1. Financial Ratio Analysis
Mohammad Azam

2. Corporation’s Financial Statements
With diverse ownership, corporations do not enjoy the secrecy that proprietorships and partnerships have.
Corporation must send each shareholder an annual report detailing the financial condition of the firm.

3. Importance of Financial Ratios:
To evaluate a company’s operating performance, managers and external users may perform ratio analysis.
Financial Ratios are ways of comparing and investigating the relationships between different pieces of financial information.

4. Importance (Continued…)
The ratios are benchmarks used to compare a company’s performance with that of previous periods and with that of other companies.
Ratio analysis is used by external users to evaluate a company’s profitability.
Financial ratio analysis evaluates the financial performance and condition of a business unit by measuring its progress toward financial goals.

5. Common-Size and Common-Base-Year Financial Statements
Income statement items as a percentage of total sales.
Provides insight into how the relative items contribute to revenues and expenses.
Balance sheet items as a percentage of total assets.
Provides a insight into the structure of the company’s assets and financing.
Common-base-year financial statements provide such comparisons to a base year.

6. Retail Company Ltd. Income Statement for the Years Ending
2008
2009
2010
Net Sales
2,188
2,123
2,715
CGS
1,692
1,667
2,105
Gross Income
496
456
610
Operating Expenses:
General & Admin
188
203
238
Selling Exp.
193
210
282
Dep. Office Equipment 37 35
Total operating Expenses
418
450
555
Net Operating Income 78 6 55
Other Expenses-Interest 8
Net Income before tax 70 47
Estimated Income tax 18 12
Net Earnings 52

7. Louise Eliason & Company
Balance Sheet
December 31, 2010
ASSETS
US $
LIABILITIES
Current Assets
Current Liabilities
Cash
96,000
Accounts payable
246,000
Net accounts receivable
367,000
Short-term notes
24,000
Inventory
177,000
Accruals & other payables
28,000
Temporary investment
12,000
Total Current Liabilities
298,000
Prepaid expenses
2,000
Total Current Assets
654,000
Long-term Liabilities
Mortgage
897,000
Fixed Assets
Other long-term liabilities
443,000
Total Long-term Liabilities
1,340,000
Land
656,000
Buildings (net of depreciation)
903,000
SHAREHOLDERS' EQUITY
Plant & equipment (net)
608,000
Capital stock
300,000
Furniture & fixtures (net)
61,000
Retained earnings
944,000
Total Net Fixed Assets
2,228,000
Total Shareholders' Equity
1,244,000
TOTAL ASSETS
2,882,000
TOTAL LIABILITIES & EQUITY

8. Ratios Ratios are indicators of change and simplify relationships.
The ratio does not tell us if the change was good or bad or even why it occurred.
A ratio changes if the numerator or denominator or both change.

9. Classification of Financial Ratios
Liquidity Ratios
Leverage Ratios
Profitability Ratios
Market Value Ratios

10. Liquidity Ratios Also called Short-term Solvency ratios.
The primary concern is the firm’s ability to pay its bills over the short run without undue stress. Following are the considered liquidity ratios:
Current Ratio
Quick Ratio
Working Capital Ratio

11. Current Ratio Current Assets Current Ratio = Current Liabilities $400
1.58
$253
5 Stars corporation has $1.58 in current assets for every $1 in current liabilities. Or
5 Stars corporation has its current liabilities covered 1.58 times over.

12. Quick Ratio or Acid-Test Ratio:
Current
Assets
Inventories s
Quick
Ratio =
Current
Liabilities s
$400-$140 = =
1.03
$253
Inventory is often the least liquid current asset. Some of the inventory may later turn out to be damaged, obsolete or lost.
Note: Using cash to buy inventory doesn’t affect the current ratio, but it reduces the quick ratio.

13. Working Capital Ratio = Current Assets – Current Liabilities Sales $
400 - $
253 = = 13 .
61% $ 1 ,
080
What Does Working Capital Mean? A measure of both a company's efficiency and its short-term financial health.

14. Leverage Ratios
Debt Ratio
Debt-to-Equity Ratio

15. Debt Ratio Total Debt Debt Ratio = Total Assets $ 488 . 50 = = . 42 $. 42 $ 1 ,
150 . 00
It tells us how much the company relies on debt to finance assets. The lower the company’s reliance on debt for asset formation, the less risky the company is since excessive debt can lead to a very heavy interest  and principal repayment burden.

16. Debt-to-Equity Ratio Total Debt Debt / Equity Ratio = Shareholde r ' s$
488 . 50 = = . 74 $
661 . 50
A measure of a company's financial leverage. Debt/equity ratio is equal to long-term debt divided by common shareholders' equity.  Investing in a company with a higher debt/equity ratio may be riskier, especially in times of rising interest rates, due to the additional interest that has to be paid out for the debt.

17. Profitability Ratios Gross Profit Margin Net Profit Margin
Return on Assets

18. Gross Profit Gross Profit Margin = Sales $ 520 . 00 = = 48 . 15% $1 ,
080 . 00
What remains from sales after a company pays out the cost of goods sold, gross profit.
The 48.15% gross profit margin means that for every dollar generated in sales, the company has cents left over to cover basic operating costs and profit.

19. Net Income Net Profit Margin = Sales $ 42 . 00 = = 3 . 89% $1 , 080 .
This number is an indication of how effective a company is at cost control.
The higher the net profit margin is, the more effective the company is at converting revenue into actual profit. The net profit margin is a good way of comparing companies in the same industry

20. Net Income Re turn on Assets = Total Assets $ 42 . 00 = = 3 . 65% $1 ,
150 . 00
An indicator of how profitable a company is relative to its total assets. 
ROA gives an idea as to how efficient management is at using its assets to generate earnings.

21. Market Value Ratios
P/E Ratio
Earnings Yield
Dividend Yield

22. P/E Ratio Pr ice per Share P / E Ratio = Earnings per Share $ 29 . 0012 . 89 $ 2 . 25
A valuation ratio of a company's current share price compared to its per-share earnings.

23. Earnings Yield Earnings per Share Earnings Yield = Pr ice per Share $2 . 25 = = 7 .
76% $ 29 . 00
The earnings yield (which is the inverse of the P/E ratio) shows the percentage of each dollar invested in the stock that was earned by the company.
The earnings yield is used by many investment managers to determine optimal asset allocations.

24. Dividends per Share Dividend Yield = Pr ice per Share $ 1 . 25 = = 4 .
31% $ 29 . 00
Dividend yield shows how much a company pays out in dividends each year relative to its share price.
In the absence of any capital gains, the dividend yield is the return on investment for a stock.
Dividend yield is a way to measure how much cash flow you are getting for each dollar invested.