Session 4 Financial Ratios 28 Jun 11

8/6/2019 Session 4 Financial Ratios 28 Jun 11

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Financial Ratio Analysis: Method for determining an organizations strengths and

weaknesses in the investment , financing and dividend areas.

Since the functional areas of an organization are closely related,FRs can signal strengths and weaknesses in management,marketing, production etc.

Financial ratios are computed from an organizations incomestatement and balance sheet.

28/06/2011Salah uddin 1

Financial Ratios


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Computing FRs reflect a situation at just onepoint in time

Comparing FRs overtime and to industryaverage gives meaningful statistics to identifyand evaluate strengths and weaknesses i.e

Trend Analysis


Financial Ratios


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RATIO:


Profitability Ratios

HOWCALCULATED:

MEASURE:

GrossMargin

GrossProfit /Sales

Total Marginavailable to

cover operatingexpenses &

yield a profit

A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue,expressed as a percentage. Represents the proportion of each dollar of revenue that the company retains as gross profit.


4/20

RATIO:



HOWCALCULATED:

MEASURE:

OperatingMargin

EBIT /Sales

Profitabilitywithout concern

for Taxes &

InterestsRETURN ON

SALES

How much a company makes (beforeinterest and taxes) on each dollar of sales. If a company's margin is increasing, it is earningmore per dollar of sales. The higher the margin,the better.

OPTG PROFITMARGIN


5/20

RATIO:



HOWCALCULATED:

MEASURE:

NetProfit

Margin

Net Income/ Sales

After - TaxProfits per $ of Sales

Often referred to simply as a company's profitmargin, the so-called bottom line is the mostoften mentioned when discussing a company'sprofitability.
http://www.investopedia.com/terms/b/bottomline.asphttp://www.investopedia.com/terms/b/bottomline.asp


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RATIO:



HOWCALCULATED:

MEASURE:

Returnon

Assets

Net Income/ Assets

After - TaxProfits per $ of

Assets

RETURN ONINVESTMENT

An indicator of how profitable a company isrelative to its assets.How efficient management is at using its assets togenerate earnings. The higher the ROA number, the better, becausethe company is earning more money on less

investment


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RATIO:



HOWCALCULATED:

MEASURE:

Return onStockholder

s Equity

Net

Income /Total

Stockholders Equity

After - TaxProfits per $ of

Stockholdersinvestment

RETURN ONEQUITY


8/20

RATIO:



HOWCALCULATED:

MEASURE:

Earnings

per Share

NetIncome / #of shares of

commonstock

Earningsavailable to

owners of common stock

PROFITGENERATED ONPER SHARE BASIS

the single most important variable indetermining a share's price


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RATIO:



HOWCALCULATED:

MEASURE:

PriceEarnings

Ratio

Market

Price pershare /

Earningsper share

Attractivenessof Firm onequity markets

Higher P/E=expected higher earnings growth


10/20

RATIO:

Sales

Net Income

EPS

Dividends / Share


Growth Ratios

HOWCALCULATED:

Annual % growthin Total Sales

Annual % growthin Profits

Annual % growth

in EPS

Annual % growthin dividends /share

MEASURE:Growth rate insales

Growth rate in

Profits

Growth rate inEPS

Growth rate inDividends /Share


11/20

RATIO:


Working Capital

HOWCALCULATED:

MEASURE:

Working

Capital

CurrentAssets -

CurrentLiabilities

Whether a Firmcan meet its

currentobligations

The greater the working capital the more likely a Firm willbe able to make its payments on timeIf a Firm has current assets exactly equal to currentliabilities, it has no working capital.


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RATIO:


Liquidity or SolvencyRatios

HOWCALCULATED:

MEASURE:

Current

Ratio

CurrentAssets /

CurrentLiabilities

Extent to whicha Firm can meet

short-termobligations

The extent to which a Firms assets can readily be turnedinto cash for meeting current obligations.Varies from industry to industry, a ratio of 3:1 is betterthan 2:1.1:1 means there is no working capital.Large Current ratio may not be a good sign meaning thatFirm is not making the most efficient use of its assets.


13/20

RATIO:


Liquidity or SolvencyRatios

HOWCALCULATED:

MEASURE:

Quick Ratio

CurrentAssets-

Inventory /Current

Liabilities

Extent to whicha Firm can meet

short-termobligations,

without relyingon sale of Inventories

Inventory is excluded as it might not turn to cash quickly.Ratio of quick assets ( cash, marketable security, accountsreceivable) to current liabilities.Despite office buildings, trucks, ware houses, finishedgoods, etc. a Firm can still risk insolvency if its ratio of quick assets is insufficient to meet bills

ACIDTEST


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RATIO:


Leverage Ratios

HOWCALCULATED:

MEASURE:

Debt Ratio Total Debt /

Total Assets

% of total fundsthat are

provided bycreditors

Also known as Debt-to asset-ratio.Indicates % of total asset amounts stated on the balancesheet that is owed to creditorsA high debt ratio indicates a high level of financial leverage


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RATIO:


Leverage Ratios

HOWCALCULATED:

MEASURE:

Debt toEquity Ratio

Total Debt /Total

Stockholder

s Equity

% of total fundsprovided

by creditors Vsby owners

A high debt/equity ratio generally means that a company hasbeen aggressive in financing its growth with debt.If a lot of debt is used to finance increased operations (high debt

to equity), the company could potentially generate moreearnings than without this outside financing. If this were toincrease earnings by a greater amount than the debt cost(interest), then the shareholders benefit as more earnings arebeing spread among the same amount of shareholders


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RATIO:


Leverage Ratios

HOWCALCULATED:

MEASURE:

TimesInterestEarned

Ratio

Profitsbefore I &T / TotalInterestCharges

A Firms abilityto meet its debt

obligations

Indicates how many times a Firm can cover itsInterest charges on a pre tax basis, failing which itwould face bankruptcyAlso referred to as "interest coverage ratio" and

"fixed-charged coverageA high ratio indicates an undesirable lack of debt orpaying down too much debt with earnings that couldbe used for other projects.


17/20

RATIO:


Activity Ratios

HOWCALCULATED:

MEASURE:

InventoryTurnover

Cost of Goods sold /

Avg.

Inventory

Whether a Firmholds excessive

stock of inventories or

selling it slowly

Slow turn over means too much capital tied up ininventorySuch capital costs money and can result in inventoryobsolescence Profits improve when you can move out inventoryquickly In retail grocery it is extremely high, an auto dealer

may only turn inventory once every few weeks


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RATIO:


Activity Ratios

HOWCALCULATED:

MEASURE:

Accounts

ReceivableTurnover

AnnualCredit Sales/ Accounts

Receivable

Avg length of time it takes aFirm to collect

credit sales (%)

Shows a firm's effectiveness in extending credit aswell as collecting debts. It measures how efficiently afirm uses its assets. A high ratio implies that extension of credit andcollection of accounts receivable is efficient. A Firm having low ratio should re-assess its creditpolicies to ensure the timely collection of impartedcredit that is not earning interest for the firm.


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RATIO:


Activity Ratios

HOWCALCULATED:

MEASURE:

Average

CollectionPeriod

AccountsReceivable/Total Credit

Sales/365

Avg length of time it takes aFirm to collectcredit sales (in

days)

Having a lower average collection period is optimal,because this means that it does not take a companyvery long to turn its receivables into cash.


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Thank you

Documents

Session 4 Financial Ratios 28 Jun 11