Download Efficiency Ratios

UNIT 3
FINANCIAL RATIOS
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RATIO DEFINED
A comparison between two numbers
showing how many times one number
exceeds the other
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WHY ANALYZE FINANCIAL
STATEMENTS?
Analyzing a financial statement
is the first step you need to
take when deciding whether or
not a company is sound enough
to risk investing your money in
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TYPES OF RATIOS
• Liquidity Ratios: Financial ratios that tell how well a
company can pay off its short-term debts and meet
unexpected needs for cash
• Efficiency Ratios: Financial ratios that indicate how
effectively a company uses its resources to generate
sales
• Leverage Ratios: Financial ratios that show how and to
what degree a company has financed its assets
• Profitability Ratios: Financial ratios that tell how much
of each dollar of sales, assets, and owner’s investment
resulted in net profit
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Liquidity Ratios
• Working Capital
– Current Assets - Current Liabilities
– Amount of money that would be left over after current
liabilities are paid off
• Current Ratio
– Current Assets/Current Liabilities
– The amount of current assets available to pay off $1 of current
debt. Stated 2:1.
• Acid Test/Quick Ratio
– 1) Cash + Marketable Securities + Accounts Receivable = Quick
Assets
– 2) Quick Assets/Current Liabilities
– A firm’s ability to liquidate assets quickly to pay off debt
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Efficiency Ratios
• Asset Turnover Ratio
– Net Sales/Total Assets
– The number of dollars in sales the firm generates from each
dollar it has invested in assets
• Inventory Turnover
– 1) Average Inventory = Beginning Inventory + Ending Inventory
divided by 2
– 2) Cost of Goods Sold /Average Inventory
– The number of times during an operating period that the
average inventory was sold
• Average Collection Period
– Accounts Receivable X 365 /Credit Sales
– How quickly a firm’s credit accounts are being collected
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Leverage Ratios
• Debt-to-Assets Ratio
– Total Liabilities/Total Assets
– Measures to what degree the assets of the
firm have been financed with borrowed
funds
• Debt-to-Equity Ratio
– Total Liabilities/Owner’s Equity
– The amount of debt incurred by the company
for each $1.00 of equity
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Profitability Ratios
• Gross Profit Margin
– Gross Profit/Net Sales
– An assessment of how well the cost of goods sold category
of expenses was controlled
• Net Profit Margin
– Net Income/Net Sales
– An assessment of management’s overall ability to control
the cost of goods sold and the operating expenses of the
firm
• Return on Investment
– Net Income/Owner’s Equity
– The amount of profit generated by the firm in relation to
the amount invested by the owners.
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Why Analyze?
Brainstorm!
1. What would the LIQUIDITY ratios tell you about a
company? How could the company use these to make
decisions?
2. What would the EFFICIENCY ratios tell you about a
company? How could the company use these to make
decisions?
3. What would the LEVERAGE ratios tell you about a
company? How could the company use these to make
decisions?
4. What would the PROFITABILITY ratios tell you about a
company? How could the company use these to make
decisions?
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