Financial Statement Analysis

Reviewer

Liquidity Ratios
come off the Balance Sheet measure as on a particular day i.e. the day that the Balance Sheet was prepared Important: measuring the ability of a company to meet both its short term and long term obligations

Current Ratio
obtained by dividing the 'Total Current Assets' of a company by its 'Total Current Liabilities test of liquidity for a company expresses the 'working capital' relationship of current assets available to meet the company's current obligations Current Ratio = Total Current Assets/ Total Current Liabilities

example from our Balance sheet:

Current Ratio = $261,050 / $176,522 Current Ratio = 1.48 Interpretation: Lumber & Building Supply Company has $1.48 of Current Assets to meet $1.00 of its Current Liability

Quick Ratio
obtained by dividing the 'Total Quick Assets' of a company by its 'Total Current Liabilities company could be carrying heavy inventory as part of its current assets, which might be obsolete or slow moving Thus eliminating inventory from current assets and then doing the liquidity test Acid Test of Liquidity

 expresses the true 'working capital' relationship of its cash, accounts receivables, prepaid and notes receivables available to meet the company's current obligations Quick Ratio = Total Quick Assets/ Total Current Liabilities Quick Assets = Total Current Assets (minus) Inventory

example from our Balance sheet:

Quick Ratio = $261,050- $156,822 / $176,522 Quick Ratio = $104,228 / $176,522 Quick Ratio = 0.59 Interpretation: Lumber & Building Supply Company has $0.59 cents of Quick Assets to meet $1.00 of its Current Liability

Debt to Equity Ratio

obtained by dividing the 'Total Liability or Debt ' of a company by its 'Owners Equity a.k.a Net Worth measures how the company is leveraging its debt against the capital employed by its owners If the liabilities > net worth, then creditors have more stake than the shareowners

Debt to Equity Ratio = Total Liabilities / Owners Equity or Net Worth example from our Balance sheet: Debt to Equity Ratio = $186,522 / $133,522 Debt to Equity Ratio = 1.40 Interpretation: Lumber & Building Supply Company has $1.40 cents of Debt and only $1.00 in Equity to meet this obligation.

Efficiency Ratios
ratios that come off the Balance Sheet and the Income Statement Important: measuring the efficiency of a company in either turning their inventory, sales, assets, accounts receivables or payables ability of a company to meet both its short term and long term obligations because if they do not get paid on time how will you get paid paid on time

DSO (Days Sales Outstanding)

shows both the average time it takes to turn the receivables into cash and the age, in terms of days, of a company's accounts receivable test of Efficiency for a company particular importance to credit and collection associates Regular DSO = (Total Accounts Receivables/Total Credit Sales) x Number of Days in the period that is being analyzed

Best Possible DSO

yields insight into delinquencies since it uses only the current portion of receivables Best Possible DSO requires three pieces of information for calculation: 1.) Current Receivables 2.) Total credit sales for the period analyzed 3.) The Number of days in the period analyzed Best Possible DSO = Current Receivables/Total Credit Sales X Number of Days

example from our Balance sheet and Income Statement:

Total Accounts Receivables (from Balance Sheet) = $97,456 Total Credit Sales (from Income Statement) = $727,116 Number of days in the period = 1 year = 360 days ( some take this number as 365 days) DSO = [ $97,456 / $727,116 ] x 360 = 48.25 days

Interpretation: Lumber & Building Supply Company takes approximately 48 days to convert its accounts receivables into cash. Compare this to their Terms of Net 30 days. This means at an average their customers take 18 days beyond terms to pay.

Inventory Turnover ratio

obtained by dividing the 'Total Sales' of a company by its 'Total Inventory test of Efficiency and indicates the rapidity with which the company is able to move its merchandise Inventory Turnover Ratio = Net Sales / Inventory Inventory Turnover Ratio = Cost of Goods Sold / Inventory

example from our Balance sheet and Income Statement:

Net Sales = $727,116 (from Income Statement) Total Inventory = $156,822 (from Balance sheet ) Inventory Turnover Ratio = $727,116/ $156,822 Inventory Turnover = 4.6 times Interpretation: Lumber & Building Supply Company is able to rotate its inventory in sales 4.6 times in one fiscal year.

Accounts Payable to Sales (%)

obtained by dividing the 'Accounts Payables' of a company by its 'Annual Net Sales indication as to how much of their suppliers money does this company use in order to fund its Sales Higher the ratio means that the company is using its suppliers as a source of cheap financing working capital of such companies could be funded by their suppliers

Accounts Payables to Sales Ratio = [Accounts Payables / Net Sales ] x 100 example from our Balance sheet and Income Statement: Accounts Payables = $152,240 (from Balance sheet ) Net Sales = $727,116 (from Income Statement) Accounts Payables to Sales Ratio = [$152,240 / $727,116] x 100 Accounts Payables to Sales Ratio = 20.9%

Interpretation: 21% of Lumber & Building Supply Company's Sales is being funded by its suppliers.

Profitability Ratios
how successful a company is in terms of generating returns or profits on the Investment that it has made in the business If a business is Liquid and Efficient it should also be Profitable

Return on Sales or Profit Margin (%)

ability to withstand competition and adverse conditions like rising costs, falling prices or declining sales in the future measures the percentage of profits earned per dollar of sales and thus is a measure of efficiency of the company Return on Sales or Profit Margin = (Net Profit / Net Sales) x 100

example from our Balance sheet and Income Statement:

Total Net Profit after Interest and Taxes (from Income Statement) = $5,142 Net Sales (from Income Statement) = $727,116 Return on Sales or Profit Margin = [ $5,142 / $727,116] x 100 Return on Sales or Profit Margin = 0.71% Interpretation: Lumber & Building Supply Company makes 0.71 cents on every $1.00 of Sale

Return on Assets
ability to utilize the Assets employed in the company efficiently and effectively to earn a good return measures the percentage of profits earned per dollar of Asset and thus is a measure of efficiency of the company in generating profits on its Assets Return on Assets = (Net Profit / Total Assets) x 100

example from our Balance sheet and Income Statement

Total Net Profit after Interest and Taxes (from Income Statement) = $5,142 Total Assets (from Balance sheet) = $320,044 Return on Assets = [ $5,142 / $320,044] x 100 Return on Assets = 1.60% Interpretation: Lumber & Building Supply Company generates makes 1.60% return on the Assets that it employs in its operations.

Return on Equity or Net Worth

ability of the management of the company to generate adequate returns for the capital invested by the owners of a company a return of 10% would be desirable to provide dividends to owners and have funds for future growth of the company Return on Equity or Net Worth = (Net Profit / Net Worth or Owners Equity) x 100 Net Worth or Owners Equity = Total Assets (minus) Total Liability

example from our Balance sheet and Income Statement:

Total Net Profit after Interest and Taxes (from Income Statement) = $5,142 Net Worth (from Balance sheet) = $133,522 Return on Net Worth = [ $5,142 / $133,522] x 100 Return on Equity or Return on Net Worth = 3.85%

Interpretation: Lumber & Building Supply Company generates a 3.85% percent return on the capital invested by the owners of the company