Course 201112Course 201112

Setting up Setting up Financial RatiosFinancial Ratios

What are Financial Ratios?• A financial ratio is a relative magnitude of two selected numerical values

taken from an enterprise's financial statements. There are many standard ratios used to try to evaluate the overall financial condition of an organization.

• Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors.

Operating Cycle

• Formula to calculate operating cycle: Operating Cycle = age of inventory + collection period

• Operating cycle definition and explanation:The operating cycle is the number of days from cash to inventory to accounts receivable to cash.It reveals how long cash is tied up in receivables and inventory.A long operating cycle means that less cash is available to meet short term obligations.

Liquidity Ratios

• Liquidity ratios measure the availability of cash to pay debt.

• In accounting, liquidity (or accounting liquidity) is a measure of the ability of a debtor to pay his debts as and when they fall due. It is usually expressed as a ratio or a percentage of current liabilities.

Profitability Ratios

• Profitability ratios measure the company's use of its assets and control of its expenses to generate an acceptable rate of return

Efficiency Ratios (Activity ratios)

• These are used to analyze how well a company uses its assets and liabilities internally.

• Efficiency ratios are important because an improvement in the ratios usually translate to improved profitability.

Operating Ratios

• The operating ratio is a financial term defined as a company's operating expenses as a percentage of revenue.

• A ratio that shows the efficiency of a company's management by comparing operating expense to net sales.