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Short-term Solvency Ratios attempt to measure the ability of a firm to meet its short-term financial obligations. In other words, these ratios seek to determine the ability of a firm to avoid financial distress in the short-run. The two most important Short-term Solvency Ratios are the Current Ratio and the Quick Ratio. (Note: the Quick Ratio is also known as the Acid-Test Ratio.)

Current Ratio

The Current Ratio is calculated by dividing Current Assets by Current Liabilities. Current Assets are the assets that the firm expects to convert into cash in the coming year and Current Liabilities represent the liabilities which have to be paid in cash in the coming year. The appropriate value for this ratio depends on the characteristics of the firm's industry and the composition of its Current Assets. However, at a minimum, the Current Ratio should be greater than one.

Top of Form

Example Problems Use the information below to calculate the Current Ratio. Current Assets: $ Current Liabilities: $ Current Ratio:

1500

1000

Bottom of Form

Quick Ratio

The Quick Ratio recognizes that, for many firms, Inventories can be rather illiquid. If these Inventories had to be sold off in a hurry to meet an obligation the firm might have difficulty in finding a buyer and the inventory items would likely have to be sold at a substantial discount from their fair market value. This ratio attempts to measure the ability of the firm to meet its obligations relying solely on its more liquid Current Asset accounts such as Cash and Accounts Receivable. This ratio is calculated by dividing Current Assets less Inventories by Current Liabilities.

these ratios can provide insight into the success of the firm's credit policy and inventory management. if the ratio is too high then the firm may be offering too large of a discount for early payment or may have too restrictive credit terms. by the Receivables Turnover Ratio. The Receivables Turnover Ratio is calculated by dividing Sales by Accounts Receivables. For example. These ratios are also known as Activity or Turnover Ratios. (Note: since Accounts Receivables arise from Credit Sales it is more meaningful to use Credit Sales in the numerator if the data is available. its credit policy.) The Days' Receivables Ratio is calculated by dividing the number of days in a year. on average. This ratio is also known as the Days' Sales Outstanding (DSO) or Average Collection Period (ACP). . the Days' Receivables indicates how long. Therefore. However. thus. Receivables Turnover and Days' Receivables The Receivables Turnover and Days' Receivables Ratios assess the firm's management of its Accounts Receivables and. it takes for the firm to collect on its sales to customers on credit. 365. In general.Top of Form Example Problems Use the information below to calculate the Quick Ratio. Current Assets: $ Inventory: $ Current Liabilities: $ Quick Ratio: 1500 500 1000 Bottom of Form Asset Management Ratios Asset Management Ratios attempt to measure the firm's success in managing its assets to generate sales. the higher the Receivables Turnover Ratio the better since this implies that the firm is collecting on its accounts receivables sooner.

Top of Form Example Problems Use the information below to calculate the Receivables Turnover and Days' Receivables Ratios. while still others use a weighted average method. When comparing one firms's Inventory Turnover ratio with that of another firm it is important to consider the inventory valuation methid used by the firms. In general. an inventory item sits on the shelf until it is sold. The Days' Inventory Ratio is calculated by dividing the number of days in a year. The Inventory Turnover Ratio is calculated by dividing Cost of Goods Sold by Inventory. others use a LIFO (last-in-first-out) method. 365. Top of Form Example Problems Use the information below to calculate the Inventory Turnover . by the Inventory Turnover Ratio. Sales: $ Accounts Receivable: $ Receivables Turnover: Days' Receivables: 1500 150 Bottom of Form Inventory Turnover and Days' Inventory The Inventory Turnover and Days' Inventory Ratios measure the firm's management of its Inventory. if the ratio is too high then the firm may be losing sales to competitors due to inventory shortages. a higher Inventory Turnover Ratio is indicative of better performance since this indicates that the firm's inventories are being sold more quickly. Therefore. Some firms use a FIFO (first-in-firstout) method. However. the Days' Inventory indicates how long. on average.

This ratio is calculated by dividing Sales by Net Fixed Assets. Top of Form . a number from the Income Statement is divided by a number from the Balance Sheet. The Income Statement reports revenues and expenses over a period of time (usually a year) whereas the Balance Sheet reports the firms assets and liabilities on a particular date. Total Assets Turnover The Total Assets Turnover Ratio measures how productively the firm is managing all of its assets to generate Sales. This ratio is calculated by dividing Sales by Total Assets. This can be of particular concern when comparing the Asset Management Ratios of one firm with another firm in the same industry. are in seaonal industries in which their assets. This occurs because. for firms in seasonal industries differences in performance may be detected when no actual difference exists simply because their Balance Sheets are published on different dates.and Days' Inventory Ratios. Fixed Assets Turnover The Fixed Assets Turnover Ratio measures how productively the firm is managing its Fixed Assets to generate Sales. especially current assets. When comparing Fixed Assets Turnover Ratios of different firms it is important to keep in mind that the values for Net Fixed Assets reported on the firms' Balance Sheets are book values which can be very different from market values. in the calculation of each of the Asset Management Ratios. Thus. and sales volume vary throughout the year. such as department stores. Cost of Goods Sold: $ Inventory: $ Inventory Turnover: Days' Inventory: 1500 500 Bottom of Form Seasonal Industries Many firms.

Example Problems Use the information below to calculate the Fixed Assets Turnover and Total Assets Turnover Ratios. Thus. the optimal mix of debt for a firm involves a tradeoff between the benefits of leverage and possibility of financial distress. Sales: $ Net Fixed Assets: $ Total Assets: $ Fixed Assets Turnover: Total Assets Turnover: 1500 1000 1500 Bottom of Form Debt Management Ratios Debt Management Ratios attempt to measure the firm's use of Financial Leverage and ability to avoid financial distress in the long run. Thus. if the firm can earn more on assets which are financed with debt than the cost of servicing the debt then these additional earnings will flow through to the stockholders. our tax law favors debt as a source of financing since interest expense is tax deductible. Debt-Equity Ratio. Debt generally represents a fixed cost of financing to a firm. With the use of debt also comes the possibility of financial distress and bankruptcy. and Equity Multiplier . These ratios are also known as Long-Term Solvency Ratios. Moreover. Debt is called Financial Leverage because the use of debt can improve returns to stockholders in good years and increase their losses in bad years.The amount of debt that a firm can utilize is dictated to a great extent by the characteristics of the firm's industry. Firms which are in industries with volatile sales and cash flows cannot utilize debt to the same extent as firms in industries with stable sales and cash flows. Debt Ratio.

Total Assets: $ Total Debt: $ Total Owners' Equity: $ Debt Ratio: Debt-Equity Ratio: Equity Multiplier: 2000 1000 1000 % Bottom of Form Profitability Ratios Profitability Ratios attempt to measure the firm's success in generating income. Top of Form Example Problems Use the information below to calculate the Debt Ratio. and Equity Multiplier. . and Equity Multiplier are essentially three ways of looking at the same thing: the firm's use of debt to finance its assets. These ratios reflect the combined effects of the firm's asset and debt management. The Debt Ratio is calculated by dividing Total Debt by Total Assets. The Equity Multiplier is calculated by dividing Total Assets by Total Owners' Equity.The Debt Ratio. Debt-Equity Ratio. Debt-Equity Ratio. The Debt-Equity Ratio is calculated by dividing Total Debt by Total Owners' Equity.

Thus.Profit Margin The Profit Margin indicates the dollars in income that the firm earns on each dollar of sales. Return on Assets (ROA) and Return on Equity (ROE) The Return on Assets Ratio indicates the dollars in income earned by the firm on its assets and the Return on Equity Ratio indicates the dollars of income earned by the firm on its shareholders' equity. Return on Assets (ROA). It is important to remember that these ratios are based on Accounting book values and not on market values. Sales: $ Net Income: $ Total Assets: $ Total Owners' Equity: $ Profit Margin: Return on Assets: Return on Equity: 2000 500 1500 1000 % % % . it is not appropriate to compare these ratios with market rates of return such as the interest rate on Treasury bonds or the return earned on an investment in a stock. Top of Form Example Problems Use the information below to calculate the Profit Margin. and Return on Equity (ROE). This ratio is calculated by dividing Net Income by Sales.

the P/E Ratio also indicates how expensive a particular stock is. where Top of Form Example Problems Use the information below to calculate the Price-Earnings Ratio . if the firm has very little or negative earnings.Bottom of Form Market Value Ratios Market Value Ratios relate an observable market value. to book values obtained from the firm's financial statements. this ratio indicates management's success in creating value for its stockholders. the stock price. where Market-to-Book Ratio The Market-to-Book Ratio relates the firm's market value per share to its book value per share. (Investors who are willing to pay a high price for a dollar of current earnings obviously expect high earnings in the future. Price-Earnings Ratio (P/E Ratio) The Price-Earnings Ratio is calculated by dividing the current market price per share of the stock by earnings per share (EPS). high P/E Ratios are associated with growth stocks. This ratio is not meaningful. however. Since a firm's book value reflects historical cost accounting. This ratio is used by "value-based investors" to help to identify undervalued stocks.) In this manner.) The P/E Ratio indicates how much investors are willing to pay per dollar of current earnings. As such. (Earnings per share are calculated by dividing net income by the number of shares outstanding.

Net Income: $ Total Owners' Equity: $ Stock Price: $ Number of Shares Outstanding: Price-Earnings Ratio: Earnings per Share: $ Market-to-Book Ratio: Book Value per Share: $ 2000 5000 25 1000 Bottom of Form Ratio Equations Short-term Solvency Ratios Current Ratio: Quick Ratio: Asset Management Ratios Receivables Turnover: Days' Receivables: .and Market-to-Book Ratio.

Inventory Turnover: Days' Inventory: Fixed Assets Turnover: Total Assets Turnover: Debt Management Ratios Times Interest Earned (TIE) Ratio: Debt Ratio: Debt-Equity Ratio: Equity Multiplier: Profitability Ratio Profit Margin: Return on Assets: Return on Equity: Market Value Ratios Price/Earnings Ratios: Market-toBook Ratio: Dividend Ratios Payout Ratio: .

FIRST LIQUIDITY RATIO Current Ratio: This ratio is obtained by dividing the 'Total Current Assets' of a company by its 'Total Current Liabilities'.Retention Ratio: Other Equations Earnings Per Share: Book Value Per Share: Financial Statement Analysis . It expresses the 'working capital' relationship of current assets available to meet the company's current obligations.e the day that the Balance Sheet was prepared. • • • Liquidity Ratios Efficiency Ratios Profitability Ratios Liquidity Ratios: Liquidity Ratios are ratios that come off the the Balance Sheet and hence measure the liquidity of the company as on a particular day i. The formula: Current Ratio = Total Current Assets/ Total Current Liabilities An example from our Balance sheet: . The ratio is regarded as a test of liquidity for a company. These ratios are important in measuring the ability of a company to meet both its short term and long term obligations.Liquidity Ratios In analyzing Financial Statements for the purpose of granting credit Ratios can be broadly classified into three categories.

522 .a Net Worth'. The formula: Debt to Equity Ratio = Total Liabilities / Owners Equity or Net Worth An example from our Balance sheet: Debt to Equity Ratio = $186. accounts receivables.522 Current Ratio = 1. prepaids and notes receivables available to meet the company's current obligations.00 of its Current Liability Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry. The ratio measures how the company is leveraging its debt against the capital employed by its owners. If the liabilities exceed the net worth then in that case the creditors have more stake than the shareowners. Sometimes a company could be carrying heavy inventory as part of its current assets. which might be obsolete or slow moving. To use the Current Ratio Calculator Click here click here SECOND LIQUIDITY RATIO .00 of its Current Liability Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry.59 The Interpretation: Lumber & Building Supply Company has $0. It expresses the true 'working capital' relationship of its cash.522 Quick Ratio = 0. The formula: Quick Ratio = Total Quick Assets/ Total Current Liabilities Quick Assets = Total Current Assets (minus) Inventory An example from our Balance sheet: Quick Ratio = $261. The ratio is regarded as an acid test of liquidity for a company.228 / $176. To use the Quick Ratio Calculator Click here click here .050 / $176.522 Quick Ratio = $104.522 / $133.48 The Interpretation: Lumber & Building Supply Company has $1. Thus eliminating inventory from current assets and then doing the liquidity test is measured by this ratio. Quick Ratio: This ratio is obtained by dividing the 'Total Quick Assets' of a company by its 'Total Current Liabilities'.822 / $176.48 of Current Assets to meet $1. THIRD LIQUIDITY RATIO Debt to Equity Ratio: This ratio is obtained by dividing the 'Total Liability or Debt ' of a company by its 'Owners Equity a.k.59 cents of Quick Assets to meet $1.Current Ratio = $261.$156.050.

It also ties into the ability of a company to meet both its short term and long term obligations. sales.40 cents of Debt and only $1. Financial Statement Analysis . As a measurement.Efficiency Ratios Efficiency Ratios: Efficiency ratios are ratios that come off the the Balance Sheet and the Income Statement and therefore incorporate one dynamic statement. These ratios are important in measuring the efficiency of a company in either turning their inventory. Best Possible DSO requires three pieces of information for calculation: • • • Current Receivables Total credit sales for the period analyzed The Number of days in the period analyzed Formula: Best Possible DSO = Current Receivables/Total Credit Sales X Number of Days The formula: .00 in Equity to meet this obligation. This is because if they do not get paid on time how will you get paid paid on time. This ratio is of particular importance to credit and collection associates. The effectiveness with which it converts its receivables into cash.Debt to Equity Ratio = 1. assets. the closer the receivables are to the optimal level.40 The Interpretation: Lumber & Building Supply Company has $1. Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry. To use the Debt to Equity Ratio Calculator Click here click here . The ratio is regarded as a test of Efficiency for a company. the closer the regular DSO is to the Best Possible DSO. of a company's accounts receivable. in terms of days. the balance sheet. You may have perhaps heard the excuse 'I will pay you when I get paid' or 'My customers have not paid me!' FIRST EFFICIENCY RATIO DSO (Days Sales Outstanding): The Days Sales Outstanding ratio shows both the average time it takes to turn the receivables into cash and the age. Best Possible DSO yields insight into delinquencies since it uses only the current portion of receivables. the income statement and one static statement . accounts receivables or payables.

Higher the ratio means that the .6 times in one fiscal year. The ratio is regarded as a test of Efficiency and indicates the rapiditity with which the company is able to move its merchandise. Inventory Turnover ratio: This ratio is obtained by dividing the 'Total Sales' of a company by its 'Total Inventory'.456 Total Credit Sales (from Income Statement) = $727.822 (from Balance sheet ) Inventory Turnover Ratio = $727. Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry. To use the Inventory Turnover Ratio Calculator Click here click here THIRD EFFICIENCY RATIO .6 times The Interpretation: Lumber & Building Supply Company is able to rotate its inventory in sales 4.822 Inventory Turnover = 4. This means at an average their customers take 18 days beyond terms to pay. The formula: Inventory Turnover Ratio = Net Sales / Inventory It could also be calculated as: Inventory Turnover Ratio = Cost of Goods Sold / Inventory An example from our Balance sheet and Income Statement: Net Sales = $727.25 days The Interpretation: Lumber & Building Supply Company takes approximately 48 days to convert its accounts receivables into cash.Regular DSO = (Total Accounts Receivables/Total Credit Sales) x Number of Days in the period that is being analyzed An example from our Balance sheet and Income Statement: Total Accounts Receivables (from Balance Sheet) = $97. Compare this to their Terms of Net 30 days. below or equal to the others in the same industry.456 / $727. This ratio gives you an indication as to how much of their suppliers money does this company use in order to fund its Sales.116 ] x 360 = 48. To use the Regular DSO Calculator Click here click here SECOND EFFICIENCY RATIO .116 Number of days in the period = 1 year = 360 days ( some take this number as 365 days) DSO = [ $97. Review the Industry Norms and Ratios for this ratio to compare their efficiency and see if they are above.116/ $156. Accounts Payable to Sales (%): This ratio is obtained by dividing the 'Accounts Payables' of a company by its 'Annual Net Sales'.116 (from Income Statement) Total Inventory = $156.

The working capital of such companies could be funded by their suppliers.142 Net Sales (from Income Statement) = $727. The ratio measures the percentage of profits earned per dollar of sales and thus is a measure of efficiency of the company.116 (from Income Statement) Accounts Payables to Sales Ratio = [$152.71% The Interpretation: .company is using its suppliers as a source of cheap financing.240 (from Balance sheet ) Net Sales = $727.142 / $727. falling prices or declining sales in the future. The formula: Accounts Payables to Sales Ratio = [Accounts Payables / Net Sales ] x 100 An example from our Balance sheet and Income Statement: Accounts Payables = $152.9% The Interpretation: 21% of Lumber & Building Supply Company's Sales is being funded by its suppliers.116] x 100 Accounts Payables to Sales Ratio = 20.Profitability Ratios Profitability Ratios: Profitability Ratios show how successul a company is in terms of generating returns or profits on the Investment that it has made in the business. The formula: Return on Sales or Profit Margin = (Net Profit / Net Sales) x 100 An example from our Balance sheet and Income Statement: Total Net Profit after Interest and Taxes (from Income Statement) = $5.116] x 100 Return on Sales or Profit Margin = 0. To use the Accounts Payables to Sales Ratio Calculator Click here click here . If a business is Liquid and Efficient it should also be Profitable. Financial Statement Analysis . Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry..240 / $727. FIRST PROFITIBILITY RATIO Return on Sales or Profit Margin (%): The Profit Margin of a company determines its ability to withstand competition and adverse conditions like rising costs.116 Return on Sales or Profit Margin = [ $5.

142 Total Assets (from Balance sheet) = $320. The ratio measures the percentage of profits earned per dollar of Asset and thus is a measure of efficiency of the company in generating profits on its Assets.044] x 100 Return on Assets = 1.00 of Sale Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry.60% The Interpretation: Lumber & Building Supply Company generates makes 1. SECOND PROFITABILITY RATIO Return on Assets: The Return on Assets of a company determines its ability to utitize the Assets employed in the company efficiently and effectively to earn a good return.522 Return on Net Worth = [ $5. Generally a return of 10% would be desirable to provide dividents to owners and have funds for future growth of the company The formula: Return on Equity or Net Worth = (Net Profit / Net Worth or Owners Equity) x 100 Net Worth or Owners Equity = Total Assets (minus) Total Liability An example from our Balance sheet and Income Statement: Total Net Profit after Interest and Taxes (from Income Statement) = $5. To use the Return on Sales or Profit Margin Calculator click here . Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry. To use the Return on Assets or Profit Margin Calculator click here THIRD PROFITABILITY RATIO .85% The Interpretation: .71 cents on every $1. The formula: Return on Assets = (Net Profit / Total Assets) x 100 An example from our Balance sheet and Income Statement: Total Net Profit after Interest and Taxes (from Income Statement) = $5. Return on Equity or Net Worth: The Return on Equity of a company measures the ability of the management of the company to generate adequate returns for the capital invested by the owners of a company.142 / $320.142 Net Worth (from Balance sheet) = $133.044 Return on Assets = [ $5.522] x 100 Return on Equity or Return on Net Worth = 3.142 / $133.60% return on the Assets that it employs in its operations.Lumber & Building Supply Company makes 0.

03 0.48 6.70 1.00 34.39 1.00 0.40 .00 1.89 51.64 Trans-Communic 1.48 0.84 Wholesale Non-Durable 1.05 34.46 33.00 1.44 0.77 0.31 Mining 1.00 2.66 1.43 Mach-trans equipment 1.74 1.50 Chem. To use the Return on Assets or Profit Margin Calculator click here Key Business Ratios: Industry Norms and Key Business Ratios: The following key business ratios were obtained from the public domain and may not be accurate. Metal 1.00 2.70 4. For more information and an extensive list of the key business ratios please contact your local Dun & Bradstreet or RMA office.41 6. Petrol. Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry.85% percent return on the capital invested by the owners of the company. Their ratios are developed and derived from the financial statements in their extensive database.00 1.00 52.00 2.00 2.16 0. includes a combination of financial statements and business ratios to help the credit community to compare a company's financial performance to its peer group by industry size and region. Current Ratio Agriculture 1.00 1.34 5.64 0.52 19.98 1.54 0.00 0.33 6. they will give you a rough idea.58 Quick Ratio Debt to Equity Sales to Inventory DSO Profit Margin % Manufacturing Leather/Textile/App 1. However.74 0.94 48.62 1.19 Construction 1.38 0.74 43. They are based on activities of numerous industries.54 Wood Related Prod 1.75 1.Lumber & Building Supply Company generates a 3.23 0.62 1.33 2.63 39.31 4.53 0. Key Business Ratios can be obtained from companies like D&B (Dun & Bradstreet) or RMA.

61 Restaurants 0.00 0.14 Automobiles 1.16 0.24 35.00 1.00 1.36 31.11 Retail Hardware 1.38 1.43 0.75 3.19 2.04 15.60 7.18 Business Services 1.61 4.Durable 1.11 0.29 .00 0.84 1.00 0.68 Gen.59 3.72 0.75 9.29 0.00 0.69 1.36 Service Industry 1.75 0.77 0.00 1.00 1.23 Apparel 1.73 0.30 4.90 Furniture 1.81 4.00 0.00 1.96 2.68 0.03 16.84 0. Merchandise 2.91 2.20 22.92 0.34 0.42 0.43 1.14 0.15 0.18 1.65 1.35 0.11 Financial Services 1.00 1.33 4.00 42.

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