Interested parties Shareholders - to measure management’s

performance Investors - to make their investment

decisions Management - to plan and control

operation

Ratio analysis is a quick and easy way of analyzing a firm’sfinancial statements.

Ratio analysis cannot accurately pinpoint the problems of the firm. It is reasonable to expect that it points to a direction for a more detailed analysis.

Financial ratio itself is not meaningful without comparing it to a benchmark. Benchmarks can be a rival firm’s financial ratio or an industry average.

Sometimes a firm’s problems can be disguised as so-called “good ratios.” For example, a high inventory turnover can be an indicator of the firm’s dangerously low level of inventory.

Liquidity Ratios Efficiency Ratios Leverage Ratios Profitability Ratios

Liquidity and leverage ratios primarily measure risk; efficiency and profitability ratios measure performance and return.

Net working capital

= Current assets - Current liability

Current ratio

Quick (acid-test) ratioliabilityCurrent

assetsCurrent ratioCurrent

liabilityCurrent

Inventory - assetsCurrent ratioQuick

Inventory turnover

Average collection period (Days sales outstanding)

Assets Turnover

Fixed assets turnover

Inventory

Salesturnover Inventory

365 sales Annual

receivable Accounts

salesdaily Average

receivable Accounts

assets Total

Sales turnoverAssets

Assets Fixed

Sales turnover assets Fixed

Debt ratio

Debt-to-Equity ratio

Times interest earned ratio

assets Total

liablities Total RatioDebt

Interest

taxesandinterest before Earnings

Equity

Debt RatioEquity -to-Debt

Gross profit margin

Operating profit margin

Sales

profit Gross

Sales

sold goods ofCost - Sales

Sales

profit Operatingmargin profit Operating

Net profit margin

Return on total assets (ROA)

Return on equity (ROE)

sales

safter taxeprofit net margin profit Net

assets total

safter taxe profitsnet assets on totalReturn

equity common

after tax profitsnet equity on Return

Used by financial managers as a structure to dissect the firm's financial statements and to assess its financial condition.

ROA =

= (net profit margin) x (assets turnover)

ROE =

= (net profit margin) x (assets turnover) x (equity multiplier)

assets Total

Sales

Sales

Taxesafter ProfitsNet

equityCommon

assets Total

assets Total

Sales

Sales

safter taxe profitsNet

Assets Total

esafter tax profitsNet

EquityCommon

esafter tax profitsNet

Campsey Computer Company: Balance Sheet as of December 31, 1995

Cash 77,500 Accounts payable 129,000Receivables 336,000 Notes payable 84,000Inventories 241,500 Other current liabilities 117,000

Total current assets 655,000 Total current liabilities 330,000Net fixed assets 292,500 Long-term debt 256,500

Common equity 361,000

Total assets 947,500 Total liabilities and equity 947,500

Campsey Computer Company: Income Statement

Sales 1,607,500$ Cost of goods sold (1,353,000)Gross profit 254,500Fixed operating expenses (143,000)Depreciation (41,500) Earnings before interest and taxes 70,000Interest (24,500) Earnings before taxes 45,500Taxes (40%) (18,200)

Net Income 27,300

Calculate the following ratios:a. Current ratio

b. Days sales outstanding

c. Inventory turnover

98.1000,330

000,655

liabilityCurrent

assetsCurrent ratioCurrent

66.6500,241

500,607,1

Inventory

Salesturnover Inventory

29.76

365500,607,1

000,336

365sales Annual

receivable AccountsDSO

d. Total assets turnover

e. Profit margin on sales

70.1500,947

500,607,1

assets Total

Sales turnoverAssets

%70.1500,607,1

300,27Sales

safter taxeprofit Net margin profit Net

f. Return on Assets

%88.2500,947

300,27

assets Total

safter taxe profitsNet ROA

%88.2500,947

500,607,1

500,607,1

300,27assets Total

Sales

Sales

safter taxe profitsNet ROA

OR

g. Return on Equity

%56.7000,361

300,27

EquityCommon

esafter tax profitsNet ROE

equityCommon

assets Total

assets Total

Sales

Sales

safter taxe profitsNet ROE

%56.7000,361

300,27

361,000

947,500

947,500

1,607,500

1,607,500

27,300 ROE

OR

h. Debt ratio

%90.61500,947

500,586assets Total

sliabilitie TotalratioDebt

Ratio CampseyIndustry Average

Current ratio 1.98 2.0

Days sales outstanding 76 days 35 days

Inventory turnover 6.7 5.6

Total assets turnover 1.7 3.0

Profit margin on sales 1.7% 1.2%

Return on assets 2.9% 3.6%

Return on equity 7.6% 9.0%

Debt ratio 61.9% 60.0%