1. Overview

• Ratios are financial indicators used in analytical procedures to quantify relationships among selected items on financial statements.

• Comparative analyses with different periods and industry ratios help identify trends important to investors, lenders, and other stakeholders.

2. Basic Financial Analysis Ratios

• Liquidity Ratios: Measure a firm’s short-term ability to pay maturing obligations.

  • Current Ratio: Current Assets / Current Liabilities

  • Quick Ratio: (Cash and Cash Equivalents + Short-term Marketable Securities + Receivables (Net)) / Current Liabilities

• Activity Ratios: Assess how effectively an enterprise uses its assets.

  • Accounts Receivable Turnover: Sales (Net) / Average Accounts Receivable (Net)

  • Days Sales in Accounts Receivable: Ending Accounts Receivable (Net) / (Sales (Net) / 365)

  • Inventory Turnover: Cost of Goods Sold / Average Inventory

  • Days in Inventory: Ending Inventory / (Cost of Goods Sold / 365)

  • Accounts Payable Turnover: Cost of Goods Sold / Average Accounts Payable

  • Days of Payables Outstanding: Ending Accounts Payable / (Cost of Goods Sold / 365)

  • Cash Conversion Cycle: Days Sales in Accounts Receivable + Days in Inventory - Days of Payables Outstanding

  • Asset Turnover: Sales (Net) / Average Total Assets

• Profitability Ratios: Measure financial performance over a period.

  • Profit Margin: Net Income / Sales (Net)

  • Return on Assets: Net Income / Average Total Assets

  • Return on Sales: Income before Interest Income, Interest Expense, and Taxes / Sales (Net)

  • Return on Equity: Net Income / Average Total Equity

  • Gross (Profit) Margin: (Sales (Net) - Cost of Goods Sold) / Sales (Net)

  • Operating Cash Flow Ratio: Cash Flow from Operations / Ending Current Liabilities

• Investor Ratios: Of particular interest to investors.

  • Basic Earnings per Share: Income Available to Common Shareholders / Weighted Average Common Shares Outstanding

  • Price Earnings Ratio: Price per Share / Basic Earnings per Share

  • Dividend Payout: Cash Dividends / Net Income

• Coverage Ratios: Measure long-term debt-paying ability.

  • Debt to Equity: Total Liabilities / Total Equity

  • Total Debt Ratio: Total Liabilities / Total Assets

  • Equity Multiplier: Total Assets / Total Equity

  • Times Interest Earned: Income before Interest Expense and Taxes / Interest Expense

3. Limitations of Ratios

• Depend on the reliability of the underlying data, which may be based on estimates and historical costs.

• Few industry benchmarks exist for comparison.

• Dissimilar business units complicate analysis.

• Inflation can affect balance sheet comparability.

• Potential manipulation of ratios by management.

• Different accounting principles can impact ratios and reduce comparability.

• Ratios may use accounting data that do not reflect fair values.

4. Other Analyses

• Common-Size Analysis: Used to compare a company’s performance with other companies or over time by expressing each balance sheet component as a percentage of total assets, and each income statement component as a percentage of total revenue.

• Analysis of Industry Statistics: Useful for comparing against industry norms and competitors.

• Trend Analysis: Analyzes trends over time.