1. Financial Management
Class #2
…………………………………………………………………
Jimmi Sinton
Te a c h i n g S e r i e s

2. 2-14 Financial Ratio Analysis
Topics
Materials
Covered
… … … … …… 1. Parties Interested in Financial Ratio
Analysis
2. Definitions and Classification of
Please read Financial Ratio
each material
3. The Use of Financial Ratio
before class
and rehearse it 4. Limitations of the Financial Ratio
after class
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

3. 2-14 Financial Ratio Analysis
To use financial information, we must interprete it
We will make sense of the financial information reported
through comprehensive financial ratios
Ratio Analysis involves methods of calculating and
interpreting financial ratios in order to assess a firm's
performance and status
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

4. 2-14 Financial Ratio Analysis
may be current or future users
Investors Government
Managers regulators
Customers Employee unions
Potential suppliers Public interest and
and creditors community groups
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

5. 2-14 Financial Ratio Analysis
Investment decisions
Credit decisions
Performance
Valuation
Legal liability amount
Going concern decisions
Unreasonable returns
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

6. 2-14 Financial Ratio Analysis
the major source of financial information is a firm's
annual report
When analyzing financial reports, one of the first
decisions is to identify the basis of comparison
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

7. 2-14 Financial Ratio Analysis
• the firm's own data from prior years (Times
Series Analysis)
• data from another firm in the same industry
(Cross Section Analysis)
• data from another firm in which the analyst may
invest
• industry averages
• benchmarks or targets
Comparability is enhanced when firms' size, capital
structure, and product mix are similar
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

8. 2-14 Financial Ratio Analysis
• Examines firm’s management of various facets
of the company’s business through its financial
statements.
• Scales balance sheet and income statement
information for easy comparison across time or
to other companies.
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

9. 2-14 Financial Ratio Analysis
liquidity
measures the ability to meet short-term obligations
leverage/debt
measures the use of financial leverage (debt) and its impact
activity/efficiency
measures the ability to contain the growth of assets, and the
ability to effectly utilize assets
profitability
measures the profitability of various segments of a company
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

10. 2-14 Financial Ratio Analysis
current assets
Current Ratio =
current liabilitie s
cash + marketable securities + receivable s
Quick ratio =
current liabilitie s
cash + marketable securities
Cash Ratio =
current liabilitie s
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

11. 2-14 Financial Ratio Analysis
total liabilitie s
Total Debt Ratio =
total assets
long term debt
Debt Equity Ratio =
stockholde rs equity
EBIT
Times Interest Earned =
interest payments
EBIT + depreciati on
Cash Coverage Ratio =
interest payments
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

12. 2-14 Financial Ratio Analysis
Sales
Asset Turnover Ratio =
Average Total Assets
Sales
NWC Turnover =
Average Net Workin g Capital
Accounts Receivable
Average Collection Period =
Annual Sales/360
J i m m i S ei ni t o n
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S r e s Financial Management

13. 2-14 Financial Ratio Analysis
Accounts Payable
Average Payment Period =
Annual Purchases/ 365
COGS
Inventory Turnover Ratio =
Average Inventory
Average Inventory
Days' Sales in Inventory =
COGS/365
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S r e s Financial Management

14. 2-14 Financial Ratio Analysis
Net Income
Net Profit Margin =
Sales
Net Income Interest
Operating Profit Margin =
Sales
Net Income Interest
Return On Assets =
Average Total Assets
Net Income
Return On Equity =
Average Equity
J i m m i S ei ni t o n
T e a c h i n g
S r e s Financial Management

15. 2-14 Financial Ratio Analysis
Dividends
Payout Ratio =
Earnings
Earnings - Dividends
Plowback Ratio =
Earnings
= 1 - Payout Ratio
Earnings - Dividends
Growth in Equity From Plowback = xROE
Earnings
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16. 2-14 Financial Ratio Analysis
Ø Developing and Using Comparative Data
Ø Distortion of Comparative Data
Ø Notes to Financial Statements
Ø Interpretation of Results
Ø Differences in Accounting Treatment
Ø Window Dressing
Ø Effects of Inflation
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17. 2-14 Financial Ratio Analysis
Limited due to several items.
Many major factors affecting profitability are not
included
- A perfect example is human resources.
Relies on past numbers, that may not be a reliable
indication of the future.
Accounting imperfections
Negative numbers. What do they mean?
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