Ratio Analysis Financial Analysis. “Copyright and Terms of Service Copyright © Texas Education...

Ratio AnalysisFinancial Analysis

“Copyright and Terms of Service

Copyright © Texas Education Agency. The materials found on this website are copyrighted © and trademarked ™ as the property of the Texas Education Agency and may not be reproduced without the express written permission of the Texas Education Agency, except under the following conditions:

1) Texas public school districts, charter schools, and Education Service Centers may reproduce and use copies of the Materials and Related Materials for the districts’ and schools’ educational use without obtaining permission from the Texas Education Agency;

2) Residents of the state of Texas may reproduce and use copies of the Materials and Related Materials for individual personal use only without obtaining written permission of the Texas Education Agency;

3) Any portion reproduced must be reproduced in its entirety and remain unedited, unaltered and unchanged in any way;

4) No monetary charge can be made for the reproduced materials or any document containing them; however, a reasonable charge to cover only the cost of reproduction and distribution may be charged.

Private entities or persons located in Texas that are not Texas public school districts or Texas charter schools or any entity, whether public or private, educational or non-educational, located outside the state of Texas MUST obtain written approval from the Texas Education Agency and will be required to enter into a license agreement that may involve the payment of a licensing fee or a royalty fee.

Call TEA Copyrights with any questions you have.

Copyright © Texas Education Agency, 2014. All rights reserved. 2

What is Ratio Analysis?

• Ratio- a comparison of two numbers• Ratio analysis- a tool businesses use to identify possible

problems as well as opportunities


Types of Financial Ratios

Type of Ratio Definition

Liquidity How well a company can pay off short-term loan obligations and meet cash needs

Efficiency How effectively a company utilizes its resources to generate revenue

Leverage Shows how a company’s assets are financed

Profitability Measures the ability of a business’s resources to generate income that results in a profit

Stock Also called value or investor ratios, examines different aspects of a company’s stock


What is Liquidity and Why is it Important?

• Liquidity- measures how quickly assets can be converted to cash

• Can determine how easily a company can meet its debt obligations


Liquidity Ratios

Ratio Formula

Working Capital- shows what is left after all liabilities are paid by the assets

= Current Assets – Current Liabilities

Current Ratio- shows the dollar value of assets for each dollar of liabilities

= Total Current Assets/Total Current Liabilities

Quick Ratio- determines the ability to meet short-term debt obligations

= (Total Current Assets – Inventories)/Total Current Liabilities


What is Efficiency and Why is it Important?

• Efficiency refers to how well assets and liabilities are managed.

• These ratios are important because the focus is on management.


Efficiency Ratios

Ratio Formula

Average collection period- how efficiently a company’s accounts receivables (or credit accounts) are handled

= Average Accounts Receivable / (Total Sales / 365)

Inventory ratios- tells how often inventory is sold; too high a ratio can lead to high storage costs

1) Inventory turnover = Cost of Goods Sold / Average Inventory2) Average days to sell inventory = Days in a Year / Inventory Turnover

Total Asset Turnover- how much a dollar of assets generates in sales

= Sales / Average Total Assets

Accounts Receivable Turnover– the average number of times accounts receivable is collected in a time period

= Sales on Account / Average Receivables


What is Leverage and Why is it Important?

• Leverage is how much debt is used to finance an asset.• It can cause a company to run the risk of bankruptcy if

there is too much debt that cannot be repaid.


Leverage Ratios

Ratio Formula

Debt to assets- measures the degree of financing of assets

= Total Debt/Total Assets

Debt to equity- measures the amount of debt financed by every dollar of equity; the higher the ratio the higher the risk to possible investors or creditors

= Total Debt/Total Equity


What is Profitability and Why is it Important?

• Profitability is sales minus the costs associated with the goods or services sold.

• Its importance is that making a profit is the most prominent goal of most businesses.


Profitability Ratios

Ratio Formula

Net profit margin- measures how well the cost of goods sold is controlled, as well as the operating expenses

= Profit after taxes / Sales

Return on investment-represents the amount of profit as it relates to the owner’s investment

=Net income / Owner’s Equity

Return on equity– measures % of profit earned on the stockholder’s investment

= Profit after taxes / Stockholder’s Equity

Return on assets– measures the profit earned from the assets of the company

= Profit after taxes / Total Assets


What are Investor Ratios and Why are they Important?

• Also referred to as ratios that affect stock• Companies raise funds by issuing stock

• Stockholders are concerned with how well a company is performing

• Dividends are paid from profits, so stockholders are concerned with earnings


Investor Ratios

Ratio Formula

Earnings per share– the amount of net income that belongs to one share of stock

= Net Income/Outstanding Shares

Price-earnings ratio– measures the amount investors are willing to pay for every dollar of profit

= Current Market Price per Share / After-tax Earnings per Share

Dividend yield– measures the return paid as dividends to stockholders

= Annual Dividends per Share / Current Market Price per Share


Ratio Demo

ABC CorporationComparative Balance Sheet

December 31, 2010 and 2011

Assets

2011

2010

Current Assets: Cash $ 7,000 $6,500 Accounts Receivable Supplies Prepaid Insurance

39,0003,5004,000

25,0005,0003,700

Total Current Assets $53,500 $40,200 Property, Plant, and Equipment: Land 40,000 54,475 Buildings 95,000 112,000 Equipment 30,000 17,000 Total Property, Plant, and Equipment 165,000 183,475 Total Assets $218,500 $223,675 Liabilities and Stockholder’s Equity Current Liabilities Accounts Payable Salaries Payable Total Current Liabilities Long-Term Liabilities Mortgage Payable Bonds Payable Total Long-Term Liabilities

$9,00017,00026,000

70,00032,000

102,000

11,30016,50027,800

79,10034,175

113,275 Total Liabilities 128,000 141,075Stockholder’s Equity Capital Stock Retained Earnings Total Stockholder’s Equity

65,00025,50090,500

54,00028,60082,600

Total Liabilities and Stockholder’s Equity $218,500 $223,675

Current Ratio = 53,500/26,000 = 2.06

Debt to Equity= 128,000/90,500 = 1.41


Graphing Ratios

Sunshine Corp.

2012 2011 2010

Current Ratio 2.10 1.80 2.30

Quick Ratio 1.39 1.06 1.10


Independent Practice Assignments

Company Comparison Chart Assignment #3 – Students will select two companies for comparison. They will prepare a chart or table (using either a spreadsheet program or a word processing program) listing the five categories of ratios with two ratios each on the left side and the top row listing the two chosen companies with three years of ratios calculated for each. One observation about the change over the years for each company as well as one conclusion or prediction must be included for each ratio. Following is a sample setup for this chart:

Company A Company B 2012 2011 2010 2012 2011 2010 Liquidity Current Ratio 1.30 1.21 1.12 1.20 1.26 1.34 Quick Ratio .30 .28 .21 .23 .16 .11

Company Comparison Chart Assignment #1 – Students will select two companies for comparison. They will prepare a chart or table (using either a spreadsheet program or a word processing program). They will list the five categories of ratios with two ratios each on the left side and the top row listing the two chosen companies with three years of ratios calculated for each. One observation about the change over the years for each company as well as one conclusion or prediction must be included for each ratio. Following is a sample setup for this chart:

Ratio Gameboard Assignment #2 – In pairs, students will create a gameboard of at least 20 spaces summarizing their understanding of ratios. There may only be five free or blank spaces. The remaining 15 should include facts and/or figures related to ratio analysis. For example, a space could have a definition, significance, or formula for current assets. If it is correct, the student could roll a die and move forward that many spaces. If the space has false information, the student has to give the correct answer or roll the die and move backward that many spaces. Students can create any type of gameboard they want as long as it is creative, entertaining, and contains at least 15 facts about ratios.

Motorola Analysis Assignment #3 – Using the website (referenced above) called, “The Case of Motorola,” the students will each read the Financial Ratio Analysis section of the document to look for explanations of at least five different ratios. The students will discuss the implications of what the results, whether they are higher than their industry or lower than their industry, actually mean. For example, the Fixed Asset Turnover ratio is higher than the Semiconductor Industry ratio, meaning that Motorola is using its assets to generate sales more resourcefully than the industry. They should include at least five ratios in their discussion of the implications of what they mean. Students will create a one- to two-page report to detail their findings.

Ratio Analysis Financial Analysis. “Copyright and Terms of Service Copyright © Texas Education...

Documents

Transcript of Ratio Analysis Financial Analysis. “Copyright and Terms of Service Copyright © Texas Education...