RATIO ANALYSIS

Ratio analysis expresses the relationship among selected items of financial statement data.

• A method or process by which the relationship of items or groups of items in the financial statements are computed, and
presented

• Used to interpret the financial statements so that the strengths and weaknesses of a firm, its historical performance and
current financial condition can be determined

• Can be expressed as a pure ratio, percentage, or as a rate

Ratio Analysis

1. Liquidity Ratios
2. Activity Ratios
3. Leverage Ratios
4. Profitability Ratios
5. Market Values

RATIOS FORMULAS COMMENTS

LIQUIDITY RATIOS
Liquidity is the ability of assets to be converted quickly into cash. Ideally, a company has to be liquid to meet current debts.

Working Capital Current Assets – Current Liabilities The excess of current assets over current liabilities
Current Ratio A rough estimate on the ability of the business to
Current Assets meet currently maturing obligations; this ratio
Current Liabilities varies in great disparity from one industry to
another.
Quick Ratio/Acid-Test Ratio A more severe test of immediate liquidity to meet
Quick Assets currently maturing obligations. Quick assets
Current Liabilities include cash, short-term investments and
receivables.
ACTIVITY RATIOS
Activity Ratios are related to the operations and operating efficiency because they measure how quickly the firm is
converting assets into cash. The goal of the firm is to maximize revenues and minimize costs, and since there is a cost to carrying
inventory and accounts receivable, the efficient firm will want to minimize the time that they hold non cash assets. The more
quickly the firm is able to move through the cycle from inventory to accounts receivable to cash, the more profit they are likely
to receive per peso of assets.

Cost of Goods Sold Indicates the number of times inventories were

Inventory Turnover acquired and sold during the period.
Average Inventory
365 days Indicates the number of times spent before the
Inventory Days
Inventory Turnover average inventory is sold to customers
Net Credit Sales Indicates the efficiency in credit and collection
Receivable Turnover
Average Receivables policies.
365 days Measures quickness in collecting receivables
Collection Period
Receivable Turnover
Measures the number of days it takes the firm to
Operating Cycle Collection Period + Inventory Days
convert inventory and receivables to cash
Net Sales Looks at sales in comparison to the long-term assets
Fixed Asset Turnover
Average Fixed Assets of the firm
Measures the firm’s ability to utilize its assets to
Net Sales
Total Asset Turnover gain revenues and profits. A low ratio could mean
Average Total Assets
that the firm is holding some nonperforming assets.
LEVERAGE RATIOS
Leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt (loans)
or assesses the ability of a company to meet its financial obligations. The leverage ratio category is important because companies
rely on a mixture of equity and debt to finance their operations, and knowing the amount of debt held by a company is useful in
evaluating whether it can pay its debts off as they come due.

Measures the use of debt to finance operations;

Total Liabilities
Debt to Equity Ratio provides a measure of the relative amount of
Owner’s Equity
resources contributed by the creditors and owners,.
Total Liabilities Measures the relative share of creditors over the
Debt Ratio
Total Assets total resources of the firm.
Measures the long-term debt paying ability of the
firm; a high number of times interest is earned ratio
EBIT indicates that the business is under-leveraged and its
Times-Interest Earned Ratio
Interest Expense return on common equity could still be improved.

EBIT = earnings before interest and taxes

PROFITABILITY RATIOS
Profitability ratios are a class of financial metrics that are used to assess a business's ability to generate earnings relative to
its revenue, operating costs, balance sheet assets and shareholders' equity over time, using data from a specific point in time.

Gross Profit Measures gross profit percentage on sales to recover

Gross Profit Margin
Net Sales operating expenses.
EBIT Examines the income of the company before taking
Operating Profit Margin
Net Sales into account the interest and taxes.
Demonstrates a better assessment of a firm’s
profitability, particularly for a company who has
Net Income
Profit Margin interest and tax obligations.
Net Sales
Net Income = earnings after interest and taxes
Net Income Measures overall asset profitability; indicates how
Return on Assets
Average Total Assets well assets have been employed by management.
Net Income Measures percentage of income derived for every
Return on Equity
Average Owner’s Equity peso of owner’s equity
MARKET VALUES
A firm’s value is relative to what an investor will pay for its stock. If demand for the stick increases, then its price will
increase. Likewise, its increase in share price can be tied to the expectation of increase in future earnings.

Indicates the value of the stock on cost perspective;

the relevance of this ratio diminishes when the
Shareholders’ Equity
Book Value balance sheet valuation does not approach fair
Average Ordinary Shares Outstanding
market values; may be computed for both common
and preferred stocks.
Perhaps the most frequently quoted ratio of earning
Net Income – Preference Dividends and growth performance; measures the value of
Earnings per share
Average Ordinary Shares Outstanding common stock by attributing to it a portion of the
company’s earnings.
Measures the number of period investment in stock
will be recovered; measures the profitability of the
Market Price per Share
Price-earnings ratio firm in relation to the market value of the stock;
Earnings per Share
measures investors’ beliefs on the growth potential
of the stock.