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Chapter Objectives
Financial Ratios
Financial Ratio Analysis Dupont Analysis Limitations of Ratio Analysis Firm Performance and Shareholder Value
Financial Ratios
Financial Ratios
Examine: How liquid is a firm? Is management generating adequate operating profits on the firms assets? How is the firm financing its assets? Is management providing a good return on the capital provided by the shareholder?
Current Ratio
Compares cash and current assets that should be converted into cash during the year with the liabilities that should be paid within the year Current Assets / Current liabilities
The conversion of accounts receivable into cash, is measured by calculating how long it takes to collect the firms receivables Accounts Receivable / Daily Credit Sales
Inventory Turnover
How many times accounts receivable are rolled over during a year Credit Sales / Accounts Receivable
How many times is inventory rolled over during the year? Cost of Goods Sold / Inventory
Inventory
175 =
(1200/365)
= 182.50
Operating Income Return on Investment (OIROIO) Operating Profit Margin Total Asset Turnover Fixed Asset Turnover Return on Assets
How efficiently a firm is using its assets in generating sales Measures the dollar sales per $1 of Assets Sales / Total Assets
Alternate OIROI
OIROI = Operating Profit Margin X Total Asset Turnover
Return on Assets
ROA = Net Income / Total Assets OIROI = Operating Income Sales Assets X Sales Total
ROA
500 / 1500
Debt Ratio
What percentage of the firms assets are financed by debt? Total Debt / Total Assets
Examines the amount of operating income available to service interest payments or The number of times the firm is earning or covering its interest payments Operating Income / Interest
73.33%
13
Return on common equity Accounting Return on the common stockholders investment Net Income / Common Equity Net Income / Common Equity 500 / 400 = 1.25 or 125%
DuPont Analysis
An alternative method to analyze a firms profitability and return on equity Allows management to see more clearly what drives return on equity and the inter-relationships among: net profit margin, asset turnover, and common equity ratio. Return on Common = ROA / Common Equity Equity Total Assets
DuPont Equation
Net Income X Eqty Sales Sales Ttl Asts / Cmn
Ttl Asts /
.267 =
1.245