BP

Current Ratio = Current Assets/Current Liabilities

· Will the firm be able to pay off its debts as they come due in the coming year?

· A higher current ratio indicates a stronger financial position

· Healthy Ratio (Rule of Thumb): 2

Quick Ratio = (Current Assets-Inventories)/Current Liability

· Firm’s ability to meet its short-term obligations without relying upon the sale of its inventories.

· A quick ratio of .9 to 1 is acceptable in most industries

Activity Ratio (how effectively the firm is managing its assets)

Inventory Turnover = Sales/Inventories

· How many times the asset is turned over during year

· Whether a firm holds excessive stocks of inventories and whether a firm is selling its inventories slowly compared to the industry average

· The faster inventory sells, the sooner cash comes in

· Too high a value can mean that the business is not keeping enough inventory on hand (strive for the most profitable rate)

· COGS (cost of goods sold)/average inventory (inventories are usually recorded at cost)

Days Sales in Inventory (DSI) = 365days/Inventory Turnover

· How many days’ sales are tied up in inventories

· Average length of time that inventory sits before it is sold

· How fast the firm can sell its products

Accounts Receivable Turnover Ratio = Sales/ Accounts Receivable

· Ability to collect cash from customer

· How many times during the year average receivables were turned into cash

Days’ Sales Outstanding (DSO) =365/receivables turnover

· How many days’ sales remain in Accounts Receivable

Fixed Asset Turnover = Sales/Fixed assets

· How effectively the firm uses its plant and equipment (Does the firm us its fixed assets as intensively as other firms in its industry?)

· Large variances between market value and book value (inflation) tend to inflate the Fixed Assets Turnover, which could cause an older company to appear more efficient than a younger company, but these ratio differences would be more reflective of when the assets were acquired rather than the inefficiency of the younger firm

Total Asset Turnover = Sales/Total Assets

· How effectively the firm uses all its assets

· It measures the company’s ability to generate sales based on its assets

Leverage Ratio (ability to pay total liabilities)

The Debt Ratio=Total Liabilities/Total assets

· Proportion of assets financed with debt

· The higher the debt ratio, the greater the pressure to pay interest and principal

· The lower the debt ratio, the lower the company’s credit risk

The Times-Interest-Earned Ratio= Earnings before interest and taxes/Interest changes

· Relate income to interest expense

· Measures the number of times operating income can cover interest expense

· Some company has no interest-bearing debt!

Profitability Ratio

Gross (Profit) Margin = (Sale-Cost of goods sold)/Sales

· The total margin available to cover operating expenses and yield a profit

Operating Profit Margin = Earning s before interest and taxes (EBIT)/Sales

· Measures the % of profit earned from each sales dollar in a company’s core business operations

· Persistently high rate is an important determinant of earnings quality

· Keeping operating cost as low as possible, given the level of desired product quality and customer service

Net Profit Margin = Net Income/Sales

· Measures the profit per dollar of sales

· The higher the %, the more profit is being generated by sales dollars

· Sub-par results generally occur because costs are too high or inefficient operations.

· If a firm sets a very high price on its products, it may get a high return on each sale but not make many sales.

Return on Total Assets = Net Income/Total Asset

· Sub-par results may reflect financing strategy

Return on Common Equity = (Net Income-preferred dividends) /Common Equity

· How much income is earned for every $1 invested

· Stockholders expect to earn a return on their money, and this ratio tells how well they are doing in an accounting sense. It is considered the “bottom-line” accounting ratio.

· BEP shows the raw earning power of the firm’s assets, before the influence of taxes and leverage.

Market Value Ratio

Price earning ratio = market price per share/earnings per share

· It shows the market price of $1 of earnings.

· Earnings per share = (net income-preferred dividends)/ number of shares of common stock outstanding (earnings available to the owners of common stock)

· P/E ratios are higher for firms with strong growth prospects and relatively little risk

Harrison, Horngren, Thomas. 2013. Fianancial Accounting (9e)

Brigham, E. F., & Houston, J.F. 2007 Fundamentals of Fianancial management (11e)