UNIT 9 FINANCIAL ANALYSIS

PREVIEW
Discussion:
1. Who do you think need financial analysis?
- the management : ban lãnh đạo
- the investors:
+ shareholders (cổ đông), creditors (chủ nợ) of the company
+ potential investors who are going to invest their money in the company’s shares
or bonds
- employees of the company
- auditors (auditing companies)
- governing agencies such as related ministries (bộ có liên quan), tax authories, …
- journalists
- students majoring in finance and accounting
2. For what purposes do they need financial analysis?
Different groups of analysts need financial analysis for different purposes.
- The management - for managerial purposes
- Potential investors analyze the company’s financial data to decide whether to
invest their money in the company or not/ to make a decision on whether investing
their money in the company or not.
- Banks as creditors need financial analysis to evaluate the company’s
creditworthiness.
+ the company’s financial ability to pay back the loans.
+ creditworthiness
+ credit rating
Creditworthiness (n) the state of being creditworthy (= having enough money for banks
to be willing to lend you money): - năng lực trả nợ
- The report gives lenders an instant picture of your creditworthiness.
- Unpaid medical debts ruined their creditworthiness.
- All bidders must have grade A creditworthiness.
- Applicants then would be graded on their creditworthiness.
- People with poor creditworthiness will have difficulty obtaining mortgage loans.
Credit rating (n) a calculation of the ability of a person, business, or government to pay
their debts: xếp hạng tín dụng
good/ high credit rating
 - Companies which are considered financially secure are usually awarded a high
credit rating.
a poor/low credit rating

3. What are the sources of data needed for financial analysis?

Sources of financial data for financial analysis can be classified into primary and
secondary sources.
 The primary sources – nguồn sơ cấp
 Financial data: is provided by the company in forms of financial reports;
financial statements and footnotes to these statements.
 Market data such as market prices of securities in …
 The secondary sources – nguồn thứ cấp
 Economic data such as GDP, CPI is readily available from government and
private sources.
- government sources such as statistics provided by functional agencies of the
government (ministries)
- private sources (individuals or institutions who do scientific researches) such as:
course-books, researches at all levels, thesis,
 events: may help explain the company’s present condition and may have a
bearing on its future prospects.

READING 1

1. Financial analysis
Financial analysis is the selection, evaluation, and interpretation of financial data, along
with other pertinent information, to assist in investment and financial decision-making.
Financial analysis may be used internally to evaluate issues such as employee
performance, the efficiency of operations, and credit policies, and externally to evaluate
potential investments and the credit-worthiness of borrowers, among other things.
The analyst draws the financial data needed in financial analysis from many sources. The
primary source is the data provided by the company itself in its annual reports and
required disclosures. The annual report comprises the income statement, the balance
sheet, and the statement of cash flows, as well as footnotes to these statements. Certain
business are required by securities laws to disclose additional information.

Besides information that companies are required to disclose (công bố) through financial
statements, other information is readily available for financial analysis. For example,
information such as the market prices of securities of publicly-traded corporations can be
found in the financial press and the electronic media daily. Similarly, information on
stock price indices for industries and for the market as a whole is available in the
financial press.
Another source of information is economic data, such as the Gross Domestic Product and
Consumer Price Index, which may be useful in assessing (đánh giá) the recent
performance or future prospects (triển vọng tương) of a company or industry (toàn
ngành). Suppose you are evaluating a company that owns a chain of retail outlets –
chuỗi cửa hang bán lẻ. What information do you need to judge (đánh giá) the company’s
performance and financial condition? You need financial data, but it does not tell the
whole story. You also need information on consumer spending, producer prices,
consumer prices, and the competition. This economic data that is readily available from
government and private sources.

Besides financial statement data, market data, and economic data, in financial analysis
you also need to examine events that may help explain the company’s present condition
and may have a bearing on its future prospects. For example, did the company recently
incur some extraordinary losses? Is the company developing a new product? Or
acquiring another company? Is the company regulated? Current events can provide
information that may be incorporated in financial analysis.
The financial analyst must select the pertinent information, analyze it, and interpret the
analysis, enabling judgments on the current and future financial condition and operating
performance of the company.
2. Classification of financial ratios
Questions for details:
1. What is a ratio?
A ratio is a mathematical relation between one quantity and another.
2. What is a financial ratio?
A financial ratio is a comparison between one bit of financial information and
another.

In financial analysis, a broad category of ratios are used. A ratio is a mathematical

relation between one quantity and another. Suppose you have 200 apples and 100
oranges. The ratio of apples to oranges is 200/100, which we can more conveniently
express as 2:1 or 2. A financial ratio is a comparison between one bit of financial
information and another. Consider the ratio of current assets to current liabilities, which
we refer to as the current ratio. This ratio is a comparison between assets that can be
readily turned into cash – current assets – and the obligations that are due in the near
future – current liabilities. A current ratio of 2:1 or 2 means that we have twice as much
in current assets as we need to satisfy obligations due in the near future.
There are six aspects of operating performance and financial condition we can evaluate
from financial ratios:
  A liquidity ratio provides information on a company’s ability to meet its short-
term debts / immediate obligations.
 A profitability ratio provides information on the amount of income from each
dollar of sales.
 An activity ratio relates information on a company’s ability to manage its
resources (that is, its assets) efficiently.
 A financial leverage ratio provides information on the degree of a company’s
fixed financing obligations and its ability to satisfy these financing obligations.
 A shareholder ratio describes the company’s financial condition in terms of
amounts per share of stock.
 A return on investment ratio provides information on the amount of profit,
relative to the assets employed to produce that profit.
ROA / ROE/ ROI
Multiple choice
1. What isn’t the same meaning with three other phrases?
A. Activity ratios B. efficiency ratios
D. asset utilization ratios D. liquidity ratios
2. …… provides information on a company’s ability to meet its short-term debts
A. Liquidity ratios B. activity ratios
C. efficiency ratios D. profitability ratios
3. Liquidity ratios provides information ……………… a company’s ability to meet
its short-term debts.
A. to B. on C. with D. for
4 Liquidity ratios provides information on a company’s ability to ……….. its short-
term debts.
A. manage B. show C. meet/ pay/ settle D. invest

COMPREHENSION QUESTIONS
1. What is financial analysis?
2. For what purpose is financial analysis used?
3. What are sources of data available for financial analysis?
4. What is a ratio?
5. What is a financial ratio?
6. By construction, what can financial ratios be classified into?
7. According to general characteristics, what can financial ratios be classified into?
VOCABULARY EXERCISES

Task 1. Match the words in the box with their definitions from 1 to 15
GDP Market price Current assets
 Data Profitability Annual reports

Liquidity Leverage Credit policy

Acquire Price index Current liabilities

Prospects Credit-worthiness Publicly-traded corporations

1. Debts that must be paid within a year or during the current business cycle
2. The chances of being sucessful in the future
3. A financial report that a company must by law present each year to its shareholders
4. The decisions a business has made about the way it will lend money or give credit
5. Facts or information, especially when examined and used to find out things or to make
decisions.
6. The amount of loan capital that a company has in relation to its share capital
7. The state of owning cash or things of value that can easily be exchanged for cash in
order to pay debts
8. Assets that a company holds for a short period of time, including cash or something
that can easily provide cash, such as products to be sold....
9. The ability of a business to produce a return on an investment based on its resources
10. Corporations offers their securities such as stocks or bonds for sale to the general
public
11. The reputation that a person or organization has for paying their debts
12. A figure that shows the change in the price of something over a period of time
13. The total final outputs of goods and services produced within an economy for any
given year by both residents and non residents
14. The price that a product or service will currently sell for.
15. To buy a company or to buy shares in a company

Task 2: Complete the sentences with words in the box

profit generation sustaining qualitative management
analysis decision ratios profitability current liabilities
quantitative numerical research figure outstanding

1. Financial analysis can be applied in a wide variety of situations to give business

managers the information they need to make critical .......................
2. Financial analysis also involves using the ............................. data contained in a
company’s statements.
3. When looking at a specific company, a financial analyst conducts .......................... by
focusing on the income statement, the balance sheet and cash flow statement.
4. The process of financial analysis provides the information about the ability of a
business entity to earn income while ......................... both short-term and long-term
growth.
5. One of the most common ways to analyze financial data is to
calculate ............................. from the data to compare against those of other companies or
against the company’s own historical performance.
6. If a company has to sell off fixed assets to pay for its ................................, this usually
means that the company isn’t making enough profits to support its operations.
7. Ratio analysis is a tool that was developed to perform ............................ analysis on
numbers found on financial statements.
8. Return on assets is a common ratio used to determine how efficient a company is at
using its assets and as a measure of .................................
9. Because the difference between cash ............................. and cash payments, businesses
should maintain a certain ratio of current assets to current liabilities in order to ensure
adequate liquidity.
10. In mature companies, low levels of liquidity can indicate poor ............................ or a
need for additional capital.

WRITING
Task 1 Translate into Vietnamese
There are four critical areas of a company’s business which can be analyzed by applying
ratio. These are liquidity, capital structure, activity and efficiency, and profitability.
Measurements of liquidity should answer the question: Can a company pay its short-term
debts? There are two ratios commonly used to answer this question. Firsly, the current
ratio, which measures the current against the current liabilities. In most cases, a healthy
company would show a ratio above 1, in other words more current assets than current
liabilities. Another method of measuring liquidity is the so-called quick ratio – this is
particularly appropriate in manufacturing industries where stock levels can disguise the
company’s true liquidity. The ratio is calsulated in the same way as above but the stocks
are deducted from the current assets.
The balance sheet will also reveal the gearing of the company – this is an indicator of the
company’s capital structure and its ability to meet its long-term debts. The ratio
expresses the relationship between shareholder’s funds and loan capital. Income gearing
is also important and shows the ratio between profit and interest paid on borrowings.
Relatively high borrowings would indicate vulnerability to an interest rate rise. Highly
geared companies generally represent a greater risk for investors.
The balance sheet and the profit and loss account can be used to assesss how efficiently
a company manages its assets. Basically, sales are compared with investment in various
assets. For example, in the retail sector, an important ratio which indicates efficiency is
sales divided by stock – the resulting figure should be much higher than in
manufacturing factor where stock tends to show a much slower turnover. Another
example of efficiency measurement is to calculate the average collection period on debts.
This is found by dividing debtors by sales per day. This can vary tremendous from
industry to industry. In the retail sector, it may well be as low as one or two days,
whereas in the heavy manufacturing and service sectors it can range from thirty to ninety
days.
Finally, profitability ratios show the manager’s use of the company’s resources. The
profit margin figure (profit before tax divided by sales and expressed as a percentage)
indicates the operational day-to-day profitability of the business. Return on capital
employed can be calculated in a number of ways. One common method is to take profit
before taxes and divided by the total assets – this is a good indicator of the use of all the
assets of the company. From a shareholder’s point of view, the return on owner’s equity
will be an important ratio; this is calculated by dividing the profit before taxes by the
owner’s equity and expressing it as a percentage. If the company does not earn a
reasonable return, the share price will fall and thus make it difficult to attract additonal
capital.
Task 2: Write a summary of the reading text
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Task 3: Translate into Vietnamese
Tỷ lệ doanh thu hàng tồn kho là thước đo hữu ích để đánh giá liệu có tồn kho hay không,
cho thấy rằng một công ty gặp khó khăn khi bán sản phẩm của mình.Tỷ lệ này được tính
là chi phí bán hàng chia cho số dư hàng tồn kho trung bình trong một năm. Đôi khi, các
nhà phân tích sử dụng doanh thu hàng năm thay vì chi phí bán hàng cho mục đích tính
toán. Từ năm 2009 đến năm 2017, tỷ lệ doanh thu của Nissan dao động trong khoảng từ
13,2 năm 2009 đến 19,18 năm 2013 và tỷ lệ trung bình là 15,7. Từ năm 2013 đến năm
2017, tỷ lệ doanh thu hàng tồn kho đã giảm nhẹ và đạt 16,2 năm 2017. Theo tiêu chuẩn
ngành công nghiệp, doanh thu hàng tồn kho của Nissan cao hơn nhiều so với các đối thủ
gần nhất. Năm 2017, tỷ lệ doanh thu hàng tồn kho của Toyota là 10.83, trong khi General
Motors có tỷ lệ doanh thu hàng tồn kho là 10. 27.

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Phân tích tỷ lệ là một công cụ để đánh giá báo cáo tài chính nhưng cũng dựa trên các con
số trong báo cáo tài chính được công bố được sử dụng làm tỷ lệ so sánh theo thời gian
hoặc giữa các công ty. Báo cáo tài chính được sử dụng như một cách để biết được tình
hình tài chính và kết quả tài chính của một doanh nghiệp. Trừ một vài ngoại lệ, chẳng
hạn như tỷ lệ liên quan đến giá cổ phiếu, phần lớn dữ liệu được sử dụng trong phân tích
tỷ lệ đến từ báo cáo tài chính.

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Trước khi tính toán các tỷ lệ tài chính, báo cáo tài chính được công bố thường được các
nhà phân tích điều chỉnh để làm cho các tỷ lệ tài chính phù hợp hơn khi so sánh theo thời
gian hoặc giữa các công ty. Về mặt đánh giá các báo cáo tài chính, các nhà phân tích có
thể điều chỉnh số thu nhập tăng hoặc giảm khi họ nghi ngờ dữ liệu được báo cáo không
chính xác do các vấn đề như quản lý thu nhập.

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Việc đánh giá phân tích báo cáo tài chính của một công ty là một dạng phân tích cơ bản
từ chi tiết đến tổng thể. Trong khi phân tích triển vọng của một công ty có thể bao gồm
một số yếu tố, bao gồm hiểu biết tình hình kinh tế hoặc ngành công nghiệp hoặc cảm
nhận về công ty hoặc sản phẩm của công ty, phân tích tỷ lệ của một công ty dựa vào kết
quả tài chính của công ty cụ thể.

CLASSIFICATION OF FINANCIAL RATIOS ON THE BASIS OF FUNCTION:

On the basis of function or test, the ratios are classified as liquidity ratios, profitability
ratios, activity ratios and solvency ratios.

Liquidity Ratios: chỉ số thanh khoản/ hệ số khả năng thanh toán nợ ngắn hạn

Liquidity ratios measure the adequacy of current and liquid assets and help evaluate the
ability of the business to pay its short-term debts. The ability of a business to pay its
short-term debts is frequently referred to as short-term solvency position or liquidity
position of the business.

Adequacy is the quality of being good enough or great enough in amount to be

acceptable. – sự phù hợp

- Several studies point to a real cause for concern over the adequacy of the diet
eaten by British children.

A person or organization's solvency is their ability to pay their debts. – khả năng trả nợ

short-term solvency position – khả năng trả nợ ngắn hạn

Generally a business with sufficient (đủ) current and liquid assets to pay its current
liabilities when they become due is considered to have a strong liquidity position and a
business with insufficient (không đủ) current and liquid assets is considered to have
weak liquidity position.

Short-term creditors like suppliers of goods and commercial banks use liquidity
ratios to know whether the business has adequate current and liquid assets to meet its
current obligations. Financial institutions hesitate (ngần ngại) to offer short-term loans
to businesses with weak short-term solvency position. – cho vay ngắn hạn cho các
doanh nghiệp có khả năng trả nợ ngắn hạn thấp

Financial institutions – tổ chức tài chính

A financial institution (FI) is a company engaged in the business of dealing with

financial and monetary transactions such as deposits, loans, investments, and currency
exchange.

Four commonly used liquidity ratios are given below:

Current ratio or working capital ratio: The current ratio is a test of a business's short-term
solvency: its capability to pay its liabilities that fall due within the next year.

A manufacturer normally needs a current ratio of around 2:1. More than this suggests
poor resource (= assets) usage and potential liquidity problems.

A current ratio is a measure of liquidity that is calculated by dividing current assets by

current liabilities.

A. Current Assets = Stock = inventories, Debtor = accounts receivable, Cash on hand and
cash at bank, other receivables, loan and advances, and other current assets.

B. Current Liability = Creditor, Short-term loan, bank overdraft, outstanding expenses,

and other current liability

Checking accounts = demand deposits

Quick ratio or acid test ratio: A quick ratio is a measure of liquidity that is calculated by
dividing current assets minus inventories by current liabilities.

The current ratio and the quick ratio help investors determine whether companies have
enough coverage to meet near-term cash requirements.

The quick ratio is calculated as total receivables plus cash and all securities readily
transferable into cash, divided by total current liabilities.
Quick Assets = Current Assets – Inventory – Prepaid Expenses

Absolute liquid ratio: This ratio measures the total liquidity available to the company.
This ratio only considers marketable securities and cash available to the company. This
ratio only tests short-term liquidity in terms of cash, marketable securities, and current
investment.

Formula: Cash + Marketable Securities / Current Liability

Current cash debt coverage ratio

Example:

For example company ABC had the following balances at the end of the year 2018:

Particulars $

Cash Flow from Operating Activities 300,000

Current Liabilities at Beginning of Year 150,000

Current Liabilities at End of Year 250,000

Step 1:

Calculate average current liabilities = $200,000

Step 2:

Apply the given figures to current cash debt coverage ratio

Current cash debt coverage ratio = = 1.5

From the above example, it can be concluded that company ABC is liquid enough to
cover its current debts conveniently with the annual cash generation from operating
activities. It doesn’t need to acquire loans or apply for other forms of credit to clear its
debts on time and is doing just fine as an entity.
Significance of current cash debt coverage ratio

The one thing that stands the current cash debt coverage ratio out from its other fellow
liquidity ratios is that it calculates the ratio on the basis of average current liabilities.
Instead of taking just one aspect of a year, it accounts for the past and future
performance, both, of an entity in terms of making debt payments.

This allows investors to identify both the factors clearly, the firm’s ability to pay
dividends on time and a forecast of the firm’s future liquidity position as well.

https://www.accountingformanagement.org/

Basic Defense Ratio:

This ratio measures the no. of days a company can cover its Cash expenses without the
help of additional financing from other sources.

Formula: (Cash + Receivables + Marketable Securities) ÷ (Operating expenses +Interest

+ Taxes) ÷ 365

Example:

Particulars Amount
Cash and Cash Equivalent 2188
Short-Term Investment 65
Receivables 1072
Stock 8338
Other Current Assets 254
Total Current Assets 11917
Accounts Payable 4560
Outstanding Expenses 809
Taxes Payable 307
Deferred Revenue 998
Income Tax Payable 227
Other Outstanding Expenses 1134
Total Current Liability 8035
Additional Details:
Operating Expenses during the year is 2188
Net Interest paid during the year is 25
Taxes paid/ for the year is 1913
Current Ratio = Current Assets/Current Liability
= 11971 ÷8035 = 1.48
Quick Ratio = (Current Assets- Inventory)/Current Liability =
(11971-8338)÷8035 = 0.45
Basic Defense Interval = (Cash + Receivables + Marketable Securities) ÷
(Operating expenses +Interest + Taxes)÷365 =
(2188+1072+65)÷(11215+25+1913)÷365 = 92.27
Absolute liquidity ratio=(Cash + Marketable Securities)÷Current
Liability
=(2188+65) ÷ 8035 = 0.28

Unfortunately, liquidity ratios are not true measure of liquidity because they tell about
the quantity but nothing about the quality of the current assets and, therefore, should be
used carefully. For a useful analysis of liquidity, these ratios are used in conjunction with
activity ratios (also known as current assets movement ratios). Examples of activity
ratios are receivables turnover ratio, accounts payable turnover ratio and inventory
turnover ratio etc.

Profitability ratios:

Profit is the primary objective of all businesses. All businesses need a consistent
improvement in profit to survive and prosper. A business that continually suffers losses
cannot survive for a long period.

Profitability ratios measure the efficiency of management in the employment of business

resources to earn profits. These ratios indicate the success or failure of a business
enterprise for a particular period of time.

Profitability ratios are used by almost all the parties connected with the business.

A strong profitability position ensures common stockholders a higher dividend income

and appreciation in the value of the common stock in future.

Creditors, financial institutions and preferred stockholders expect a prompt payment of

interest and fixed dividend income if the business has good profitability position.
Management needs higher profits to pay dividends and reinvest a portion in the business
to increase the production capacity and strengthen the overall financial position of the
company.

Some important profitability ratios are given below:

Homework: Tìm hiểu công thức tính cho mỗi chỉ số và ý nghĩa hay mục đích của mỗi
chỉ số.

Net profit (NP) ratio

Gross profit (GP) ratio

Price earnings ratio (P/E ratio)

Operating ratio

Expense ratio

Dividend yield ratio

Dividend payout ratio

Return on capital employed ratio

Earnings per share (EPS) ratio

Return on shareholder’s investment/Return on equity

Return on common stockholders’ equity ratio

Activity ratios:

Activity ratios (also known as turnover ratios) measure the efficiency of a firm or
company in generating revenues by converting its production into cash or sales.
Generally a fast conversion increases revenues and profits.

Activity ratios show how frequently the assets are converted into cash or sales and,
therefore, are frequently used in conjunction with liquidity ratios for a deep analysis of
liquidity.

Some important activity ratios are:

Average collection period

Average payment period

Fixed assets turnover ratio

Working capital = current assets – current liabilities

Activity Ratio Analysis

General information on the activity ratio analysis

To understand if the company’s use of assets and process of running the operations are
efficient or not, the activity ratio analysis is applied. Also referred as operation ratio
analysis, or turnover ratio analysis, it includes calculating a set of indicators that allow
making conclusions on how effectively the firm uses its inventories, accounts receivable
and fixed assets.

Activity ratio calculation and analysis

Total Asset Turnover = Asset turnover ratio (chỉ số doanh thu trên tổng tài sản)

A ratio that measures the assets activity and firm’s ability of generating sales through its
assets is total asset turnover. To compute it the net sales have to be divided by average
total assets:

Total Asset Turnover = Net Sales ÷ Average Total Assets

It is obvious, that the higher this ratio, the better it is for a firm because this means it can
generate more sales with some certain level of assets. Total asset turnover ratio can be
compared with other similar-sized companies within the industry; the comparison with
different industries businesses or noticeably smaller or greater firms wouldn’t be
adequate.

Current asset turnover (doanh thu trên tài sản ngắn hạn)

Similar to total asset turnover is current asset turnover ratio. The difference is that
current asset turnover is measuring firm’s ability of sales generation from its current
assets, such as cash, inventory, accounts receivable, etc.:

Current Asset Turnover = Net Sales ÷ Average Current Assets

Bigger values for this ratios are preferable because this means the ability of generating
more sales from some certain amount of current assets.

Working Capital Turnover (Sales to Working Capital)

The working capital turnover ratio, which is also being calculated while performing
the liquidity analysis, has the following formula:

Sales to Working Capital = Sales ÷ Average Working Capital

This ratio measures the amount of cash needed to generate a certain level of sales.
Considering this, high working capital most likely indicates a working capital profitable
use. In other words, sales should be adequate in relation to the working capital available.
However, a comparison with other similar companies or industry average should be
made before drawing any conclusions.

Accounts Receivable Turnover = Receivables turnover ratio

To measure how many times accounts receivable can be turned by a company into cash,
we should calculate the accounts receivable turnover ratio. This ratio indicating the
liquidity of the accounts receivable can be computed as follows:

Accounts Receivable Turnover (Times) = Net Sales ÷ Average Net Receivables

The results of the calculations may be presented either in times per year or in days. If
measured in times per year, the decreasing trend of this ratio would be negative for a
company, meaning the ability to turn accounts receivable into cash has become lower.
However, when measured in days, the decreasing trend of this ratio is desirable, because
it would mean fewer days are needed to turn the receivables into cash. The formula for
the calculation of the accounts receivable in days is slightly different:

Accounts Receivable Turnover (Days) = Average Gross Receivables ÷ (Net Sales ÷ 360)

Often referred as average collection period, the accounts receivable turnover in days can
also be computed as follows:

Average Collection Period (Accounts Receivable Turnover in Days) = 360 ÷ Accounts

Receivable Turnover (Times)

Basically, this indicator is measuring the number of days between the date credit sale has
been made and the day, when the money has been received from buyer.

Accounts payable turnover

This is another ratio that can be used for performing the activity analysis of a firm. In
opposition to accounts receivable turnover, this ratio measures the number of times per
year a company pays its debt to suppliers (creditors). It can be calculated as follows:

Accounts payable turnover (Times) = Cost of goods sold ÷ Accounts payable

Higher accounts payable turnover ratio indicates the ability of a firm to pay its debt to
creditors frequently and regularly. The alternative formula for this ratio is as follows:

Accounts Payable Turnover = Purchases ÷ Average Accounts Payable

Days Payable Outstanding

To measure the number of days that is averagely needed by a firm to pay the debt to its
creditors, the days payable outstanding ratio is being computed. This can be done with
use of the following formula:

Days Payable Outstanding = Accounts payable ÷ Average daily cost of sales

Generally, the low value of this ratio means efficient working capital usage. However,
greater days payable outstanding ratio not necessarily indicates the bad position of a
firm, because delaying payments to suppliers to the very last date can be made by a
company regularly in order to shorten the cash converting cycle. Thus, the analysis
should include reviewing the liquidity ratios too, because high days payable outstanding
ratio and, at the same time, bad liquidity position of a company would indicate that it has
problems paying its debt to creditors.

Inventory turnover (Days Inventory Outstanding)

This ratio indicates how many days a firm usually needs to turn inventory into sales. The
computation formula is as follows:

Inventory turnover (days inventory outstanding) = Cost of Goods Sold ÷ Average

Inventory

Lower inventory turnover ratio would indicate that less time is needed for a company to
turn the inventory to sales. Commonly, the decreasing trend of company’s inventory
turnover indicates its working capital improvement.

A formula for the computation of this ratio measured in days is as follows:

Inventory Turnover in Days = Average Inventory ÷ Cost of Goods Sold ÷ 365

This formula calculates a certain number of days needed for the inventory of a firm to be
converted to cash. There is also an alternative formula for this ratio:

Inventory Turnover in Days = 360 ÷ Inventory turnover (Days Inventory Outstanding)

Cash Turnover

The efficiency of company’s usage of cash is indicated by the cash turnover ratio. It
measures a number of times that the firm’s cash has been spent through over some
period. The formula for calculating this ratio is as follows:

Cash Turnover = Sales ÷ Average Cash and Cash Equivalents

Normally, the high value of this ratio is considered to be better, because this would mean
that the company is using its cash effectively and turning it over more frequently.
However, in some cases high value of this ratio ratio can indicate that the firm has
insufficient funds and may soon require short-term financing. An alternative formula for
this ratio also includes marketable securities to the calculation:

Cash Turnover = Sales ÷ Average Cash and Cash Equivalents and Marketable
Securities

Operating Cycle

Operating cycle is the number of days needed by a company to turn its inventories to
cash. In other words, it is a period between the date goods are acquired and the date of
cash realization from sales. Normally, the operating cycle of a business lasts less than a
year, however, exceptions exist. Operating cycle computation formula is as follows:

Operating Cycle = Accounts Receivable Turnover in Days + Inventory Turnover in Days

Cash Conversion Cycle

Another measurement of company’s working capital use efficiency is the cash

conversion cycle. It is defined as a number of days needed by a company for revenue
generation from its assets. It is also often referred as net operating cycle and can be
calculated with use of the following formula:

Cash Conversion Cycle = Inventory Conversion Period + Receivables Conversion

Period - Payables Conversion Period
Divided into three stages, the calculation of the cash conversion cycle includes the
following:

 measuring the time, needed by a firm to get materials, produce and sell the ready
product;

 measuring the time, needed by a firm to collect the cash for goods sold (accounts
receivable);

 measuring the time, needed by a firm to pay the debt to its suppliers.

Summary

The activity ratio analysis is being applied for the measurement of the company’s
working capital usage efficiency. Activity ratios indicate if a firm manages its
inventories, cash, receivables and payables and other assets well.

Solvency ratios:

Solvency ratios (also known as long-term solvency ratios) measure the ability of a
business to survive for a long period of time. These ratios are very important for
stockholders and creditors.

Solvency ratios are normally used to:

- Analyze the capital structure of the company – cơ cấu vốn của công ty

Evaluate the ability of the company to pay interest on long term borrowings – lãi cho
vốn vay dài hạn

Evaluate the ability of the company to repay principal amount of the long term loans
(debentures, bonds, medium and long term loans etc.).

Evaluate whether the internal equities (stockholders’ funds) and external equities
(creditors’ funds) are in right proportion. – có tỷ trọng phù hợp không

Some frequently used long-term solvency ratios are given below:

Homework:

-Tìm hiểu công thức tính của các chỉ số dưới đây, ý nghĩa và mục đích sử dụng của
chúng.
Debt to equity ratio = gearing

Times interest earned (TIE) ratio

Proprietary ratio

Fixed assets to equity ratio

Current assets to equity ratio

Capital gearing ratio

Cách phân chia 2: Classification on the basis of financial statements:

(Đọc thêm)

Income statement/profit and loss ratios:

Income statement/profit and loss account ratios are those ratios that are calculated by
using the items of income statement/profit and loss account of a particular period only.
Examples of income statement/profit and loss account ratios are net profit ratio, gross
profit ratio, operating ratio, and times interest earned ratio etc.

Balance sheet ratios:

Balance sheet ratios are those ratios that are calculated by using figures from the balance
sheet only. The figures must be used from the balance sheet of the same period.
Examples of balance sheet ratios are current ratio, liquid ratio, and debt to equity ratio
etc.

Composite ratios:

These ratios are calculated by using the items of both income statement and balance
sheet for the same period. Composite ratios are, therefore, also known as mixed ratios
and inter-statement ratios. Numerous composite ratios are computed depending on the
need of analyst. Some examples are inventory turnover ratio, receivables turnover ratio,
accounts payable turnover ratio, and working capital turnover ratio etc.

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