1. (using financial statements)
FINANCIAL RATIOS
(using financial statements)
Balance sheet
- Common-sized balance sheet shows assets,
liabilities, and equity as a % of total assets.
Income statement
- Common-sized income statement shows
income and expense items as a % of sales.
Statement of cash flows

2. (standardized measures)
FINANCIAL RATIOS
(standardized measures)
Used by managers for planning and evaluation
Used by credit managers to assess risk
Used by investors to assess stocks and bonds
Used to compare with industry and over time

3. FINANCIAL RATIOS Types of ratios
Liquidity
-ability to meet short term debt
Asset management
-efficiency in using resources
Financial leverage management
-level of risk due to debt
Profitability
-effectiveness in generating profits
Market-based
-market’s view of the firm

4. Liquidity Ratios Current ratio = Current assets Current liabilities
CR = $50,190 / $25,523
CR = vs. 2.4 Ind. Avg.
Quick ratio = Current assets – inventories Current liabilities
QR = ($50,190 - $27,530) / $25,523
QR = .89 vs Ind. Avg.

5. Asset Management Ratios
Avg collection period = Accounts receivable Annual credit sales/365
ACP = $18,320 / ($112,760/365)
ACP = 59.3 days vs. 47 days Ind. Avg.
Inventory turnover = Cost of sales Average inventory
Inv. Turn. = $85,300 / ($27,530 + $26,470)/2
Inv. Turn. = vs. 3.9 Ind. Avg.

6. Asset Management Ratios
Fixed-asset turnover = Sales Net fixed assets
FAT = $112,760 / $31,700
FAT = vs. 4.6 Ind. Avg.
Total asset turnover = Sales Total assets
TAT = $112,760 / $81,890
TAT = vs Ind. Avg.

7. Financial Leverage Management
Debt ratio = Total debt Total assets
DR = $47,523 / $81,890
DR = 58% vs. 47% Ind. Avg.
Debt-to-equity ratio = Total debt Total equity
D/E = $47,253 / $34,367
D/E = 138.3% vs. 88.7% Ind. Avg.

8. Financial Leverage Management
Times interest earned = EBIT Interest charge
Coverage Ratio = $11,520 / $3,160
Coverage Ratio = vs. 6.7 Ind. Avg.
Equity multiplier = Total assets Total equity
EM = $81,890 / $34,367
EM = vs Ind. Avg.

9. Profitability Ratios Gross profit margin = Sales - Cost of sales Sales
GPM = ($112,760 - $85,300) / $112,760
GPM = 24.4% vs. 25.6% Ind. Avg.
Net profit margin = EAT Sales
NPM = $5,016 / $112,760
NPM = 4.45% vs. 5.1% Ind. Avg.

10. Profitability Ratios ROI = EAT Total Assets ROI = $5,016 / $81,890
ROI = 6.13% vs. 9.28% Ind. Avg.
ROE = EAT Stockholders equity
ROE = $5,016 / $34,367
ROE = 14.6% vs % Ind. Avg.

11. Market-Based Ratios
P/E ratio = Market price per share Current earnings per share
Market to book ratio= Market price per share Book value per share

12. Dividend Policy Ratios
Payout ratio = Dividends per share EPS
Dividend yield = Expected dividends per share Stock price

13. Financial Ratio Analysis
Trend analysis
XYZ current ratio
Cross-sectional analysis
XYZ current ratio
Industry averages
Both simultaneously
XYZ current ratio
Industry averages

14. Relationships Among Ratios
ROI = EAT  Sales = EAT Sales Total assets Total assets or
ROI = Net profit  Total Asset = NPM  TAT margin turnover
and
ROE = EAT  Total assets = EAT Total assets Equity Equity
ROE = ROI  Equity = ROI  EM multiplier

15. Relationships Among RatiosIf
ROE = ROI  Equity = ROI  EM multiplier
and
ROI = Net profit  Total Asset = NPM  TAT margin turnover
then
ROE = Net profit  Total Assets  Equity margin turnover multiplier or
ROE = NPM  TAT  EM

16. Relationships Among Ratios
This is the Dupont formula:
ROE = Net profit  Total Assets  Equity margin turnover multiplier or
ROE = NPM  TAT  EM

17. Dupont Formula 14.6% = 4.45%  1.38  2.38 17.5% = 5.10%  1.82  1.89
Example of the Dupont formula:
ROE = NPM  TAT  EM
Company:
14.6% = 4.45%  1.38  2.38
Industry average:
17.5% = 5.10%   1.89

18. Sources of Information
Dun and Bradstreet
Robert Morris Associates
Prentice-Hall’s Almanac of Business and Industrial Ratios
Moody’s
Standard and Poor’s
Annual reports
10K’s
Trade associations
Trade journals
Commercial banks
Financial Research Associates
Computerized data bases