4. Ratio Analysis
A. Liquidity ratios
◦ ratios that relates the firm’s cash and other
assets to its current liabilities
Liquid asset
◦ an asset that can be easily converted into cash
without significant loss of its original value
4
5. 5
Current ratio
A measure of liquidity calculated by dividing the firm’s current
assets by its current liabilities.
Indicates the extent to which current liabilities are covered by
assets expected to be converted into cash in the near future
s
Liabilitie
Current
assets
Current
ratio
Current
Liquidity ratios
6. 6
Liquidity ratios
Quick (Acid test) ratio
◦ A measure of liquidity calculated by dividing the firm’s
current assets minus inventory by its current liabilities.
◦ Deducts inventories from current assets and divides the
remainder by current liabilities
◦ A variation of the current ratio
s
Liabilitie
Current
s
Inventorie
-
assets
Current
ratio
Quick
7. Ratio Analysis
7
B. Activity Ratios
Measure the speed with which various accounts are
converted into sales or cash, or inflows or outflows
Ratios that measure how effectively a firm is managing
its assets
8. Activity Ratios
Inventory turnover ratio
Measures the activity, or liquidity, of a firm’s inventory
8
s
Inventorie
Sold
Goods
of
Cost
Inventory turnover ratio
9. Activity Ratios
Average Collection Period
The average amount of time needed to collect accounts
receivable.
Alternatively known as Days sales outstanding (DSO)
9
365
sales
Annual
s
Receivable
day
per
sales
Average
s
Receivable
Average Collection
Period /DSO
10. Activity Ratios
Average Payment Period
The average amount of time needed to pay accounts
payable.
10
365
purchases
Annual
Payables
Accounts
day
per
purchases
Average
Payables
Accounts
Average Payment Period
11. Total Asset Turnover
Indicates the efficiency with which the firm uses its assets
to generate sales.
11
Activity Ratios
assets
Total
Sales
Total Asset Turnover
12. C. Debt Ratios
Measures the proportion of total assets financed by the firm’s
creditors.
The higher this ratio, the greater the firm’s degree of indebtedness
and the more financial leverage it has.
Financial leverage
◦ the use of debt financing
Debt ratio
12
Ratio Analysis
assets
Total
s
liabilitie
Total
13. Debt ratios
Debt-to-Equity Ratio
Measures the relative proportion of total liabilities and common stock
equity used to finance the firm’s total assets.
13
equity
stock
Common
s
liabilitie
Total
Debt-to-Equity Ratio
14. Debt ratios
Times Interest Earned Ratio (TIE Ratio)
Measures the firm’s ability to make contractual interest payments
Sometimes called the interest coverage ratio
14
Charges
Interest
EBIT
Times Interest Earned Ratio
15. Ratio Analysis
D. Profitability Ratios
These ratios enable analysts to evaluate the firm’s
profits with respect to a given level of sales, a
certain level of assets, or the owners’ investment.
15
16. Profitability Ratios
Gross Profit Margin:
Measures the percentage of each sales dollar
remaining after the firm has paid for its goods.
Gross Profit Margin
Gross profit = Sales- Cost of goods sold
16
Sales
profit
Gross
17. 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; the “pure profits”
earned on each sales dollar
Operating Profit Margin
17
Profitability Ratios
Sales
profit
Operating
18. Profitability Ratios
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.
Net Profit Margin
Net profit= Earnings available for common stockholders
18
Sales
profit
Net
19. Profitability Ratios
Earnings Per Share (EPS)
Represents the number of dollars earned during
the period on behalf of each outstanding share of
common stock.
EPS
19
g
outstandin
stock
common
of
Number
rs
stockholde
common
to
available
income
Net
20. Profitability Ratios
Return On Total Assets (ROA)
Measures the overall effectiveness of management in
generating profits with its available assets
Also called the Return on Investment (ROI).
ROA
20
assets
Total
rs
stockholde
common
to
available
income
Net
21. Profitability Ratios
Return On Equity (ROE)
Measures the return earned on the common
stockholders’ investment in the firm.
ROE
21
equity
Common
rs
stockholde
common
to
available
income
Net
22. Ratio Analysis
E. Market Ratios
Relate a firm’s market value, as measured by its
current share price, to certain accounting values.
22
23. Market Ratios
Price/Earnings (P/E) Ratio
Measures the amount that investors are willing to pay for
each dollar of a firm’s earnings
The higher the P/E ratio, the greater the investor
confidence.
P/E Ratio
23
share
per
Earnings
share
per
price
Market
24. Market Ratios
Market/Book (M/B) Ratio
Provides an assessment of how investors view the firm’s
performance.
M/B Ratio
Book value per share
24
share
per
Book value
share
per
price
Market
g
outstandin
shares
common
of
Number
equity
Common
