Use of Ratios

Interpret financial statements Evaluate performance (Both Time Series & Cross Sectional) Analyze financial position in terms of Time, Industry and Expectations (TIE Analysis) Identify possible problem areas Assist Decision Making

Limitations
Companies are not exactly alike in the nature of their operations. Different companies use different accounting policies. Ratios are primarily a starting point from which to identify further questions related to present position & future directions of the operations and so they do not provide answers in themselves. A single ratio can mislead the users. The financial statements being compared should be dated at the same point in time during the year. Audited financial statement should be used to analyze ratios. Time series analysis ignores the impact of inflation.

Types of Ratios
Liquidity Ratios Profitability Ratios Efficiency /Management Performance / Activity Ratios Financial Risk/ Gearing/ Leverage Ratios Market Ratios Investors Ratios

Liquidity Ratios
Current Ratio = CA / CL Quick Ratio or Acid Test or Liquid Asset Ratio = (CA Ending Inventory) / CL

Financial Risk /Gearing/ Leverage Ratios

Debt/Equity Ratio = Long-term loan * 100 / Stockholders equity Debt Ratio = Total Liability / Total Asset Times Interest Earned Ratio or Interest Coverage Ratio = EBIT / Interest Fixed-Payment Coverage Ratio = Earnings before interest and taxes + Lease Payments / Interest + Lease Payments + {( Principle payments + Preferred stock dividends)*[(1/(1-T )]}

Activity (Efficiency) Ratios

Inventory (Stock) Turn over = Cogs / Av. Inventory Average age of Inventory or Stockholding Period = (Av. Inventory * 365) / Cogs

Activity Ratios (continued)

Receivable Turn over = Sales/Accounts Receivable Average Collection Period= (Accounts Receivables * 365) / Sales Payable Turn over = Purchase/Accounts payable Average Payment Period = (Accounts Payable * 365) / Purchase

Activity Ratios (continued)

TA Turnover Ratio = Sales / TA FA Turnover Ratio = Sales / Net FA

Profitability Ratios
ROCE = EBIT * 100 / (FA + CA CL) Net Profit Margin = (Net Profit * 100) / Sales Operating Profit Margin = (Operating Profit * 100) / Sales Gross Profit Margin = (GP * 100) / Sales

Profitability Ratios (continued)

ROA = (Earnings Available for Common Stock Holders * 100) / TA ROE= (Earnings Available for Common Stock Holders *100)/Stockholders Equity EPS = Earnings Available for Common Stock Holders/ Number of Common Stock Outstanding

Market Ratio
P/E Ratio = Market Price / EPS Market/Book Ratio = Market Price / Book Value per Share Where BV per Share = [A(L+ PS)]/ Number of CS Outstanding