Assignment

About Ratio Analysis, Uses & Types

Submitted By: Name: Reg.No: Section: Ali Mumtaz Gondal BBA-SP09-12 C

Submitted To: Sir.Taqi Zaidi

Submission Date: Oct10, 2010.

COMSATS Institute of Information & Technology

Ratio Analysis
Ratio Analysis enables the business owner/manager to spot trends in a business and to compare its performance and condition with the average performance of similar businesses in the same industry. To do this compare your ratios with the average of businesses similar to yours and compare your own ratios for several successive years, watching especially for any unfavorable trends that may be starting. Ratio analysis may provide the all-important early warning indications that allow you to solve your business problems before your business is destroyed by them. By apply Ratio Analysis to Financial Statements (Balance Sheet and the Statement of Income) we can able to analyze the success, failure, and progress of your business. Financial ratios are categorized according to the financial aspect of the business which the ratio measures.

Liquidity Ratios
It can be defined as a ratio that indicates what proportion of a company's assets can be readily converted into cash in the short term. That is also known as solvency. They focus on the firm's current assets and current liabilities on the balance sheet. Some of the liquidity ratios are:
y y y y y y y

Current ratio Quick ratio Inventory turn over Receivable turnover Defensive interval ratio Activity ratio Acid turnover

Current Ratios:
The Current Ratio is one of the best known measures of financial strength. It is figured as shown below: Total Current Assets Current Ratio = ____________________ Total Current Liabilities If you decide your business's current ratio is too low, you may be able to raise it by:
y

Paying some debts.

y y y y y

Increasing your current assets from loans or other borrowings with a maturity of more than one year. Converting non-current assets into current assets. Increasing your current assets from new equity contributions. Putting profits back into the business.

Quick Ratios:
y y

The Quick Ratio is sometimes called the "acid-test" ratio and is one of the best measures of liquidity. It is figured as shown below: Cash + Government Securities + Receivables Quick Ratio = _________________________________________ Total Current Liabilities

Inventory Turnover Ratio: This ratio reveals how well inventory is being managed. It is important because the more times inventory can be turned in a given operating cycle, the greater the profit. The Inventory Turnover Ratio is calculated as follows: Net Sales Inventory Turnover Ratio = ___________________________ Average Inventory at Cost Receivable Turnover Ratio: This ratio indicates how well accounts receivable are being collected. If receivables are not collected reasonably in accordance with their terms, management should rethink its collection policy. If receivables are excessively slow in being converted to cash, liquidity could be severely impaired. The Accounts Receivable Turnover Ratio is calculated as follows: Net Credit Sales/Year __________________ = Daily Credit Sales 365 Days/Year Accounts Receivable Accounts Receivable Turnover (in days) = _________________________ Daily Credit Sales

Assets Management Ratios

Asset Management ratios help analyzes how quickly a company's resources can be converted to cash or sales. These tutorials define the ratios and walk you through the calculations, including where on the financial statements the numbers can be found. Days Sales Outstanding (DSO): The days sales outstanding ratio (DSO) gives an indication of how long it takes to collect accounts receivables, comparing outstanding receivables to average daily sales. Fixed Assets Turnover Ratio: The fixed assets turnover ratio measures how fixed assets are used to generate sales, by comparing sales to net fixed assets. Inventory Turnover Ratio: The inventory turnover ratio compares sales to inventories, reflecting a company's ability to convert inventory into cash. Total Asset Turnover Ratio: The total assets turnover ratio measures the use of all assets in terms of sales, by comparing sales with net total assets. Asset Management Ratios Study Sheet: Its all about ratios like Days Sales Outstanding (DSO), Fixed Asset Turnover, Total Asset Turnover, and Inventory Turnover.

Debt Management Ratios

Debt Management ratios help evaluates a company's long-term solvency, measuring the extent to which the company is using long-term debt. These tutorials define the ratios and walk you through the calculations, including where on the financial statements the numbers can be found. Debt Ratio: The debt ratio indicates how much of a company's assets are provided through debt. This is the proportion of funding that is provided by creditors. This interactive tutorial walks you

through the calculations, including where Total Assets and Total Liabilities are on the Balance Sheet.

Total Liabilities Debt/Worth Ratio = _______________ Net Worth Generally, the higher this ratio, the more risky a creditor will perceive its exposure in your business, making it correspondingly harder to obtain credit.

Debt to Equity Ratio: The debt to equity ratio indicates how much of a company's financing is provided through debt as compared to equity. EBITDA Coverage: The EBITDA coverage ratio shows if earnings are able to satisfy all financial obligations including leases and principal payments. (EBITDA is short for earnings before interest, taxes, depreciation, and amortization.) Equity Multiplier: The equity multiplier ratio is the factor by which assets grew from the use of debt. TIE Ratio: The TIE Ratio shows the ability to pay interest charges out of earnings. (TIE stands for times interest earned).

Profitability Ratio
It can be defined as a ratio that explains the profitability of a company during a specific period of time. It explains how profitable a company is. These ratios can be compared during different financial years to see the overall performance of a company. Gross Profit Margin: The gross profit margin looks at cost of goods sold as a percentage of sales. This ratio looks at how well a company controls the cost of its inventory and the manufacturing of its
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products and subsequently passes on the costs to its customers. The larger the gross profit margin, the better for the company. Gross Profit Ratio = Gross Profit x 100 / Sales Where Gross Profit = sales - direct costs Operating Profit Margin: Operating profit is also known as EBIT and is found on the company's income statement. EBIT is earnings before interest and taxes. The operating profit margin looks at EBIT as a percentage of sales. The operating profit margin ratio is a measure of overall operating efficiency, incorporating all of the expenses of ordinary, daily business activity. Net Profit Margin: When doing a simple profitability ratio analysis, net profit margin is the most often margin ratio used. The net profit margin shows how much of each sales dollar shows up as net income after all expenses are paid. For example, if the net profit margin is 5%, which means that 5 cents of every dollar is profit. The net profit margin measures profitability after consideration of all expenses including taxes, interest, and depreciation Net Profit Ratio = Net Profit x 100 / Sales Cash Flow Margin: The Cash Flow Margin ratio is an important ratio as it expresses the relationship between cash generated from operations and sales. The company needs cash to pay dividends, suppliers, service debt, and invest in new capital assets, so cash is just as important as profit to a business firm. The Cash Flow Margin ratio measures the ability of a firm to translate sales into cash. The calculation is: Cash flow from operating cash flows/Net sales =%.

Return on Assets
The Return on Assets ratio is an important profitability ratio because it measures the efficiency with which the company is managing its investment in assets and using them to generate profit. It measures the amount of profit earned relative to the firm's level of investment in total assets. The return on assets ratio is related to the asset management category of financial ratios. Return on Assets = Net Income / Average Total Assets Where Total Assets = (Beginning Total Assets + Ending Total Assets) / 2 Net Income is taken from the income statement and total assets are taken from the balance sheet. The higher the percentage, the better, because that means the company is doing a good job using its assets to generate sales.

Return on Equity
The Return on Equity ratio is perhaps the most important of all the financial ratios to investors in the company. It measures the return on the money the investors have put into the company. This is the ratio potential investors look at when deciding whether or not to invest in the company. The calculation is: Net Income/Stockholder's Equity = _____%. Net income comes from the income statement and stockholder's equity comes from the balance sheet. In general, the higher the percentage, the better, with some exceptions, as it shows that the company is doing a good job using the investors' money. Return on Equity (ROE) = Net Income / Average Stockholders Equity Where Average Stockholders Equity = (Beginning Stockholders Equity + Ending Stockholders Equity) / 2 Cash Return on Assets:

The cash return on assets ratio is generally used only in more advanced profitability ratio analysis. It is used as a comparison to return on assets since it is a cash comparison to this ratio as return on assets is stated on an accrual basis. Cash is required for future investments. The calculation is: Cash flow from operating activities/Total Assets = _____%. The numerator is taken from the Statement of Cash Flows and the denominator from the balance sheet. Net Income is taken from the income statement and total assets are taken from the balance sheet. The higher the percentage, the better, because that means the company is doing a good job using its assets to generate sales. Earnings Per Share (EPS): Earnings Per Share (EPS) = Net Income / Weighted Average Number of Common Shares Outstanding The Return on Assets ratio is an important profitability ratio because it measures the efficiency with which the company is managing its investment in assets and using them to generate profit. It measures the amount of profit earned relative to the firm's level of investment in total assets. The return on assets ratio is related to the asset management category of financial ratios. Return on Assets = Net Income / Average Total Assets Where Total Assets = (Beginning Total Assets + Ending Total Assets) / 2
(THaNKS)