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Ratios You Must Remember Before Opening A Financial Statement
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Ratios You Must Remember Before Opening A Financial Statement


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Ratios You Must Remember Before Opening A Financial Statement

Ratios You Must Remember Before Opening A Financial Statement

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  • 1. Wali Memon2010 Wali Memon 1
  • 2. THE USE OF FINANCIAL RATIOS •Financial Ratio are used as a relative measure that facilitates the evaluation of efficiency or condition of a particular aspect of a firms operations and status •Ratio Analysis involves methods of calculating and interpreting financial ratios in order to assess a firms performance and status2010 Wali Memon 2
  • 3. (1) (2) (1)/(2)Year End Current Assets/Current Liab. Current Ratio1994 $550,000 /$500,000 1.101995 $550,000 /$600,000 .92 2010 Wali Memon 3
  • 4. Three sets of parties are interested in ratio analysis: Shareholders Creditors Management2010 Wali Memon 4
  • 5. There are two types of ratio comparisons that can be made: Cross-Sectional Analysis Time-Series Analysis •Combined Analysis uses both types of analysis to assess a firms trends versus its competitors or the industry2010 Wali Memon 5
  • 6. A single ratio rarely tells enough to make a soundjudgment.Financial statements used in ratio analysis must befrom similar points in time.Audited financial statements are more reliable thanunaudited statements.The financial data used to compute ratios must bedeveloped in the same manner.Inflation can distort comparisons.2010 Wali Memon 6
  • 7. Liquidity Activity Debt Profitability2010 Wali Memon 7
  • 8. Liquidity refers to the solvency of thefirms overall financial position, i.e. a"liquid firm" is one that can easily meet itsshort-term obligations as they come due.A second meaning includes the concept ofconverting an asset into cash with little orno loss in value.2010 Wali Memon 8
  • 9. Net Working Capital (NWC) NWC = Current Assets - Current LiabilitiesCurrent Ratio (CR) Current Assets CR = Current LiabilitiesQuick (Acid-Test) Ratio (QR) Current Assets - Inventory QR = Current Liabilities 2010 Wali Memon 9
  • 10. Activity is a more sophisticatedanalysis of a firms liquidity,evaluating the speed with whichcertain accounts are converted intosales or cash; also measures a firmsefficiency2010 Wali Memon 10
  • 11. Cost of Goods SoldInventory Turnover (IT) IT = Inventory Accounts ReceivableAverage Collection Period (ACP) ACP = Annual Sales/360 Accounts PayableAverage Payment Period (APP) APP= Annual Purchases/360 SalesFixed Asset Turnover (FAT) FAT = Net Fixed Assets SalesTotal Asset Turnover (TAT) TAT = 2010 Wali Memon Total Assets 11
  • 12. Debt is a true "double-edged" sword as it allows for thegeneration of profits with the use of other peoples (creditors)money, but creates claims on earnings with a higher priority thanthose of the firms owners.Financial Leverage is a term used to describe the magnification ofrisk and return resulting from the use of fixed-cost financing suchas debt and preferred stock.2010 Wali Memon 12
  • 13. There are Two General Typesof Debt Measures•Degree of Indebtedness•Ability to Service Debts2010 Wali Memon 13
  • 14. Total LiabilitiesDebt Ratio DR= Total Assets (DR)Debt-Equity Ratio Long-Term Debt DER= (DER) Stockholders’ Equity Earnings Before Interest & Taxes (EBIT)Times Interest Earned TIE= Interest Ratio (TIE) Earnings Before Interest & Taxes + Lease PaymentsFixed Payment Coverage Ratio FPC= Interest + Lease Payments (FPC) +{(Principal Payments + Preferred Stock Dividends) 2010 Wali Memon X [1 / (1 -T)]} 14
  • 15. •Profitability Measures assess the firms ability to operate efficiently and are of concern to owners, creditors, and management •A Common-Size Income Statement, which expresses each income statement item as a percentage of sales, allows for easy evaluation of the firm’s profitability relative to sales.2010 Wali Memon 15
  • 16. Gross Profit Margin (GPM) Gross ProfitsOperating Profit Margin (OPM) GPM= SalesNet Profit Margin (NPM) Operating Profits (EBIT) OPM = SalesReturn on Total Assets (ROA) Net Profit After Taxes NPM=Return On Equity (ROE) Sales Net Profit After TaxesEarnings Per Share (EPS) ROA= Total AssetsPrice/Earnings (P/E) Ratio Net Profit After Taxes ROE= Stockholders’ Equity Earnings Available for Common Stockholder’s EPS = Number of Shares of Common Stock Outstanding Market Price Per Share of Common Stock P/E = Earnings Per Share 2010 Wali Memon 16
  • 17. DuPont System of Analysis •DuPont System of Analysis is an integrative approach used to dissect a firms financial statements and assess its financial condition •It ties together the income statement and balance sheet to determine two summary measures of profitability, namely ROA and ROE2010 Wali Memon 17
  • 18. The firms return is broken into three components:•A profitability measure (net profit margin)•An efficiency measure(total asset turnover)•A leverage measure (financial leverage multiplier)2010 Wali Memon 18
  • 19. An approach that views all aspects of the firms activities to isolate key areas of concern Comparisons are made to industry standards (cross-sectional analysis) Comparisons to the firm itself over time are also made (time-series analysis)2010 Wali Memon 19
  • 20. 2010 Wali Memon 20
  • 21. 2010 Wali Memon 21
  • 22. Wali Memon2010 Wali Memon 22