This document discusses key financial ratios used to evaluate a firm's performance in key areas: liquidity, activity, debt position, and profitability. Liquidity ratios like the current and quick ratios measure a firm's ability to meet short-term obligations. Activity ratios like inventory turnover and accounts receivable measures assess how efficiently a firm converts accounts into sales or cash. Debt ratios like the debt ratio indicate how much debt a firm uses. Profitability ratios like gross profit margin, net profit margin, and return on assets measure what percentage of sales and assets are converted into profits.

1. EVALUATING A FIRM’S
FINANCIAL
PERFORMANCE
Financial Ratio Analysis

2. Liquidity
• The liquidity of the firm is measured by its ability to satisfy
its short-term obligations as they come due.
• Liquidity refers to the solvency of the firm’s overall
financial position – the ease with which it can pay bills.
• HOW LIQUID IS THE FIRM – Can we pay the bills?

3. LIQUIDITY RATIO
• Current Ratio
• Quick Ratio or Acid Test

4. Activity
• Measure the speed with which various accounts are
converted into sales or cash – Inflow or outflows.
• Need to asses the activity (liquidity) of specific current
accounts
• Inventory, Accounts Receivable and Accounts Payable

5. Activity Ratio
• Inventory Turn-over
• Average Collection Period
• Average Payment Period
• Total Asset Turn-over

6. Debt Position
• The debt position of a firm indicates the amount of other
people’s money being used to generate profits.
• The more debt a firm uses in relation to its total assets the
greater its financial leverage.
• Financial Leverage – is the magnification of risk and
return introduced through he use of fixed cost financing
such as debt and preferred stock.

7. Debt Position
• Debt Ratio

8. Profitability
• These measures enable the analyst to evaluate the firm’s
profits with respect to a given level of sales, certain level
of assets , or the owners investment.
• Without profits, a firm could not attract outside capital.
Owners , creditors and management pay close attention
to boosting profits because of its great importance in the
marketplace.

9. PROFITABILITY RATIO
RATIO DEFINITION FORMULA
GROSS
PROFIT
MARGIN
Measures the percentage of each peso
sales remaining after the firm has paid its
goods. The higher the GPM, he better.
(Lower the relative cost of merchandise
sold)
GPM = SALES – COGS/
SALES
GPM = GP / SALES
NET PROFIT
MARGIN
Measures the percentage of each peso
sales remaining after all cost, expenses
including taxes, interest and preferred
stock have been deducted. ( Higher the
better)
NPM = Earnings
available to common
stockholders/ sales
OPERATING
PROFIT
MARGIN
Measures the percentage of each peso
sales remaining after all cost and
expenses other than interest, taxes and
PSD are deducted. The are called pure
profits . The higher the better.
OPM = Operating
Profits/Sales
EARNINGS
PER SHARE
Number of Peso earned during the period
on behalf of each outstanding share of
common stock.
EPS = Net Income /
Number of Shares of
common stock
outstanding

10. PROFITABILITY RATIO
RATIO DEFINITION FORMULA
RETURN ON TOTAL
ASSETS (ROI)
Measures the overall
effectiveness of
management in generating
profits with its available
asset.
Return on Total Assets =
Earnings avail for Common
Stockholders/ Total Assets
RETURN ON COMMON
EQUITY (ROE)
Measures the return earned
on the common
stockholders investment of
the firm.
ROE = EARNINGS
AVAILABLE FOR COMMON
STOCKHOLDERS/COMMO
N STOCK EQUITY