RATIO ANALYSIS
FIN 254 - ALIF
1. Current Ratio:
measures the firm’s ability to pay its Short term obligations.
Current ratio = Current Assets ÷ Current Liabilities
Interpretation: Current ratio 1.97 times implies that, In 2012 the Company had
$1.97 of Current assets to pay each $1 of Current liabilities.
Analysis: Higher value is better.
Recommendation: If the value of current ratio decreases that means the Company’s
solvency position is getting weak. The Company has to improve their performance
by investing more in Current assets and Investment must come from long term
sources of Capital.
2. Quick Ratio:
measures the firm’s ability to pay Current liabilities with Its most liquid asset.
Quick ratio = (Current Assets - Inventory) ÷ Current Liabilities
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Interpretation: Quick Ratio 1.51 times implies that, In 2012 the Company had $1.51
of Current asset excluding Inventory to pay each $1 of Current liabilities.
Analysis: Higher value is better.
Recommendation: If the value of quick ratio is lower than 1 that means the
company’s Solvency Position is getting weak. So, the company has to improve their
performance by selling inventory or decrease investment on inventory.
3. Inventory turnover:
measures the number of times a company has sold and restocked its inventory over a
specific period of time.
Inventory turnover = Cost of Goods sold ÷ Inventory
Interpretation: Inventory turnover 7.2 times implies that the company has sold and
restocked its inventory 7.2 times over a year.
Analysis: depends on different industries.
Recommendation: depending on the Average age of inventory.
4. Average age of Inventory:
measures the average number of days a company takes to sell off inventory.
Average age of Inventory = Number of days in an accounting
period ÷ Inventory turnover
Interpretation: Average age of inventory 50.7 days implies that the company takes
50.7 days on an average to sell inventory.
Analysis: Lower value is better.
Recommendation: If average age of inventory increases then it would be better to
increase inventory turnover by increasing sales.
5. Average Collection period:
measures the average number of days needed to collect accounts receivable.
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Average Collection period = Accounts Receivable ÷ Avg. sales
per day
*Avg. sales per day = sales / total period of days
Interpretation: Average Collection period 59.7 days implies that It takes the firm
59.7 days to collect an Accounts receivable.
Analysis: Decreasing value is good if and if it’s above the other competitors.
Recommendation: depends on the company's credit term.
6. Total Asset turnover:
measures how frequently the assets are generating sales.
Total Asset turnover = Sales ÷ Total Assets
Interpretation: Total Asset turnover 0.85 implies that the company sold $0.85 of
goods from each dollar of investment in assets.
Analysis: highest value is better.
Recommendation: If total asset turnover decreasing then increasing in sell will be
the recommendation.
7. Debt Ratio:
measures the percentage of capital come from debt.
Debt Ratio = Total Liabilities ÷ Total Assets
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*total = current + long term
Interpretation: Debt ratio 45.7% implies that the company raised $45.7 from debt
for each $100 of asset investment.
Analysis: depends on Time-interests earned ratio.
Recommendation: If times interest earned ratio is lower than 3 then the company
should increase equity financing and decrease debt financing.
8. Time Interest Earned Ratio:
measures the ability of a company to pay interest.
Times Interest Earned Ratio = Earnings before Interest
(Operating Profit) ÷ Interest expense
Interpretation: Times Interest Earned Ratio 4.5 implies that the company’s
operating profit is 4.5 times higher than interest expense.
Analysis: Ratio-3 is standard. Higher is better and lower is increasing chances of risk
and bankruptcy.
Recommendation: If times interest earned ratio is lower than 3 then the company
should increase equity financing and decrease debt financing.
9. Gross Profit Margin:
measures the percentage of gross profit earned from revenue.
Gross Profit Margin = Gross Profit ÷ Sales
Gross profit = Sales - Cost of Goods sold
Interpretation: Gross profit margin 32.1% implies that the company has earned
$32.1 of Gross profit from each $100 of Revenue.
Analysis: higher value is better because more money is available.
Recommendation: decreasing cost of goods sold to increase gross profit.
10. Operating Profit Margin:
measures the percentage of Operating profit earned from revenue.
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Operating Profit Margin= Operating Profits ÷ Sales
Operating profit = Gross profit - Operating expense
Interpretation: Operating profit margin 13.6% implies that the company has earned
$13.6 of Operating profit from each $100 of Revenue.
Analysis: pure profit so higher value is better.
Recommendation: increase operating profit by decreasing operating expenses.
11. Net Profit Margin:
measures the percentage of profit available for common shareholders earned from
revenue.
Net Profit Margin = Net Profit - Prefer dividend ÷ Sales
Earnings available for common shareholders = net profit - prefer dividend
Interpretation: Net profit margin 7.2% implies that the firm has earned $7.2 of
earning for common shareholders for each $100 of revenue.
Analysis: higher value is better.
Recommendation: increase earnings available for common shareholders by
decreasing expenses.
12. Earnings per Share:
measures the profit earned from each share outstanding in the market.
Earnings per Share = Earnings available for common
shareholders ÷ number of shares of common stock
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Interpretation: Earnings per share $2.90 implies that the shareholders earn $2.90
profit for each share they own.
Analysis: higher is better because more they earn , more will be demand for the
share.
Recommendation: increase earnings for common shareholders by decreasing
expense of cost of goods sold.
13. Return on Total Assets:
measures the profitability of the company’s investment in assets.
Return on Total Assets (ROA) = Earnings available for
common shareholders ÷ Total assets
*Earnings available for common shareholders = net profit - prefer dividend
Interpretation: Return on total assets 6.1% implies that the firm earned $6.1 of
profit from each $100 of assets investment.
Analysis: higher value is better.
Recommendation: If increasing, assets profitability is improved.
14. Return on Equity:
measures the profit earned by the shareholders from their investment.
Return on Equity (ROE) = Earnings available for common
shareholders ÷ Common stock equity
Interpretation: Return on equity 12.6% implies that the shareholders of the firm
earn $12.6 of profit from each $100 they invested in the firm.
Analysis: higher value is better.
Recommendation: If increasing, shareholders profitability is improved.
15. Price earnings ratio:
measures the share performance compare to earnings.
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Price Earnings Ratio = Market closing price per share of
common stock ÷ Earnings per Share (EPS)
Interpretation: Price earning ratio 11.1 times implies that the shareholders of the
company are willing to pay 11.1 times more than its earnings.
Analysis: higher is better but too much higher is bad. Sometimes higher is better
because it means that the company will do good in future.
Recommendation: standard-30. If value is more higher than 30 then increase
earnings per share and if the value is too lower than 30 then increase the market
price of the share.
16. Market/Book Ratio:
measures the market price compare to the share’s book value.
M/B Ratio = Market closing price per share of common stock
÷ Book value of per share of common stock
Book value = Common stock eequity ÷ number of shares of
common stock outstanding
Interpretation: M/B Ratio 1.40 times implies that the market value of the share is
1.4 times higher than the book value of per share.
Analysis: higher and higher value is better.
Recommendation: if ddeclining increase the market price by taking good decision
that will increase the shareholder’s wealth.