BUSINESS ANALYSIS

Ratio Analysis
Instructor
Athar Hussain
 What Does Ratio Analysis Tell You?

• Investors and analysts employ ratio analysis to

evaluate the financial health of companies by
scrutinizing past and current financial
statements.
• Comparative data can demonstrate how a
company is performing over time and can be
used to estimate likely future performances. 
What Does Ratio Analysis Tell You?
• This data can also compare a company's financial
standing with industry averages while measuring
how a company stacks up against others within the
same sector.
• More Over, Investors can use ratio analysis easily
because, it is found on a company's financial
statements.
Thus, A ratio is the relation between two amounts
showing the number of times one value contains or is
contained within the other.
 Application of Ratio Analysis

• The fundamental basis of ratio analysis is to

compare multiple figures and derive a
calculated value.
• By itself, that value may hold little to no value.
Instead, ratio analysis must often be applied to
a comparable to determine whether or a
company's financial health is strong, weak,
improving, or deteriorating.
 Ratio Analysis Against Benchmarks

• Benchmarks are also frequently implemented by

external parties such lenders. Lending institutions
often set requirements for financial health. If these
benchmarks are not met, an entire loan may be
callable or a company may be faced with an adjusted
higher rate of interest to compensation for this risk. 
• Companies may set internal targets for what they
want their ratio analysis calculations to be equal to.
These calculations may hold current levels steady or
strive for operational growth.
 Five major categories of ratios
• Liquidity: Can we make required payments?
• Asset management: Right amount of assets vs.
sales?
• Debt management: Right mix of debt and equity?
• Profitability: Do sales prices exceed unit costs, and
are sales high enough as reflected in Profit Margin,
Return On Equity, and Return On Assets?
• Market value: Do investors like what they see as
reflected in Price/Earning ratios?
 Balance Sheet: Assets

2021E 2020
Cash 85,632 7,282
AR 878,000 632,160
Inventories 1,716,480 1,287,360
Total CA 2,680,112 1,926,802
Gross FA 1,197,160 1,202,950
Less: Deprec. 380,120 263,160
Net FA 817,040 939,790
Total assets 3,497,152 2,866,592
 Liabilities and Equity

2021E 2020
Accounts payable 436,800 524,160
Notes payable 600,000 720,000
Accruals 408,000 489,600
Total CL 1,444,800 1,733,760
Long-term debt 500,000 1,000,000
Common stock 1,680,936 460,000
Retained earnings (128,584) (327,168)
Total equity 1,552,352 132,832
Total L & E 3,497,152 2,866,592
Income Statement

2021E 2020

Sales 7,035,600 5,834,400

COGS 5,728,000 5,728,000
Other expenses 680,000 680,000
EBITDA 627,600 (573,600)
Depreciation 116,960 116,960
EBIT 510,640 (690,560)
Interest exp. 88,000 176,000
EBT 422,640 (866,560)
Taxes (40%) 169,056 (346,624)
Net income 253,584 (519,936)
 Forecasted current and quick ratios for
2021.

CA $2,680
CR01 = = CL = 1.85 $1,445

$2,680 – $1,716
=CA - Inv. = 0.67 $1,445
QR01 = CL

 Expected to improve but still below the industry average.

 Liquidity position is weak.
What is the inventory turnover ratio vs. the
industry average?

Sales
Inv. turnover =
Inventories
=
= 4.10x. $7,036
$1,716

2021 2020 Ind.

Inv. T. 4.1x 4.5x 6.1x
 Comments on Inventory
Turnover
• Inventory turnover is below industry
average.
• D’Leon might have old inventory, or its
control might be poor.
• No improvement is currently forecasted.
DSO is the average number of days after making a sale before receiving cash.

Receivables
DSO = Average sales per day

= = = 44.9.
Receivables $878
Sales/360 $7,036/360
 Appraisal of DSO

2021 2020 Ind.

DSO 44.9 39.0 32.0

 D’Leon collects too slowly, and is getting worse.

 D’Leon has a poor credit policy.
F.A. and T.A. turnover vs.
industry average

Fixed assets Sales

turnover = Net fixed assets
= = 8.61x.

$7,036
$817

Total assets Sales

turnover = Total assets

= = 2.01x.
$7,036
$3,497
 2021 2020 Ind.
FA TO 8.6x 6.2x 7.0x
TA TO 2.0x 2.0x 2.6x

 FA turnover projected to exceed industry average. Good.

 TA turnover not up to industry average. Caused by excessive current assets
(A/R and Inv.)
Calculate the debt ratio, Time interest ratio, and EBITDA coverage ratios.

Total debt
Debt ratio = Total assets
= = 55.6%.

$1,445 + $500
$3,497

EBIT
TIE = Int. expense
= = 5.8x.
$510.6
$88
 How do the debt management ratios compare with industry averages?

2021 2020 Ind.

D/A 55.6% 95.4% 50.0%
TIE 5.8x -3.9x 6.2x

Too much debt, but projected to improve.

Profit margin vs. industry average?
NI $253.6
P.M.
Sales= = = 3.6%.
$7,036

2021 2020 Ind.

P.M. 3.6% -8.9% 3.5%

Very bad in 2020, but projected to

exceed industry average in 2021. Looking good.
BEP vs. Industry Average?

EBIT
BEP = Total assets

$510.6
= = 14.6%.
$3,497
 2021 2020 Ind.
BEP 14.6% -24.1% 19.1%

• BEP removes effect of taxes and financial

leverage. Useful for comparison.
• Projected to be below average.
• Room for improvement.
Return on Assets

Net income
ROA = Total assets

$253.6
= = 7.3%.
$3,497
 Net income
ROE = Common equity

=
= 16.3%. $253.6
$1,552

2001 2000 Ind.

ROA 7.3% -18.1% 9.1%
ROE 16.3% -391.4% 18.2%

Both below average but improving.

Calculate and appraise the P/E,
P/CF, and M/B ratios.

Price = $12.17.

EPS = NI___= = $1.01.

Shares out. $253.6
250

Price per share $12.17

EPS $1.01

P/E = 12x.
• 2021 2020 Ind.
• P/E 12.0x -0.4x 14.2x
• P/E: How much investors will pay for $1 of
earnings. High is good.
What are some potential problems and
limitations of financial ratio analysis?
• Comparison with industry averages is
difficult if the firm operates many different
divisions.
• “Average” performance not necessarily
good.
• Seasonal factors can distort ratios.
• “Window dressing” techniques can make
statements and ratios look better.
 What are some qualitative factors
analysts should consider when evaluating
a company’s likely future financial
performance?

• Are the company’s revenues tied to 1 key

customer?
• To what extent are the company’s revenues
tied to 1 key product?
• To what extent does the company rely on a
single supplier?
(More…)
 What are some qualitative factors analysts should
consider when evaluating a company’s likely future
financial performance?
• What percentage of the company’s business is
generated overseas?
• Competition
• Future prospects
• Legal and regulatory environment
Thank You