CLASSIFICATIONS OF RATIO ANALYSIS

Financial Statements Analysis LIQUIDITY RATIOS Provide information about

☛What is Financial Statement Analysis? the firm’s ability to pay its
-A method which involves careful selection of current obligations and
data from financial statements in order to asses continue operations.
LEVERAGE RETIOS Measure the company’s
and evaluate the firms past performance, its
use of debt finance assets
present condition, and future business and operations.
potentials. ASSET Measure how the firm
MANAGEMENT uses its assets to generate
☛What is the objective of Financial Statement RATIOS revenue and income.
Analysis? COST Measure how well a firm
To identify the company’s financial strength and MANAGEMENT controls its costs.
weaknesses and about the: RATIOS
PROFITABILITY Measure earnings in
1. Profitability of the business firm;
RATIOS relation to some basis
2. Firm’s ability to meets its obligations; such as assets, sales or
3. Safety of investment in the business; and capital.
4. Effectiveness of management in running the GROWTH RATIOS Measure the changes in
firm. the economic status of a
frim over a period of time.
TECHNIQUES USED IN FS ANALYSIS VALUATION RATIOS Measure of shareholder
HORIZONTAL Comparison of figures value as reflected in the
ANALYSIS shown in the financial price of the firm’s stock.
(Trend Analysis) statements of two or more
consecutive periods.
Percentage Change =
__More Recent Value –Prior
Period Value__

Prior Period Value

VERTICAL The process of comparing
ANALYSIS figures in the financial
(Common-Size statements of a single
Analysis) period. This is accomplished
by expressing all the figures
in the statements as
percentages of an important
item such as total assets in
the balance sheet or total or
net sales in the income
statement.
RATIO ANALYSIS Utilizes ratios to provide
users of such statements
with relevant information
about the firm’s liquidity,
use of leverage, asset
management, cost control,
profitability, growth and
valuation.
 LIQUIDITY RATIOS
Ratio Formula Significance
1. Current Ratio Current Assets Test of short-term debt paying ability.
Current Liabilities

2. Acid Test or Quick Assets* Measures the firm’s ability to pay its
Quick Ratio Current short-term debts from its most liquid
Liabilities assets without having to rely on
inventory.
 Quick Assets = Cash  Cash Equivalent 
Net Receivables  Marketable Securities

 Cash Ratio Cash  Cash Equivalent  Net Receivables A more conservative variation in Quick
Securities Current Ratio. It tests short-term liquidity
Liabilities without having to rely on receivables
and inventory.

 Cash to Cash  Cash Equivalent  Net Receivables 

Current Securities Current
Assets Ratio Liabilities Measure the liquidity of current assets.

Operating Cash Flow Show the significance of cash flow for

 Cash Flow Current Liabilities setting current obligation as they
Ratio become due.
Cash Equivalents  Net Receivables 
3. Defensive Marketable Securities Reflects the percentage near-cash items
Internal Daily Operating to the daily operating cash flow.
Cash Flow
Shows the amount of current
Increase In Retained Earnings  investment that was “financed” by
4. Investment Depreciation Current depreciation and increase in retained
Financing Investment earnings.

Weighted Non-Cash Current Assets* A measure of the liquidity of current

5. Liquidity Index Current Assets assets stated in days. It shows the
 Balances x the average days they are period-to-period changes in an entity’s
removed from conversion to cash. liquidity.

LEVERAGE RATIOS
Ratio Formula Significance
 Average Total Assets
Financial Average Amount of total assets financed by
Leverage Common Equity equity. The higher the ratio, the
Ratio greater is the leverage (assets financed
by debt) and the greater the risk.

1. Financial Return on Common Equity If the index exceeds 1.0, it is favourable

Leverage Return on and the use of financial leverage is
Index Assets successful.
Measure extent to which the assets
2. Interest- Interest- Bering Debt having explicit cost (total capital) are
Bearing Debt Equity Interest- financed by interest bearing debt.
Ratio Bearing Debt
Total Liabilities Measures the percentage of funds
3. Total Debt Total Assets(Capital) provided by creditors.
Ratio

Total Liabilities Compares resources provided by

4. Debt to Equity Equity creditors with resources provided by
Ratio shareholders.
A more conservative measure of long-
5. Debt to Total Liabilities term debt- payment ability than the
Tangible Net Equity ̶Intangible Assets debt ratio or debt to equity ratio.
Worth Ratio
6. Times- Earnings before interest and
Interest- Tax (EBIT) Interest Indicates the margin of safety for
Earned Ratio Expense payment of fixed interest charges.

EBIT Interest Portion of Operating

7. Fixed Charge Lease Indicates the margin of safety for
Coverage Interest  payment of all fixed charges.
Ratio Interest portion of
Operating Lease

8. Operating Operating Cash Flow Measure the portion of total liabilities

Cash Flow to Total Debt that can be paid out of the cash flows
Total Debt from operations.
Ratio

NOTE: *Since interest expense is tax

*As leverage increases, the risk borne by deductible, leverage increase the
creditors, as well as the risk that the firm may company’s return when it is
not be able to meet its maturing obligations, Profitable.
increases.

ASSET MANAGEMENT RATIO

 Ratio Formula Significance
Indicates if a firm holds excessive
1. Inventory Turnover Cost of Sales stocks of inventories that are
Average unproductive and that lessen the
Inventory company’s profitability.

2. Average Age of Number of Days in a Year Measures the average number of days
Inventories or Inventor that inventory is held before sale.
Number of Days of Inventory y Turnover Ratio

3. Receivables Net Credit Sales Average Measure the average number of days
Turnover Ratio Ave. to collect a receivable.
Accounts Receivable
Number of Days In a Year
4. Average Age of Receivab Measures the average number of days
Receivable les Turnover to collect a receivable.
Ratio

5. Operating Ave. Age of Inventories 

Cycle Average Age of Receivable Measure the average number of days
to convert inventories to cash.
Average Accounts Payable
6. Average Age of Accounts Average Determines whether the firms are
Payable Daily Purchases paying its invoices on a timely basis.

7. Fixed Assets Nets Sales Measures the level of use of property,

Turnover Ratio Average plant and equipment.
Nets Fixed Assets

8. Total Assets Nets Sales Measures the level of capital

Turnover Ratio Average investment relative to sales volumes.
Total Assets

9. Total Capital Nets Sales Measures the level of total assets

Turnover Ratio Capital having explicit costs relative to sales
Total* volume.

*Total Capital = total assets

having explicit costs (equity
 interest-bearing debt)

Total Capital 200B ̶ Total

10. Investment Capital, 200A Measures the percentage change in
Rate Total the total capital.
Capital 200A
11. Plowback Ratio Amount Available for Measures the percentage of net
Reinvestment income available for investment.
Net  A high rate means less external
Income financing.

COST MANAGEMENT RATIOS

Ratio Formula Significance
Measure how much can be spent for
1. Gross Profit Net Sales ̶ Cost of sales marketing, R&D,
Rate Net Sales And administrative costs while still
reaching targeted income.

2. Labor Cost Labor Cost Measures the percentage of labor cost

Ratio Net Sales to sales.

Number of Workers,200B̶ Used as a measure of operational

3. Employment Number of Workers, 200A growth. It is compared with the
Growth Rate Number of investment rate to determine whether
Workers, 200A capital is being substitute for labor.

PROFITABILITY RATIOS
Ratio Formula Significance
1. Profit Margin
on Sales Net Income Measures the percentage of net
Net Sales income to sales.

2. Net Operating
Income to EBIT Net Sales Measures the percentage of operating
Sales income to sales.
3. Return on
Investment
Net Income Indicates whether management is
Average Total using funds wisely.
Assets

A variation of the Return on Total

4. Net Operating EBIT Assets that excludes non-interest-
Income to Equity  Interest – bearing debt from total assets.
Total Capital Bearing Debt

5. Marginal A variation of the Net Operating

Profitability Change in EBIT Income to Total Capital Ratio.
Rate Change in
Capital

6. Return on
Common Net Income ̶ Preferred Measures the return on the carrying
 Equity Dividends Average amount of equity.
Common
Equity

7. Marginal
return on Change in Net Income A variation of the return on common
Common Change in Common equity.
Equity Equity

8. Return on Net Income ̶

Total Equity Dividends on
Redeemable
Preferred Stock
Average Total Equity
Net Operating Profit after Taxes less
9. Economic Capital Charge* or Total Cost of Capital A measure of the shareholder value
Value Added *Capital Charge = total capital Creation.
(EVA) employed x Weighted Average Cost of
Capital

GROWTH RATIOS
Ratio Formula Significance

1. Basic Earnings Income Available to Common Reflects the company’s earning power,
per Share Stockholders e.g., its ability to generate income from
(BEPS) Average normal operations.
Common Shares Outstanding

2. Earnings Yield Earnings per Share Shows the relationship of earnings per
Market Price per share to the market price per share.
Share

3. Cash Flow per Cash provided by An indicator of short-term capacity to

Share Operations less Preferred make capital outlays and dividend
Dividends Comm payments.
on Shares Outstanding

Shows whether a firm pays out most of

4. Dividend Cash Dividends per Common Shares its earnings in dividends or reinvest the
Pay-out Ratio Earnings per earnings internally.
Share

5. Dividend Yield Cash Dividends per Shows the relationship of common

Common Shares dividends per share to the market price
Market Price per per share of such shares.
Common Share
6. Ratio of Net Cash provided Measures the ability to pay dividends
Operating Cash by Operations from current operating sources.
Flows to Cash Cash Dividends
Dividends

7. Internal Amount Retained Measures the percentage increase in

Growth Rate Asset Base assets kept in the business.

Measures the relationship of the

8. Sustainable Return Dividend earnings retained and the return
Equity Growth On x 1- Pay-out thereon.
Rate Common Ratio
Equity

VALUATION RATIOS
Ratio Formula Significance
1. Book value per _________Equity________ Measures the amount of net assets
share Shares outstanding available to the shareholders of a given
type of stock.
2. Market to Book ___Market Price per Share__ Measures how high is the shares’
Ratio Book Value per share market price in relation to book value.
Well managed firms should sell at high
multiples of their book value.
3. Price- Earnings ____Market Price_____ Measures the relationship between the
Ratio Earnings per Share shares’ market price and earnings per
share. Growth companies are likely to
have high PE ratio.
4. Return to _Dividend yield + Capital Gains_ Measures what shareholders actually
Shareholders Measurement Period earn over a specified period of years.
5. Q-Ratio _Market value of all Securities_ Reflects the market’s valuation of new
Replacement Cost of Assets investment. When the Q- ratio is
greater than (1.0), it means that the
firm is earning returns greater than the
invested.
6. Return on Dividends per Share + A calculation of the return on the price
Shareholders’ _MV of Reinvested Earnings_ of a common share.
Investment (ROSI) Price per Share