Mamdouh Medhat MS/2/20-21

PRINCIPLES OF FINANCE
Section (1)

The Four Key Financial Statements

Income Balance Sheet Statement of Statement of

Statement Retained Earnings Cash Flows

Section (1) Mamdouh Medhat 1

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THE FOUR KEY FINANCIAL STATEMENTS

(cont'd)
Income Statement Balance Sheet
Items USD($) Liabilities + Equity
Revenue (+$) (source of money)

Expenses (-$) Current liabilities (<=1

year) Debt
Net Profit (=$)
Long-term liabilities Financing
Assets
(use of money) (>1 year)
paid-in capital
Retained earnings Equity
Preferred stock Financing
common stock

Section (1) Mamdouh Medhat 2

Types of Ratio Comparisons

• Cross-sectional analysis

• Benchmarking

• Industry comparative analysis

• Time-series analysis

• Combined Analysis

Section (1) Mamdouh Medhat 3

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Financial Ratio Analysis

Liquidity Ratios Activity Ratios Debt Ratios

Profitability
Market Ratios
Ratios

Section (1) Mamdouh Medhat 4

Liquidity Ratios
Current Ratio Quick (Acid-Test) Ratio
(times) (times)
• The current ratio is a measure of the • The quick (acid-test) ratio is like the
firm’s ability to meet its short-term current ratio except that it excludes
obligations. It is calculated as: inventory. It is calculated as:

𝑡𝑜𝑡𝑎𝑙 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑜𝑡𝑎𝑙 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

= =
𝑡𝑜𝑡𝑎𝑙 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑡𝑜𝑡𝑎𝑙 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Section (1) Mamdouh Medhat 5

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Financial Ratio Analysis

Liquidity Ratios Activity Ratios Debt Ratios

Profitability
Market Ratios
Ratios

Section (1) Mamdouh Medhat 6

Activity Ratios
Inventory Turnover Average age of inventory
(times) (in days)
• Inventory turnover commonly • Inventory turnover can be easily
measures the activity, or liquidity, of a converted into an average age of
firm’s inventory. It is calculated as: inventory by dividing it into 365 as
follow:
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 (𝐶𝑂𝐺𝑆)
= 365
𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 =
𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑡𝑢𝑟𝑛 𝑜𝑣𝑒𝑟

Section (1) Mamdouh Medhat 7

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Activity Ratios (cont’d)

Average Collection Period
(ACP) (in days)
• The average collection period, or
average age of accounts receivable, is
useful in evaluating credit and
collection policies. It is calculated as:
𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
= ×365
𝑎𝑛𝑛𝑢𝑎𝑙 𝑠𝑎𝑙𝑒𝑠
Average Payment Period
(APP) (in days)
• The average payment period is the
average amount of time needed to
pay accounts payable. Annual
purchases represent a % of COGS or
annual sales. APP is calculated as:
𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒
= ×365
𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠

Section (1) Mamdouh Medhat 8

Activity Ratios (cont’d)

Total Asset Turnover
(times)
• The total asset turnover indicates the
efficiency with which the firm uses its
assets to generate sales. It is
calculated as:

𝑛𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
=
𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Section (1) Mamdouh Medhat 9

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Financial Ratio Analysis

Liquidity Ratios Activity Ratios Debt Ratios

Profitability
Market Ratios
Ratios

Section (1) Mamdouh Medhat 10

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Debt Ratios
Debt Ratio
(%)
• The debt ratio, sometimes called the
debt to assets ratio, measures the
proportion of total assets financed by
the firm’s creditors. 𝑡𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
• The higher this ratio, the greater the = ×100
𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
amount of other people’s money
being used to generate profits. It is
calculated as:

Section (1) Mamdouh Medhat 11

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Debt Ratios
Times Interest Earned Ratio
(times)
• The times interest earned ratio,
sometimes called the interest coverage
ratio, measures the firm’s ability to make
interest payments. 𝐸𝐵𝐼𝑇
• Earning before interest and taxes = =
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
operating profits.
• The higher its value, the better able the
firm is to fulfil its interest obligations. It is
calculated as:

Section (1) Mamdouh Medhat 12

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