**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.