Financial Ratios

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 income statement and balance sheet.

Salah uddin

28/06/2011

Financial Ratios

Computing FRs reflect a situation at just one point in time Comparing FRs overtime and to industry average gives meaningful statistics to identify and evaluate strengths and weaknesses i.e Trend Analysis

Salah uddin

28/06/2011

Profitability Ratios
RATIO:

HOW CALCULATED:
Gross Margin Gross Profit / Sales

MEASURE:
Total Margin available to cover operating expenses & yield a profit

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

Salah uddin

28/06/2011

Profitability Ratios
RATIO:

HOW CALCULATED:
Operatin gMargin EBIT / Sales

MEASURE:
Profitability without concern for Taxes & Interests

RETURN ON SALES OPTG PROFIT MARGIN How mucha company makes (before interestand taxes)on each dollar of sales. Ifa company's margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.
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Profitability Ratios
RATIO:

HOW CALCULATED:

MEASURE:

Net Profit Margin

Net Income / Sales

After - Tax Profits per $ of Sales

Often referred to simply as a company's profit margin, the so-calledbottom lineis the most often mentioned when discussing a company's profitability.
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Profitability Ratios
RATIO:

HOW CALCULATED:
Return on Assets Net Income / Assets

MEASURE:
After - Tax Profits per $ of Assets

RETURNON INVESTMENT An indicator of how profitable a company is relative to its assets. How efficientmanagement isat using its assets to generate earnings. The higher the ROA number, the better, because the company is earning more money on less investment
Salah uddin 28/06/2011

Profitability Ratios
RATIO:

HOW CALCULATED:

MEASURE:

Return on Stockholder s Equity

Net Income / Total Stockholder s Equity

After - Tax Profits per $ of Stockholders investment

RETURNON EQUITY
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Profitability Ratios
RATIO:

HOW CALCULATED: Net

Earnings per Share Income / # of shares of common stock

MEASURE:
Earnings available to owners of common stock

PROFIT GENERATEDON PERSHAREBASIS

the single mostimportant variable in determining a share's price

Salah uddin

28/06/2011

Profitability Ratios
RATIO:

HOW CALCULATED:

MEASURE:

Price Earnings Ratio

Market Price per share / Earnings per share

Attractiveness of Firm on equity markets

HigherP/E= expectedhigher earningsgrowth

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Growth Ratios
RATIO: Sales

Net Income EPS Dividends / Share

HOW CALCULATED: Annual % growth in Total Sales Annual % growth in Profits Annual % growth in EPS Annual % growth in dividends / share

MEASURE: Growth rate in sales Growth rate in Profits Growth rate in EPS Growth rate in Dividends / Share

Salah uddin

28/06/2011

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Working Capital
RATIO:

HOW CALCULATED:
Current Assets Current Liabilities

MEASURE:
Whether a Firm can meet its current obligations

Working Capital

The greater the working capital the more likely a Firm will be able to make its payments on time If a Firm has current assets exactly equal to current liabilities, it has no working capital.

Salah uddin

28/06/2011

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Liquidity or Solvency Ratios

RATIO:

HOW CALCULATED:
Current Assets / Current Liabilities

MEASURE:
Extent to which a Firm can meet short-term obligations

Current Ratio

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

Salah uddin

28/06/2011

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Liquidity or Solvency Ratios

RATIO:

Extent to which a Firm can meet Current short-term Assetsobligations, Quick Ratio Inventory / without relying Current on sale of Liabilities Inventories Inventory is excluded as it might not turn to cash quickly. Ratio of quick assets ( cash, marketable security, accounts receivable) to current liabilities. Despite office buildings, trucks, ware houses, finished goods, etc. a Firm can still risk insolvency if its ratio of quick assets is insufficient to meet bills
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ACID TEST

HOW CALCULATED:

MEASURE:

Leverage Ratios
RATIO:

HOW CALCULATED:

MEASURE:
% of total funds that are provided by creditors

Debt Ratio

Total Debt / Total Assets

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

Salah uddin

28/06/2011

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Leverage Ratios
RATIO:

HOW CALCULATED:
Debt to Equity Ratio Total Debt / Total Stockholder s Equity

MEASURE:
% of total funds provided by creditors Vs by owners

A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. If a lot ofdebt isused to finance increasedoperations (high debt to equity), the company could potentially generate more earningsthan without thisoutside financing.If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit asmoreearnings are being spread among the same amount of shareholders

Salah uddin

28/06/2011

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Leverage Ratios
RATIO:

Times Interest Earned Ratio

HOW CALCULATED: Profits

before I & T / Total Interest Charges

MEASURE:
A Firms ability to meet its debt obligations

Indicates how many times a Firm can cover its Interest charges on a pre tax basis, failing which it would face bankruptcy Also referred to as "interest coverage ratio" and "fixed-charged coverage A high ratio indicates an undesirable lack of debt or paying down too much debt with earnings that could be used for other projects.
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Activity Ratios
RATIO:

HOW CALCULATED:
Inventory Turnover Cost of Goods sold / Avg. Inventory

MEASURE:
Whether a Firm holds excessive stock of inventories or selling it slowly

Slow turn over means too much capital tied up in inventory Such capital costs money and can result in inventory obsolescence Profits improve when you can move out inventory quickly In retail grocery it is extremely high, an auto dealer may only turn inventory once every few weeks

Salah uddin

28/06/2011

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Activity Ratios
RATIO:

HOW CALCULATED:
Accounts Receivable Turnover

MEASURE:
Avg length of time it takes a Firm to collect credit sales (%)

Annual Credit Sales / Accounts Receivable

Shows a firm's effectiveness in extending credit as well as collecting debts.Itmeasures how efficiently a firm uses its assets. A high ratio implies that extension of credit and collection of accounts receivable is efficient. A Firm having low ratio should re-assess its credit policies to ensure the timely collection of imparted credit that is not earning interest for the firm.
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Activity Ratios
RATIO:

HOW CALCULATED:
Average Collection Period Accounts Receivable/ Total Credit Sales/365

MEASURE:
Avg length of time it takes a Firm to collect credit sales (in days)

Having a loweraverage collection periodis optimal, because this means that it does not take a company very long to turn its receivables into cash.

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28/06/2011

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Thank you

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28/06/2011

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