Ratio Analysis

Financial Analysis Comparing Financial Statements Condensed Statement Analysis Trend Analysis Ratio Analysis Comparison with Similar Businesses Analysis of Non-Financial Factors

Homework Take-Up

Ratio Analysis TODAY Analysis of Liquidity Analysis of Borrowing Capacity Rate of Return IN THE FUTURE Many, Many More!

Analysis of Liquidity Creditors want to make sure that a business is able to pay their debts Businesses can sell all their assets and creditors can collect

Analysis of Liquidity Working Capital – How much cash is on hand after paying current liabilities – Current Assets – Current Liabilities Current Ratio – Expresses working capital as a ratio = Current Assets__ Current Liabilities – General rule is 2:1, but varies by industry – Don’t want the ratio to be too low or too high

Analysis of Liquidity WHAT DO BOTH WORKING CAPITAL AND CURRENT RATIO ASSUME ABOUT ALL ASSETS?

Quick Ratio Only uses assets that are quickly converted to cash Cash Accounts Receivable Marketable Securities – SELL! SELL! SELL! = Cash + A/R + Marketable Securities Current Liabilities General rule is 1:1

Lovett’s Lazer Tag Condensed Balance Sheet Dec. 31, 2013 Assets Current Assets Cash10,200 Accounts Receivable 300 Merchandise Inventory3,400 Prepaid Expenses1,200 Total Current Assets15,100 Total Fixed Assets124,000 Total Assets139,100 Liabilities and Owner’s Equity Current Liabilities 24,300 Long-Term Liabilities43,000 Total Liabilities67,000 Total Owner’s Equity72,100 Total Liabilities and Owners Equity139,100

Turnover Ratios

Restaurant – Table Turnover How many times can the restaurant get different people at the same table throughout the night More Turnover = More $$$$$ (revenue) Accounting – Merchandise (Inventory) Turnover How many times can a restaurant sell their average inventory in a certain accounting period = Cost of Goods Sold Average Inventory

Turnover Ratios Accounts Receivable Collection Period – How long does it take a business to collect an average accounts receivable? =Average A/R x 365 Net Sales on Credit – General rule: 45 days for a company with 30 day collection terms – Too High: Too many uncollectible = less $$$ – Too Low: Collection policies are too strict = lost business

Analysis of Borrowing Capacity Equity and Debt Ratio – Potential Lenders look at these ratios – How much of the business is financed by Debt Equity – Lenders want to see higher Equity Ratio – Business Owners want to see higher Debt Ratio

Analysis of Borrowing Capacity Equity Ratio = Owner’s Equity x 100% Total Assets Debt Ratio = Totals Debts x 100% Total Assets Debt Ratio + Equity Ratio = 100% – Debt and Equity are the only ways to finance a business

Rates of Return Rate of Return On Sales – How much are our sales contributing to the bottom line. =Net Income x 100% Net Sales Rate of Return on Average Owner’s Equity – The Owner or Investor could be putting their money towards other businesses/ markets

Rate of Return on Average Owner’s Equity Steps – 1 – Average beginning and ending Owner’s Equity – 2 = Net Income_____ x 100% Average Owner’s Equity Must be greater than the return the owner could get from other investments

All Ratios I have provided you with a handout of all of the ratios on a convenient two sided page! You will be allowed to take this into the exam with you – The formulas are not the important part What the #’s mean and how to analyze them are crucial

Comparison with Similar Businesses Many of the ratios and percentages we have discussed become more useful when compared to the competition – For example: compare net income with the industry average Gives further information on the success of the firm

Homework Reminder: There will be a quiz/test on all internal control lessons on Tuesday Today’s work: Page – 14, 17,19,20,21,22