Financial Ratio Analysis How can published financial statements be used to assess financial performance?
Financial Ratio Types • Market Value • Profitability • Asset Activity • Leverage • Liquidity
Market Value Ratios • Examples: Market-to-Book; Price-Earnings • Questions: How do securities markets value the company’s assets? Earnings?
Profitability Ratios • Examples: Return on assets, equity, invested capital; gross, net profit margin • Questions: How profitable is the company per dollar invested in the business; per dollar of sales?
Asset Activity Ratios • Examples: asset turnover, average collection period, inventory conversion period, payables deferral period • Questions: How efficiently does the company use its assets? How long does it take assets or liabilities to turn into cash?
Leverage Ratios • Examples: Debt/assets; Debt/equity; Interest coverage • Questions: How much of a burden does debt pose relative to assets, equity or cash flow? How risky is the company?
Liquidity Ratios • Examples: Current ratio, quick ratio, interval measure • Questions: How easily can the company meet its immediate cash requirements? How risky is the company?
Financial Ratios Relative to What? • By themselves, financial ratios have no meaning. We need to compare to: • Past data for the same company • Data for similar companies (e.g., same industry) • Other ratios (i.e., DuPont ratios, Cash Conversion Cycle)
A Good Source of Company Ratios www.investor.reuters.com
DuPont Ratios Net Income x Sales x Assets = Net Income Sales Assets Equity Equity Net profit X Asset x Equity = ROE margin turnover multiplier