Chapter 04

the quantitative relation between

two amounts
 Balance Sheet P&L Ratio or Balance Sheet
Ratio Income/Revenue and Profit & Loss
Statement Ratio Ratio
Financial Ratio Operating Ratio Composite Ratio
Current Ratio Gross Profit Ratio Fixed Asset
Quick Asset Operating Ratio Turnover Ratio,
Ratio Expense Ratio Return on Total
Cash Ratio Net profit Ratio Resources Ratio,
Proprietary Ratio Stock Turnover Return on Own
Debt Equity Ratio Funds Ratio,
Ratio Earning per Share
Ratio, Debtors’
Turnover Ratio,
 Liquidity Ratios
 Asset Management / Efficiency
Ratios
 Debt Management Ratios
 Profitability Ratios
 Market Value Ratios
 RATIO ANALYSIS
•Ratio-analysis is a concept or technique of
Financial analysis.
•Financial Ratio analysis has assumed
important role as a tool for appraising the real
worth of an enterprise, its performance during
a period of time and its pit falls.

•Financial Ratio Analysis is a vital apparatus

for the interpretation of financial statements.
 Provide information of the company in
respect of the liquidity, profitability, use of
assets and capital structure
 Eliminate the effects of the scale and size of
different companies or different years of the
same company so comparison can be
provided.
 Appraise the performance of the company,
make predictions for future performance
and assist in future planning
 Enable comparison of the performance of the
company
 - in different years
 - with its budgets and forecasts
 - with other companies in similar trades
 Ratios standardize numbers and facilitate
comparisons.
 Ratios are used to highlight weaknesses
and strengths.
 Liquidity: Can we make required payments?
 Asset management /Efficiency: right amount of
assets vs. sales?
 Debt management: Right mix of debt and
equity?
 Profitability: Do sales prices exceed unit costs,
and are sales high enough as reflected in PM,
ROE, and ROA?
 Market value: Do investors like what they see
as reflected in P/E and M/B ratios?
 Current ratio = Current assets
Current liabilities
 CR = $50,190 / $25,523

 CR = 1.97 vs. 2.4 Ind. Avg.

 Quick ratio = Current assets – inventories

Current liabilities
 QR = ($50,190 - $27,530) / $25,523

 QR = .89 vs. .92 Ind. Avg.

 Avg collection period = Accounts receivable
Annual credit sales/365
 ACP = $18,320 / ($112,760/365)

 ACP = 59.3 days vs. 47 days Ind. Avg.

 Inventory turnover = Cost of sales

Average inventory
 Inv. Turn. = $85,300 / ($27,530 + $26,470)/2

 Inv. Turn. = 3.16 vs. 3.9 Ind. Avg.

 Fixed-asset turnover = Sales
Net fixed assets
 FAT = $112,760 / $31,700

 FAT = 3.56 vs. 4.6 Ind. Avg.

 Total asset turnover = Sales

Total assets
 TAT = $112,760 / $81,890

 TAT = 1.38 vs. 1.82 Ind. Avg.

 Fixed-asset turnover = Sales
Net fixed assets
 FAT = $112,760 / $31,700

 FAT = 3.56 vs. 4.6 Ind. Avg.

 Total asset turnover = Sales

Total assets
 TAT = $112,760 / $81,890

 TAT = 1.38 vs. 1.82 Ind. Avg.

 Debt ratio = Total debt
Total assets

 DR = $47,523 / $81,890

 DR = 58% vs. 47% Ind. Avg.

 Debt-to-equity ratio = Total debt

Total equity

 D/E = $47,253 / $34,367

 D/E = 138.3% vs. 88.7% Ind. Avg.

 Times interest earned = EBIT
Interest charge

 Coverage Ratio = $11,520 / $3,160

 Coverage Ratio = 3.65 vs. 6.7 Ind. Avg.

 Equity multiplier = Total assets

Total equity

 EM = $81,890 / $34,367

 EM = 2.38 vs. 1.89 Ind. Avg.

 Gross profit margin = Sales - Cost of sales
Sales
 GPM = ($112,760 - $85,300) / $112,760

 GPM = 24.4% vs. 25.6% Ind. Avg.

 Net profit margin = EAT

Sales
 NPM = $5,016 / $112,760

 NPM = 4.45% vs. 5.1% Ind. Avg.

 ROI = EAT
Total Assets

 ROI = $5,016 / $81,890

 ROI = 6.13% vs. 9.28% Ind. Avg.

 ROE = EAT
Stockholders equity

 ROE = $5,016 / $34,367

 ROE = 14.6% vs. 17.54% Ind. Avg.

 P/E ratio = Market price per share
Current earnings per share

 Market to book ratio= Market price per share

Book value per share
 DuPont analysis examines the return on equity
(ROE) analyzing profit margin, total asset
turnover, and financial leverage. It was created
by the DuPont Corporation in the 1920s.
 ROE = Profit Margin x Total Asset Turnover x
Leverage Factor
 ROE = (Net Income/Revenues) x
(Revenues/Total Assets) x (Total Assets/
Shareholders' Equity)
 The DuPont Analysis is important determines what is
driving a company's ROE; Profit margin shows the
operating efficiency, asset turnover shows the asset use
efficiency, and leverage factor shows how much
leverage is being used.
 DuPont analysis allows analysts to dissect a company,
efficiently determine where the company is weak and
strong and quickly know what areas of the business to
look at (i.e., inventory management, debt structure,
margins) for more answers.
 The DuPont analysis looks uses both the income
statement as well as the balance sheet to perform the
examination
• The dates and duration of the financial statements being
compared should be the same. If not, the effects of
seasonality may cause erroneous conclusions to be drawn.

• The accounts to be compared should have been prepared

on the same bases. Different treatment of stocks or
depreciations or asset valuations will distort the results.

• In order to judge the overall performance of the firm a

group of ratios, as opposed to just one or two should be
used. In order to identify trends at least three years of ratios
are normally required.
 Changes in price level will affect the
comparability of the ratios between two
financial periods.
 Changes in external environment will affect
the comparison.
 Differences in management and
background of various businesses
may affect the comparison.
 Different accounting definitions, methods,
techniques and policies used by various
businesses may affect the comparability.
 It is difficult to set up a proper standard for
good performance.
 Short term fluctuations may not be reflected.