This document discusses ratio analysis and its use in analyzing a firm's financial statements. Ratio analysis can provide an overview of a firm's performance, risks, and financial condition by measuring liquidity, efficiency, leverage, and profitability. However, ratios alone do not provide a complete picture and may disguise underlying problems, so more detailed analysis is needed. Common financial ratios are defined and their calculations explained.

1. Interested parties Shareholders - to measure management’s performance Investors - to make their investment decisions Management - to plan and control operation Ratio analysis is a quick and easy way of analyzing a firm’s financial statements.

2. Ratio analysis cannot accurately pinpoint the problems of the firm. It is reasonable to expect that it points to a direction for a more detailed analysis. Financial ratio itself is not meaningful without comparing it to a benchmark. Benchmarks can be a rival firm’s financial ratio or an industry average. Sometimes a firm’s problems can be disguised as so-called “good ratios.” For example, a high inventory turnover can be an indicator of the firm’s dangerously low level of inventory.

3. Liquidity Ratios Efficiency Ratios Leverage Ratios Profitability Ratios Liquidity and leverage ratios primarily measure risk; efficiency and profitability ratios measure performance and return.

4. Net working capital = Current assets - Current liability Current ratio Quick (acid-test) ratio

5. Inventory turnover Average collection period (Days sales outstanding) Assets Turnover Fixed assets turnover

6. Debt ratio Debt-to-Equity ratio Times interest earned ratio

7. Gross profit margin Operating profit margin

8. Net profit margin Return on total assets (ROA) Return on equity (ROE)

9. Used by financial managers as a structure to dissect the firm's financial statements and to assess its financial condition. ROA = = (net profit margin) x (assets turnover) ROE = = (net profit margin) x (assets turnover) x (equity multiplier)

11. Calculate the following ratios: Current ratio Days sales outstanding Inventory turnover

12. Total assets turnover Profit margin on sales

13. Return on Assets OR

14. Return on Equity OR

15. Debt ratio