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Fin420-Chapter 3 Financial Ratio and Analysis

This document discusses financial ratio analysis. It begins by outlining the learning objectives of understanding how to calculate and interpret financial ratios to analyze a company's performance. It then defines financial ratios and their uses, types of ratio analysis including cross-sectional and time-series. It also outlines the main categories of ratios and provides examples of specific ratios to calculate under each category, including liquidity, activity, leverage, profitability, and market ratios. It concludes by noting some limitations of ratio analysis.

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Emmy Azman
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169 views29 pages

Fin420-Chapter 3 Financial Ratio and Analysis

This document discusses financial ratio analysis. It begins by outlining the learning objectives of understanding how to calculate and interpret financial ratios to analyze a company's performance. It then defines financial ratios and their uses, types of ratio analysis including cross-sectional and time-series. It also outlines the main categories of ratios and provides examples of specific ratios to calculate under each category, including liquidity, activity, leverage, profitability, and market ratios. It concludes by noting some limitations of ratio analysis.

Uploaded by

Emmy Azman
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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CHAPTER 3

Financial Ratios and Analysis

□ Types of Analysis
□ Types of Financial ratios
□ Limitations of Ratios Analysis
Learning Objectives

By the end of this chapter, learners should be


able to:

❑Calculate financial ratios;


❑Analyze and interpret the company’s
performance based on ratio analysis.
Financial Ratios

□ As an Analysis tools (i.e. to interpret


and evaluate firm’s performance)
□ Base on Financial Statement
□ Users (i.e. Financial Managers, Investors,
Creditors or interested parties)
□ Two ways to interpret:
■ Trend analysis(i.e. time series analysis)
■ Comparative analysis (i.e. cross-
sectional analysis)
Types of Ratio Analysis

□ Cross Sectional Analysis


▪ The comparison of different firms’ financial ratios
at the same point in time.
▪ E.g :- Digi would like to compare with Maxis and
Celcom in its Broadband Subscriber performance.
Types of Ratio Analysis

□ Time-Series Analysis
▪ Evaluates performance over time.
▪ The comparison of current to past performance to
determine whether it is progressing as planned.
▪ E.g :- Maxis would like to compare its current
Broadband Subscriber performance to last year
performance in terms of sales area and volume.
Financial Ratios (cont..)

□ Group into 5 categories


■ Liquidity ratios (i.e. how liquid the firms to meet
short-term obligation)
■ Activity ratios (i.e. to measure efficiency of
assets to generate sales)
■ Leverage ratios (i.e. how firms finance its assets,
to determine the capital structure)
■ Profitability ratios (i.e. measure the efficiency of
firms to generate profit)
■ Market/Equity Ratios
Financial Ratios (cont..)

Liquidity Ratios
Current Assets
Current Ratio = Current
Liabilities
Answer in X, higher ratio reflect the ability to pay its short term obligations
on time

Quick Ratio CA– Inventory-Prepayment


CL
=
Answer in X, higher ratio reflect the ability to pay its short term obligations
without rely on inventories
Financial Ratios (cont..)

Liquidity Ratios
Net Working = CA - CL
Capital
Answer in $, higher (i.e. positive value), suggest that firm is liquid and able
to pay its short term obligations.
Financial Ratios (cont..)
Activity Ratios
Inventory COGS
Turnover = Inventory
Answer in X, higher ratio reflect the effectiveness of inventory to generate
sales
Average A/c Receivables
Collection Period Sales
Answer in=Days, higher ratio indicates that firm has problem in collecting
debt
Financial Ratios (cont..)
Activity Ratios

A/C Sales
Receivable = A/C
Turnover Receivable
Answer in X, higher ratio reflect the effectiveness in collecting receivables
Financial Ratios (cont..)
Activity Ratios
Fixed Assets Sales
Turnover = Net Fixed Assets
Answer in X, higher ratio reflect the effectiveness of fixed assets to generate
sales
Sales
Total Assets = Total Assets
Turnover
Answer in X, higher ratio reflect the effectiveness of total assets to generate
sales
Financial Ratios (cont..)
Leverage or Solvency Ratios
Debt Total Debt
Rati = Total Assets
Answer in o
%, higher ratio reflect the higher amount of debt to finance assets

Debt to Total Debt


Equity = Equity
Answer in %, higher ratio reflect the higher amount of debt (i.e. capital
structure
Financial Ratios (cont..)
Leverage or Solvency Ratios
Time Interest EBIT
Earned = Interes
t
Answer in X, higher ratio indicates that firm can meet loan requirement and
lower risk of default
Financial Ratios (cont..)
Profitability Ratios
Gross Profit Gross
Margin = Profit
Sales
Answer in %, higher ratio indicates higher contribution margin

Operating Operating Profit (EBIT)


Profit Margin = Sales
Answer in %, higher ratio indicates better productivity (i.e. operations)
Financial Ratios (cont..)
Profitability Ratios
Net Profit Earnings After Tax
Margin = Sales
Answer in %, higher ratio indicates better income to shareholders

Return On Earnings After Tax


Assets = Total Assets
Answer in %, higher ratio indicates higher return on firm’s investment
Financial Ratios (cont..)
Profitability Ratios

Return On = Earnings After Tax


Equity Total Equity

Answer in %, higher ratio indicates higher return to shareholders


Financial Ratios (cont..)
Market/Equity Ratios
Earning Earnings After Tax
Per = No. of common
AnswerShare
shares
in $, higher ratio indicates better income per share

Price to Market Price p/share


= EPS
Earnings
Answer in X, higher ratio indicates the firm’s market price is overvalued
Financial Ratios (cont..)
Market/Equity Ratios
Dividend Ordinary Dividends
= Market Price per Share
Per Share
Answer in $, higher ratio indicates the amount of dividend received by
shareholders for each unit of shares held

Dividend Dividend Per Share


= Earning Per Share
Payout Ratio
Answer in $, higher ratio indicates the proportion of earning that is
distributed as dividends to shareholders.
Financial Ratios (cont..)
Market/Equity Ratios
Dividend Latest Dividends
= No. of common shares
Yield
Answer in %, higher ratio indicates the return earned on shares
Financial Ratio Analysis
Income Statement for the year ended December 31,
2003
Financial Ratio Analysis (cont..)
Balance Sheet as at December 31, 2000 &2003
Liquidity Ratios
Profitability Ratios
Activity Ratios
Leverage or Solvency Ratios
To Answer Financial Ratio Q
□ Calculate the ratios according to its Main
Financial Ratio (i.e. Liquidity Ratio – Current
Ratio, Quick Ratio etc) and follow with other
Main Financial Ratios…
□ Then Compare and Comments (i.e. vertical
analysis or horizontal analysis) according to
Main Financial Ratio.
Example : Calculate Liquidity Ratios
(i.e. current ratio and quick ratio)

C $2,68
CR = A = 0 =
1.85x. CL $1,44
5
CA - Inv.
QR CL
=
$2,680 -
= $1,716 =
0.67x. $1,445
Comments on Liquidity Ratios (i.e.
CR and QR)
2002 Ind.
CR 1.85x 2.7x
QR 0.67x 1.0x

■ Both ratios are below the industry


average.
■ Liquidity position is weak.
Limitations of Financial Ratios

1. Non-comparative data – difficult to identify the


industry category a particular company belongs due
to diversification practiced by the company.
2. Different accounting treatments – certain items in
the financial statements might not be consistent
from one firm to another due to differences in
accounting system.
3. Unreliable figures – the figures published may
overstate the real figure to please the investors and
show off good financial conditions of the company.

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