Financial Ratios

Business Finance
2.2 : Financial Ratios

Lecture Notes

University of Santo Tomas- Senior High School

March 8, 2018

Lecture Notes 2.2: Financial Ratios

 Financial Ratios

Overview:

1 Financial Ratios
Efficiency Ratio

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Guide Questions

1 How will you solve efficiency ratios?

2 How will you analyse, interpret and compare the efficiency
ratios of sample companies?

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Recall:

Main Categories of Financial Ratios

1 Liquidity
2 Profitability
3 Efficiency
4 Leverage

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Recall:

Main Categories of Financial Ratios

1 Liquidity
2 Profitability
3 Efficiency
4 Leverage

Efficiency Ratios
Efficiency refers to the speed with which various current accounts
are converted into sales, and ultimately, cash. It is a company’s
ability to be efficient in its operations.

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Efficiency Ratios
• Accounts Receivable Turnover
It measures the efficiency by which accounts receivable are
managed.
Sales
Accounts Receivable Turnover = Account Receivable
• Average Collection Period (average age of AR, days’
receivable or days sales)
The accounts receivable turnover ratio becomes more
meaningful when converted to days’ receivable.
365
Average Collection Period = Account Receivable Turnover

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Efficiency Ratios
• Inventory Turnover
This measures the company’s efficiency in managing its
inventories.

Inventory Turnover = Cost Inventory

of Good Sold

• Average Age of Inventory (days’ inventory)

The inventory turnover ratio becomes more meaningful when
converted to days’ inventories.
365
Average Age of Inventory = Inventory Turnover

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Efficiency Ratios
• Accounts Payable Turnover
It provides information regarding the rate by which trade
payables are paid average payment period (days’ payable).

Accounts Payable Turnover = Purchases

Inventory

Accounts Payable Turnover = TradeCost of Sales

Accounts Payable
• Average Payment Period (days’ payable)
365
Average Payment Period = Accounts payable turnover

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Efficiency Ratios
• Total Asset Turnover
It measures the company’s ability to generate revenues for
every peso of asset invested.
Sales
Total Asset Turnover = Total Assets
• Operating cycle
It covers the period from the time the merchandise is bought
to the time the proceeds from the sale are collected.

Operating Cycle = Ave col period + Ave age of inventory

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Efficiency Ratios
• Cash conversion cycle
This is inversely related to the operating cycle.

Cash Conversion Cycle

= Ave col period + Ave age of inventory − ave age of payables
or

Cash Conversion Cycle = Operating Cycle − average age of payables

Average Total Assets

Total asset (beg) + Total asset (end)

Average Total Assets = 2

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Example: Solve for the efficiency ratios.

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Example: Solve for the efficiency ratios.

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Solutions to examples 1 and 2:

• Accounts Receivable Turnover = P 2,000,000 = 44.44

P 45,000
Interpretation: The company was able to generate P44.44 for every
P1.00 of accounts receivable.

365
• Average collection period = 44.44 = 8.21 ≈ 8 days
Interpretation: The company had an average of 8 days collecting its
accounts receivable.

• Inventory Turnover = P 1,300,000 = 10

P 130,000
Interpretation: For every P1.00 of inventory, there exists P10 of cost
of goods sold.

• Average Age of Inventory = 365

10 = 36.5 ≈ 37days
Interpretation: The company had an average of 37 days per
inventory turnover.

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Exercises: (by pair)

1 Total asset is Php750, 000 and sales is Php1, 500, 000. What is the
total asset turnover?
2 Accounts receivable turnover is 4. What is the average collection
period assuming annual data are used? What is the average
collection period assuming quarterly data are used?
3 Sales for the year amount to Php100, 000. Accounts receivable
amount to Php12, 000. what is the average collection period
assuming annual data are used? What is the average collection
period assuming quarterly data are used?
4 Current assets amount to Php 30,000 while noncurrent assets are
Php50, 000. Sales amount to Php200, 000. What is the total asset
turnover?
5 The quick ratio is 1.7 while the current ratio is 2.5. The current
liabilities amount to Php5, 000. Cost of goods sold is Php52, 500.
What is the inventory turnover? Average age of inventory?

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

L. Gitman, M. Joehnk, R. Billingsley, S. Besley and E. Bringham. Business

Finance, (Contributors: A. Altarejos and E. V. Magbata), JO-ES
Publishing House (2017). Cengage Learning; ISBN: 9789716555097

A. Gamatero. Business Finance, (2017). DIWA Learning Systems INC.

https://www.brainyquote.com/topics/financial.

Lecture Notes 2.2: Financial Ratios

 Financial Ratios Efficiency Ratio

Quote:
“Secrecy is the enemy of efficiency, but don’t let anyone know
it.”

- Ric Ocasek

Lecture Notes 2.2: Financial Ratios