Final Presentation

PROJECT RATIOS 2

Project Ratios

(No Corrective Action Offered by Instructor)

Kevin Sessions

BUS 368 Venture Capital & Banking

Edward Crawford

Feb 28, 2022

Introduction

Financial ratios are helpful tools for business managers and stakeholders to assess and compare financial relationships between accounts on a company's financial statements. They allow for financial analysis throughout a company's history, economic, or employment market (Ahrendsen, B. L., & Katchova, A. L., 2018). We will discuss the various financial ratios and their impact on business financial position.

Liquidity Ratios

A liquidity ratio is a financial ratio used to assess a company's capacity to meet its short-term borrowing needs (Asbari, M. 2020). The current, quick, and cash ratios are the three most crucial liquidity ratios. During credit evaluation, investors consider choosing liquidity ratios above 1.0. A company with healthy liquidity ratios has a high chance of being approved for credit.

Current Ratio = Current Assets / Current Liabilities

When current assets exceed current liabilities, the ratio is larger than 1.0, which is desirable. If the ratio is equal to 1.0, it indicates that the current assets are just enough to cater for the short-term liabilities, and when the ratio is less than 1.0, it indicates that the corporation is unable to meet its short-term obligations (Putra, A. H. P. K.,2021)

Quick Ratio = (Cash + Accounts Receivables + Marketable Securities) / Current Liabilities    

Divide the total of cash and cash equivalents, short-term investments, and account receivables by the company's current obligations to get the quick ratio. When a company's quick ratio is less than 1, it does not have enough liquid assets to cover its current liabilities and should be avoided. If the quick ratio is significantly lower than the current ratio, current assets rely mainly on inventory. Because inventories are not included in current assets, the fast ratio is more conservative than the current ratio (Asbari, M. 2020).

Leverage Ratios

A leverage ratio is a type of financial ratio that shows how much debt a company has compared to other entities on its statement of financial position, profit and loss account, or cash flow statement (Pedrosa, Í. 2019). These ratios show how debt and equity finances can be used to finance the company's assets and activities.

Debt to Equity = Total liabilities / Total Shareholders' Equity.

This ratio indicates how much debt you have every $1.00 of equity. A debt-to-equity ratio of 0.5 means that for every $1.00 in equity, you have $0.50 in debt. A debt-to-equity ratio greater than 1.0 shows more debt than equity. So, if the debt-to-equity ratio is 1.5, you have $1.50 in debt for every $1.00 in equity. A debt-to-equity ratio below 1.0 is considered to be good. However, a negative ratio is too risky for an entity (Katchova, A. L. 2018). 

Debt to Total Assets = Total liabilities / Total assets 

When measured over a while, this ratio of debt-financed assets to total assets demonstrates how a company's assets have grown and acquired through time. A ratio of more than one indicates that debt is used to fund a significant share of the assets. i.e., the corporation owes more money than it owns (Pedrosa, Í. 2019). A high ratio can also signal that a corporation is putting itself in danger of owing on its debts whenever interest rates unexpectedly spike.

Interest Coverage = Earnings Before Interest and Tax (EBIT) / Interest expense

It is a leverage metric used to assess a firm's ability to pay interest on its existing obligations. Lenders frequently utilize this ratio to assess the riskiness of lending money to a company. A greater interest coverage ratio implies that the company is better financially and can satisfy its interest commitments. On the other hand, an interest coverage ratio of less than one indicates that the company is in dire financial shape and cannot pay off its short-term interest commitments (Katchova, A. L. 2018).

Management Efficiency Ratios

Efficiency Ratio shows the proportion of how much a business manages its day-to-day operations. These ratios, in general, look at how well a corporation uses its assets and manages its debts (Guerard, J. B.,2021)

Accounts Receivable Turnover = Revenue / Average Accounts Receivables 

This ratio indicates how rapidly a business recovers payments from its clients. It is a measure of how effective a firm's credit practices are and the amount of receivables investment required to keep the company's sales level up. A higher accounts receivable turnover is a benefit to any entity. If an organization's accounts receivable turnover is too low, it implies that it is having trouble retrieving from its clients or that it is extending credit too freely (Kumoro, D. F. C.,2020)

Accounts Payable Turnover = Total Purchases / Average Accounts Payables 

Although accounts payable are liabilities rather than assets, their pattern is significant since they are a significant funding source for operating activities, influencing operational efficiency. This percentage is significant since it indicates how well a business manages its bills. A higher accounts payable turnover ratio implies that the company is not keeping track of its bills well or that its suppliers are not providing advantageous credit terms. It is preferable to have a low turnover of accounts payable (Kumoro, D. F. C., 2020). 

Days Sales Outstanding = (Accounts Receivable / Net Credit Sales) x Number of days

Day's sales outstanding measures the average number of days that it takes a company to collect payment for a sale. It is often determined on a monthly, quarterly, or annual basis. To compute DSO, divide the average accounts receivable during a given period by the total value of credit sales during the same period and multiply the result by the number of days in the period measured (Yuwono, T., & Asbari, M. 2020).

Days of Inventory = (Average Inventory / Cost of Sales) x 365 days

 This is the average number of days a corporation retains its goods before selling. Divide the average inventory cost by the cost of items sold, then multiply by the time integration, normally 365 days. The number of days in inventory can determine whether or not a company is working efficiently (Yuwono, T., & Asbari, M. 2020).   

Profitability Ratios

 Investors use profitability ratios to measure and evaluate how well a company can generate income (profit) from its financial operations over time (Krithika, M. 2017). They demonstrate how effectively a business uses its assets to generate profit and value for its shareholders. The high profitability ratio shows that the company is doing well in revenue, profit, and cash flow.

Gross Margin = Gross profit / Sales Revenue

Gross profit margin is calculated by dividing gross profit by sales revenue. It displays how much money a company makes after deducting the costs of producing its commodities. A higher gross profit margin ratio indicates that core activities are more efficient, allowing the company to meet expenditures, fixed costs, royalties, and depreciation while still producing net earnings. A low-profit margin, on the other hand, shows a high cost of goods sold, which can cause poor purchasing policies, low selling prices, low sales, severe market competition, or ineffective sales promotion techniques (Guerard, J. B., 2021)

Operating Margin = Operating Income / Sales

Operating profit margin - examines earnings as a proportion of sales before deducting interest and taxes. Companies with high operating profit margins can better cover fixed costs and interest on commitments, have a higher chance of surviving a global recession, and offer cheaper pricing than counterparts with lower profits. Because competent management may significantly improve a company's profitability by reducing its operational costs, the operating profit margin is usually used to gauge the strength of its administration (Yuwono, T., & Asbari, M. 2020).

Return on Assets = Net income / Total Assets

 This ratio expresses how much profit a corporation makes after taxes for every dollar of assets it owns. It also calculates a company's asset intensity. The lower a company's earnings per dollar of assets, the more asset-intensive it is. To produce revenue, very asset-intensive businesses must make significant investments in machinery and equipment (Gultekin, M. 2021). 

Return on Equity = Net Income / Shareholders Equity

Return on equity (ROE) is a profitability ratio that measures how successfully a firm manages its capital from its shareholders. The higher the return on equity (ROE), the better its management is at creating earnings from its equity funding. As with any financial data, comparing companies in the same industry when using ROE (Purnomo, A. 2018).

Conclusion

Financial ratios determine the profitability, solvency, liquidity level, and efficiency to survive in the industry. They are used to compare the financial statements of companies in the same industry (Asbari, M. 2020).

References

Ahrendsen, B. L., & Katchova, A. L. (2012). Financial ratio analysis using ARMS data. Agricultural Finance Review.

Balakrishnan, V., Kothandapani, G., & Krithika, M. (2017). A study on Profitability Ratio Analysis of the Sundaram Finance Ltd in Chennai. International Journal of Innovative Science and Research Technology, 2(5), 135-137.

Guerard, J. B., Saxena, A., & Gultekin, M. (2021). Financing Current Operations and Efficiency Ratio Analysis. In Quantitative Corporate Finance (pp. 79-98). Springer, Cham.

HASANUDDIN, R., DARMAN, D., TAUFAN, M. Y., SALIM, A., MUSLIM, M., & Putra, A. H. P. K. (2021). The Effect of Firm Size, Debt, Current Ratio, and Investment Opportunity Set on Earnings Quality: An Empirical Study in Indonesia. The Journal of Asian Finance, Economics and Business, 8(6), 179-188.

Kumoro, D. F. C., Novitasari, D., Yuwono, T., & Asbari, M. (2020). Analysis of the Effect of Quick Ratio (QR), Total Assets Turn Over (TATO), and Debt To Equity Ratio (DER) on Return On Equity (ROE) at PT. XYZ. Journal of Industrial Engineering & Management Research, 1(3), 166-183.

Pedrosa, Í. (2019). Firms’ leverage ratio and the Financial Instability Hypothesis: an empirical investigation for the US economy (1970–2014). Cambridge journal of economics, 43(6), 1499-1523.