FINANCIAL RATIOS
FINANCIAL RATIOS
Financial Analysis
Financial Ratios
• Important tool to analyze company’s performance at a point of time
& over certain period of time
• To show relationships among financial statements
• Used by investors, managers etc. to analyze and interpret firm’s
financial position and performances
TYPES OF FINANCIAL RATIOS
Types of Ratios
• Liquidity Ratios
• Measure firm’s working capital management and ability to
pay short-term obligations
• Activity Ratios
• Indication of the effectiveness of firm’s investment decision
and management ability to utilize firm’s assets
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Types of Ratios
• Leverage Ratios
• Indication of firm’s effectiveness in financing decisions and propensity
to use debt in financing assets (measure its financial risk)
• Profitability Ratios
• Firm’s effectiveness in working capital mgmt, investment decisions,
financing decisions and the overall profitability
• Market or Equity Ratios
• Concern of stockholders
Liquidity Ratios
• Measure firm’s ability to meet its maturing or short-term obligations
• Focus on availability of short-term assets to pay short-term
obligations
• Higher liquidity is preferred: higher ability to meet short-term
obligations
Liquidity Ratios
• Liquidity ratios refer to the ability of a company to pay its short-term obligations
using current assets
NWC = Current Assets −
Current Liabilities
Current Assets
CR =
Current Liabilities
Current Assets − Inventory
QR =
Current Liabilities
Liquidity Ratios
Activity/Asset Management Ratios
• Measures the effectiveness of the firm in managing its assets
• Efficiency in handling firm’s operations
Activity/Asset Management Ratios
• Asset management or activity ratios measure the efficiency of a company in using
assets to generate sales or cash.
Sales
ARTO =
Acc Receivables
Acc Receivables
ACP = x 360
Sales
Acc Payables
APP = x 360
Purchases
COGS
ITO =
Inventory
Sales
FATO =
Fixed Assets
Sales
TATO =
Total Assets
Activity/Asset Management Ratios
Activity/Asset Management Ratios
Activity/Asset Management Ratios
Leverage/Debt Management Ratios
• Leverage and debt ratios measure a company’s level of debts and its ability to
fulfill and pay for financial obligations.
Total Liabilities
DR = x 100
Total Assets
Total Liabilities
DER = x 100
Total Equity
EBIT
TIE =
Interest Expenses
Leverage/Debt Management Ratios
• Measure the extent to which the firm uses debt to finance its
investment
• How well can firm meet its interest payment obligations
• Measure the financial risks related to the financing used
Leverage/Debt Management Ratios
Profitability Ratios
• Profitability ratios measure a company effectiveness to generate profits from
investment and sales.
Gross Profit
GPM = x 100
Sales
Net Profit
NPM = x 100
Sales
EBIT
OPM = x 100
Sales
Profitability Ratios
Net Profit
ROA = x 100
Total Assets
Net Profit
ROA = x 100
Total Equity
Profitability Ratios
• Measure the combined effects of liquidity, asset management, and
debt management on overall operating results of the firm
• Ability to satisfy firm’s goal to maximize the owners’ wealth, to attract
new capital and to grow
• Relative contribution margin from sales
Profitability Ratios
Profitability Ratios
Profitability Ratios
Market Ratios
• Market ratio measures a company ability to generate market value from
investment.
Net Profit - Dividend
EPS =
Total Number of Shares Outstanding
Dividend
DPS =
Total Number of Shares Outstanding
DPS
DY =
Market Price of a Share
Market Ratios
• Important to publicly traded firms
• Used in stock valuation process
• Investment portfolio decision
• Depends on overall performance of the firm
Market Ratios
Market Ratios
LIMITATIONS OF FINANCIAL RATIOS
Ratio analysis is very important to financial managers to uncover trends,
strengths, and weaknesses. However, it has some drawbacks especially when
using industry average index.
1. Unreliable Figures - The practice of "window dressing" may result in hypothetical
figures so that the company will look good in the eyes the investors.
2. Different Accounting Treatments - There are certain items in the financial
statements are not consistent from one firm to another due to differences in accounting
system (e.g., LIFO or FIFO in inventories management).
3. Non-Comparative Data - Sometimes it is difficult to classify industry for
comparison as a result of the diversification practiced by many companies in the market
place.
4. Benchmark on average index - Industry averages are just average. Comparison
should actually be done with above average industry.
