LAP: QS-043

Objectives

Explain how financial ratios are used.

Demonstrate how to interpret profitability ratios.

Objective

Explain how financial ratios are used.

Using Ratios

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Tools

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Assess performance

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Make comparisons

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Calculated by dividing one number into another

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Give meaningful information about various aspects of our lives

Ratios in Financial Analysis

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Profitability

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Efficiency

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Level of debt

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And more

Many Different Types

Objective

Demonstrate how to interpret profitability ratios.

Sales Growth

Are sales increasing or decreasing?

Sales Growth = Year Two total revenue – Year One total revenue Year One total revenue

Sales Growth Example Year One sales = $4,075,522 Year Two sales = $5,294,247 (From income statement) 5,294,247 - 4,075,522 = .299 or 29.9% 4,075,522 What does this mean?

Sales in Year Two are 30% higher than they were in Year One.

Earnings per Share (EPS) What are profits on a per share basis?

EPS = net earnings outstanding shares

EPS Example

2004 net earnings = $390,559 2004 basic shares outstanding = 397,173 (From income statement) $390,559 = .98 or 98¢ per share 397,173 What does this mean? For this time period, the company earned 98¢ for each share of stock. 98¢ Corporate office 1 Share

Profit Margin

How much of a company’s sales is profit?

What does this mean? For this time period, this company kept as net profit 8.8¢ for every dollar of sales.

Return on Equity (ROE)

How well are stockholders’ investments being used?

ROE = Net income Shareholders’ equity

ROE Example

Net income = $390,559 (From income statement) Shareholders’ equity = $2,474,218 (From balance sheet) $390,559 = .158 or 15.8% $2,474,218 What does this mean? For this time period, the company earned a 15.8% return on shareholders’ equity.

Price-earnings (PE) How much are investors willing to pay for earnings?

PE = Stock price per share Earnings per share

PE Example

PE = 23.52 = 24 .98

For this time period and compared to the average market PE of 15, investors have high expectations for this company’s performance.

Price-earnings and Growth (PEG) How well are investor expectations reflected in growth?

PEG = PE = Stock price per share / earnings per share EPS growth Change in EPS / Beginning EPS

PEG Example PEG = 24 = .54

44 What does this mean? For this time period, the stock is priced lower than indicated by the company’s growth. It may be undervalued.

How to Win Quick Case Investors by Inflating Sales Channel Stuffing: An illegal method of inflating sales and earnings by sending distributors more product than they actually need

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What do financial managers hope to gain?

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Why doesn’t it usually work?

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How does it affect financial analysis ratios?

MarkED

Acknowledgments Original Developers Christopher C. Burke, Jane Wright, MarkED Version 1.0

Copyright © 2007 MarkED Resource Center

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