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MGMT6190Chapter6-KeyFinancialRatios.pptxChapter 6 Key Financial Ratios
Key Financial Ratios
Ratios are mathematical calculations that the company can use to evaluate its performance. They help the company to determine whether trends are improving or deteriorating. They are calculated by comparing two numbers with each other. The most valuable use of ratios is to compare this year’s ratios with the same ratios for the previous year, and with the ratios of other companies in a similar business. Ratios also serve as goals for future performance.
Liquidity Ratios
Current Ratio compares current assets with current liabilities to measure the company’s ability to pay bills in the coming year. This ratio is generally included in bank covenants for which a minimum of 1.5 is required. The Metropolitan Manufacturing Company (pages 24/126) current ratio is as follows;
| 2016 | 2015 | |
| Current Assets/ Current Liabilities | $2,009,000/$898,000 | $1,645,000/$619,000 |
| Current Ratio | 2.23 | 2.65 |
Liquidity Ratios
Quick Ratio compares current assets (excluding inventory) with current liabilities to measure more closely the company’s ability to pay bills in the coming year. The Metropolitan Manufacturing Company (pages 24/129) quick ratio is as follows;
| 2016 | 2015 | |
| Quick Assts/ Current Liabilities | $780,000/$898,000 | $714,000/$619,000 |
| Quick Ratio | .87 | 1.15 |
Working Capital Management Ratios
Days sales outstanding measures the average number of days that the company is taking to collect accounts receivable from the customers. The Metropolitan Manufacturing Company (pages 24/61/131) days sales outstanding is as follows;
| 2016 | 2015 | |
| Annual Revenue/365 | $4,160,000/365 | $3,900,000/365 |
| Average Revenue per Day | $11,397 | $10,685 |
| Accounts Receivable/ Average Revenue per Day | $637,000/$11,397 | $597,000/$10,685 |
| Days Sales Outstanding | 56 days | 56 days |
Working Capital Management Ratios
The inventory turnover ratio provides an overview of how effectively the company manages its inventory. The Metropolitan Manufacturing Company (pages 24/61/138) inventory turnover ratio is as follows;
| 2016 | 2015 | |
| Cost of Goods Sold/ Average Inventory | $2,759,000/$1,229,000 | $2,593,000/$931,000 |
| Inventory Turnover | 2.24 times | 2.79 times |
Measures of Profitability
The Gross Profit Percentage measure the percentage of revenue remaining after the cost of goods sold has been subtracted. The Metropolitan Manufacturing Company (pages 61/142) gross profit percentage is as follows;
| 2016 | 2015 | |
| Gross Profit/ Revenue | $1,401/$4,160 | $1,307/$3,900 |
| Gross Profit Percentage | 34% | 34% |
Measures of Profitability
The Return on Assets measures the profitability of the company relative to the total amount of assets the owners have invested in the business. The Metropolitan Manufacturing Company (pages 24/61/144) return on assets is as follows;
| 2016 | 2015 | |
| Net Income/ Assets | $156,000/$3,202,000 | $190,000/$2,863,000 |
| Return on Assets | 4.9% | 6.6% |
Measures of Profitability
The Return on Equity measures the company’s ability to use borrowed funds and owner’s money effectively. The Metropolitan Manufacturing Company (pages 24/61/144) return on equity is as follows;
| 2016 | 2015 | |
| Net Income/ Stockholders Equity | $156,000/$2,004,000 | $190,000/$2,894,000 |
| Return on Equity | 7.8% | 10.0% |
Measures of Profitability
The Return on Sales measures the overall operating efficiency of the company. The Metropolitan Manufacturing Company (pages 24/61/145) return on sales is as follows;
| 2016 | 2015 | |
| Net Income/ Revenue | $156,000/$4,160,000 | $190,000/$3,900,000 |
| Return on Sales | 3.75% | 4.9% |
Financial Leverage Ratios
The Debt/Equity Ratio measures the risk from the perspective of both the company and existing and potential lenders. The Metropolitan Manufacturing Company (pages 24/150) debt/equity ratio is as follows;
| 2016 | 2015 | |
| Long-Term Debt/ Stockholders Equity | $300,000/$2,004,000 | $350,000/$1,894,000 |
| Debt/Equity Ratio | 15% | 18.5% |
Financial Leverage Ratios
EBITDA stands for Earnings before Interest, Taxes, Depreciation and Amortization. The Metropolitan Manufacturing Company (pages 61/150) EBITDA calculation is as follows;
| 2016 | |
| Net Income | $156,000 |
| Interest | 48,000 |
| Taxes | 156,000 |
| Depreciation | 56,000 |
| Amortization | 0 |
| EBITDA | $416,000 |
Financial Leverage Ratios
The Interest Coverage is the cushion that the company has between the amount of cash it generates before interest expense and taxes and the amount of interest it must pay on its debt. The Metropolitan Manufacturing Company (pages 24/150) interest coverage is as follows;
| 2016 | |
| EBITDA/ Interest Expense | $416,000/$48,000 (8% x ($300,000 + $300,000) |
| Interest Coverage | 8.7 times |
