Ratio analysis
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Transcript of Ratio analysis
Financial Health & Financial Ratios
Financial Health Indicators Analyses
Financial Ratios
1. Debt Management 1. Debt ratio2. Times-Interest-Earned Ratio
2. Liquidity 1. Current Ratio2. Quick Ratio
3. Asset Management 1. Inventory turnover Ratio2. Day’s Sales Outstanding
Ratio3. Total Assets Turn over Ratio
4. Profitability 1. Profit Margin on Sales2. Return on Total Assets3. Return on Common Equity
5. Market Value (Trend) 1. Price to Earnings Ratio2. Market/Book Ratio (Book
value per share)
1. Debt Management Analyses
Contemporary Engineering Economics, 5th edition. ©2010
Debt Financing (Financial Leverage) Analyses
Contemporary Engineering Economics, 5th edition. ©2010
1.1 Debt Ratio
Debt Ratio = Total Debt Total Assets
• If the Debt Ratio is One (Unity), then the Company has used all its Assets to finance its Debts
• A ratio more than one indicates that the company has more debt than its assets
• Creditor’s prefer low Debt Ratios, because the lower the ratio, the greater is the cushion against creditor’s losses
Contemporary Engineering Economics, 5th edition. ©2010
1.2 Times-Interest-Earned Ratio
Times Interest Earned Ratio =Operating Profit (Earnings before Interest & taxes (EBIT)
Interest Expenses
• Higher values will favor the company in repaying its interest and debts.
• Value below 1.5 is unsafe for the company• Failure to meet this obligation (value of 1 )
possibly results in bankruptcy.
Contemporary Engineering Economics, 5th edition. ©2010
Illustration Question
A) A Company has SR 10 million of debts in its balance sheet and SR 15 million of assets.
Calculate the Debt ratio.
B) If that company’s interest expenses are SR239,000 and EBIT 3,493,000; calculate Times-Interest-Earned ratio.
Contemporary Engineering Economics, 5th edition. ©2010
Answer
A) Debt Ratio= Total Debt = 10 million
= 0.67 (67%) Total Assets 15 million
B) Times-Interest-Earned Ratio = EBIT
Interest Expenses= 3493,000 = 14.6
239,000Contemporary Engineering Economics, 5th edition. ©2010
2. Liquidity Analysis
Contemporary Engineering Economics, 5th edition. ©2010
2.1 Current Ratio
Current Ratio = Current AssetsCurrent Liabilities
It shows the company’s ability to pay back its short-term liabilities with short term assets.A ratio above 1 is required for the survival (ratio above 2 is favorable)
Contemporary Engineering Economics, 5th edition. ©2010
2.2 Quick Ratio
Quick Ratio = Current Assets – Inventories
Current Liabilities
It is an indicator of a company’s short-term liquidity
It ,measure how a company can meet its obligations, without depending on its inventory (Least liquid of current assets)
The ratios of the company should be compare with that of industry average.
Contemporary Engineering Economics, 5th edition. ©2010
Illustration Question
The balance sheet of SABIC for January 2012 provides the following details. Calculate the Current Ratio and Quick Ratio of SABIC and comment on it.
Total Current Assets – SR 138,216 million
Total Current Liabilities – SR 49,847 million
Inventories – SR 31,442 millionContemporary Engineering Economics, 5th edition. ©2010
Answer
Current Ratio = Current AssetsCurrent Liabilities = 138,216 = 2.77 49,847
Quick Ratio = Current Assets – Inventories Current Liabilities
= 138,216 - 31442 = 106,774 = 2.14 49,847 49,847
Comment: Both the ratios are above 2 and the company’s liquidity is so strong
Contemporary Engineering Economics, 5th edition. ©2010
3. Asset Management Analysis
Contemporary Engineering Economics, 5th edition. ©2010
3.1 Inventory Turnover Ratio
Inventory Turnover Ratio = Sales Average Inventory
It measures how many times the company sold and replaced its inventory during the period.
The ratio should be compared with the industry averages (Low turn over implies poor sales and excess inventory & high ratio implies strong sales)
Contemporary Engineering Economics, 5th edition. ©2010
3.2 Day’s Sales Outstanding (DSO)/ Accounts Receivable Turnover Ratio
DSO = Accounts Receivable
Average Sales per dayAverage Sales per day = Annual Sales 365
It is a measure of the average number of days that a company takes to collect revenue after a sale has been made.
Low DSO means fewer days to collect the accounts receivable and favor in reinvesting money.
Contemporary Engineering Economics, 5th edition. ©2010
3.3 Total Assets Turnover Ratio
Total Assets Turnover = Sales Total Assets
It measure the effectiveness in using Total Assets to generate Revenue
Higher ratios will favor the company.
Contemporary Engineering Economics, 5th edition. ©2010
Illustration Question
Calculate the Asset Management Ratios of SABIC using the following information for the quarterly ending June 2012.
Sales – SR 46,528 million Average Inventory – SR 31,442 millionAccounts Receivable – SR 30,517
millionAverage sales per day – SR 517 millionTotal Assets – SR 339,006 millionContemporary Engineering Economics, 5th edition. ©2010
Answer
Inventory Turnover Ratio = Sales = 46,528 = 1.48
Average Inventory 31,442
DSO = Accounts Receivable = 30,517 = 59 days
Average Sales per day 517
Total Assets Turnover = Sales = 46,528 = 0.14
Total Assets 339,006
Contemporary Engineering Economics, 5th edition. ©2010
Answer (Comments)
Inventory Turnover Ratio is comparatively lower (1.48) and will not favor the company
The DSO is lower than 2 months (59 days) and will favor the company in reinvesting
Total Assets Turn Over Ratio is comparatively lower (0.14) and will not favor the company
Contemporary Engineering Economics, 5th edition. ©2010
4. Profitability Analysis
Contemporary Engineering Economics, 5th edition. ©2010
4.1 Profit margin on Sales
Profit Margin on Sales = =Net Income Available to Common
StockholdersSales
The higher margins shows higher returns to stockholders.
Contemporary Engineering Economics, 5th edition. ©2010
4.2 Return on Total Assets
Return on Total Assets = = Net Income + Interest Expenses (1 – tax
rate)Average Total Assets
It measures the return on total assets
Used for comparison & higher ratios are favorable
Contemporary Engineering Economics, 5th edition. ©2010
4.3 Return on Common Equity
Return on Common Equity = = Net Income Available to Common
Stockholders Average Common Equity
It shows how much income is earned for every Riyal invested by common stockholders
Used for comparison and higher ratios favor the company's performance
Contemporary Engineering Economics, 5th edition. ©2010
Illustration Question
The following details of a Company are given for the quarter ending June 2012.
Sales (Million SR) - 16,528 Net Income available to common stockholders (Million (SR) -
9076Total Assets (Million SR) – 33,900Net Income (Million SR) – 12,000Interest Expenses (Million SR) – 250Tax Rate – 2%Average Common Equity (million SR) - 19150
Calculate the ratios of the of the profitability analysis.
Contemporary Engineering Economics, 5th edition. ©2010
Answer
Profit Margin on Sales = = Net Income Available to Common Stockholders
Sales= 9076/16528 = 0.55
Return on Total Assets = = Net Income + Interest Expenses (1 – tax rate)
Average Total Assets= 12000 + 250 (1- 2%)/ 33,900 = 12000 + 245 /
33,900 = 0.36
Return on Common Equity = = Net Income Available to Common Stockholders
Average Common Equity= 9076/19150 = 0.47
Contemporary Engineering Economics, 5th edition. ©2010
5. Market Value Analysis
Contemporary Engineering Economics, 5th edition. ©2010
5.1 Price to Earnings Ratio (P/E Ratio)
P/E Ratio = Price per ShareEarnings Per Share
It shows how much investors are willing to pay per Riyal of reported profits
P/E Ratio is high for firms with high growth prospects
Contemporary Engineering Economics, 5th edition. ©2010
5.2 Book Value per Share
Book Value per Share == Total Stockholders Equity – Preferred
Stock Average Number of Shares
Outstanding It is used to calculate the per share
value of a company based on its equity available to shareholders (public).
Higher values favor the company’s market valueContemporary Engineering Economics, 5th edition. ©2010
Illustration Question
The following details of a company are given and based on it calculate P/E ratio and Book Value per Share.
Share Price (SR) – 1000Earnings per Share (SR) – 250 Total Stockholders equity (million SR) – 50,000 Preferred Stockholders equity – 32,000Number of Shares Outstanding – 10,000
Contemporary Engineering Economics, 5th edition. ©2010
Answer
P/E Ratio = Price per Share
Earnings Per Share
= 1000 = 4
250
Book Value per Share = Total Stockholders Equity – Preferred Stock Average Number of
Shares Outstanding
= 50,000 – 32,000 = 18,000 = 1.8
10,000 10,000
Contemporary Engineering Economics, 5th edition. ©2010