Ratio_Analysis_Interpretation_of

Week2–RatioAnalysis&InterpretationofFinancialStatementsChapters27,281ThePurposeofFinancialStatements•Thepurposeoffinancialstatementsistoprovidereliable,relevantandusefulinformationtousers.•Thefinancialstatementsareusedbymanagement,shareholders,lenders,suppliers,auditors,governmentauthorities,etc.•Financialstatementsprovideapictureofthefinancialpositionandperformanceofacompany.2WhatareFinancialStatementRatios?•Afinancialstatementratioisanumericalvaluethatallowuserstoevaluatethecompany’sperformanceandposition.•Financialratiosareusedtohelpusersbetterunderstandthenumberspresentedbythebalancesheetandincomestatement.3Whataretheyusedfor?•Financialstatementratiosareusedinanalyticalprocedures.Theymaybeused:(1)tocompareacompany’sperformancethisyearwithlastyear.(2)tocompareacompany’sperformancewithanothercompany(acompetitor).(3)tocompareacompany’sperformancewiththeindustryaverage.4TypesofRatiosTherearegenerallyfourtypesoffinancialstatementratios.Eachtypeofratioisusedfordifferentpurposes.(1)Activity(orefficiencyratios)(2)Solvency(orliquidityratios)(3)Leverage(ordebtratios)(4)Profitabilityratios5ActivityRatiosActivityratiosareusedtoevaluatehowefficientlyacompanyisconvertingbalancesheetitemsintocashorsales.1)Inventoryturnover2)Dayssalesoutstanding3)Accountspayableturnover4)Totalassetturnover6InventoryTurnoverRatioCalculatedas:CostofgoodssoldAverageinventoryWhatdoesitmean?Itshowsthenumberoftimesinventoryisreplacedduringayear.Ahighratiomeansthecompanyisefficientandreplacesinventoryoften.Alowratiomeansthecompanyisnotefficientandishavingtroublesellinginventory.7DaysSalesOutstandingRatioCalculatedas:AccountsReceivableSales/365Whatdoesitmean?Itshowsthenumberofdaysinayearthataccountsreceivableisoutstanding.Ahighratioindicatesthecompanyisnotefficientatcollectingreceivablesfromcustomers.Alowratioindicatesthecompanyisefficientanddoesabetterjobatcollectingreceivables.8AccountsPayableTurnoverRatioCalculatedas:AccountsPayablePurchases/365Whatdoesitmean?Itshowsthenumberofdaysinayearthataccountspayableisoutstanding.Ahighratioindicatesthecompanyisnotefficientatpayingsuppliers.Alowratioindicatesthecompanyisefficientatpayingsuppliers.9TotalAssetTurnoverRatioCalculatedas:SalesAveragetotalassetsWhatdoesitmean?Itshowshowefficientlyacompanyisusingassetstogeneratesales.Ahighratioindicatesthecompanyisefficientatusingassetstogeneratesales.Alowratioindicatesthecompanyisnotefficientatusingassetstogeneratesales.10SolvencyRatiosSolvencyorliquidityratiosindicatetheabilityofacompanytopayoffshort-termliabilitiesusingshort-termassets.1)Currentratio2)Quickratio(acidtestratio)3)Networkingcapital11CurrentRatioCalculatedas:CurrentAssetsCurrentLiabilitiesWhatdoesitmean?Itshowstheabilityofacompanytopayoffshort-termdebtbyusingshort-termassets.Ahighratioindicatesgreaterabilitytopayoffshort-termdebt.Alowratioindicatesgreaterriskofnotbeingabletopayoffshort-termdebt.12QuickRatioCalculatedas:Currentassets-inventoryCurrentLiabilitiesWhatdoesitmean?Itshowstheabilityofacompanytopayoffshort-termdebtbyusingshort-termassets,excludinginventory.Ahighratioindicatesgreaterabilitytopayoffshort-termdebt.Alowratioindicatesgreaterriskofnotbeingabletopayoffshort-termdebt.13NetWorkingCapitalCalculatedas:Currentassets–CurrentliabilitiesWhatdoesitmean?Itshowswhetheracompanyhasmoreshort-termassetsrelativetoshort-termliabilities.Apositiveresultmeanstherearemoreshort-termassetsrelativetoshort-termliabilities.Anegativeresultmeansthereisashortageofshort-termassetsavailabletopayoffshort-termliabilities.14LeverageRatiosLeverageratiosindicatetheabilityofacompanytosettlelong-termliabilitiesandtopayofffinancingcosts.1)Debtratio2)Debttoequityratio3)Interestcoverageratio15DebtRatioCalculatedas:TotalliabilitiesTotalassetWhatdoesitmean?Itshowstheproportionofliabilitiesinrelationtototalassetsofacompany.Ahighratiomeanstherearefarmoredebtthanassetsandindicatesgreaterrisktocreditors.Alowratiomeanstherearemoreassetsavailabletopayoffdebtandindicateslessrisktocreditors.16DebttoEquityRatioCalculatedas:Long-termdebtTotalequityWhatdoesitmean?Itshowstheproportionofdebtinrelationtototalequity.Ahighratiomeansacompanydoesnothaveenoughequitytopayoffdebt.Alowratiomeansacompanyhasenoughequitytocoverforitsdebtholdings.17InterestCoverageRatioCalculatedas:EarningsbeforeinterestandtaxesInterestexpenseWhatdoesitmean?Itshowstheabilityofacompanytopayoffinterestcostsonlong-termdebtfromearnings.Ahighratiomeansacompanywillnothavedifficultypayinginterestcosts.Alowratiomeansacompanywillhavedifficultypayinginterestcosts.18ProfitabilityRatiosTheprofitabilityratiosindicatetheabilityofacompanytogenerateaprofit.1)Grossprofitmargin2)Operatingprofitmargin3)Netprofitmargin4)Returnonequity5)Earningspershare19GrossProfitMarginCalculatedas:Sales–CostofGoodsSoldSalesWhatdoesitmean?GrossprofitisSalesminusCOGSItshowstheabilityofacompanytoeffectivelycontrolcostsandsetpricing.Ahighratiomeansacompanyhasgoodcontrolsovercosts&pricing(higherprofitsperitemsold).Alowratiomeansacompanyhaspoorcontrolsovercosts&pricing(lowerprofitsperitemsold).20Ope