financial ratios

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Analyzing Analyzing Financial Financial Statements Statements

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Page 1: Financial Ratios

Analyzing Analyzing Financial Financial StatementsStatements

Page 2: Financial Ratios

Analyzing Financial StatementsAnalyzing Financial Statements

Financial Statements enhance the decision making ability and offer a

means to assess the status of a business.

They are not a substitute for common sense.

Page 3: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

4 Key Financial Criteria4 Key Financial Criteria

▸Liquidity▸Solvency

▸Profitability▸Financial Efficiency

Page 4: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

LiquidityLiquidity

Ability to meet financial obligations without disrupting normal ongoing

operations.

Page 5: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

LiquidityLiquidity

1. Working capital Total current assets

- Total current liabilities Working capital

should be positive!

Page 6: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

LiquidityLiquidity1. Working capital

Current Assets = $34,000 - Current Liabilities = $23,000 TOTAL $11,000

Page 7: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

LiquidityLiquidity2. Current Ratio

(CA) $65,000 (CL) $20,000 = 3.25:1

Expressed as xx:1

Page 8: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

LiquidityLiquidity

2. Current Ratioa. If the ratio is greater than (1:1), the business is considered liquid.”b. If the ratio is less than 1:1, the business is considered “Not liquid”

reflecting a high degree of short-term cash flow risks.c. The higher the ratio, the more liquid the business

d. As a ratio, it is not dependent on the size of a business and comparisons to other businesses can be made.

Page 9: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

SolvencySolvency

Ability of a business’ debt repayment capacity if all assets are liquidated.

Ability to continue as a viable business after financial adversity.

Page 10: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

SolvencySolvency

1. Debt to Asset Ratio

Total Liabilities Total Assets

Page 11: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

SolvencySolvency

1. Debt to Asset Ratio

Total liabilities Total Assets

The higher the ratio, the greater the risk exposure.

Page 12: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

SolvencySolvency

1. Debt to Asset Ratio

(TL) $ 560,000 = .51:1 (TA) $1,100,000

Page 13: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

SolvencySolvency2. Equity to Asset Ratio (% ownership)

Total Equity Total Assets

the lower the ratio, the more creditors have in the business. (Higher is better)

Page 14: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

SolvencySolvency

3. Debt to Equity Ratio (Leverage)

Total Liabilities Total Equity

Page 15: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

SolvencySolvency

3. Debt to Equity Ratio (Leverage)

$345,000 = 1.47:1 $234,000

Page 16: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

SolvencySolvency

3. Debt to Equity Ratio (leverage)

Total Liabilities Total Equity

the lower the ratio, then creditors have less money in the business that the owner (lower is better)

Page 17: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

ProfitabilityProfitability

Measures the extent to which a business generates a profit from the use of labor,

management, and capital

Page 18: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

ProfitabilityProfitability1. Return on Assets

Net income from operation +interest expense

- value of unpaid operator and family labor and management

Average total assets

the higher the ratio, the more profitable the business

Page 19: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

ProfitabilityProfitability

2. Return on Equity Net income from operation

- value of unpaid operator and family labor and management

Average total equity

Page 20: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

ProfitabilityProfitability2. Return on Equity

Net income from operation - value of unpaid operator and family

labor and management Average total equity

the higher the ratio, the more profitable the business

Page 21: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

ProfitablityProfitablity

2. Return on Equity $75,000

- $23,000 = 9 % $560,000

Page 22: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

Financial EfficiencyFinancial Efficiency

Measures the degree of efficiency in using labor, management, and capital

Financial Efficiency analysis deals with the relationships between inputs and outputs.

Page 23: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

Financial EfficiencyFinancial Efficiency

1. Asset Turnover Ratio Gross revenues Average total assets

Page 24: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

Financial EfficiencyFinancial Efficiency

1. Asset Turnover Ratio $300,000 = .23:1

$1,300,000

Page 25: Financial Ratios

Analyzing Financial Analyzing Financial StatementsStatements

Financial EfficiencyFinancial Efficiency1. Asset turnover ratio

Gross revenues Average total assets

measures how effective assets generate revenue

the higher the ratio, the more efficiently assets are being used to generate revenue.