ACT 2 RATIOS _1 Instructions FORMULAS AND MEANINGS

Financial ratios can be calculated by comparing two figures in the accounts which are related. It
may be one number expressed as a percentage of another number or simply one number
divided by another one. They need to be compared to another ratio either over time or with
other companies in the same industry.

Note: For learning purposes we will work using financial statements (Balance Sheet and Income
statement) provided by your teacher for one year only.

Instructions: Use this document and Balance Sheet and Income Statement attached supporting
documents to calculate the following 6 ratios and explain the meaning of each result.

LIQUIDITY RATIOS: MEASURES THE FIRMS ABILITY TO PAY ITS SHORT TERMS DEBTS .
(Liquid assets: those easily converted into cash).

1. Current ratio Current assets A typical business with a current ratio between
1.5:1and 2:1 should not experience liquidity problems.
Current liabilities For 1 dollar of current liability the business has 1.5 of
current assets
1.38
Liquidity problems, range should
be between 1.5 – 2.0
2. Acid test ratio Current assets - stocks(inventory) acid test =1 or very close to 1. The company has
sufficient working capital.
Current liabilities
More severe test of liquidity because stocks are not
1.13 considered (stocks could become obsolete or could
not be sold that’s why it is excluded from the assets).
No liquidity problems, above 1.
If a business has a 1:1 ratio it means that its current
assets less stock do not cover its currents liabilities.

3. Networking Total current assets - Total current Though is not really a ratio is often used to measure
a firm’s overall liquidity.
Capital liabilities

23,050
Positive liquidity
PROFITABILITY RATIOS: MEASURES HOW WELL THE FIRM IS USING ITS
RESOURCES

4. Earnings per share Net profit aaaaaaa Price of each share.

# Of ordinary share

3.22 per share

ACTIVITY RATIOS: MEASURES HOW WELL A FIRM USES ITS ASSETS

5. Inventory turnover Cost of goods sold Measures the #of times in a year that
a business sells the value of its
Average stocks (inventory) inventory.

6.81 of times in a year

the business sells the
value of its inventory.

6. Debt to equity: total liabilities It is s a measure of borrowing

total owners’ equity power.

A 3:1 ratio is the upper limit of

0.89
This shows that for every
dollar, .89 cents goes to
debts, which maintains
earnings in the owner´s
equity.
normal for most banks,
meaning for every $3 in debt
there is at least $1 in equity
(owner's money)..
??? of debt for every dollar the
owners provide .