1. 1 Ratios Ratios è Two types: èLiquidity ratios (Solvency ratios) èProfitability ratios è Single ratio by itself is not very meaningful

2. 2 Liquidity Ratios Liquidity Ratios Measure the short-term ability of the business to pay its debts. WHO CARES? WHO CARES? Short-term creditors such as bankers and suppliers.

3. 3 Current ratio Current ratio Acid-test ratio Acid-test ratio Debt ratio Debt ratio Equity ratio Equity ratio Collection Period Collection Period Inventory turnover Inventory turnover Times Interest Earned ratio Times Interest Earned ratio Liquidity Ratios

4. 4 Current Ratio Indicates short-term debt- paying ability Current Assets Current Liabilities

5. 5 Acid-Test Ratio Indicates immediate short- term debt-paying ability Indicates immediate short- term debt-paying ability Total current assets (less inventory and prepaid expenses) Current Liabilities

6. 6 Debt Ratio Proportion of total assets that are financed with borrowed money. Total Liabilities Total Liabilities Total Assets Total Assets

7. 7 Equity Ratio Proportion of total assets financed with shareholder’s money Total equity Total assets

8. 8 Collection Period How many days’ sales are represented by Account Receivables Accounts Receivable Average Charge sales / day

9. 9 Inventory Turnover Ratio 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

10. 10 Company’s ability to cover its interest expense Net Income Interest Expense Times Interest Earned

11. 11 Solvency Ratios Solvency Ratios Measure the ability of the enterprise to survive over a long period of time WHO CARES? WHO CARES? Long-term creditors and stockholders

12. 12 Debt to total assets ratio Debt to total assets ratio Times interest earned ratio Times interest earned ratio Cash debt coverage ratio Cash debt coverage ratio Free cash flow Free cash flow Solvency Ratios

13. 13 Debt to Total Assets Ratio Indicates % of total assets provided by creditors Total Liabilities Total Assets Illustration 14-24

14. 14 Times Interest Earned Ratio Indicates company’s ability to meet interest payments as they come due Income Before Interest Expense & Income Tax Interest Expense Illustration 14-25

15. 15 Cash Debt Coverage Ratio Indicates long-term debt-paying ability (cash basis) Cash provided by operations Cash provided by operations Average total liabilities Average total liabilities Illustration 14-26

16. 16 Profitability Ratios Measure the income or operating success of an enterprise for a given period of time WHO CARES? Everybody WHO CARES? Everybody WHY? A company’s income affects: WHY? A company’s income affects: é its ability to obtain debt and equity financing é its liquidity position é its ability to grow é

17. 17 Return on assets ratio Return on assets ratio Profit margin ratio Profit margin ratio Assets turnover ratio Assets turnover ratio Gross profit rate Gross profit rate Operating expenses to sales ratio Operating expenses to sales ratio Cash return on sales ratio Cash return on sales ratio Profitability Ratios

18. 18 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. Illustration 14-30

19. 19 Profit Margin Ratio Indicates net income generated by each dollar of sales Higher value suggests favorable return on each dollar of sales. Illustration 14-31 Net income Net sales

20. 20 Asset Turnover Ratio Indicates how efficiently assets are used to generate sales Net sales Average total assets Illustration 14-32

21. 21 Gross Profit Rate Indicates margin between selling price and cost of good sold Gross profit Net sales Illustration 14-34

22. 22 Operating Expenses to Sales Ratio Indicates the cost incurred to support each dollar of sales Operating expenses Net sales Illustration 14-35

23. 23 Cash Return on Sales Ratio Indicates net cash flow generated by each dollar of sales Indicates net cash flow generated by each dollar of sales Cash provided by operations Net sales Illustration 14-36

24. 24 Estimates Financial statements are based on 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. To the extent that these estimates are inaccurate, the financial ratios and percentages are also inaccurate.

25. 25 Cost Traditional financial statements are based on historical cost and are not adjusted for price level changes. 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. 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 20 th ! The amount listed for Assets is likely no longer the same or what was profitable at December 31 may no longer be !) 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 20 th ! The amount listed for Assets is likely no longer the same or what was profitable at December 31 may no longer be !)

26. 26 Alternative Accounting Methods One company may use the FIFO method, while another company in the same industry may use LIFO. 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. 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. In addition to differences in inventory costing methods, differences also exist in reporting such items as depreciation, depletion, and amortization.