Financial

Ratios
 Financial
Ratios
There are several major financial ratios obtainable from the
firm’s financial statements that reveal the financial health of
a firm

Provides a broader basis for comparison than raw numbers

do
Without the year-to-year or other industry / firm
comparative ratios, the ratios on their own are of little use in
judging the health of future of the industry / firm being
analyzed
 Two types of comparisons

Industry Trend Analysis

comparison
are computed and compared with are computed and compared with
the industry average. their past performance.
Through industry comparison, the the company can determine if their
company may be able to compare financial performance has
their performance as against their improved or not over the years.
competitors and how they are A powerful tool to ascertain what
faring with them. actions should be undertaken in the
future.
 Liquidity
Ratios
provide insight of the firm’s capability to pay
its current obligations.
It is the first item in the financial analysis that
creditors or suppliers look into to ascertain
whether they will grant credits or not to the
debtors.
3 Liquidity Ratios:
Working Capital
Current Ratio
Quick Ratio
 Working
Capital
It is computed by getting the difference between
the current assets and current liabilities of the year’s
(period’s) statement of financial position.

Working Capital = Current Assets - Current Liabilities

A positive working capital means the firm is able to
meet its current maturing obligation with a safety
cushion to meet other unexpected or unrecorded
current liabilities.
 It is probably the most
frequently used measure of

Current
liquidity.
Assess the firm’s ability to
meet its current obligations

Ratio
by using its current assets.
of more than one is an
indication that the firm is
liquid and in a good position
to meet its currently
maturing obligations

Current Ratio = Current Assets

-------------
Current Liabilities
Quick
140

120

Ratio
100

80

It has a more strongest test of liquidity than 60

current ratio.
Sum of cash, marketable securities, and 40
account receivables, which are considered the
most liquid assets, is used instead of the total 20

current assets.
The higher the quick ratio, the more liquid the 0
Item 1 Item 2 Item 3 Item 4 Item 5
firm is

Quick Ratio = Cash + Marketable Securities + Accounts Receivable

---------------------------------------------
Current Liabilities
 Sometimes called
Asset Management
Ratio

Activity
Attempt to measure how efficient
the firm is in managing its assets.

(Efficiency) These activity ratios are used to

Ratio
determine how rapid accounts
receivable goes back to cash and
inventory are converted into sales
and back to cash.

A high turnover ratio is associated

with good asset management and
low turnover ratios with bad asset
management.
 Accounts Receivable
Turnover
used to estimate how fast the
Net Credit Sales
accounts receivable is to be
converted into cash during the Quick Ratio = -------------------------
year. Average accounts receivable
the ratio of the net credit sales
and the average accounts
receivable
the average accounts
receivable is the average of
the beginning and ending
accounts receivable
if net credit sales is not
available, then the net sales
can be used
 Average Collection
Period
It measures how efficient the
firm’s collection policy is by
computing the number of
days to collect the Accounts Collection 360
receivables.
Period = -------------------------
accounts receivable turnover
 Inventory Turnover
It shows how efficient the firm
is in handling its inventory. Inventory Cost of Goods Sold
It measures how fast the Turnover = ------------------------
inventory is turned into sales. Average Inventory
A low inventory turnover rate
may point to overstocking,
obsolescence, or deficiencies
If the inventory turnover
in the product line or
marketing effort. declines from 1.28 to 11.1
the ratio of cost of goods sold INDICATES a problem with
and the average inventory. regards to stocking of
Remember that the average
inventory is the average of
goods
the beginning and ending
inventory.
 Inventory Turnover
Average age of inventory
determines how long the firm
can sell its inventory.

Average age of 360

Inventory = ------------------------
Inventory Turnover
Operating Cycle
It measures the time it takes to
convert the inventories and
receivables to cash. Operating Cycle = Average Collection
The shortest the operating Period
cycle, the better. +
An increasing value of Average age of
operating cycle is an indication Inventory
that the company is not
efficient with this matter and
has to be discussed for
possible solution.
Total Asset TurnoverA low value would mean that the
company needs to identify the
It measures the firm’s ability on how reasons to improve in generating
efficient and fast they are to generate sales.
sales. High total asset turnover indicates an
A high value is desired for the total efficient asset management.
asset turnover ratio. Low total asset turnover indicates an
inefficient asset management

Total Asset Net Sales

Turnover = ------------------
Average Total Assets
Leverage Ratios
Indicate up to what event the
firm has financed its assets
by borrowing
The firm that uses debt
financing rather than equity
financing increases its risk.
reflects the financial risk that
the firm is facing.
The more debt it incurs, the
higher the firm’s leverage
ratio is and the higher the
financial risk it will face.
 Debt Ratio
the ratio of the total liabilities
and the average total assets
shows what portion of the Total Asset Net Sales
total assets is financed by Turnover = ------------------
the creditors and by the Average Total Assets
stockholders.
A debt ratio of more than
50% implies that the
company has higher debt
than capital
Debt to It measures the proportion of

Equity Ratio the total liabilities to the

invested capital.
A high debt to equity ratio
means that the firm financed
the assets mostly by debts,
while a low debt to equity
Total Asset Net Sales ratio means that the firm
Turnover = ------------------
paid for the assets by means
Average Total Assets
of capital infusion by the
stockholders.
Times interest
earned ratio
Refers as to how many times
the earnings before interest
and tax (EBIT) can cover the
Times interest EBIT
interest charges.
earned ratio = ---------------- It measures as to how
Interest Expense capable is the firm in paying
its interest obligation
Profitability
Ratio
Used to measure the
financial status of the firm
and ability to generate profit.
Measure management
effectiveness in terms of rate
of return to sales, assets and
equity.
 Gross Profit Margin
It is a measurement of a
company’s manufacturing
and distribution efficiency
Gross Gross Profit
during the production
Profit = ----------------
process.
Margin Net Sales
The gross profit tells an
investor the percentage of
sales left after subtracting
the cost of goods sold.
 Net Profit Margin
(Return on Sales)
It is another measurement of Net Income after interest
management’s efficiency. Profit and taxes
An important basis of the Margin = ----------------------
competing firms of the same Net Sales
industry to compare the
quality of their operations.
Return on Investment
(ROI)
It measures the income Net Income after interest
generated for every peso Profit and taxes
investment made in the firm. Margin = ----------------------
The higher the income Net Sales
generated per peso
investment, the better.
Return on Return on
Asset Equity
(ROA) (ROE)
These two are the commonly used Return on
Investment.

Return Preferred
Return Net Income after interest
on NIAT - Dividend Payment
on and taxes (NIAT)
Equity = -------------------------
Total = ----------------------
Average stockholders’ equity
Assets Average total assets
- Preferred Stock
 Measure the firm’s performance as
perceived by the general market.
Investors value the firm through its
stock price traded in the stock

Market exchange
The higher the stock price, the better the

Value
performance is a perceived by the
market

Ratios
Profitability, safeness, quality of top
management, future projects, and other
factors are reflected in the firm’s stock
price.
strong indicators of what investors think
of the firm’s past performance and
future prospects.
Earnings per share (EPS)
NIAT - Preferred Dividend Payment
EPS = ------------------------------------
Common Stock Outstanding

Measures the income EPS share tend to be lower

generated per common stock when there are more common
held. shares issued.

The ratio of the difference

For this reason firms would
of net income and
rather prefer accumulating
preferred dividend
funds by issuing bonds so as
requirement and the
not to dilute the EPS
common stock
outstanding.
Price / Earnings Ratio (P/E)
A useful indicator of what the investor
perceives about the firm’s future
prospects.
Depends primarily on two factors:
The future growth in earnings and Market
the risk that is directly associated
Price per share
with expected earnings.
Increases as the price of stock P/E Ratio = --------------
increases. EPS
This will let the investors feel
confident that future earnings of the
firm will improve.
Book Value Per Share
The ratio of the difference of total By comparing the book value
stockholders’ equity and preferred and market value, the firm
stock and common shares can draw other information on
outstanding. how the investors look at the
Preferred stock does not have a book company.
value since it is considered a hybrid
financing.
Book Value v.s. Market Value
Book Total Stockholders’ Equity
the former is the value of the firm
Value - Preferred Stock
on the perspective of accounting
Per = -------------------------
while the latter signifies the
Share Common Shares Outstanding
market valuation of the firm’s
equity.
Market to Book Value
Ratio
It is perceived by the market
as the value of the firm’s
security.
A high value would mean Market to
that investors are Book Market Price per share
complacent when it comes Value = -------------------------
to the market value of the Ratio Book value per share
firm’s resources, capabilities
of the top management,
and expected growth of the
firm.
Dividend
Ratio
Dividend Yield
It is the ratio of dividends
earned per share and the
stock’s market price per
share.

Dividends
Dividend per share
Yield = --------------
Market Price per
Share
 It indicates what part of

Dividend
earnings per share is the
declared dividend per share.

Payout
Dividend
Dividends
per share
Payout = --------------
Ratio
Ratio Earnings per
Share
Cash Flow
Statement
Analyzes changes in cash and
cash equivalents which primarily
comprise cash on hand and
demand deposit, together with
short-term, highly liquid
investments that are readily
convertible to a known amount of
cash and that are subject to an
insignificant risk of changes in
value.
Cash Flow
Statement
Guidance notes indicate that an
investment normally meets the
definition of a cash equivalent
when it has a maturity of three
months or less from the date of
acquisition.
Equity investments are normally
excluded unless they are in
substance a cash equivalent.
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