NORTHERN UNIVERSITY B A N G L A D E S H

Presentation on:

Ratio analysis

Md. Zamanur RahmanAsst. Professor

Department of BBANorthern University Bangladesh

Presented To:

Prepared By

Department of BBA

JAKIR KHAN

Ratio analysisRatio analysis is used to evaluate relationships among financial statement items. The ratios are used to identify trends over time for one company or to compare two or more companies at one point in time. Financial statement ratio analysis focuses on three key aspects of a business: 

i. Liquidityii. Profitabilityiii. Solvency.

Liquidity ratios:Liquidity ratios measure the ability of a company to repay its short-term debts and meet unexpected cash needs.

Current ratio: The current ratio is also called the working capital ratio, as working capital is the difference between current assets and current liabilities. This ratio measures the ability of a company to pay its current obligations using current assets. The current ratio is calculated by dividing current assets by current liabilities.

2011 2010

Current assets $38,366 $38,294

Current liabilities 27,945 30,347

Current ratio 1.4 : 1 1.3 : 1

This ratio indicates the company has more current assets than current liabilities. Different industries have different levels of expected liquidity. Whether the ratio is considered adequate coverage depends on the type of business, the components of its current assets, and the ability of the company to generate cash from its receivables and by selling inventory.

Acid-test ratio. The acid-test ratio is also called the quick ratio. Quick assets are defined as cash, marketable (or short-term) securities, and accounts receivable and notes receivable, net of the allowances for doubtful accounts. These assets are considered to be very liquid (easy to obtain cash from the assets) and therefore, available for immediate use to pay obligations. The acid-test ratio is calculated by dividing quick assets by current liabilities.

2011 2010

Cash $6,950 $6,330

Accounts receivable, net 18,567 19,230

Quick Assets $25,517 $25,560

Current Liabilities $27,945 $30,347

Acid-test ratio .9 : 1 .8 : 1

The traditional rule of thumb for this ratio has been 1:1. Anything below this level requires further analysis of receivables to understand how often the company turns them into cash. It may also indicate the company needs to establish a line of credit with a financial institution to ensure the company has access to cash when it needs to pay its obligations.

Receivables turnover:. The receivable turnover ratio calculates the number of times in an operating cycle (normally one year) the company collects its receivable balance. It is calculated by dividing net credit sales by the average net receivables. Net credit sales is net sales less cash sales. If cash sales are unknown, use net sales. Average net receivables is usually the balance of net receivables at the beginning of the year plus the balance of net receivables at the end of the year divided by two. If the company is cyclical, an average calculated on a reasonable basis for the company's operations should be used such as monthly or quarterly.

2011 2010 2009

Net credit sales $129,000 $97,000

Accounts receivable 18,567 19,230 $17,599

Average receivables (18,567+19,230)/2= (19,230+17,599)/2=

18,898.5 18,414.5

Receivables turnover $129,00/$18,898.5 = $97,00/$18,414.5 =

6.8 times 5.3 times

Calculation of Receivables Turnover

Inventory turnover: The inventory turnover ratio measures the number of times the company sells its inventory during the period. It is calculated by dividing the cost of goods sold by average inventory. Average inventory is calculated by adding beginning inventory and ending inventory and dividing by 2. If the company is cyclical, an average calculated on a reasonable basis for the company's operations should be used such as monthly or quarterly.

2011 2010 2009

Cost of goods sold $70,950 $59,740

Inventory 12,309 12,202 $12,102

Average inventory (12,309+12,202)/2= (12,202+12,102)/2=

12,255.5 12,152

Inventory turnover

$70,950/$12,255.5= $59,740/$12,152=

5.8 times 4.9 times

Profitability ratios:

Profitability ratios measure a company's operating efficiency, including its ability to generate income and therefore, cash flow. Cash flow affects the company's ability to obtain debt and equity financing.

Profit margin: The profit margin ratio, also known as the operating performance ratio, measures the company's ability to turn its sales into net income. To evaluate the profit margin, it must be compared to competitors and industry statistics. It is calculated by dividing net income by net sales.

2011 2010

Net income/(loss) $ 8,130

Net sales 129,000

Profit margin 6.3% (1.4%)

Asset turnover: The asset turnover ratio measures how efficiently a company is using its assets. The turnover value varies by industry. It is calculated by dividing net sales by average total assets.

2011 2010 2009

Net sales $129,000 $97,000

Total assets 114,538 118,732 $102,750

Average total assets (114,538+118,732)/2= (118,732+102,750)/2=

116,635 110,741

Asset turnover $129,00/$116,635= $97,00/$110,741 =

1.1 times .9 times

Return on assets: The return on assets ratio (ROA) is considered an overall measure of profitability. It measures how much net income was generated for each $1 of assets the company has. ROA is a combination of the profit margin ratio and the asset turnover ratio. It can be calculated separately by dividing net income by average total assets or by multiplying the profit margin ratio times the asset turnover ratio.

The information shown in equation format can also be shown as follows:

2011 2010 2011 2010

Net income/(loss) $ 8,130 $(1,400) Profit margin 6.3% (1.4%)

Average total assets 116,635 110,741 Asset turnover

1.1 times .9 times

Return on assets 6.97% (1.3%) Return on assets

6.93% * (1.3%)

Return on common stockholders' equity. The return on common stockholders' equity (ROE) measures how much net income was earned relative to each dollar of common stockholders' equity. It is calculated by dividing net income by average common stockholders' equity. In a simple capital structure (only common stock outstanding), average common stockholders' equity is the average of the beginning and ending stockholders' equity.

Calculation of Return on Common Stockholders' Equity 2011 2010 2009

Net income/(loss) $ 8,130 $ (1,400)

Total stockholders' equity

71,593 65,385 $68,080

Average stockholders' equity

(71,593+65,385)/2= (65,385+68,080)/2=

68,489 66,732.5

Return on common stockholders' equity

$8,130/$68,489= $(1,400)/$66,732.5=

11.9% (2.1%)

Return on preferred stockholders' equity.

Solvency ratiosSolvency ratios are used to measure long-term risk and are of interest to long-term creditors and stockholders.

Debt to total assets ratio. The debt to total assets ratio calculates the percent of assets provided by creditors. It is calculated by dividing total debt by total assets. Total debt is the same as total liabilities.

2011 2010

Current liabilities $27,945 $ 30,347

Long-term debt 15,000 23,000

Total debt $ 42,945 $ 53,347

Total assets $114,538 $118,732

Debt to total assets 37.5% 44.9%

The 2011 ratio of 37.5% means that creditors have provided 37.5% of the company's financing for its assets and the stockholders have provided 62.5%.

Times interest earned ratio: The times interest earned ratio is an indicator of the company's ability to pay interest as it comes due. It is calculated by dividing earnings before interest and taxes (EBIT) by interest expense.

2011 2010

Income before interest expense and income taxesIncome (loss) before taxes $13,550 $(2,295)

Interest expense 1,900 1,500

EBIT $15,450 $ (795)

Interest Expense $ 1,900 $ 1,500

Times interest earned 8.1 times

N/M

A times interest earned ratio of 2–3 or more indicates that interest expense should reasonably be covered. If the times interest earned ratio is less than two it will be difficult to find a bank to loan money to the business.

Thank You Everybody