross profit margin then it is
good.

Operating Profit Margin:

It tells the profitability without concern for taxes and interest.

Operating profit margin = EBIT / Sales

2006 = 389 / 10711 = 3.63 %

2005 = 432 / 8490 = 5.09 %

It is not better than the previous so the company is not in good position.
Net Profit Margin:
Net profit margin = net income / sales

2006 = 190 / 10711 = 0.04 %

2005 = 432 / 8490 = 0.10 %

It tells the after tax profit per $ of sales. It is not better than the previous so the company is in not
performing well.

Return on Asset:
Return on asset = net income / total asset

2006 = 190 / 4363 = 4.35 %

2005 = 359 / 3696= 9.71 %

It tells after tax profit per dollar of asset and also called ROI.It is not better than the previous so
the company is not healthy and not performing efficiently.

Return on Equity:
Return on equity = net income / total stock holders equity

2006 = 190 / 431 = 44.08 %

2005 = 359 / 246 = 145.93 %

It tells after tax profits per dollar of stockholders investment in the firm. We have seen a much
decrease in it. So it will show bad impact on the company. This shows that the company is not
performing well.

Earning Per Share:

Earning per share = net income / number of share of common stock outstanding

2006 = 190 / 416 = 0.45

2005 = 359 / 412 = 0.87

It tells the earning available to the owners of common stock. It also decreases in 2006 and it
shows that the company is not doing its operations well.
Growth ratios
Sales Growth:
Sales growth = current sales – previous sales / previous sales

2006 = 10711 – 8490 / 8490 = 26.16 %

2005 = 8490 - 6921 / 6921 = 22.67 %

It tells the firms growth in sales. It is above than the previous year so it is good for the company.

Net Income Growth:

Net income growth = current N.I – previous N.I / previous N.I

2006 = 190 - 359 / 359 = -47.08 %

2005 = 359 - 588 / 588 = -38.95 %

It tells the firm growth rate in profits .so the profit growth rate is not better than the previous year
so the company is not going in good direction.

Conclusion:
The conclusion of the financial position of the company Amazon.com is not good as we have
seen that the sales are increasing from 2004 – 2006 but it will not affect the profits of the
company because the company net profit growth goes negatively. And we have also seen the
decrease in the profitability, liquidity and other ratios of the company. This shows that the
company sales are increasing but there are some other factors involved in it which affect the
company negatively. The company overall financial position is decreasing. We have seen the
increase in the average inventory sales period, average collection period. The company return on
assets and return on equity also decreases. We have seen the increase in the total assets turnover
and interest earned ratio which shows positive impact on the business. But if we overall look at
the financial position of the company then we say that the financial position of the company is
bad. In simple words we can say that the company is not going in right direction.

Reference:

http://blog.accountingcoach.com/days-sales-in-inventory/