Ratio Analysis

Financial Ratio Analysis
Interested parties
Shareholders - to measure management’s performance
Investors - to make their investment decisions
Management - to plan and control operation
Ratio analysis is a quick and easy way of analyzing a firm’s financial statements.

Cautions For Ratio Analysis
Ratio analysis cannot accurately pinpoint the problems of the firm. It is reasonable to expect that it points to a direction for a more detailed analysis.
Financial ratio itself is not meaningful without comparing it to a benchmark. Benchmarks can be a rival firm’s financial ratio or an industry average.
Sometimes a firm’s problems can be disguised as so-called “good ratios.” For example, a high inventory turnover can be an indicator of the firm’s dangerously low level of inventory.

Categories of Financial Ratios
Liquidity Ratios
Efficiency Ratios
Leverage Ratios
Profitability Ratios
Liquidity and leverage ratios primarily measure risk; efficiency and profitability ratios measure performance and return.

Liquidity Ratios
Net working capital
= Current assets - Current liability
Current ratio
Quick (acid-test) ratio

Efficiency Ratios
Inventory turnover
Average collection period (Days sales outstanding)
Assets Turnover
Fixed assets turnover

Leverage Ratios
Debt ratio
Debt-to-Equity ratio
Times interest earned ratio

Gross profit margin
Operating profit margin

Net profit margin
Return on total assets (ROA)

Return on equity (ROE)

Du Pont System of Analysis
Used by financial managers as a structure to dissect the firm's financial statements and to assess its financial condition.
ROA =

= (net profit margin) x (assets turnover)
ROE =
= (net profit margin) x (assets turnover) x (equity multiplier)

Ratios – example

Ratios – example continued
Calculate the following ratios:
Current ratio
Days sales outstanding
Inventory turnover

Total assets turnover
Profit margin on sales

Return on Assets
OR

Return on Equity
OR

Debt ratio

Example - results

Ratio Analysis

by engineer sood on Sep 19, 2008

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