FINANCIAL

STATEMENT
ANALYSIS
USING RATIOS
 FINANCIAL RATIO ANALYSIS
- is a comparison in fraction,
proportion, decimal or percentage
of two significant figures taken
from the financial statements.
 FINANCIAL RATIO ANALYSIS
- expresses the direct
relationship between two or more
items in the statement of financial
position and statement of
comprehensive income of a
business firm.
 PURPOSE
 Through ratio analysis, the
financial statements user comes
into possession of measures which
provide insight into the
profitability of operations, the
soundness of
 the firm’s short –term and long-
term financial condition and the
efficiency with which management
has utilized the resources entrusted
to it.
LIMITATIONS OF FINANCIAL
RATIOS
1. Ratios must be used only as
financial tools, that is, as
indicators of weakness or
strength and not to be regarded
as good or bad per set.
2. Financial ratios are generally
computed directly from the company’s
financial statements without
adjustment. Conventional financial
statements prepared in accordance
with International Financial Reporting
Standards (IFRS) have a no. of
weaknesses that managers must
consider if the ratios are to be
meaningful.
3. Ratios are a composite of many
different figures – some
covering a time period, others
an instant time and still others
representing averages.
4. Ratios to be meaningful should
be evaluated with the use of
certain yardsticks. The most
common of these are:
a. company’s own experience (prior years)
b. Other companies in the same industry
(industry averages)
c. A standard set by management (a budget)
d. Rules of thumb
 1. LIQUIDITY/SOLVENCY
RATIOS
These ratios give us an idea of
the firm’s ability to pay off
debts that are maturing within a
year or within the next
operating cycle.
Name Formula Significance
Current Primary test of
solvency to meet
Ratio Total Current
current obligations
Assets from current assets
Total Current as a going
Liabilities concern, measure
of adequacy of
working capital.
Name Formula Significance
AcidTest A more severe
or Quick Total Quick test of
Ratio Assets immediate
Total Current solvency; test of
Liabilities ability to meet
demands from
current assets.
Name Formula Significance
Cash Measures short-term
Flow Cash + Marketable liquidity by
Securities + Cash Flow considering as cash
Liquidity From Operating Act.
resources numerator
Ratio Current Liabilities
cash plus cash
equivalents plus
cash flow from
operating activities.
Name Formula Significance
Working Current Assets
Capital less
Current
Liabilities
Indicates relative
Working Working Capital liquidity of total
Capital to Total Assets assets and
Total distribution of
Assets resources employ.
 2. ACTIVITY/ASSET
MANAGEMENT RATIOS
These ratios give us an idea of how
efficiently the firm is using its
assets.
Good asset management ratios are
necessary for the firm to keep its
costs low and thus, its net income
high.
Name Formula Significance
1. Velocity of
a)Trade Net Credit collection of
receivable Sales *
tradeaccounts
Average Trade
turnover and notes; test
Receivable
(net) of efficiency of
collection.
Name Formula Significance
b) Average 360 days Evaluates the
collection Receivable liquidity of
period or Turnover accounts
Or
number of Accounts receivable and
days’ sales Receivable the effectiveness
un- Net Sales/360
of the firm’s
collected
credit policies.
Name Formula Significance
2.Inventory Cost of goods Measures
Turnover sold efficiency of the
a)
Average firm in managing
Merchandise
turnover Merchandise and selling
Inventory inventories.
Measures average
b) Days
supply in
360 days number of days to
Inventory/ Inventory sell or consume the
Average Sale Turnover average inventory.
period
Name Formula Significance
3. Assets/ Measures
Net Sales
Investment
Average Total efficiency of the
or Assets
Turnover Investment firm in managing
Or all assets to
Total Assets
generate
revenue.
 3. DEBT MANAGEMENT AND
LEVERAGE RATIOS
These ratios would tell us how the firm
has financed its assets as well as the
firm’s ability to repay its long-term debt.
It indicate how risky the firm is and how
much of its operating income must be
paid to creditors rather than shareholders.
Name Formula Significance
Shows proportion of
Debt
Total Liabilities all assets that are
Ratio Total Assets financed with debt.
Indicates proportion
of assets provided
Equity Total Owner’s by owners. Reflects
Ratio Equity financial strength
Total Assets and caution to
creditors.
Name Formula Significance
Measures debt
Debt to Total Liabilities relative to amounts
Equity Total Owners
Equity
of resources
provided by owners.
Ratio
Time Net Income Measures how
Before Interest many times interest
Interest and Taxes expense is covered
Earned Annual Interest
by operating profit.
Charges
4. PROFITABILITY RATIOS
These ratios give us an idea of how
profitable the firm is operating and
utilizing its assets.
It combines the asset and debt
management categories and show
their effects on return on equity.
Name Formula Significance
Measures profit
Gross
Gross Profit generated after
Profit Net Sales consideration of
cost of product
Margin
sold.
Measures profit
Operating Operating generated after
Profit Profit consideration of
Net Sales operating costs.
Margin
Name Formula Significance
Net Profit Measures profit
Net Profit
generated after
Margin Net Sales
consideration of
Rate of
Return on
all expenses and
Net Sales revenues.
Net Profit
Measures overall
Rate of Ave. Total efficiency of the firm
Return on Assets in managing assets
Alt. Formula:
Assets Asset Turnover and generating
(ROA)* X
Net Profit Margin
profits.
Name Formula Significance
Rate of Net Income Measures rate
Return on Average of return on
Equity ** Ordinary Equity
resources
provided by
owners.