Ratio

Analysis
Ruth Fernandez, MSc
Septemeber 2024

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 OBJECTIVES:

• Liquidity Ratios
• Asset Management Ratios
• Debt Management Ratios
• Profitability Ratios

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 RATIO ANALYSIS
Ratio analysis helps the firms by comparing a company’s financial performance to similar firms in
the industry to understand the company’s position in the market, with this, the management can
then use the information to formulate decisions that aim to improve the company’s position in the
market.

This analysis is mainly used by external analysts to determine various aspects of a business, such as
its:

Profitability (if a specific firm can use the resources that are available to generate revenues)

Liquidity (if assets can be readably converted to cash to spend or invest)

Solvency (if the firm can meet its obligation and has the ability to continue the business)
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 RATIO ANALYSIS

Let us divide the ratios into four categories.

1.Liquidity ratios, gives an idea of the firm’s ability to pay off debts that are maturing within a
year.

2.Asset management ratios, gives an idea of how efficiently the firm is using its assets.

3.Debt management ratios, gives an idea of how the firm has financed its assets as well as the
firm’s ability to repay its long-term debt.

4.Profitability ratios, gives an idea of how profitably the firm is operating and utilizing its assets.

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 LIQUIDITY RATIO
The liquidity ratios help answer this question:

“Will the firm be able to pay off its debts as they come due and thus remain a viable
organization?” If the answer is no, liquidity must be addressed.

Liquidity ratios are used by banks, creditors, and suppliers to determine if a client can honor their
financial obligations as they come due.

Common liquidity ratios include the following:

 Current Ratio
 Acid-test/Quick Ratio
 Cash Ratio 5
 CURRENT RATIO
Current Ratio
The primary liquidity ratio, which is calculated by dividing current assets by current liabilities. The
current ratio helps investors understand more about a company's ability to cover its short-term debt
with its current assets.
Current ratio = Current assets / Current
liabilities
Example:
Current assets = 150,000 + 200,000 + 250,000
Your business holds: = ₱600,000
*Cash = ₱150,000
*Marketable securities = ₱200,000 Current liabilities = 150,000 + 150,000
*Inventory = ₱250,000 = ₱300,000
*Short-term debt = ₱150,000 6
*Accounts payables = ₱150,000 CURRENT RATIO = 600,000/300,000 = 2.0x
Current Ratio = 67,334,803,230 /
39,028,100,222

= 1.73

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 LIQUIDITY RATIO
Quick, or Acid Test Ratio
The second liquidity ratio is the quick, or acid test, ratio, the acid-test ratio, it shows the company's
ability to convert its assets into cash to satisfy its immediate liabilities.

Example:
Current assets = 150,000 + 200,000 = ₱350,000
Your business holds:
Inventory = ₱250,000
*Cash = ₱150,000 Current liabilities = 150,000 + 150,000
*Marketable securities = ₱200,000 = ₱300,000
*Inventory = ₱250,000
*Short-term debt = ₱150,000 QUICK RATIO = 350,000 - 250,000 / 300,000
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*Accounts payables = ₱150,000 = 0.33
Quick Ratio = 67,334,803,230 -
28,446,987,863 / 39,028,100,222

= 38,887,815,367 /
39,028,100,222

= 0.996 or 1%

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 CASH RATIO
Cash Ratio
The cash ratio is generally more conservative. It measures the company's ability to cover its debts
and obligations, because it sticks strictly to cash or cash-equivalent holdings—leaving other assets,
including accounts receivable, out of the equation.

Example:
Cash and Cash Equivalents = 150,000 + 200,000
Your business holds: = ₱350,000
*Cash = ₱150,000 Current liabilities = 150,000 + 150,000
*Marketable securities = ₱200,000 = ₱300,000
*Inventory = ₱250,000
*Short-term debt = ₱150,000 CASH RATIO = 350,000 / 300,000 = 1.17 10
*Accounts payables = ₱150,000
= 16,957,684,321 /
39,028,100,222 5

= 0.43%

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 ASSET MANAGEMENT RATIO
Asset management ratio can measure how effectively the firm is managing its assets.

Ratios under Asset Management can answer this question:

Does the amount of each type of asset seem reasonable, too high, or too low in view of current and
projected sales?

Common asset management ratios include the following:

 Inventory Turnover Ratio

 Day Sales Outstanding

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 INVENTORY TURNOVER RATIO
Inventory Turnover Ratio
As the name implies, these ratios show how many times the particular asset is “turned over” during
the year. A slow turnover implies weak sales and possibly excess inventory, while a faster ratio
implies either strong sales or insufficient inventory.

Example: Sales = ₱14,780,000

Inventories = ₱1,500,000 + ₱2,000,000
*Inventory (2019) = ₱1,500,000 = ₱3,500,000
*Inventory (2020)= ₱2,000,000
*Net Sales = ₱14,780,000 INVENTORY TURNOVER RATIO
= 14,780,000 / 3,500,000 = 4.22 13
 DAY SALES OUTSTANDING
Day Sales Outstanding

Accounts receivable are evaluated by the days sales outstanding (DSO) ratio, also called the
average collection period (ACP). It is calculated by dividing accounts receivable by the average
daily sales to find how many days’ sales are tied up in receivables. Thus, the DSO represents the
average length of time the firm must wait after making a sale before receiving cash.

DSO = Accounts Receivables / Net Credit Sales X Number

of Days

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 DAY SALES OUTSTANDING

Example: Accounts Receivables / Sales x number of

days
For month of August:
*Account Receivables = ₱100,000 DAY SALES OUTSTANDING
*Net Sales= ₱220,000 = 100,000 / 220,000 = 0.45 x 31
=14.09 Days

DSO = Accounts Receivables / Net Credit Sales X Number

of Days

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 DEBT MANAGEMENT RATIO
Debt Management Ratios attempt to measure the firm's use of Financial Leverage
and ability to avoid financial distress in the long run. These ratios are also known
as Long-Term Solvency ratios. The use of debt will increase, or “leverage up” a
firm’s ROE if the firm earns more on its assets than the interest rate it pays on
debt. However, debt exposes the firm to more risk than if it financed only with
equity.

Common debt management ratio include the following:

 Total Debt to Total Capital

 Times Interest Earned Ratio
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 TOTAL DEBT TO TOTAL CAPITAL
Total Debt to Total Capital
The ratio of total debt to total capital measures the percentage of the firm’s capital provided by
debtholders.

Example:
DEBT TO CAPITAL RATIO
You have a ₱40,000 short-term liabilities and = (40,000 + 70,000) / (40,000 + 70,000) +
₱70,000 long-term liabilities on your balance (20,000 + 5,000 + (8,000 x 5))
sheet. You’ve also issued ₱20,000 preferred
stock, ₱5,000 in minority interest, and have = 110,000 / (110,000 + 25,000 + 40,000)
around 8,000 outstanding shares trading at ₱5 = 0.629 or 63% 17
per share.
 TIME INTEREST EARNED RATIO
Time Interest Earned Ratio

TIE ratio also known as interest coverage ratio, indicates how well a company can
cover its interest payments on a pretax basis. The larger the time interest earned,
the more capable the company is at paying the interest on its debt.
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 TIME INTEREST EARNED RATIO
Time Interest Earned Ratio

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 PROFITABILITY RATIO
Accounting statements reflect events that happened in the past, but they also provide clues about
what’s really important—that is, what’s likely to happen in the future. The liquidity, asset
management, and debt ratios can tell us something about the firm’s policies and operations. Now,
we turn to the profitability ratios, which reflect the net result of all of the firm’s financing policies
and operating decisions.

Common profitability ratio include the following:

 Operating Margin
 Net Profit Margin
 Return on Total Assets

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 OPERATING MARGIN
Operating Margin
Operating margin ratio demonstrates how much revenues are left over after all
the variable or operating costs have been paid. It can measure of a company's
overall profitability from operations. It is the ratio of operating profits to
revenues. It is calculated by dividing operating income (EBIT) by sales.

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OPERATING MARGIN

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 NET PROFIT MARGIN
Net Profit Margin
Net profit margin helps investors assess if a company's management is generating
enough profit from its sales and whether operating costs and overhead costs are
being contained.

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NET PROFIT MARGIN

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 RETURN ON TOTAL ASSETS
Return on Total Assets
ROTA measure how effectively the firm or the organization can earn a return on its investment that
is made in assets. Basically, it depicts how efficiently the firm or the company or the organization
can convert the amount or the money which is used to purchase those assets into operating profits
or operating income.

Return on Total Assets

= 493,244 / 4,295,236

= 11.48% 25
THANK YOU!

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