Ratio Analysis

Financial Analysis

Block and Hirt Chapter 3

Ratios

      Profitability Ratios

      Asset Utilization Ratios

      Liquidity Ratios

      Debt Utilization Ratios

Ratios

       Profitability

     Profit Margin

     Return on Assets (investment)

     Return on Equity

       Asset Utilization

     Receivable turnover

     Average Collection Period

     Inventory turnover

     Fixed Asset turnover

     Total asset turnover

       Liquidity Ratios

     Current Ratio

     Quick Ratio

       Debt Utilization Ratios

     Debt to total Assets

     Times interest earned

     Fixed charge coverage

 

Profitability Ratios

      Profit margin

      Return on Assets (investment)

      Return on equity

 

      These all measure the ability of the firm to earn an adequate return on sales, assets and investment.

Profitability Ratios

      Profit margin = Net income / Sales

      Return on assets = Net Income / total assets = (Net Income / Sales * Sales / total assets)

      Return on Equity = Net Income / Stockholders equity = Return on assets / (1-debt/assets)

Profitability Ratios

      Compare each ratio result with the industry average.

      Du Pont system of analysis

   High profit margin = good cost control

   High asset turnover = efficient use of assets.

   Use return on assets and return on equity (one formula is taken from the other)

   Debt can be used to boost return on equity (but increases risk)

   Take care with the age of the assets.

Asset Utilization Ratios

      Receivables turnover = Sales (credit) / Receivables

      Average collection period = Accounts receivable / Average daily credit sales

      Inventory turnover = Sales / Inventory

      Fixed Asset turnover = Sales / fixed Assets

      Total Asset turnover = Sales / total assets

Liquidity Ratios

      Current ratio = current assets / current liabilities

      Quick ratio = (current assets inventory) / current liabilities

Debt Utilization Ratios

      Debt to total assets = total debt / total assets

      Times interest earned = income before interest and taxes / interest

      Fixed charge coverage = income before fixed charges and taxes / Fixed charges

Ratios

      All the ratios are more meaningful if used in the context of industry averages.

      Trend analysis can be used to look at trends in ratio movements over time and over businesses.