176’ Chapter. 5 Figure 5.1. Summary of Most Commonly Basic Significance 1. Ratios Used To Evaluate Short-Term Financial Pe Solvency And Liquidity) Name 1. Current ratio 2. Acid-test ratio or quick ratio 2A. Cash Ratio Formula Total Current Assets ‘Total Current Liabilities Total Quick Assets* Total Current Liabilities Cash + Marketable Securities Total Current Liabilities * Cash + Marketable Securities + Accounts receivable 3. a) Working Capital to total assets b) Working Capital 4. Cash Flow Liquidity ratio ratio Working Capital Total Assets Current Assets /ess Current Liabilities Cash + Marketable Securities + Cash Flow from Operating Activities Current Liabilities Quick Assets Projected Daily Operational. Expenses Used Ratios: Their Formulas and rosition (Short-Term Significance Primary test of solvency to meet current obligations from current assets as a going concern; measure of adequacy of working capital A more severe test of immediate solvency; test of ability to meet demands from current assets. Indicates relative liquidity of total assets and distribution of resources employed. Measures short-term __ liquidity by considering as cash resources (numerator) cash plus an equivalents plus cash flow from operatin: activities, ere Measures length of time in days the firm can Operate on its present liquid resources.Financial Statements Analysis I AT7 I. Ratios Used Te ‘i 'o Evaluate Asset Liquidity And Management Efficiency; Activity Nai ime. Formula Significance La ee Net credit sales * Velocity of collection of weaver Average Trade trade accounts and Receivable (net) notes; test of efficiency of collection. b) ) Average, a 360 days Evaluates the liquidity of period Receivable Turnover accounts receivable and enna of or the firm's credit policies. days’ es Accounts Receivable theglictel Net Sales / 360 2. Inventory Turnover a) Merchandise Cost of goods sold Measures efficiency of turnover Average Merchandise _the firm in managing Inventory and selling inventories. b) Finished Cost of goods sold -do- goods ‘Average Finished goods inventory Inventory ¥ or Net Sales if net credit sales figure is not available. ©) Goods in Cost of goods Measures efficiency of process manufactured the firm in managing turnover ‘Average Goods-in and selling inventories. Process Inventory d) Raw materials Raw Materials Used Number of times raw turnover Fverage Raw Materials ‘materials inventory was Inventory used and replenished during the period. e) Days’ supply 360 days Measures average in inventory. Tnventory Turnover number of days to sell or consume the average inventory. 3. Working Capital Net Sales Indicates adequacy and turnover Ave. Working Capital activity of working capital. 4... Percent of each ‘Amount of each Indicates relative in- current asset to current asset item vestment in each ‘total current assets Total Current Assets current asset.£78, NChapter sO SN 5. Current assets turnover 6. Payable turnover 7. Operating cycle 8. Cash Cycle BA. Days cash 9. Free cash flow 10. Investment or assets turnover “41, Sales to fixed “assets (plant assets turnover) 12. Capital intensity ratio Cost of Sales + Operating Expenses + Income Taxes + Other Expenses (net) (excluding depreciation and amortization) Ave. Current Assets Net purchases ‘Average Accounts Payable Average Conversion Period of Inventories + Average Collection Period of Receivable + Days Cash Operating Cycle — Average Payment Period Ave. Cash balance Cash operating costs + 360 days Net cash from operating activities — Cash used for investing activities and Dividends Net Sales ‘Ave. Total Investment or Total Assets Net Sales Ave. Fixed Assets (net) Total Assets Net Sales, ————__— ‘Measures movement and utilization of current resources to meet operating requirements. Measure efficiency of the company in meeting trade payable. Measures the length of time required to convert cash to finished goods; then to receivable and then back to cash. Measures availability of cash to meet average daily cash requirement. Excess of operating cash flow over basic needs Measures efficiency of the firm in managing all assets, Tests roughly the efficiency of Management in keeping plant properties employed, Measures efficiency of the firm to generate sales through employment of its resources.Financial Statements Analysis - II _179 . Ratios IIL. Ratios Used To Evaluate Long-Term Financial Position or Stability / Leverage Name Formula Significance 1. Debt ratic ‘s ae ___ Total Liabilities ‘Shows proportion ofall Total Assets assets that are financed with debt. a it ic Fal rae __ Total Equity __Indicates proportion of Total Assets assets provided by owners. Reflects financial strength and caution to creditors. 3, Debt to equity Total Liabilities Measures debt reiative roe Total Equity to amounts of resources provided by owners. 4. Fixed Assets to Fixed Assets (net) Reflects extent of % long-term Total Long-term investment in long-term liabilities Liabilities assets financed from long-term debt. 5. Fixed assets to Fixed Assets (net) Measures the proportion total equity Total Equity of owners’ capital invested in fixed assets. 6. Fixed assets to Fixed Assets (net) Measures investment in. total equity Total Assets long-term capital assets. 7. Book value per Ordinary Measures recoverable share of ordinary shareholders’ equity amount in the event of shares No. of outstanding liquidation if assets are ordinary shares realized at their book values. 8. Times interest Net Income before Measures how many earned Interest and Taxes times interest expense ‘Annual Interest is covered by operating Charges profit. 10. Times preferred Net Income Indicates ability to dividend After Taxes, provide dividends for requirement Preferred-Dividends preference earned Requirement shareholders. 11. Times fixed Net Income before Measures coverage charges earned Taxes and Fixed Charges Fixed Charges (Rent + Interest + Sinking Fund payment before taxes*) capability more broadly than times interest, earned by including other fixed charges,180 Chapter 5 12. Cash Coverage Ratio, IV. Ratios Used To Measure Profitability And. Name Gross profit margin 2. Operating profit margin 3. Net profit margin (Rate of return on net sales) + Fixed Charges Formula ___ Formula ___ Gross Profit Net Sales Operating Profit Net Sales Net Profit Net Sales Returns To Investors Significance Measures profit generated after consideration of cost of product sold. Measures profit generated after consideration of operating costs. Measures profit generated after consideration of all expenses and revenues. * Sinking fund payment before taxes = Sinking fund payment after taxes 4. Cash Flow Margin 5. Rate of return on assets (ROA) * 6. Rate of return on equity ** 7. Earnings per share 8. Price/earnings ratio Cash Flow from operating activities _ Net Sales __Net Proft_ Ave. Total Assets Alternative formula: Asset Turnover x Net Profit margin Net Income ‘Ave. Ordinary Equity Net income less preference dividends requirement Ave. ordinary shares outstanding Market Value per Share of Ordinary Shares 1 - Tax rate Measures ability of the firm to translate sales to cash. Measures overall efficiency of the firm in managing assets and generating profits: Measures rate of return on resources provided by owners. Peso return on each ordinary.share. Indicative of ability to + Pay dividends, Measures relationship between price of ordinary shares in theFinancial Statements Analysis - 181 Earnings per share of open market and profit Ordinary Shares earned on a per-share . basis. 8A. Market by book Market Value Price Measures the amount ratio Book Value per share investors will pay per peso of equity used to finance the firm's assets. 9. Dividend Payout Dividends per share Shows percentage of Earnings per share earnings paid to shareholders. 10. Dividend Yield Annual Shows the rate earned Dividends per share by shareholders from Market Value per share dividends relative to of ‘current price of stock. Ordinary Shares 11. Dividends per Dividends Shows portion of share Paid/Declared income distributed to Ordinary shares shareholders on a per outstanding share basis. a 12. Rate of retum on Net Income Measures the average current ‘Ave. Current Assets profitability of current assets assets invested. 13. Rate of return per Rate of returnon + Shows profitability of turnover of Ave. Current assets each turnover of current current assets Current Assets assets. turnover * If there is interest-bearing debt, Rate of return on assets is computed as follows: ‘A measure of the Net Income +. [Interest expense (1 - Tax rate] —» roauctvity of ‘Average Total Assets Besa ** May also be computed as follows: of how the assets ame are financed. ROE = Return on Assets x Equity Multiplier : Equity Multiplier = zi, Equity Ratio