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.