[FDNBUSF] Unit 7: Financial Ratio Analysis

Financial ratios

provide a second method for standardizing the financial information on the income statement and balance sheet

Financial ratios

generally compared to ratios from previous years; or ratios of other firms in the same industry

financially liquid

if a firm is able to pay its bills on time

Liquidity

ability to convert assets into cash quickly

Overall liquidity

analyzed by comparing the firm’s current assets to the firm’s current liabilities

Liquidity of specific assets

analyzed by examining the timeliness in which the firm’s liquid assets are converted into cash

Liquidity ratios

used to determine a debtor's ability to pay off current debt obligations without raising external capital

Current ratio
Quick ratio
Days sales outstanding

(3) Liquidity ratios

Current ratio

measures a company's ability to pay off its current liabilities with its current assets such as cash, accounts receivable and inventories

Quick ratio

measures a company's ability to meet its short-term obligations with its most liquid assets and therefore excludes inventories from its current assets

Days sales outstanding (DSO)

average number of days that receivables remain outstanding before they are collected

Days sales outstanding (DSO)

used to determine the effectiveness of a company's credit and collection efforts in allowing credit to customers, as well as its ability to collect from them

Days sales outstanding (DSO)

When measured at the individual customer level, it can indicate when a customer is having cash flow troubles, since the customer will attempt to stretch out the amount of time before it pays invoices

Asset management efficiency ratios

measure a firm’s effectiveness in utilizing its assets to generate sales

Asset management efficiency ratios

commonly referred to as turnover ratios as they reflect the number of times a particular asset account balance turns over during a year

Inventory Turnover Ratio
Total Asset Turnover Ratio

(2) Asset Management Efficiency Ratios

Inventory turnover ratio

shows how many times a company has sold and replaced inventory during a given period

Inventory turnover ratio

can help businesses make better decisions on pricing, manufacturing, marketing and purchasing new inventory

Total Asset Turnover Ratio

represents the amount of sales generated per dollar invested in firm’s assets

Total Asset Turnover Ratio

calculates net sales as a percentage of assets to show how many sales are generated from each dollar of company assets

Capital structure

refers to the way a firm finances its assets

Debt ratio

Capital Structure Ratios

Debt ratio

measures the proportion of the firm’s assets that are financed by borrowing or debt financing

Times Interest Earned Ratio

a coverage ratio that measures the proportionate amount of income that can be used to cover interest expenses in the future

Profitability Ratios

used to evaluate the company’s ability to generate income as compared to its expenses and other cost associated with the generation of income during a particular period

Gross Profit Margin
Net Profit Margin
Earnings Per Share

(3) Profitability Ratios

Gross Profit Margin

calculates the percentage of sales that exceeds the cost of cost of goods sold

Gross Profit Margin

measures how efficiently a company uses its material and labor to products profitably

Net Profit Margin

measures how much income is generated from each dollar of sales after adjusting for all expenses

Earning per share

a market prospect ratio that measures the amount of net income earned per share of stock outstanding

Earning per share

amount of money each share of stock would receive if all of the profits were distributed to the outstanding shares at the end of the year

Earnings per share

a calculation that shows how profitable a company is on a shareholder basis

Trend Analysis

comparing a firm’s recent financial ratios with the past financial ratios provides insight into whether the firm is improving or deteriorating over time

Capital Structure

the mixture of debt and equity used to finance a corporation