Tools of Operational Analysis- Ratio Analysis •Ratio analysis is a method of analyzing the financial statements to determine various relationships between selected items reported on financial statements. •Ratios are fractions where the numerator is expressed as a portion of the denominator. •A %; a numeric value; a quantity; per-unit •Ratios are useful only when compared to useful criteria. •Other properties & industry average •Ratios from prior periods •Planed ratio goals
Users of Ratios •Management •Evaluate financial results and monitor performance •Creditors •Assess risks of their loans or credits •Owners •Measure return on their investments •Assess risks of their investments
Type of Ratio Analysis 1.Liquidity Ratios 2.Solvency Ratios 3.Profitability Ratios 4.Turnover Ratios 5.Operating Ratios •
Liquidity Ratios •Measure the ability of the business to meet maturing short term obligations •Focuses on the Relationship between Current Assets and Current Liabilities •Examples: •Current Ratio •Acid Test / Quick Ratio •A/R as Percentage of Revenue •A/R Turnover •A/R Average Collection Period •Operating Cash Flows to Current Liabilities Ratio
Sheet1 NumeratorDenominatorResults Liquidity Ratios Current Ratio$1,324$2,5580.52 Quick Ratio$977$2,5580.38 875+102 OCF to Current Liabilities$1,089$2,5300.43 (2558+2501)/2 AR%$906.5$12,3177.36% (875 + 938)/2 AR Turnover$12,317$906.513.59 (875 + 938)/2 Average Collection Period$365$1426.86 12317/906.5 Solvency Ratios Solvency Ratio$5,910$6,6910.88 2558 + 4133 Total Liabilities to Total Assets$6,691$5,910113.2% 2558 + 4133 Debt Equity Ratio$6,691-$781-8.57 2558 + 4133 OCF to Total Liabilities$1,089$7,04415.46% (7398 + 6691)/2 # of Times Interests Earned$520$1643.17 356 + 164 OCF to Interest$1,253$1647.64 1089 + 164 Profitability Ratios Profit Margin$198$12,3171.61% Operating Efficiency Ratio$526$12,3174.27% Gross ROA$520$7,4476.98% 5910 + 8983/2 Net ROA$198$7,4472.66% 5910 + 8983/2 ROE$198$40249.25% 1585 + (-781)/2 EPS$198$3500.57 366.9 + 333/2 P/E Ratio$29.17$0.5751.56 Turnover Ratios Working Capital Turnover$12,317-$177-69.78 (881+ (-1234)/2 Fixed Asset Turnover$12,317$1,2389.95 1307+1168/2 Sheet2 Sheet3 Ratio Analysis - Ratio Analysis . Tools of Operational Analysis * Ratio Analysis Ratio analysis is a method of analyzing the financial statements to determine various relationships between selected items reported on financial statements. Ratios are fractions where the numerator is expressed as a portion of the denominator. A %; a numeric value; a quantity; per-unit Ratios are useful only when compared to useful criteria. Other properties & industry average Ratios from prior periods Planed ratio goals * Users of Ratios Management Evaluate financial results and monitor performance Creditors Assess risks of their loans or credits Owners Measure return on their investments Assess risks of their investments * Type of Ratio Analysis Liquidity Ratios Solvency Ratios Profitability Ratios Turnover Ratios Operating Ratios * Liquidity Ratios Measure the ability of the business to meet maturing short term obligations Focuses on the Relationship between Current Assets and Current Liabilities Examples: Current Ratio Acid Test / Quick Ratio A/R as Percentage of Revenue A/R Turnover A/R Average Collection Period Operating Cash Flows to Current Liabilities Ratio * Liquidity Ratios Current Ratio: Current Assets631,638.54 Current Liabilities448,332.18 = 1.41 Quick (Acid Test) Ratio: Quick Assets493,327.84 Current Liabilities448,332.18 = 1.1 Operating Cash Flows to Current Liabilities: Operating Cash Flows1,843,778.59 Avg. Current Liabilities 331,649.18 = 5.56 * Benchmarks: Current Ratio: 1-1.5:1 Quick Ratio: 0.75-1:1 OCF to CL: 2:1 Liquidity Ratios – A / R Ratios Accounts Receivable Percentage: Avg. Accounts Receivable 433,503.16 Total Revenue9,047,481.48 = 5% Accounts Receivable Turnover: Total Revenue9,047,481.48 Avg. Accounts Receivable 433,503.16 = 20.87 times Average Collection Period: Days in Year365.00 A/R Turnover20.87= 17.49 Days * Benchmarks: AR%: 4-10% AR Turnover: 20-30 times Avg. Collection Period: 12-18 days Solvency Ratios Measure the extent to which the Business is financed by Debt Indicates the ability of the Business to meet its Debts Obligations and the risk involved in the investment Examples: Total Assets to Total Liabilities Ratio (Solvency) Total Liabilities to Total Asset Ratio Total Liabilities to Total Equity Ratio (Debt-Equity) Number of Times Interest Earned Operating Cash Flows to Total Liabilities Operating Cash Flows to Interest * Solvency Ratios Total Assets to Total Liabilities(Solvency Ratio): Total Assets20,423,265.81 Total Liabilities17,528,332.18 = 1.17 Total Liabilities to Total Assets: Total Liabilities17,528,332.18 Total Assets20,423,265.81 = 0.86 Cash Flow from Operating Activities to Total Liabilities: Cash Flow from Operating Activities 1,843,778.59 Average Total Liabilities 17,411,649.18 = 11% * Benchmarks: Solvency ratio: 2:1 TL/TA: 60-90% Cash Flow from Operat. Actv./TL: >20 % Solvency Ratios Cash Flow from Operating Activities to Interests: Cash Flow from Operating Activities & Interest Expense3,487,076.75 Interest Expense1,643,298.16 = 2.12 Times Number of Times Interest Earned: Net Income before Interest & Income Tax2,545,620.84 Interest Expense1,643,298.16 =1.55 Times Total Liabilities to Total Equity: Total Liabilities 17,528,332.18 Total Stockholders Equity 2,894,933.63 = 6.05 * Benchmarks: TL/TE: 2:1 # of Times Interest Earned: 2-3 times Cash Flow from Opert. Act. to Interest: >1 Activity (Turnover) Ratios Measures how efficiently some of the assets of the Business are being utilized Illustrates the Effectiveness of Controls over the amount invested in certain areas Examples: Inventory Turnover Ratio Working Capital Turnover Fixed Asset Turnover * Turnover Ratios Inventory Turnover: Cost of Sales for the Period Avg. Inventory during the Period24,215.53 Working Capital Turnover: Revenue 9,047,481.48 Avg. Working Capital 277,223.42 = 32.64 Times Fixed Asset Turnover: Revenue9,047,481.48 Total Avg. Fixed Assets19,478,491.11 = 0.46 Times * No Benchmarks Profitability Ratios Measures Management’s overall Effectiveness and Efficiency Indicates the Returns generated on Sales and Investments Examples: Net Income to Revenue Ratio (Profit Margin) Operations Efficiency Ratio Gross Return on Assets Net Return on Assets Return on Stockholder’s Equity (ROE) Earnings per Share Price Earnings Ratio * Profitability Ratios Net Income to Revenue (Profit Margin): Net Income after Income Tax 902,322.68 Total Revenue 9,047,481.48 = 9.97% Operating Efficiency Ratio: Income Before Fixed Charges (GOP)3,927,785.48 Total Revenue9,047,481.48 = 43% * Benchmarks: Net Income to Rev.: 11% Operating Efficiency Ratio: 35% Profitability Ratios Net Return on Assets (Net ROA): Net Income after Income Tax 902,322.68 Total Avg. Assets 20,294,615.01 = 4.5% Gross Return on Assets (Gross ROA): Income before Interest & Income Tax 2,545,620.84 Total Avg. Assets20,294,615.01 = 12.54% Return on Equity (ROE): Net Income after Income Tax 902,322.68 Avg. Owners’ Equity 2,882,965.83 = 31.3% * No Benchmarks Profitability Ratios Earnings per Share (EPS): Net Income after Income Tax 902,322.68 Avg. #Shares Outstanding 500,000 = $1.80 Price Earnings (P/E): Market Price per Share$20.00 Earnings per Share$ 1.80 = 11.1 * EPS: 1-10 means stock is undervalued and market is declining, 11-17-fair value 18-25 – overvalued and increasing 25-bubble Usefulness of Financial Ratios Users Class of RatiosGMsCorporate ExecutivesOwnersBankers Operating1 (1)2 (2)3 (5)4 (4) Solvency4 (5)3 (3)1 (2)1 (1) Turnover1 (2)2 (5)3 (4)4 (5) Profitability4 (3)2 (1)1 (1)3 (2) Liquidity3 (4)1 (4)2 (3)4 (3) * DuPont Formula ROA =Profit Margin xAsset Turnover =Net IncomexSales SalesAv. Total Assets =902,322.68x$9,047,481.48 9,047,481.48$20,294,615.01 =0.0997x0.4458 =0.045 or 4.5% * ROA - 3 Ways to Win, 1 Way to Lose Asset TurnoverProfit Margin HighHigh HighLow LowHigh LowLow *