Ratio Analysis

1
Ratio Analysis

• Ratio analysis is a particular type of financial
  statement analysis where the relationship between
  two or more items from the financial statements
  is analyzed.
• A particular ratio might include information from
  various sources, including information not
  typically contained in the financial statements,
  such as market price of a stock.

2
Objectives of Creditors

• Short-term creditors, both trade creditors and
  lending institutions, are primarily concerned
  with the firms ability to pay its bills in a
  timely fashion.
• Long-term creditors are concerned with the firms
  long-term ability to repay any loan amounts as
  well as the interest on that debt.

3
Objectives of Equity Investors

• Investors are concerned with many things, but
  probably the most important consideration is the
  companys ability to generate income in the
  future.
• Profitable operations for the company usually
  translate into dividends and stock price
  appreciation for the investors.

4
Objectives of Management

• Members of management have the respon-sibility of
  leading the firm through the day-to-day
  activities. The results of these activities are
  reflected in the financial statements.
• Thus, management has two main concerns regarding
  financial statement analysis
• 1) to present the information in the most
  favorable light, and
• 2) to monitor the overall performance.

5
Measuring Profitability

• Profitability refers to the companys ability to
  generate income. Profitability ratios are used
  to measure a firms past performance and to aid
  in the prediction of future profits.
• Most business people agree that long-term profits
  are more important than short-term profits, yet
  most of the commonly used ratios focus on
  short-term profitability.

6
Profit Margin After Income Tax Ratio

• Net income after taxes Sales
• Use after-tax income instead of before-tax.
  Some people argue that since taxes are a normal
  expense that is incurred, the effect of income
  taxes should be included.

7
Return on Equity Ratio

• Net income after taxes Equity
• This ratio measures the profitability on the
  amount of investment by the company owners rather
  than the total investment in assets.

8
Measuring Liquidity

• Liquidity refers to the companys ability to
  generate cash as needed to pay its short-term
  obligations.
• Short-term creditors (current and potential) are
  particularly concerned with a companys liquidity
  measures.
• Liquidity measures focus on the liquidity of the
  assets available to the company.

9
Current Ratio

• Current assets Current liabilities
• This ratio is a comparison of the level of
  current assets available to pay the current
  liabilities. This is a very widely used ratio.

10
Quick Ratio

• Cash M/S A/R
• Current liabilities
• Also called the acid-test ratio, this is a more
  stringent measure of liquidity. The focus is
  placed on the quick assets, those that can be
  quickly turned into cash.

11
Receivables Turnover Ratio

• Sales Accounts
  receivable
• A measurement of how quickly a company collects
  their accounts receivable. The higher the
  turnover, the more quickly the receivables are
  being collected.

12
Measuring Solvency

• Solvency refers to the ability to meet long-term
  obligations resulting from debt.
• These measurements are similar to the liquidity
  measures, except the focus is on all assets and
  liabilities rather than the current assets and
  liabilities.
• These measures are of interest to long-term
  creditors, stockholders, and management.

13
Debt Ratio

• Total liabilities Total
  assets
• Measures the percentage of a companys assets
  that is financed by debt, rather than equity.
  Debt Equity 100

14
Coverage Ratio

• Earnings before interest
• Interest expense
• Also called the times interest earned ratio.
  An indication of the companys ability to make
  interest payments.

15
Using the Ratios

• After calculating the ratios for a particular
  company, you might want to do some or all of the
  following
• Compare ratios to industry averages,
• Look for company trends,
• Consider the industry environment, and
• Draw conclusions