Ratio Analysis And Example.pdf

8/14/2019 Ratio Analysis And Example.pdf

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Liquidity Ratios

1. Working capital = Current assets - Current liabilities

20X2: $715,000 - $695,000 = $20,000

20X1: $665,000 - $700,000 = ($35,000)

Current assets2. Current ratio (working capital ratio) =

Current liabilities

$715,000(20X2) =

$695,000= 1.03

$665,000

(20X1) = $700,000 = 0.95

(Industry average = 1.5)

The ratio, and therefore Gi's ability to meet its short-term obligations, has improved, though it islow compared to the industry average.

Cash equivalents + Marketable securities + Net receivables3. Acid -test (quick )ratio

=Current liabilities

$50,000 + $75,000 + $300,000(20X2) =

$695,000= 0.61

$35,000 + $65,000 + $290,000(20X1) = $700,000 = 0.56

(Industry average = 0.80)

The industry average of .80 is higher than Gi's ratio, which indicates that Gi may have troublemeeting short-term needs.

Cash equivalents + Marketable securities4. Cash ratio =

Current liabilities

$50,000 + $75,000(20X2) =

$695,000= 0.18

$35,000 + $65,000(20X1) = $700,000 = 0.14



Activ ity Ratios

Net credit sales1. Accounts receivable turnover = Average gross receivables

$1,800,000=

($300,000 + $290,000) / 2

$1,800,000=

$295,000

= 6.10 times

This ratio indicates the receivables' quality and indicates the success of the firm in collectingoutstanding receivables. Faster turnover gives credibility to the current and acid-test ratios.

Average gross receivables2. Accounts receivable turnover in days = Net credit sales / 365

365 days=

Receivable turnover

365=

6.1

= 59.84 days

This ratio indicates the average number of days required to collect accounts receivable.

Cost of goods sold

3. Inventory turnover = Average inventory

$1,000,000=

($290,000 + $275,000) / 2

$1,000,000=

$282,500

= 3.54 times

This measure of how quickly inventory is sold is an indicator of enterprise performance. Thehigher the turnover, in general, the better the performance.





Profitability Ratios

Note: Some forms of the profitability ratios below use net income less preferred dividends in thenumerator to better measure returns accruing to common shareholders.

Net income1. Net profi t margin =

Net sales

$200,000=

$1,800,000

= 11.11%

This ratio indicates profit rate and, when used with the asset turnover ratio, indicates rate ofreturn on assets, as shown in item 3 below.

2. Return on total assets = Net income ÷ Average total assets

= $200,000 / $2,532,500

= 7.9%

3. DuPont r eturn on assets = Net profit margin x Total asset turnover

Net income Net sales=

Net salesx

Average total assets

= 11.11% x 0.71 times = 7.9%

Note that this ratio uses both net profit margin and the total asset turnover. This ratio allows for

increased analysis of the changes in percentages. The net profit margin indicates the percentreturn on each sale while the asset turnover indicates the effective use of assets in generatingthat sale.

Net income + Interest expense (1 - Tax rate)4. Return on i nvestment =

Average (Long-term liabilities + Equity)

$200,000 + $10,000 (1 - 0.34)=

($650,000 + $1,270,000 + $600,000 + $1,150,000) / 2

= 11.3%

ROI measures the performance of the firm without regard to the method of financing.

Net income - Preferred dividends5. Return on common equity =

Average common equity

$200,000 - $0=

($1,270,000 + $1,150,000) / 2

= 16.5%



Net operating income6. Net operating marginpercentage

=Net sales

$800,000 – 486,970=

$1,800,000

= 17.39%

Gross (profit) margin7. Gross (profit) marginpercentage

=Net sales

$800,000=

$1,800,000

= 44%

Operating cash flow8. Operating cash flow per share =

Common shares outstanding

$255,000=

100,000 shares

= $2.55 per share



Investor Ratios

Earnings before interest and taxes

1. Degree of financial leverage = Earnings before taxes

$303,030 + $10,000=

$303,030

= 1.033

The degree of financial leverage is the factor by which net income will change with a change inearnings before interest and taxes. The degree of financial leverage indicates the leveragefactor for recurring earnings.

Net income - Preferred dividends2. Earnings per share =

Weighted average number of common shares outstanding

$200,000 - $0=

100,000 shares

= $2/share

Market price per share3. Price/earnings ratio =

Diluted earnings per share

$12=

$2

= 6

This statistic indicates the investment potential of an enterprise; a rise in this ratio indicates thatinvestors are pleased with the firm's opportunity for growth.



Dividends per common share4. Dividend payout ratio =

Diluted earnings per share

$0.80 = $2

= 40%

This ratio indicates the portion of current earnings being paid out in dividends.

Dividends per common share5. Dividend yield =

Market price per common share

$0.80 =

$12

= 6.67%

This ratio indicates the relationship between dividends and market price.

Total stockholders' equity - Preferred stock6. Book value per share =

Number of common shares outstanding

$1,270,000=

100,000 shares

= $12.70

This ratio indicates the amount of stockholders' equity that relates to each share of commonstock. Note that preferred stock should be stated at liquidity value if other than book value.



Long-term Debt-paying Ability Ratios

Total liabilities

1. Debt / Equity = Common stockholders' equity

(20X2) = $1,345,000 / $1,270,000 = 1.06

(20X1) = $1,300,000 / $1,150,000 = 1.13

This ratio indicates the degree of protection to creditors in case of insolvency. The lower thisratio the better the company's position. In Gi's case, the ratio is very high, indicating that amajority of funds come from creditors. However, the ratio is improving.

Total liabilities2. Debt ratio =

Total assets

(20X2) = $1,345,000 / $2,615,000 = 51.4%(20X1) = $1,300,000 / $2,450,000 = 53.1%

This debt ratio indicates that more than half of the assets are financed by creditors.

Recurring income before taxes and interest3. Times interest earned =

Interest

$303,030 + $10,000 =

$10,000

= 31.30 times

This ratio reflects the ability of a company to cover interest charges. It uses income beforeinterest and taxes to reflect the amount of income available to cover interest expense.

Operating cash flow4. Operating cash fl ow / Total debt =

Total debt

$255,000=

$1,345,000

= 18.96%

This ratio indicates the ability of the company to cover total debt with yearly cash flow.

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Ratio Analysis And Example.pdf