QUANTITATIVE DECISION-MAKING AIDS

Tiffany Gail C. Clamucha

I. TOPIC OUTLINE
a. Ratio Analysis
i. Liquidity Ratio
1. Current Ratio
2. Acid Test Ratio
ii. Leverage Ratio
1. Debt to assets
2. Times interest earned
iii. Operations Ratio
1. Inventory Turnover
2. Total assets turnover
iv. Profitability Ratio
1. Profit on margin revenues
2. Return on Investment
b. Queueing Theory
c. Economic Order Quantity Model

II. RATIO ANALYSIS

This is a method of quantifying a company’s financial performance
over time and relative to its peers.

When we say over time, it means that a company is not only

focused on where it is today, instead, it is more interested in knowing
how the company has performed over time, what changes have
worked, and what risks still exist looking to the future.

When we say relative to its peers, it measures how a company

stacks up against others within the same sector. For example, if you
are in an automobile sector, like Toyota, you only compare your
financial performance with the same automobile sector, like Ford.

i. LIQUIDITY RATIO
One type of Ratio Analysis is Liquidity Ratio. It is a
measure of the organization’s ability to convert assets into
cash in order to meet its debt obligations.

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 It is favorable to invest in companies with high liquidity
ratio because the more likely the company is able to cover
its short-term debts.

Lower ratios should be a warning sign to investors

because it suggests that a company may have trouble
meeting its short-term obligations and struggle to fund its
long-term operations.

1. CURRENT RATIO
Under liquidity ratio is the Current ratio, which
measures a company’s ability to pay off its current
liabilities (such as debt, which should be payable
within a year), with its current assets (such as
cash, accounts receivables, and inventories.)

Formula: To find the current ratio, divide the

company’s current assets, which are cash, inventory,
and receivables, by its current liabilities: its debts and
other payables

Example: For example, we calculate the current

ratios of Apple, Walt Disney, and Costco Wholesale
for the fiscal year 2017:

For every $1 of current debt, Costco Wholesale had

99 cents available to pay for debt.

Likewise, Walt Disney had 81 cents in current assets

for each dollar of current debt.

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Apple, meanwhile, had more than enough to cover its
current liabilities if they were all theoretically due
immediately.

As we can see here, if the current ratio is less than 1,

the company may have trouble paying its short-term
obligations if they come due at a particular time.

So generally, creditors who are expecting to be paid

in the next 12 months are looking for higher current
ratios because this means that they have a greater
chance of being re-paid in the expected amount of
time.

2. ACID TEST RATIO

Another type of liquidity ratio is the acid test
ratio, which measures a company's capacity to
pay its current liabilities without needing to sell its
inventory or obtain additional financing.
The acid-test ratio disregards current assets
that are difficult to liquidate quickly such as
inventory.
Why does acid test ratio apply this? This is
because inventory can often take several months
or even years to turn into cash. So many financial
experts believe that it is not a good indicator of a
company’s ability to pay short-term bills.
Since it indicates the company’s ability to
instantly use its near-cash assets to pay down its
current liabilities, it is called the acid test ratio. An
"acid test" is a slang term for a quick test designed
to produce instant results.

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 Formula:

This is the acid test ratio formula. We subtract

the company’s inventory from its current
assets, and divide the difference by the
business’ current liabilities.

Example:

As an example, let us look at Lester’s Printing

Company. The company has a current asset of
95, 125 and an inventory of 5, 412. The
difference, which is 89, 713 will be divided by
the current asset of the company, which is
29,999. The acid test ratio is 2.99.

ii. LEVERAGE RATIO

The Leverage ratio or a tool that determines the dependency
of companies on debt for building capital. Leverage ratio
helps investors assess how capable the companies are in
managing their debts and whether it would be fruitful for
investors to invest in these companies.

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Example:

Though we know that the amount of debt helps build capital,

investors look more at it as a liability.

For example, Queen Karla’s Company has a leverage ratio

of 2.33. This figure presents us a high leverage ratio and it
indicates that Queen Karla’s Company uses more debt
than equity to build its resources. And when the debt is
more, the repercussions might turn more severe, including
bankruptcies.

1. DEBT TO ASSETS RATIO

Formula: Divide the company’s total outstanding debt by the

amount of company’s assets.

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Example:

Berna’s office supplies corp., for example, has a short-term

debt of 10,000 and long-term debt of 15,000. We add the
two, which gives us 25,000, then we divide it by the
company’s assets of 75,000 to arrive at leverage ratio of
0.33.

This figure tells us that the company has a low ratio and is
considered a safe investment because the company is not
highly leverages and thus has the ability to pay their
interests and principal payments.

2. TIMES INTEREST EARNED RATIO

Another type of Leverage ratio is Times Interest Earned
Ratio or a measure of a company’s ability to meet its debt
obligation based on its current income.

Formula: Times Interest Earned is calculated by dividing

the company’s EBIT or the earnings before interest and
taxes by the interests that are payable on its debts.

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 Example: Suppose that Arn Arn’s Lending Corporation
has a net income of 1 million with interest expenses
totaling to 200,000, and it owes taxes totaling to 300,000.
So we add 1 M, 200k, and 300k to get the EBIT, then
divide the sum to the interest expense which is 200k.

Its Ratio is 7.5.

This figure tells us that Arn Arn’s income is 7.5 times

greater than its annual interest expense. So basically, it
can pay its interest expense 7 and ½ times over.

iii. OPERATING RATIO

The third type of Ratio Analysis is the Operating Ratio which

compares a company’s total operating expense to its net sales.

- Operating expenses can include: Accounting and legal

fees, Bank charges, Office supply costs, Rent and utility
expenses, Repair and maintenance costs, and Salary
and wage expenses.

Formula: The formula to determine an operating ratio is to divide a

company’s total operating expenses by its net sales.

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Example: For example, Aling Nena’s Corporations added its cost
of good sold and administrative and sales expenses and came up
with a total of 750,000 as its operating expenses. It divided the
figure by its net sales for the year which were 1.2 million. Thus
Aling Nena’s operating ratio is 0.625. This figure means that 63% of
the company's net sales are operating expenses.

1. INVENTORY TURNOVER RATIO

Under the operating ratio is The inventory turnover
ratio or the number of times a company has sold and
replenished its inventory over a specific amount of time.
A low inventory turnover ratio implies weak sales and
possibly excess inventory, also known as overstocking.
It may indicate a problem with the goods being offered
or a result of too little marketing.

Formula: Inventory Turnover Ratio may be calculated

by dividing the cost of goods sold by average
inventory.

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 Example: For example, Lito wants to invest in a
department store. He gets cost of good sold of
200,000 and its annual average inventory figure of
20,000 to get an inventory turnover of 10. This figure
means that Lito turned or sold out its inventory 10
times during the year.

2. TOTAL ASSETS TURNOVER

Another type of operating ratio is The asset turnover
ratio which measures how effectively a company uses
its assets to generate revenue or sales.

Formula: Total Assets Turnover may be calculated by

dividing the company’s revenue or the the money
generated from normal business operations by its
assets or a resource of value that a company owns that
helps the company run its business.

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 Example: Suppose company ABC had total revenue of 10
billion at the end of its fiscal year and its total assets was $4
billion.

ABC Company's Asset Turnover Ratio = 10 billion / 4 billion

= 2.5

On the other hand, company XYZ - a competitor of ABC in

the same sector - had total revenue of 8 billion at the end of
the same fiscal year. Its total assets were 1.5 billion.

XYZ Company's Asset Turnover Ratio = 8 billion / 1.5 billion

= 5.33

Though ABC has generated more revenue for the year, XYZ
is more efficient in using its assets to generate income as its
asset turnover ratio is higher.

iv. PROFITABILITY RATIO

Another type of ratio analysis is Profitability ratio, which
represents how profitable owner’s funds have been utilized
in the company. Basically, profitability is the capacity to
make a profit, and a profit is what is left over from income
earned after you have deducted all costs and expenses
related to earning the income.

1. PROFIT MARGIN ON REVENUES

One type of profitability ratio is Profit Margin on revenues,
which measures how much profit your business has
generated for each peso of sale.

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Formula: To find out how much of every peso of revenue is
kept in the form of profit, divide the net income by total net
sales or revenue.

Example: A’s Corporation revenue, for example, was 1

million. After taking out expenses and other operational
costs which amounts to 800,000, A’s net profit is 200,000.

So, we Subtract the operational costs from the revenue to

come up with a net profit of 200,000. Then, to get the profit
margin, we divide the net profit of 200,000 by the revenue
which is 1 million. So the company’s profit margin is 20%.

What does this figure mean?

This basically means that 20% of every peso in revenue was

profit.

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2. RETURN ON INVESTMENT
Return on investment, on the other hand, measures the
probability of gaining returns from investments.

Formula: : Return on investment (ROI) is calculated by

dividing the profit earned on an investment by the cost of
that investment.

Example: For example, suppose Jo invested P1,000 in Slice

Pizza Corp. in 2017 and sold the shares for a total of P1,200
one year later.

To calculate the return on this investment, divide the net

profits (1,200 - 1,000 = 200) by the investment cost (1,000),
for an ROI of 20%.

This figure shows that the total returns is 20% greater than
the associated cost.

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III. QUEUING THEORY
To define, Queuing theory is a branch of mathematics that studies how
lines form, how they function, and why they malfunction. Queuing
theory examines every component of waiting in line, including the
arrival process, service process, number of servers, number of system
places, and the number of customers

How does queuing theory works? Queues can occur whenever

resources are limited. For example, a queue can grow if there are
limited number of tellers in a bank or servers in a supermarket.

However, some queuing is tolerable in any business and a total

absence of a queue would suggest a costly overcapacity. Overcapacity
is a condition that occurs when demand for a product is less than the
amount of product that a business could potentially supply to the
market. 

Example: For example, customers arrive at a shop with one counter at

a rate of 30 per hour. It takes about 3 minutes to serve a customer.
What is the inter-arrival for customers?

Okay so 30 customers arrive at a shop per hour and the shop only has
one service point. It takes about three minutes to serve a customer.
What is the inter-arrival time?

So I’ll give you guys an easy formula for getting inter-arrival time and
that is the time taken divided by the number of customers arriving.

So it has taken them one hour for 30 customers to arrive.

So 30 customers arrive in one hour. Now 1 hour is not a very easy unit
to process so let’s convert that to 60 minutes right because one hour is
60 mins. So 60 mins divided by 30 customers is 2.

And because we have minutes divided by customers it will be 2

minutes per customer. So that is the inter-arrival time. It takes 2
minutes for each customer to arrive.

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IV. ECONOMIC ORDER QUANTITY MODEL
Lastly is the Economic Order Quantity Model. This is a formula used to
determine inventory orders, particularly to lower their inventory
ordering and carrying cost.

Formula: EOQ= √2DS/H

• S: Set-up costs (Order cost)
• D: Demand Rate
• H: Holding costs

Example: Assume, for example, a retail clothing shop carries a line of

men’s jeans, and the shop sells 1,000 pairs of jeans each year. It costs
the company $5 per year to hold a pair of jeans in inventory, and the fixed
cost to place an order is $2.

The EOQ formula is the square root of (2 x 1,000 pairs x $2 order cost) /
($5 sholding cost) or 28.3 with rounding.

The ideal order size to minimize costs and meet customer demand is
slightly more than 28 pairs of jeans.

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