FINANCIAL RATIOS LECTURE (IMPORTANT)

Importance of financial ratios:
- Help interpret financial statements
- Provide clarity on raw numbers
- Show relationships between financial variables
Key aspects of financial ratios:
- Standardize performance: Allows comparison between different sized companies (e.g. $2,000,000 vs $2,000,000,000).
- Show trends over time: Indicates whether a company is improving, stagnant, or declining.
- Highlight strengths and weaknesses: Identifies areas needing attention (e.g. profits okay, but debt rising).
- Assist in decision making: Investors, lenders, managers analyze ratios for informed decisions.
Clarification:
- Ratios do not replace financial statements; they provide meaning to the data.

Four key categories:
- Profitability Ratios: Measures a company's earnings.
- Asset Utilization Ratios (Efficiency Ratios): Measures effective use of assets.
- Liquidity Ratios: Assesses the ability to pay short-term liabilities.
- Debt Utilization Ratios: Analyzes reliance on borrowed funds.

Introduction to Profit Margin:
- Definition: Shows how well a company converts sales into profit.
- Formula: ( \text{Profit Margin} = \frac{\text{Net Income}}{\text{Sales}} )
- Calculating Profit Margin:
  - Net income and sales data sourced from the income statement.
  - Calculation yields a profit margin of 6%, indicating TJS keeps 6¢ for each dollar of sales.
- Industry average comparison: 9.4% (Rated as subpar).
Importance of Profit Margin:
- Reflected in cost control and pricing power efficiency; impact critical toStakeholders (managers, investors).
- Potential causes for low margin include rising costs and weak pricing power.
- Suggestions for improvement: Renegotiation with suppliers, cost-management strategies.

Receivables Turnover:
- Definition: Number of times receivables are collected annually.
- Formula: ( \text{Receivables Turnover} = \frac{\text{Sales}}{\text{Receivables}} )
- Calculated rate: 2.03 times, better than industry average of 1.25 (Rated as good).
Average Collection Period:
- Definition: Time taken for receivables to be collected.
- To find this, annual sales must convert to daily sales:
  - Formula: ( \text{Average Daily Sales} = \frac{\text{Sales}}{365} )
- Result: 180 days to collect receivables, which aligns with collection frequency (Rated as good).
Inventory Turnover:
- Definition: Frequency of inventory sales.
- Formula: ( \text{Inventory Turnover} = \frac{\text{Sales}}{\text{Inventory}} )
- Result: 1.46 times per year (Rated as okay).
- Recommendations include improving sales forecasts and focusing on faster-moving products.
Fixed Asset Turnover:
- Definition: Efficiency of utilizing fixed assets for sales.
- Formula: ( \text{Fixed Asset Turnover} = \frac{\text{Sales}}{\text{Fixed Assets}} )
- Result: 2.31
- Comparison with industry average of 2.4, rated as subpar.
Total Asset Turnover:
- Definition: Efficiency of utilizing all assets to generate sales.
- Formula: ( \text{Total Asset Turnover} = \frac{\text{Sales}}{\text{Total Assets}} )
- Result: 0.32, rated as subpar against industry average of 1.1.
- Concerns regarding the management of assets impacting cash flow and loan repayment.

Current Ratio:
- Definition: Company’s capability to pay short-term liabilities.
- Formula: ( \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} )
- Result: 2.01, suggesting TJS has $2.01 in assets for every $1 in liabilities (Rated as okay).
Quick Ratio:
- Definition: Stricter liquidity assessment excluding inventory.
- Formula: ( \text{Quick Ratio} = \frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}} )
- Result: 1.49, indicating sufficient liquidity even after excluding inventory (Rated as good).

Debt to Total Assets Ratio:
- Definition: Indicates financial structure based on borrowed funds.
- Formula: ( \text{Debt to Total Assets} = \frac{\text{Total Debt}}{\text{Total Assets}} )
- Result: 47%; compared to industry average (rated as subpar).
- Insights: High reliance on borrowed funds raises financial risk.
Times Interest Earned Ratio:
- Definition: Ability to cover interest payments.
- Formula: ( \text{Times Interest Earned} = \frac{\text{EBIT}}{\text{Interest}} )
- Result: 2.51, indicating struggle to comfortably cover interest payments (Rated as subpar).

Return on Assets (ROA):
- Definition: Profit earned per dollar of assets.
- Formula: ( \text{ROA} = \frac{\text{Net Income}}{\text{Total Assets}} )
- Result: 1.93% (subpar).
- Alternate calculation: ( \text{ROA} = \text{Profit Margin} \times \text{Total Asset Turnover} )
  - Yielding same result, indicating issues with asset efficiency.
Return on Equity (ROE):
- Definition: Profit earned per dollar of shareholder equity.
- Formula: ( \text{ROE} = \frac{\text{Net Income}}{\text{Stockholders' Equity}} )
- Result: 3.6%, significantly below industry average (rated as subpar).
- Alternate calculation: ( \text{ROE} = \frac{\text{ROA}}{1 - \text{Debt Ratio}} )

Preview of upcoming class discussions concerning chapter four and exam preparations.
Personal engagement activity: Students asked to pick a Super Bowl team – New England Patriots or Seattle Seahawks as an informal engagement.