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- 1.Ratio Analysis Accounting for Managers

2. Financial Analysis

- Assessment of the firms past, present and future financial conditions

- Done to find firms financial strengths and weaknesses

- Primary Tools:

- Financial Statements

- Comparison of financial ratios to past, industry, sector and all firms

3. Objectives of Ratio Analysis

- Standardize financial information for comparisons

- Evaluate current operations

- Compare performance with past performance

- Compare performance against other firms or industry standards

- Study the efficiency of operations

- Study the risk of operations

4. Uses for Ratio Analysis

- Evaluate Bank Loan Applications

- Evaluate Customers Creditworthiness

- Assess Potential Merger Candidates

- Analyze Internal Management Control

- Analyze and Compare Investment Opportunities

5. Types of Ratios

- Financial Ratios:

- Liquidity Ratios

- Assess ability to cover current obligations

- Leverage Ratios

- Assess ability to cover long term debt obligations

- Operational Ratios:

- Activity (Turnover) Ratios

- Assess amount of activity relative to amount of resources used

- Profitability Ratios

- Assess profits relative to amount of resources used

- Valuation Ratios:

- Assess market price relative to assets or earnings

6. Liquidity Ratios

- Current Ratio

- Current Assets / Current Liabilities

- Current Assets include Cash, Marketable Securities, Accounts Receivable and Inventory

- Current Liabilities include Accounts Payable, Debt Due within one year, and Other Current Liabilities

7. Liquidity Ratios

- Quick Ratio or Acid Test

- Current Assets minus Inventory / Current Liabilities

- A more precise measure of liquidity, especially if inventory is not easily converted into cash.

8. Liquidity Ratios

- Cash Ratio

- Reserve borrowing capacity - the credit limit sanctioned by the bank

9. Liquidity Ratios

- Interval Measure

- Calculated to asses a firms ability to meet its regular cash outgoings

10. Leverage Ratios

- Leverage ratios measure the extent to which a firm has been financed by debt.

- Leverage ratios include:

- Debt Ratio

- Debt--Equity Ratio

- Generally, the higher this ratio, the more risky a creditor will perceive its exposure in your business.Thus, high leverage ratios make it more difficult to obtain credit (loans).

11. Leverage Ratios Cont.

- Leverage ratios also include theInterest-coverage Ratio, Fixed coverage Ratio etc, .

- In contrast to the leverage ratios discussed on previous slide, the higher the Interest Coverage Ratio (Times-Interest-Earned Ratio), the more credit worthy the firm is, and the easier it will be to obtain credit (loans).

12. Total Debt Ratio

- Proportion of interest bearing debt in the Capital structure.

- In general, the lower the number, the better.

13. Debt-Equity Ratio

- The Debt-Equity Ratio indicates the percentage of total funds provided by creditors versus by owners.

- This ratio indicates the extent to which the business relies on debt financing (creditor money versus owners equity).

14.

- Treatment of

- Preference Capital

- Lease Payments

15. Interest Coverage Ratio

- interest coverage ratio indicates the extent to which earnings can decline without the firm becoming unable to meet its annual interest costs.

- Also called theTimes-Interest-Earned Ratio , this calculation shows how many times the firm could pay back (or cover) its annual interest expenses out of earnings before interest and taxes (EBIT).

16. Interest Coverage Ratio DA = Depreciation and Amortization expenses 17. Fixed Coverage Ratio

- Principal repayments are added to interest payments

18. Activity Ratios

- Activity ratios measure how effectively a firm is using its resources, or how efficient a company is in its operations and use of assets.

- In general, the higher the ratio, the better.

- Activity ratios include:

- Inventory turnover

- Accounts receivable turnover

- Average collection period .

- Total assets turnover

- Fixed assets turnover

19. Inventory Turnover Ratio

- The inventory turnover ratio indicates how fast a firm is selling its inventories

- This ratio indicates how well inventory is being managed, which is important because the more times inventory can be turned (i.e., the higher the turnover rate) in a given operating cycle, the greater the profit.

20. Inventory Turnover Ratio Cont.

- In the absence of information. Instead of CGS we can use Sales

- In the case of CGS and Inventory both are valued at cost. While the sales are valued at market prices

- Therefore better to use CGS

21. Accounts Receivable Turnover

- The accounts receivable turnover ratio, indicates the average length of time it takes a firm to collect credit sales (in percentage terms), i.e., how well accounts receivable are being collected.

- If receivables are excessively slow in being converted to cash, liquidity could be severely impaired.

22. Average Collection Period

- The average collection period is the average length of time (in days) it takes a firm to collect on credit sales.

23. Net Assets Turnover

- The total assets turnover ratio, indicates how efficiently a firm is using all its assets to generate revenues.

- This ratio helps to signal whether a firm is generating a sufficient volume of business for the size of its asset investment

24. Profitability Ratios

- Profitability ratios measure managements overall effectiveness as shown by returns generated on sales and investment.

- Profitability ratios include

- Gross profit margin

- Operating profit margin

- Net profit margin

- Return on total assets (ROA)

- Return on stockholders equity (ROE)

- Earnings per share (EPS)

- Price-earnings ratio (P/E).

25. Gross Profit Margin

- The gross profit margin is the total margin available to cover operating expenses and yield a profit. This ratio indicates how efficiently a business is using its labor and materials in the production process, and shows the percentage of net sales remaining after subtracting cost of goods sold.

- The higher the ratio, the better.A high gross profit margin indicates that a firm can make a reasonable profit on sales, as long as it keeps overhead costs under control.

26. The DuPont System

- Method to breakdown ROE into:

- ROA and Equity Multiplier

- ROA is further broken down as:

- Profit Margin and Asset Turnover

- Helps to identify sources of strength and weakness in current performance

- Helps to focus attention on value drivers

27. The DuPont System 28. The DuPont System 29. The DuPont System 30. The DuPont System

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