Financial Ratios
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Transcript of Financial Ratios
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Analyzing Analyzing Financial Financial StatementsStatements
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Analyzing Financial StatementsAnalyzing Financial Statements
Financial Statements enhance the decision making ability and offer a
means to assess the status of a business.
They are not a substitute for common sense.
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Analyzing Financial Analyzing Financial StatementsStatements
4 Key Financial Criteria4 Key Financial Criteria
▸Liquidity▸Solvency
▸Profitability▸Financial Efficiency
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Analyzing Financial Analyzing Financial StatementsStatements
LiquidityLiquidity
Ability to meet financial obligations without disrupting normal ongoing
operations.
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Analyzing Financial Analyzing Financial StatementsStatements
LiquidityLiquidity
1. Working capital Total current assets
- Total current liabilities Working capital
should be positive!
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Analyzing Financial Analyzing Financial StatementsStatements
LiquidityLiquidity1. Working capital
Current Assets = $34,000 - Current Liabilities = $23,000 TOTAL $11,000
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Analyzing Financial Analyzing Financial StatementsStatements
LiquidityLiquidity2. Current Ratio
(CA) $65,000 (CL) $20,000 = 3.25:1
Expressed as xx:1
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Analyzing Financial Analyzing Financial StatementsStatements
LiquidityLiquidity
2. Current Ratioa. If the ratio is greater than (1:1), the business is considered liquid.”b. If the ratio is less than 1:1, the business is considered “Not liquid”
reflecting a high degree of short-term cash flow risks.c. The higher the ratio, the more liquid the business
d. As a ratio, it is not dependent on the size of a business and comparisons to other businesses can be made.
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Analyzing Financial Analyzing Financial StatementsStatements
SolvencySolvency
Ability of a business’ debt repayment capacity if all assets are liquidated.
Ability to continue as a viable business after financial adversity.
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Analyzing Financial Analyzing Financial StatementsStatements
SolvencySolvency
1. Debt to Asset Ratio
Total Liabilities Total Assets
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Analyzing Financial Analyzing Financial StatementsStatements
SolvencySolvency
1. Debt to Asset Ratio
Total liabilities Total Assets
The higher the ratio, the greater the risk exposure.
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Analyzing Financial Analyzing Financial StatementsStatements
SolvencySolvency
1. Debt to Asset Ratio
(TL) $ 560,000 = .51:1 (TA) $1,100,000
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Analyzing Financial Analyzing Financial StatementsStatements
SolvencySolvency2. Equity to Asset Ratio (% ownership)
Total Equity Total Assets
the lower the ratio, the more creditors have in the business. (Higher is better)
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Analyzing Financial Analyzing Financial StatementsStatements
SolvencySolvency
3. Debt to Equity Ratio (Leverage)
Total Liabilities Total Equity
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Analyzing Financial Analyzing Financial StatementsStatements
SolvencySolvency
3. Debt to Equity Ratio (Leverage)
$345,000 = 1.47:1 $234,000
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Analyzing Financial Analyzing Financial StatementsStatements
SolvencySolvency
3. Debt to Equity Ratio (leverage)
Total Liabilities Total Equity
the lower the ratio, then creditors have less money in the business that the owner (lower is better)
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Analyzing Financial Analyzing Financial StatementsStatements
ProfitabilityProfitability
Measures the extent to which a business generates a profit from the use of labor,
management, and capital
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Analyzing Financial Analyzing Financial StatementsStatements
ProfitabilityProfitability1. Return on Assets
Net income from operation +interest expense
- value of unpaid operator and family labor and management
Average total assets
the higher the ratio, the more profitable the business
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Analyzing Financial Analyzing Financial StatementsStatements
ProfitabilityProfitability
2. Return on Equity Net income from operation
- value of unpaid operator and family labor and management
Average total equity
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Analyzing Financial Analyzing Financial StatementsStatements
ProfitabilityProfitability2. Return on Equity
Net income from operation - value of unpaid operator and family
labor and management Average total equity
the higher the ratio, the more profitable the business
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Analyzing Financial Analyzing Financial StatementsStatements
ProfitablityProfitablity
2. Return on Equity $75,000
- $23,000 = 9 % $560,000
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Analyzing Financial Analyzing Financial StatementsStatements
Financial EfficiencyFinancial Efficiency
Measures the degree of efficiency in using labor, management, and capital
Financial Efficiency analysis deals with the relationships between inputs and outputs.
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Analyzing Financial Analyzing Financial StatementsStatements
Financial EfficiencyFinancial Efficiency
1. Asset Turnover Ratio Gross revenues Average total assets
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Analyzing Financial Analyzing Financial StatementsStatements
Financial EfficiencyFinancial Efficiency
1. Asset Turnover Ratio $300,000 = .23:1
$1,300,000
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Analyzing Financial Analyzing Financial StatementsStatements
Financial EfficiencyFinancial Efficiency1. Asset turnover ratio
Gross revenues Average total assets
measures how effective assets generate revenue
the higher the ratio, the more efficiently assets are being used to generate revenue.