Transcript No Slide Title

Ratios
Two
types:
Liquidity ratios (Solvency ratios)
Profitability ratios
Single
ratio by itself is not very
meaningful
1
Liquidity Ratios
Measure the short-term ability
of the business to pay its
debts.
WHO CARES?
Short-term creditors such as
bankers and suppliers.
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Liquidity Ratios
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Current ratio
Acid-test ratio
Debt ratio
Equity ratio
Collection Period
Inventory turnover
Times Interest Earned ratio
3
Current Ratio
Indicates short-term debtpaying ability
Current Assets
Current Liabilities
4
Acid-Test Ratio
Indicates immediate shortterm debt-paying ability
Total current assets (less
inventory and prepaid expenses)
Current Liabilities
5
Debt Ratio
Proportion of total assets that are
financed with borrowed money.
Total Liabilities
Total Assets
6
Equity Ratio
Proportion of total assets
financed with shareholder’s money
Total equity
Total assets
7
Collection Period
How many days’ sales are
represented by Account Receivables
Accounts Receivable
Average Charge sales / day
8
Inventory Turnover Ratio
Number of times a business
has been able to sell and
replace its inventory in one
year
Cost of Goods Sold
Average Inventory
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Times Interest Earned
Company’s ability to cover its
interest expense
Net Income
Interest Expense
10
Solvency Ratios
Measure the ability of the
enterprise to survive over a
long period of time
WHO CARES?
Long-term creditors and
stockholders
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Solvency Ratios
 Debt
to total assets ratio
 Times interest earned ratio
 Cash debt coverage ratio
 Free cash flow
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Illustration 14-24
Debt to Total Assets Ratio
Indicates % of total assets
provided by creditors
Total Liabilities
Total Assets
13
Illustration 14-25
Times Interest Earned Ratio
Indicates company’s ability to
meet interest payments as they
come due
Income Before Interest
Expense & Income Tax
Interest Expense
14
Illustration 14-26
Cash Debt Coverage Ratio
Indicates long-term debt-paying
ability (cash basis)
Cash provided by operations
Average total liabilities
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Profitability Ratios
Measure the income or operating success
of an enterprise for a given period of time
WHO CARES? Everybody
WHY? A company’s income affects:
 its ability to obtain debt and equity
financing
 its liquidity position
 its ability to grow
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Profitability Ratios
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Return on assets ratio
Profit margin ratio
Assets turnover ratio
Gross profit rate
Operating expenses to sales ratio
Cash return on sales ratio
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Illustration 14-30
Return On Assets Ratio
Reveals the amount of net
income generated by each
dollar invested
Net income
Average total assets
Higher value suggests favorable
efficiency.
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Illustration 14-31
Profit Margin Ratio
Indicates net income generated
by each dollar of sales
Net income
Net sales
Higher value suggests favorable
return on each dollar of sales.
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Illustration 14-32
Asset Turnover Ratio
Indicates how efficiently
assets are used to generate
sales
Net sales
Average total assets
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Illustration 14-34
Gross Profit Rate
Indicates margin between
selling price and cost of good
sold
Gross profit
Net sales
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Operating Expenses
to Sales Ratio
Illustration 14-35
Indicates the cost incurred to
support each dollar of sales
Operating expenses
Net sales
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Illustration 14-36
Cash Return on Sales Ratio
Indicates net cash flow
generated by each dollar of
sales
Cash provided by operations
Net sales
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Estimates

Financial statements are based on
estimates.
– allowance for uncollectible accounts
– depreciation
– costs of warranties
– contingent losses
To the extent that these estimates are inaccurate,
the financial ratios and percentages are also
inaccurate.
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Cost
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Traditional financial statements are based on
historical cost and are not adjusted for price
level changes.
This needs to be considered when relying on
them for analysis.
Also, by the time financial statements are
prepared for a company, time has passed (i.e.
December 31 numbers are being reported to
the public on March 20th ! The amount listed for
Assets is likely no longer the same or what was
profitable at December 31 may no longer be !)
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Alternative Accounting Methods
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One company may use the FIFO method, while
another company in the same
industry may
use LIFO.
If the inventory is significant for both
companies, it is unlikely that their current ratios
are comparable.
In addition to differences in inventory costing
methods, differences also exist in reporting
such items as depreciation, depletion, and
amortization.
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