FINANCIAL RATIOS

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FINANCIAL RATIOS
EVALUATION OF PROFITABILITY
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EVALUATION OF PROFITABILITY
Profit marginNet Income / Net sales

• Also known as Return on Sales
• Net income is taken after taxes
• Measure of Net Income a company makes per unit of
  sales

Asset Turnover Net Sales / Average total assets

• Measure of how efficient a company is using
  assets to produce sales

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EVALUATION OF PROFITABILITY
Return on Assets Net Income / Average total
assets
To measure how much income a company makes for
each of Asset
Return on Equity Net Income / Average
stockholders equity

• Also known as Return on Investment
• Measure of the income earned on owners investment

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EVALUATION OF LIQUIDITY
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EVALUATION OF LIQUIDITY
Working Capital Current Assets- Current
Liabilities

• A Measure of liquidity
• Represents current assets remaining after payment
  of all current liabilities
• The dollar value of Working capital can be
  misleading since it may include value of slow
  moving inventory. Inventory that cannot be used
  to clear a companys short term debt.
• The value of Working Capital does not consider
  the size of the company.

Caution
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EVALUATION OF LIQUIDITY
Current Ratio Current Assets/current
Liabilities

• Measure of a firms short term liquidity
• Compares the current debt owed with the current
  assets available to pay the debt

Quick Ratio (Cash Marketable SecuritiesAccounts
Receivable)/Current Liabilities

• The Acid test ratio
• Good indicator of firms ability to pay creditors
  since inventories are not included

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EVALUATION OF ACTIVITY
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EVALUATION OF ACTIVITY
Average Days sales uncollected 365 days /
receivable turnover

• Measure of how many days on average a company has
  to wait for Accounts
  Receivable to turn to cash

Inventory TurnoverCost of goods sold/Average
inventory

• Measure of how fast a company can convert its
  inventories into sales
• Quicker the better
• Inventory sitting on shelves implies holding
  costs
• Risk of inventory becoming obsolete

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EVALUATION OF ACTIVITY
Receivable TurnoverNet Sales / Average Accounts
Receivable

• Measure of frequency with which a company turns
  its accounts receivables to cash
• Measure of a companys Credit and Collection
  policies
• Who qualifies for credit and who does not
• How long customers are given to pay their bills
• How aggressive is the company in collecting its
  debts
• If ratio is increasing need to determine whether
  company doing better job of collection or Sales
  going up
• If ratio is going down need to determine whether
  company lagging in sales or collection efforts
  are failing

Caution
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EVALUATION OF LEVERAGE
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EVALUATION OF LEVERAGE
Debt to Equity Total liabilities / Total
Stockholders Equity

• Extent to which a business is financed by debt as
  opposed to invested capital (Stockholders Equity)
• From lenders stand point the lower the ratio
  safer the company- since company has less
  existing debt
• May also imply low growth rate - company may be
  financing its growth by using excess cash flow
  from operations

Debt to Total Assets Total liabilities / Total
Assets

• Measure of firms ability to carry long term debt
• As a rule of thumb amount of debt should not
  exceed 50 of the value of assets