Financial Ratio Analysis 1
2
As part of the system of financial control in an organisation, it will be necessary to have ways of measuring the progress of the enterprise, so that managers know how well the company concerned is doing. The financial situation of a company will obviously affect its share price. The answer to some of the following questions can be obtained from accounting reports produced by the company: i. Is the company profitable? ii. Is the company growi ng? iii. Does the company have satisfactory liquidity? iv. I s the company's gearing level acceptable? v. What is the company's dividend policy? The usual way of interpreting accounting reports is to calculate and then to analyse certain ratios (Ratio Analysis). The key to obtain meaningful information from ration analysis is comparison (that is, comparing ratios over time within the same business to establish whether the business is improving or declining, and comparing ratios between similar businesses to see whether Ratios are used in the financial aspects of businesses. They are used for comparison purposes in finding out how their company is doing compared to prior years and compared to other businesses in the same industry. There are four main categories ratios are placed in; profitability ratios, liquidity ratios, operating ratios and solvency ratios. Profitability Ratios 1. Profitability ratios are used in determining the profitability of a company . Three ratios used in this category are gross profit margin, operating profit margin and net profit margin. The gross profit margin ratio is determined by dividing the difference between sales and cost o f goods sold by the total sales amount. The operating profit margin ratio is determined by subtracting the total o f cost of goods sold plus operat in g expenses from the total sales. This amount is then divided by total sales. The net profit margin ratio is determined by subtracting the total of cost of goods sold, operating expenses, and all other expenses from total sales. This amount is divided by the total sales. These ratios are then compared to prior year's ratios to find out if profitability increased or decreased. The higher these numbers are t he better. Liquidity Ratios 2. The two liquidity ratios used are t he quick ratio and the current ratio. These rat ios judge how well a co mpany is able to pay off its short-term debts. The qu ick ratio is determined by taking the current assets minus inventory, then dividing it by the current liabilities. The current ratio is determined by dividing the current assets by the current liabili ties. These ratios again are co mpared to prior year's ratios and industry averages.
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Transcript of Financial Ratio Analysis 1
8/7/2019 Financial Ratio Analysis 1
http://slidepdf.com/reader/full/financial-ratio-analysis-1 1/2
As part of the system of financial control in an organisation, it will be necessary to have ways of
measuring the progress of the enterprise, so that managers know how well the company concerned is
doing. The financial situation of a company will obviously affect its share price. The answer to some of
the following questions can be obtained from accounting reports produced by the company: i. Is the
company profitable? ii. Is the company growing? iii. Does the company have satisfactory liquidity? iv. Is
the company's gearing level acceptable? v. What is the company's dividend policy? The usual way of
interpreting accounting reports is to calculate and then to analyse certain ratios (Ratio Analysis). The key
to obtain meaningful information from ration analysis is comparison (that is, comparing ratios over time
within the same business to establish whether the business is improving or declining, and comparing
ratios between similar businesses to see whether
Ratios are used in the financial aspects of businesses. They are used for comparison purposes infinding out how their company is doing compared to prior years and compared to other
businesses in the same industry. There are four main categories ratios are placed in; profitabilityratios, liquidity ratios, operating ratios and solvency ratios.
Profitability Ratios
1. Profitability ratios are used in determining the profitability of a company. Threeratios used in this category are gross profit margin, operating profit margin and net profit
margin. The gross profit margin ratio is determined by dividing the difference betweensales and cost of goods sold by the total sales amount. The operating profit margin ratio is
determined by subtracting the total of cost of goods sold plus operating expenses from thetotal sales. This amount is then divided by total sales. The net profit margin ratio is
determined by subtracting the total of cost of goods sold, operating expenses, and allother expenses from total sales. This amount is divided by the total sales. These ratios are
then compared to prior year's ratios to find out if profitability increased or decreased. Thehigher these numbers are the better.
Liquidity Ratios
2. The two liquidity ratios used are the quick ratio and the current ratio. These ratios judge
how well a company is able to pay off its short-term debts. The quick ratio is determinedby taking the current assets minus inventory, then dividing it by the current liabilities.
The current ratio is determined by dividing the current assets by the current liabilities.These ratios again are compared to prior year's ratios and industry averages.
8/7/2019 Financial Ratio Analysis 1
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Operating Ratios
3. Several operating ratios are used in businesses to examine expenses and profitability.These ratios are often used for expense control purposes. The three main operating ratios
are the inventory turnover ratio, the sales-to-receivable ratio and the return-on-assets
ratio. The inventory turnover ratio is determined by divided the cost of goods sold by theaverage inventory. The sales-to-receivables ratio is determined by dividing the sales bythe accounts receivable. The return-on-assets ratio is determined by dividing the net
profit by the total assets.
Solvency Ratios
4. Solvency ratios measure a company's ability to pay its long term debts. The two mainsolvency ratios used in businesses are the debt-to-worth ratio and the working capital
ratio. The debt-to-worth ratio is calculated by dividing the total liabilities by the total
tangible net worth of the company. The working capital ratio is not really a ratio, butrather a dollar amount. It is calculated by subtracting the current liabilities from thecurrent assets.
Dividend Policy Ratio
5. A less common ratio used is to measure dividend policy. A dividend yield ratio isdetermined by dividing the dividends per share by the share price. This ratio helps judge
the profitability of dividends in a company.
