1. Unit 3: Financial Ratios

3. Ratio Defined
A comparison between two numbers showing how many times one number exceeds the other

4. Why Analyze Financial Statements?
Analyzing a financial statement is the first step you need to take when deciding whether or not a company is sound enough to risk investing your money in

5. Types of Ratios
Liquidity Ratios: Financial ratios that tell how well a company can pay off its short-term debts and meet unexpected needs for cash
Efficiency Ratios: Financial ratios that indicate how effectively a company uses its resources to generate sales
Leverage Ratios: Financial ratios that show how and to what degree a company has financed its assets
Profitability Ratios: Financial ratios that tell how much of each dollar of sales, assets, and owner’s investment resulted in net profit

6. Liquidity Ratios Working Capital Current Assets - Current Liabilities
Amount of money that would be left over after current liabilities are paid off
Current Ratio
Current Assets/Current Liabilities
The amount of current assets available to pay off $1 of current debt. Stated 2:1.

7. Liquidity Ratios Acid Test/Quick Ratio
Cash + Marketable Securities + Accounts Receivable = Quick Assets
Quick Assets/Current Liabilities
A firm’s ability to liquidate assets quickly to pay off debt

8. Efficiency Ratios Asset Turnover Ratio Net Sales/Total Assets
The number of dollars in sales the firm generates from each dollar it has invested in assets
Inventory Turnover
Average Inventory = Beginning Inventory + Ending Inventory divided by 2
Cost of Goods Sold /Average Inventory
The number of times during an operating period that the average inventory was sold

9. Efficiency Ratios Average Collection Period
Accounts Receivable X 365 /Credit Sales
How quickly a firm’s credit accounts are being collected

10. Leverage Ratios Debt-to-Assets Ratio Total Liabilities/Total Assets
Measures to what degree the assets of the firm have been financed with borrowed funds
Debt-to-Equity Ratio
Total Liabilities/Owner’s Equity
The amount of debt incurred by the company for each $1.00 of equity

11. Profitability Ratios Gross Profit Margin Gross Profit/Net Sales
An assessment of how well the cost of goods sold category of expenses was controlled
Net Profit Margin
Net Income/Net Sales
An assessment of management’s overall ability to control the cost of goods sold and the operating expenses of the firm

12. Profitability Ratios Return on Investment Net Income/Owner’s Equity
The amount of profit generated by the firm in relation to the amount invested by the owners

13. Why Analyze? Brainstorm!
What would the LIQUIDITY ratios tell you about a company? How could the company use these to make decisions?
What would the EFFICIENCY ratios tell you about a company? How could the company use these to make decisions?
What would the LEVERAGE ratios tell you about a company? How could the company use these to make decisions?
What would the PROFITABILITY ratios tell you about a company? How could the company use these to make decisions?