1. Definition of financial ratio FINANCIAL RATIO  One of the most common tools of managerial decision making  Financial ration involve the comparison of various figures from the financial statements in order to gain information about a company’s performance  Ratios may serve as indicators, clues or red flags

2. Use and users of ratio analysis FINANCIAL RATIO  Two uses of financial ratio: to track individual firm performance over time and to make comparative judgments regarding firm performance  Another common usage: to make relative performance comparisons  Users of financial ratios include parties both internal and external to the firm  External users- security analysts, current and potential investors, creditors, competitors and industry observers  Internal users- managers

3. PROFITABILITY RATIO FINANCIAL RATIO  To measure how well a business is performing in terms of profit  If a company is having a higher profitability ratio compared to its competitor, it can be defined as the company is doing better than that particular competitor  The higher or same profitability ratio of a company compared to its previous period also indicates that the company is doing well

4. PROFITABILITY RATIO FINANCIAL RATIO GROSS PROFIT MARGIN  Gives the value of gross profit earned by the company over sale  FORMULA: Gross Profit Margin= (Total sales- Cost of goods sold) Sales

5. PROFITABILITY RATIO FINANCIAL RATIO RETURN ON EQUITY  Gives the value of profit that is earned against every invested dollar in the stock of the firm  FORMULA= Net income Shareholder Equity

6. ASSET UTILIZATION RATIO FINANCIAL RATIO  Tell a small business how well their assets are working to generate sales  Cash is always the best asset but it does not generate any revenue  The other assets (accounts receivable, inventory, fixed assets) do generate sales revenue  Asset utilization ratio calculates the total revenue earned for every dollar of assets a company owns  For eg; with an asset utilization ratio of 52%, a company earned $0.52 for each dollar of assets held by the company

7. LEVERAGE RATIO FINANCIAL RATIO  To evaluate/calculate a company’s debt level  FORMULA= Total debt Total asset  For eg; Company XYZ has $10 million of debt and $15 million of assets So, XYZ’s debt ratio= $10,000,000 $15,000,000 Every dollar of its assets, Company XYZ has 67 cents of debt = 0.67 (67%)

8. LEVERAGE RATIO FINANCIAL RATIO  Debt-to-Equity Ratio FORMULA= Total debt Total Equity Company XYZ’s debt-to-equity ratio= $10,000,000 $10,000,000 So, for every dollar for Company XYZ (owned by shareholders), Company XYZ owes $1 to creditors = 1.0 (100%)

9. LIQUIDITY RATIO FINANCIAL RATIO  Used to determine a company’s ability to pay off its short-terms debts obligations  So, the higher the value of the ratio, the larger the margin of safety that the company possesses to cover short-term debts  A company’s ability to turn short-term assets into cash to cover debts is of the utmost importance when creditors are seeking payment

10. LIQUIDITY RATIO FINANCIAL RATIO  Used to determine a company’s ability to pay off its short-terms debts obligations  So, the higher the value of the ratio, the larger the margin of safety that the company possesses to cover short-term debts  A company’s ability to turn short-term assets into cash to cover debts is of the utmost importance when creditors are seeking payment

11. LIQUIDITY RATIO FINANCIAL RATIO  EXAMPLE As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings’ current assets amounted to $1,575.60, while current liabilities amounted to $606.90.

12. LIQUIDITY RATIO FINANCIAL RATIO  EXAMPLE As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings’ quick assets (liquid assets- easily convertible into cash) amounted to $756.40, while current liabilities amounted to $606.90.

13. LIQUIDITY RATIO FINANCIAL RATIO  EXAMPLE As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings’ cash assets amounted to $233.20, while current liabilities amounted to $606.90.

14. MARKET VALUE RATIO FINANCIAL RATIO  Evaluate the economic status of your company in the wider marketplace  Market value ratios include the earnings per share, price earnings ratio, the price/cash ratio, dividend yield, book value per share, market value per share and market/book ratio  Market value ratios give management an idea of what the firm’s investors think of the firm’s performance and future prospects

15. EARNINGS PER SHARE FINANCIAL RATIO  Earnings per share is the figure used in the company’s price earnings ration which is used to determine how much investors are willing to pay per share of stock  Usually, investors compare earnings per share to the market price per share of the stock they own EARNINGS PER SHARE (EPS)= Net income available to common shareholders Number of common shares outstanding = $84,000 = $0.21 EPS $400,000

16. PRICE EARNINGS RATIO FINANCIAL RATIO  A company’s price earnings ratio can change often, even on a daily basis, because the market price of the stock can change  Investors use the price earnings ratio extensively in investment analysis  Different industries, different businesses and different economic time periods often mean different and varying price to earnings ratios for companies PRICE EARNINGS RATIO= Current market price of company’s stock Earnings per share of stock

17. DIVIDEND YIELD FINANCIAL RATIO  Dividends per share are the amount of dividends that a publicly-traded company pays per share of common stock, over their reporting period that they have issued  The proportion of earnings used to pay out as dividends to investors and retained by the company is called dividend payout ratio  Investors use dividends as a signal. If dividends per share drop, then investors take that as a signal that the company is not doing well financially DIVIDENDS PER SHARE= Dividends Paid ($) Numbers of shares outstanding common stock

18. BOOK VALUE PER SHARE FINANCIAL RATIO  The purpose is to relate shareholder’s equity to the number of shares of common stock outstanding  Since the numbers of shares of preferred stock are not considered, this gives a more ‘real’ value to the common shares outstanding BOOK VALUE PER SHARE= Shareholder’s Equity-Preferred Stock Average outstanding common stock

19. MARKET TO BOOK RATIO FINANCIAL RATIO  Used by security analysts to determine of a stock is undervalued or overvalued  If a stock is undervalued, the price is expected to rise. If it is overvalued, the price is expected to fall  Market to book looks at the value the market places on the book value of a company MARKET TO BOOK = Share price of the stock Book value per share