This document discusses various financial ratios used in ratio analysis. It covers ratios related to liquidity, asset utilization, debt utilization, profitability, and market value. Key ratios include the current ratio, quick ratio, accounts receivable turnover, inventory turnover, debt-to-assets ratio, profit margins, return on equity, and price-to-earnings ratio. It also discusses DuPont analysis and relationships between ratios. Problems that can impact ratio analysis and interpretation are noted, such as inflation and different inventory accounting methods between companies.

1. Financial Analysis
(Chapter 3)
 Ratio Analysis
Liquidity
Asset Utilization
Debt Utilization
Profitability
Market Value
 DuPont Relationships
 Ratio Analysis and
Wealth Maximization
 Some Analytical
Problems

2. RATIO ANALYSIS
Ratio Defined:
Simply one number divided by another.
Why Calculate Ratios?
Make data more meaningful.
High - Low - Avg: How do you judge?
Industry Averages:
Dun & Bradstreet
Robert Morris Associates
Trade Associations

3. Ratio Analysis (Continued)
Prior Period Ratios:
Calculated from the firm’s previous
financial statements (e.g., trend analysis)
Current Goals:
Often, goals are stated in the form of ratios.
Benchmarking:
A group of “selected” companies (e.g., form
your own industry).

4. Common Size Ratios
Common Size Balance Sheet
Each item is stated as a % of total assets.
Common Size Income Statement
Each item is stated as a % of sales.

5. Liquidity Ratios
Liquidity Ratios:
Ability to meet short-term obligations
Current Ratio =
Current Assets
Current Liabilities
Quick Ratio =
Current Assets - Inventory
Current Liabilities

6. Asset Utilization Ratios
Effective use of assets in the process of
generating sales.
Receivables Ratios
Note: Ideally, credit sales should be used
for the receivables ratios. However, only
total sales are available at times.
Accounts Receivable Turnover =
Sales
Accounts Receivable
Average Collection Period =
Accounts Receivable
Sales 360
= 360 (Acct. Rec Turnover)
.
AKA: Days Sales Outstanding

7. Asset Utilization Ratios
(Continued)
Inventory Turnover
Note: COGS is sometimes used in lieu
of sales, and average inventories
may replace ending inventories.
Inventory Turnover =
Sales
Inventories

8. Asset Utilization Ratios
(Continued)
Asset Turnover Ratios
Note: Net fixed assets equals gross fixed
assets minus accumulated depreciation.
Fixed Assets Turnover =
Sales
Net Fixed Assets
Total Assets Turnover =
Sales
Total Assets

9. Debt Utilization Ratios
(Use of Financial Leverage)
Leverage Ratios:
Expense
Interest
EBIT
=
Earned
Interest
Times
Assets
Total
s
Liabilitie
Total
=
Ratio
Debt

10. Debt Utilization Ratios
(Continued)
Fixed Charge Coverage Ratio*
Payments
Lease
+
Interest
Payments
Lease
+
EBIT
*Could also be adjusted to include principal
payments on loans.

11. Profitability Ratios
(Ability to Earn an Adequate Return)
Profit Margins:
Sales
Taxes
After
Income
Net
=
Margin
Profit
Net
Sales
EBIT
=
Margin
Profit
Operating
Sales
Profit
Gross
=
Margin
Profit
Gross

12. Profitability Ratios
(Continued)
Return on Investment Ratios:
Equity
Common
EAC
=
Equity
Common
on
Return
Equity
rs'
Stockholde
Taxes
After
Inc
Net
=
Equity
Total
on
Return
Assets
Total
Taxes
After
Inc
Net
=
Assets
on
Return
AKA:
ROI

13. DuPont Relationships
Assets
Total
Liab
Total
-
1
ROA
=
Equity
Total
on
Return
Assets
Total
Income
Net
=
Sales
Income
Net
Assets
Total
Sales
=
Margin)
Profit
Net
Turnover)(
(Asset
=
Assets
on
Return












(ROA)

14. Market Value Ratios
(Investors’ Reactions)
 Notes: (1) Book Value Per Share = (Com Equity)/(# of Shares)
(2) Cash flow per share equals net income plus depreciation or
amortization divided by the number of shares outstanding.
Share
Per
Sales
Share
Per
Price
Sales
to
Price
Share
Per
Flow
Cash
Share
Per
Price
Flow
Cash
to
Price
Share
Per
Value
Book
Share
Per
Price
=
Value
Book
to
Price
Share
Per
Earnings
Share
Per
Price
=
Ratio
(P/E)
Earnings
Price



15. Ratio Analysis and
Wealth Maximization
Expenses
Sales
Assets
Net
Profit
Margin
Total
Asset
Turnover
Return
on
Assets Return
on Total
Equity
Debt to
Assets
Ratio Preferred
Stock
Financing
Return
on
Common
Equity

16. Ratio Analysis and Wealth
Maximization (Continued)
Return
on
Common
Equity
X
Book Value
Per
Share
=
Earnings
Per
Share
Earnings
Per
Share
X
Price
Earnings
Ratio
= Price Per Share

17. Some Analytical Problems
Involving Asset Quality
It is possible to increase ROI by avoiding
the purchase of new plant and equipment
(i.e., keep the asset base low). Of course,
the firm may suffer in the long run.
A high level of accounts receivable may
improve the current ratio, but what if a
large percentage of accounts are
uncollectible?

18. Some Additional
Analytical Problems
Inflation
Sales and profits may increase simply
because of rising prices, even without an
increase in physical volume.
Replacement costs of assets may be higher
than historical costs.
Inventory Accounting
If firms employ different techniques (e.g.,
LIFO, FIFO), comparability of ratios is
impaired.
Industry Averages
Some firms operate in more than one.