FINANCIAL ANALYSIS AND REPORTING

FINANC
IAL
RATIOS
 FINANCIAL ANALYSIS AND REPORTING

CATEGORIES OF FINANCIAL
RATIOS
1. Liquidity Ratios
2. Activity Ratios
3. Debt Ratios
4. Profitability
5. Market
Ratios
Ratios
 FINANCIAL ANALYSIS AND REPORTING

LIQUIDITY
RATIOS
The liquidity of a firm is measured by its ability to satisfy its short-
term obligations as they come due. Liquidity refers to the solvency
of the firm’s overall financial position—the ease with which it can
pay its bills. MISSION
The two basic measures of liquidity are the working capital, current
ratio and the quick (acid-test) ratio.
 FINANCIAL ANALYSIS AND REPORTING
Working Capital
It is calculated from the assets and liabilities on a corporate
balance sheet, focusing on immediate debts and the most liquid
assets.
It provides insight into a company's short-term liquidity and
efficiency. (Investopedia) MISSION

Working Capital Current assets Current liabilities

 FINANCIAL ANALYSIS AND REPORTING
Current Ratio
one of the most commonly cited financial ratios, measures the
firm’s ability to meet its short-term obligations.
Generally, the higher the current ratio, the more liquid the firm is
considered to be.
MISSION
Current Ratio Current assets
Current liabilities
 FINANCIAL ANALYSIS AND REPORTING
Quick (Acid-Test) Ratio
is similar to the current ratio except that it excludes inventory, which is
generally the least liquid current asset. The generally low liquidity of
inventory results from two primary factors: (1) many types of inventory
cannot be easily sold because they are partially completed items,
special-purpose items, and the like; and (2) inventoryMISSION
is typically sold on
credit, which means that it becomes an account receivable before being
converted into cash.

Current assets Inventory

Quick Ratio
Current liabilities
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ACTIVITY
RATIOS
Activity ratios measure the speed with which various accounts are
converted into sales or cash—inflows or outflows.
A number of ratios are available for measuring the activity of the
MISSION
most important current accounts, which include inventory, accounts
receivable, and accounts payable.
 FINANCIAL ANALYSIS AND REPORTING

Inventory Turnover
commonly measures the activity, or liquidity, of a firm’s
inventory.

Inventory Turnover Cost of Goods Sold MISSION

Inventory

Average age of inventory

Average number of days’ sales in inventory.

Average age of 360 / Inventory Turnover

inventory
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Average Collection Period

or average age of accounts receivable, is useful in evaluating credit
and collection policies.

Average Accounts ReceivableMISSION

Collection Average sales per day
Period
Accounts Receivable
Annual sales/360
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Average Payment Period

or average age of accounts payable, the average amount of time
needed to pay accounts payable

Average
Accounts payable
Payment Average purchases per day
Period
Accounts payable
Average purchases per day
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Total Asset Turnover

indicates the efficiency with which the firm uses its assets
to generate sales.

Total Asset Turnover Sales

Total Assets
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DEBT RATIOS
Financial Leverage
is the magnification of risk and return introduced through the use
of fixed-cost financing, such as debt and preferred stock. The more
MISSION
fixed-cost debt a firm uses, the greater will be its expected risk
and return.

2 General Types of Debt

Measures 1. Degree of indebtedness
2. Ability to service debts
 FINANCIAL ANALYSIS AND REPORTING

DEBT RATIOS
1. Degree of indebtedness
measures the amount of debt relative to other significant balance
sheet amounts. A popular measure of the degree of indebtedness is
MISSION
the debt ratio.
 FINANCIAL ANALYSIS AND REPORTING

DEBT RATIOS
2. Ability to service debts
reflects a firm’s ability to make the payments required on a
scheduled basis over the life of a debt.
MISSION

Coverage ratios
ratios that measure the firm’s ability to pay certain fixed charges.
 FINANCIAL ANALYSIS AND REPORTING

DEBT RATIO
measures the proportion of total assets financed by the firm’s
creditors. The higher this ratio, the greater the amount of other
people’s money being used to generate profits.
MISSION
Debt Ratio Total liabilities
Total assets
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Times Interest Earned Ratio

sometimes called the interest coverage ratio, measures
the firm’s ability to make contractual interest payments. The
higher its value, the better able the firm is to fulfill its interest
obligations.

Times Interest Earnings before interest and taxes

Earned Ratio Interest
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Fixed-Payment Coverage Ratio

measures the firm’s ability to meet all fixed-payment obligations, such
as loan interest and principal, lease payments, and preferred stock
dividends.

Fixed-Payment Earnings before interest and taxes + Lease payments

Coverage Ratio Interest + Lease payments
+ [( Principal payments + Preferred stock dividends )] x
[1 / (1 T )]
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PROFITABILITY
RATIOS
There are many measures of profitability. As a group, these
measures enable the analyst to evaluate the firm’s profits with
respect to a given level of sales, a certain level of assets, or the
owners’ investment. Without profits, a firm could not attract
outside capital. Owners, creditors, and management pay close
attention to boosting profits because of the great importance
placed on earnings in the marketplace.
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PROFITABILITY
RATIOS
A popular tool for evaluating profitability in relation to sales is the
common-size income statement. Each item on this statement is
expressed as a percentage of sales. Common-size income
statements are especially useful in comparing performance
across years. Three frequently cited ratios of profitability that can
be read directly from the common-size income statement are (1)
the gross profit margin, (2) the operating profit margin, and (3) the
net profit margin.
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Gross Profit Margin

measures the percentage of each sales dollar remaining after the
firm has paid for its goods. The higher the gross profit margin, the
better(that is, the lower the relative cost of merchandise sold).

Gross Profit Margin Sales Cost of goods sold

Sales
Gross profit
Sales
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Operating Profit Margin

measures the percentage of each sales dollar remaining after all
costs and expenses other than interest, taxes, and preferred stock
dividends are deducted.

Operating Profit Margin Operating profits

Sales
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Net Profit Margin

measures the percentage of each sales dollar remaining after all
costs and expenses, including interest, taxes, and preferred stock
dividends, have been deducted. The higher the firm’s net profit
margin, the better.
Earnings available for
Net Profit Margin common stockholders
Sales
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Earnings per Share (EPS)

represents the dollar amount earned on behalf of each share—not
the amount of earnings actually distributed to shareholders.

Earnings available for

Earnings per Share common stockholders
Number of shares of
common stock outstanding
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Return on Total Assets (ROA)

often called the return on investment (ROI), measures the overall
effectiveness of management in generating profits with its available
assets. The higher the firm’s return on total assets, the better.

Earnings available for

Return on total common stockholders
assets (ROA) Total assets
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Return on Common Equity (ROE)

measures the return earned on the common stockholders’ investment
in the firm. Generally, the higher this return, the better off are the
owners.

Earnings available for

Return on common stockholders
Common Equity
Common stock equity
(ROE)
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MARKET
RATIOS
Market ratios relate the firm’s market value, as measured by its
current share price, to certain accounting values. These ratios give
insight into how well investors in the marketplace feel the firm is
doing in terms of risk and return. They tend to reflect, on a relative
basis, the common stockholders’ assessment of all aspects of the
firm’s past and expected future performance.
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Price/Earnings (P/E) Ratio

commonly used to assess the owners’ appraisal of share value. The P/E
ratio measures the amount that investors are willing to pay for each dollar
of a firm’s earnings. The level of the price/earnings ratio indicates the
degree of confidence that investors have in the firm’s future performance.
The higher the P/E ratio, the greater is investor confidence.

Price/earnings Market price per share of common stock

(P/E) ratio Earnings per share
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Market/Book (M/B) Ratio

provides an assessment of how investors view the firm’s performance. It
relates the market value of the firm’s shares to their book—strict
accounting—value.

Book value per Common stock equity

share of
Number of shares of common
common stock
stock outstanding
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THANYO
K U