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Ratio Analysis

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Accounting for Managers

Financial Analysis

• Assessment of the firm’s past, present and future financial conditions • Done to find firm’s financial strengths and weaknesses • Primary Tools:

– Financial Statements – Comparison of financial ratios to past, industry, sector and all firms

**Objectives of Ratio Analysis
**

• Standardize financial information for comparisons • Evaluate current operations • Compare performance with past performance • Compare performance against other firms or industry standards • Study the efficiency of operations • Study the risk of operations

Uses for Ratio Analysis • • • • • Evaluate Bank Loan Applications Evaluate Customers’ Creditworthiness Assess Potential Merger Candidates Analyze Internal Management Control Analyze and Compare Investment Opportunities .

Types of Ratios • Financial Ratios: – Liquidity Ratios • Assess ability to cover current obligations – Leverage Ratios • Assess ability to cover long term debt obligations • Operational Ratios: – Activity (Turnover) Ratios • Assess amount of activity relative to amount of resources used – Profitability Ratios • Valuation Ratios: • Assess profits relative to amount of resources used • Assess market price relative to assets or earnings .

Liquidity Ratios • Current Ratio – Current Assets / Current Liabilities • Current Assets include Cash.2 : 1 Current Liabilities 1555.75 . Marketable Securities. Accounts Receivable and Inventory • Current Liabilities include Accounts Payable. Debt Due within one year.92 Current Ratio 1. and Other Current Liabilities Current Assets 1870.

75 .Inventory 720.Liquidity Ratios • Quick Ratio or Acid Test – Current Assets minus Inventory / Current Liabilities – A more precise measure of liquidity.46 : 1 Current Liabilities 1555. especially if inventory is not easily converted into cash.53 Quik Ratio 0. Current Assets .

08 0.Liquidity Ratios • Cash Ratio Cash Ratio Cash Marketable Securities 26.17 Current Liabilities 1555.75 – Reserve borrowing capacity .the credit limit sanctioned by the bank .

369.870.39 77 Days 3.92 1.94 / 360 .Liquidity Ratios Interval Measure •Calculated to asses a firms ability to meet its regular cash outgoings Current As sets Inventory Interval Measure Average Daily operating expenses 1.150.

the higher this ratio. the more risky a creditor will perceive its exposure in your business. Thus. – Leverage ratios include: – Debt Ratio – Debt--Equity Ratio – Generally.Leverage Ratios – Leverage ratios measure the extent to which a firm has been financed by debt. . high leverage ratios make it more difficult to obtain credit (loans).

. and the easier it will be to obtain credit (loans). Fixed coverage Ratio etc. Leverage ratios also include the Interestcoverage Ratio. . the more credit worthy the firm is. In contrast to the leverage ratios discussed on previous slide. the higher the Interest Coverage Ratio (Times-Interest-Earned Ratio).Leverage Ratios Cont.

87 . Total Debt 1. the better.229.Total Debt Ratio – Proportion of interest bearing debt in the Capital structure.646 Net Assets 1901.06 Debt Ratio 0. the lower the number. – In general.

– This ratio indicates the extent to which the business relies on debt financing (creditor money versus owner’s equity).81 . Total Debt 1.06 Debt Equity Ratio 1.Debt-Equity Ratio – The Debt-Equity Ratio indicates the percentage of total funds provided by creditors versus by owners.229.83 Net Worth 972.

• Treatment of – Preference Capital – Lease Payments .

this calculation shows how many times the firm could pay back (or cover) its annual interest expenses out of earnings before interest and taxes (EBIT). – Also called the Times-Interest-Earned Ratio.46 .Interest Coverage Ratio – interest coverage ratio indicates the extent to which earnings can decline without the firm becoming unable to meet its annual interest costs.61 Interest Coverage Ratio 2.4 Interest 143. EBIT 342.

46 DA = Depreciation and Amortization expenses .59 Interest Coverage Ratio 2.Interest Coverage Ratio EBITDA 342.7 Interest 143.61 41.

Fixed Coverage Ratio – Principal repayments are added to interest payments • Fixed Coverage Ratio EBITDA repay m ent Interest Loan 1-Tax Rate EBITDA Lease rentals Fixed Coverage Ratio m ent Pref.Dividend Interest Lease rentals Loan repay 1-Tax Rate .

Activity Ratios – Activity ratios measure how effectively a firm is using its resources. Total assets turnover Fixed assets turnover . the better. – Activity ratios include: Inventory turnover Accounts receivable turnover Average collection period. or how efficient a company is in its operations and use of assets. the higher the ratio. – In general.

26 7461.6 Avg Inventory (244.Inventory Turnover Ratio – The inventory turnover ratio indicates how fast a firm is selling its inventories – This ratio indicates how well inventory is being managed.053..81) / 2 360 42 days InventoryTurnover Days of InventoryHolding .e. which is important because the more times inventory can be turned (i. Inventory Turnover Ratio Cost of Goods Sold 3. the higher the turnover rate) in a given operating cycle. the greater the profit.66 8.

Inventory Turnover Ratio Cont. – In the absence of information. While the sales are valued at market prices – Therefore better to use CGS . Instead of CGS we can use Sales – In the case of CGS and Inventory both are valued at cost.

how well accounts receivable are being collected.Accounts Receivable Turnover – The accounts receivable turnover ratio.717..23 7.e. indicates the average length of time it takes a firm to collect credit sales (in percentage terms).18 .7 Avg AR 483. liquidity could be severely impaired. i. – If receivables are excessively slow in being converted to cash. Credit Sales A R Turnover Avg AR Sales 3.

360 ACP 47 days AR Turnover .Average Collection Period – The average collection period is the average length of time (in days) it takes a firm to collect on credit sales.

– This ratio helps to signal whether a firm is generating a sufficient volume of business for the size of its asset investment Sales 3.95 times Net Assets 1901.87 . indicates how efficiently a firm is using all its assets to generate revenues.23 Net Assets Turnover 1.Net Assets Turnover – The total assets turnover ratio.717.

Profitability Ratios – Profitability ratios measure management’s overall effectiveness as shown by returns generated on sales and investment. . Profitability ratios include – – – – – – – Gross profit margin Operating profit margin Net profit margin Return on total assets (ROA) Return on stockholders’ equity (ROE) Earnings per share (EPS) Price-earnings ratio (P/E).

the better.9% Sales 3.717. This ratio indicates how efficiently a business is using its labor and materials in the production process. – The higher the ratio.Gross Profit Margin – The gross profit margin is the total margin available to cover operating expenses and yield a profit.179 or 17. and shows the percentage of net sales remaining after subtracting cost of goods sold.23 . GP Margin Gross Profit 663. A high gross profit margin indicates that a firm can make a reasonable profit on sales.57 0. as long as it keeps overhead costs under control.

The DuPont System • Method to breakdown ROE into: – ROA and Equity Multiplier • ROA is further broken down as: – Profit Margin and Asset Turnover • Helps to identify sources of strength and weakness in current performance • Helps to focus attention on value drivers .

The DuPont System ROE ROA Profit Margin Equity Multiplier Total Asset Turnover .

The DuPont System ROE ROA Profit Margin Equity Multiplier Total Asset Turnover ROE ROA Equity Multiplier Net Income Total Assets Total Assets Common Equity .

The DuPont System ROE ROA Profit Margin Equity Multiplier Total Asset Turnover ROA Profit Margin Total Asset Turnover Net Income Sales Sales Total Assets .

The DuPont System ROE ROA Profit Margin Equity Multiplier Total Asset Turnover ROE Profit Margin Total Asset Turnover Equity Multiplier Net Income Sales Total Assets Sales Total Assets Common Equity .

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