2. 17-1 Ratios can be expressed in three different ways: 1. Ratio (e.g., current ratio of 2:1) 2. % (e.g., profit margin of 2%) 3. $ (e.g., EPS of $2.25) CAUTION! “Using ratios and percentages without considering the underlying causes may be hazardous to your health!” lead to incorrect conclusions.” Ratios

3. 17-2 Categories of Ratios l Liquidity Ratios Indicate a company’s short-term debt-paying ability l Equity (Long-Term Solvency) Ratios Show relationship between debt and equity financing in a company l Profitability Tests Relate income to other variables

4. 17-3 Liquidity Ratios ¶Current (working capital) ratio ·Acid-test (quick) ratio u Cash flow liquidity ratio ¸Accounts receivable turnover ¹Number of days’ sales in accounts receivable ºInventory turnover u Total assets turnover 651 10 Ratios You Must Know

5. 17-4 Equity (Long-Term Solvency) Ratios »Equity (stockholders’ equity) ratio u Equity to debt 10 Ratios You Must Know

6. 17-5 Profitability Tests u Return on operating assets “profit margin” ¼Net income to net sales (return on sales or “profit margin”) ROE ½Return on average common stockholders’ equity (ROE) u Cash flow margin ¾Earnings per share u Times interest earned $ 10 Ratios You Must Know

7. 17-6 Now, let’s look at Norton Corporation’s 1999 and 1998 financial statements.

8. 17-7

9. 17-8

10. 17-9

11. 17-10 Now, let’s calculate the 10 ratios based on Norton’s financial statements.

12. 17-11 We will use this information to calculate the liquidity ratios for Norton.

13. 17-12 Working Capital* The excess of current assets over current liabilities. * While this is not a ratio, it does give an indication of a company’s liquidity.

14. 17-13 Current (Working Capital) Ratio Current Ratio $65,000 $42,000 ==1.55 : 1 Measures the ability of the company to pay current debts as they become due. Current Ratio Current Assets Current Liabilities = #1

15. 17-14 Acid-Test (Quick) Ratio Quick Assets Current Liabilities = Acid-Test Ratio Quick assets are Cash, Marketable Securities, Accounts Receivable (net) and current Notes Receivable. #2

16. 17-15 Quick Assets Current Liabilities = Acid-Test Ratio Norton Corporation’s quick assets consist of cash of $30,000 and accounts receivable of $20,000. Acid-Test (Quick) Ratio #2

17. 17-16 Quick Assets Current Liabilities = Acid-Test Ratio $50,000 $42,000 =1.19 : 1= Acid-Test Ratio Acid-Test (Quick) Ratio #2

18. 17-17 Sales on Account Average Accounts Receivable Accounts Receivable Turnover = Accounts Receivable Turnover = 26.70 times $494,000 ($17,000 + $20,000) ÷ 2 Accounts Receivable Turnover = This ratio measures how many times a company converts its receivables into cash each year. #3 Average, net accounts receivable Net, credit sales

19. 17-18 Number of Days’ Sales in Accounts Receivable Measures, on average, how many days it takes to collect an account receivable. Days’ Sales in Accounts Receivables = 365 Days Accounts Receivable Turnover = 13.67 days = 365 Days 26.70 Times Days’ Sales in Accounts Receivables#4

20. 17-19 Number of Days’ Sales in Accounts Receivable In practice, would 45 days be a desirable number of days in receivables? #4 Days’ Sales in Accounts Receivables = 365 Days Accounts Receivable Turnover = 13.67 days = 365 Days 26.70 Times Days’ Sales in Accounts Receivables

21. 17-20 Inventory Turnover Cost of Goods Sold Average Inventory Inventory Turnover = Measures the number of times inventory is sold and replaced during the year. = 12.73 times $140,000 ($10,000 + $12,000) ÷ 2 Inventory Turnover = #5

22. 17-21 Inventory Turnover Cost of Goods Sold Average Inventory Inventory Turnover = Would 5 be a desirable number of times for inventory to turnover? = 12.73 times $140,000 ($10,000 + $12,000) ÷ 2 Inventory Turnover = #5

23. 17-22 Equity, or Long–Term Solvency Ratios This is part of the information to calculate the equity, or long-term solvency ratios of Norton Corporation.

24. 17-23 Here is the rest of the information we will use.

25. 17-24 Equity Ratio Equity Ratio = Stockholders’ Equity Total Assets Equity Ratio = $234,390 $346,390 67.7%= Measures the proportion of total assets provided by stockholders. #6

26. 17-25 Net Income to Net Sales A/K/A Return on Sales or Profit Margin Net Income to Net Sales = Net Income Net Sales Net Income to Net Sales = $53,690 $494,000 = 10.9% Measures the proportion of the sales dollar which is retained as profit. #7

27. 17-26 Net Income to Net Sales A/K/A Return on Sales or Profit Margin Net Income to Net Sales = Net Income Net Sales Net Income to Net Sales = $53,690 $494,000 = 10.9% Would a 1% return on sales be good? #7

28. 17-27 Return on Average Common Stockholders’ Equity (ROE) Return on Stockholders’ Equity = Net Income Average Common Stockholders’ Equity = $53,690 ($180,000 + $234,390) ÷ 2 = 25.9% Return on Stockholders’ Equity Important measure of the income-producing ability of a company. #8

29. 17-28 Earnings per Share Earnings Available to Common Stockholders Weighted-Average Number of Common Shares Outstanding = Earnings per Share $53,690 (17,000 + 27,400) ÷ 2 == $2.42 The financial press regularly publishes actual and forecasted EPS amounts. #9 Earnings Per Share

30. 17-29 Quick assets are defined as Cash, Marketable Securities and net receivables. a.True b.False Quick assets are defined as Cash, Marketable Securities and net receivables. a.True b.False Question

31. 17-30 No more ratios, please!