welcome to financial ratio analysis so financial ratio analysis is one of the analytical tools that finance managers and analysts use to measure how financially healthy a company is so in this topic we would like to answer some of the questions like how do financial ratios as an analytical tool help us interpret and analyze a company's financial position which is the balance sheet and performance which is the income statement including the liquidity solvency profitability leverage and market value of a fear and also how are these financial statements based on racial analysis can provide as a foundation for projecting a firm's future so racial analysis involves methods of calculating and interpreting financial ratios to analyze and monitor a firm's performance it's not only important that you are familiar with the formulas or you memorize the formulas and you know how to compute for these formulas it's more important that you know how to interpret the result of this ratios for you to be able to analyze and monitor affirmative performance so just like physical illness or disease laboratory tests and so sometimes it takes a week months or even years not to monitor the health of a person so gonna be the man say some company so if there are problems a racial analysis for example so financial ratios involve the use of numerical values taken from both income statement and balance sheet that's why it's very important for us to become familiar with the statement of operations that includes your sales revenue so gross profit operating profit net income or earnings available for common shareholders so dependence type of the organization and signature of the business young chart of accounts now for state of the financial position so as we all know it's categorized into three you have your assets liabilities and stockholders equity so so humongous numerical values or figures nathan would be coming from your income statement and balance sheet all right so these are the five major financial ratios we have liquidity ratios activity ratios stability ratios profitability ratios and market ratios liquidity ratios okay they are also known as solvency ratios when we say liquid they but we're talking about cash so cash is king cash flows right so enough nakash and company current obligation it's the company liquid okay it's the company solving mandalay bank you convert your current assets to the company into cash all right so there are two liquidity ratios under it we have current ratio and we also have quick ratio now activity ratios also known as working capital ratio or efficiency analysis or efficiency ratios it answers how efficient is the company in using its assets okay to generate sales for the company it also talks about the speed company a company does it take for a company to do that and of course the total assets turnover now for stability ratios how does it differ from liquidity ratios stability ratios measure the ability of a company to pay its long-term obligation obligations those loans and debts that are payable after a year sometimes five years 10 years 20 years and and some of these ratios include debt ratio that equity ratio and times interest earned ratios is a subpoena popular ratio is of course in profitability ratios as we all know investors in a company and management they are mainly concerned in profitability both in the short run and long run for creditors to month must after cylinder onsen liquidity ratios and stability ratios because they would like to know if make a new company okay now profitability ratios include gross profit margin operating profit margin net profit margin earnings per share return on assets and return on equity whereas market rate system um price earnings ratio market book ratio dividend yield book value per share is used okay in the competition of some of our market ratios and of course price earnings growth ratio liquidity ratios measure a company's ability to meet its short-term obligations so we have two under liquidity ratios we have current ratio and quick ratio or also known as acid test ratio as you notice they have common denominators we have current liabilities for current ratio it includes all your current assets what are your current assets that include your cash marketable securities accounts receivables inventories and other prepayments whereas for a quick ratio okay you exclude inventory in the competition so only cash marketable securities accounts receivables and other current assets except for your inventory the question is why do we have to exclude inventory in the competition of ratio as we all know quick ratio is a better measurement of the liquidity of a company than current ratio inventory is not part of the competition because inventory is the least liquid among all the current assets matagal or mahira convert into cash why it takes time to convert raw materials into work in progress and to finish goods right and eventually sell them and receive cash from the sales of your goods and services okay next activity ratios activity ratios measure um how efficiently the company is managing its assets so it answers the question how fast or how slow the company is when it comes to managing its receivables when it comes to collecting receivables how fast or slow is the company when it comes to paying its obligations how fast or slow the company is in converting its inventory into cash and how efficient the company is in managing its total assets so as to generate sales for the company so pug turnover what did you notice for example accounts receivables turnover accounts payable turnover inventory turnover denominator so if it's accounts receivables turnover pansino the denominator is your accounts receivable senegal accounts receivable net sales that's why you numerator mo is net sales what about a house payable turnover accounts payable because raw materials or purchases from your suppliers to produce your goods and service stoma so the denominator is accounts payable and your numerator is your net purchases what about inventory turnover so your denominator is inventory and your numerator is cost of goods sold because your cost of goods sold that includes your um inventory at the beginning of the year plus any purchases plus any fried in and less inventory at the end of the year so union cost of goods sold and of course total assets turn over in a month total assets is your denominator and of course net sales well net sales means deducted human sales returns and allowances in some books they use average accounts receivables bucket why is it good to use average accounts receivables instead of the accounts receivables on a specific year or time period it's because average mustang measurement you own value accounts receivables so for example if your accounts receivable last year is 1 million pesos and then this year it's 5 million pesos so definitely computer accounts receivables turn over more okay but if you get the average at least you get you know the the nearest okay um amount of your accounts receivables okay now gonna dinaman buy like a house and inventory and even total assets turn over now average collection period how do we compute for average collection period so 365 days or it depends if the given problem is 360 days but if the problem is silent we use 365 days divided by the result of your accounts receivables turnover when it comes to average payment period 365 days your numerator divided by the accounts payable turnover your result method and average age of your inventory 365 days divided by your inventory turnover the result of this one okay so block period how many days does it take for a company to collect its accounts receivable um receivables some company average payment period demand the anonymous so that's it and the next we have that ratio it talks about the amount of other people's money being used to generate profits it's also known as leverage it's also known as capital structure ratio okay it measures if the company has the ability to pay its long-term obligation so those ratios included here are debt ratio debt equity ratio and times interest earned so when computing for that ratio this is the formula total liabilities over total assets what percentage of your on total assets is financed by creditors then that equitation among the formula is total liabilities over stockholders equity and times interest earned net income before tax or it's also known as operating income okay it means to say before you deduct your interest and taxes divided by the interest expenses of your long-term obligations so it measures um the ability of the company to pay its contractual payments so there are numerous ratios under profitability ratios as you notice the denominator for gross profit margin operating profit margin and net profit margin is your net sales you would like to know what is the percentage of your gross profit in relation to your sales what is the relationship or percentage of your operating profit in relation to your sales how big or how small is your net profit in comparison to your net sales next earnings per share the formula is net income minus preferred dividends if any if there are preferred dividends and divided by the common shares outstanding as we all know the preferred shareholders are preferred priority when it comes to giving out dividends so s net income minus preferred dividends for the preferred shareholders or also known as net income available for common shareholders shareholders return on assets net income divided by total assets and return on equity your net income divided by your total stockholders equity now market ratios relate the firm's market value as measured by its current market price to certain accounting values we have market book ratio so the formulae is market price some markets the stock market divided by the book value per share the book value per share is computed as your total stockholders equity minus your preferred stocks equity divided by the average common shares outstanding we also have price earnings ratio computed as market price divided by your eps and of course your dividend yield dividend per share per share divided by your beginning stock price now let's dig into the details of liquidity ratios so the first one is current ratio so again the formula is current assets divided by your current liabilities so for example um in the balance sheet of bartlett company you can see here that the total current assets of the company is one million two hundred twenty three thousand divided by the current liabilities which is six hundred twenty thousand so the result is 1.97 times what does it mean so current ratio measures the ability of a company to pay its current obligations using its current assets the question is obligations gamete and current assets we're not talking about total assets we're merely talking about current assets your current assets never let like cash marketable securities accounts receivables and inventories enough battle to pay all the current liabilities of bartlett company amounting to 620 000. as you can see here the total current assets they are bigger than your um current liabilities so liabilities current assets by 1.97 times or almost two times so for example if a company has a current ratio of two that means it can pay twice as much as its current liabilities okay so the higher the current ratio the better for it indicates a greater degree of liquidity normally one is good okay at least apartment lung your current assets and current liabilities and ideally two okay so juan company i merong current liability now one peso that means to say merong two pesos the current assets and some companies current liabilities now quick resource asset test ratio amount as i mentioned it deducts inventory so one million two hundred twenty three thousand minus 289 000 so that's 934 000 divided by your current liabilities of 620 000. so the result is 1.5 times it provides a better measure of the company's overall liquidity than your current ratio and same thing with current ratio the higher the ratio the better so come here and some currently there are some one peso and 50 centavos the current assets indica current obligations okay now inventory turnover the formula is cost of goods sold i mentioned turnover you know denominator so how much is cost of goods sold senate impeachment income statement okay inventory in a regarding a cost of goods so that's two million eighty thousand divided by the inventory under your current assets 289 thousand so 7.2 times in a year narrow plan is shown inventory is it a good sign or a bad sign is it good for a company to have 7.2 times so for one it's very important that you ask what the nature of the business is inventories into sales and eventually into cash and to better understand the speed one way to measure it is through average age of inventory how many days it takes for a company to convert its inventory into cash so the average age of inventory is computed as 365 days divided by your inventory turnover so inventory turnover a 7.2 times so 365 days divided by 7.2 so the result is 50.7 days what does it mean it takes 15.7 days or almost 51 days for a company to convert its inventory into cash valley 51 days and google the auras it takes you 51 days the question is is it good or is it bad it depends if it's a perishable item for example vegetable it takes you 51 days okay to sell that to convert that perishable goods okay into cash is it good or is it bad it's not good if we talk about um equipments machineries yamang attractors sima transportation vehicles metagalium you can say that 51 days is normally short so depending on the nature of products goods or services now receivables turn over in a month uh we're talking about the speed of your company when it comes to collecting okay your receivables sales revenue under your income statement is three million seventy four thousand divided by the accounts receivables of five hundred three thousand so six point eleven to better understand this let's compute for the average collection period you would like to know how many days does it take for your company to collect its debts or receivables okay so 365 days divided by receivables turnover the compute in kalina is 6.11 times so 365 days divided by 6.11 times it takes 59.7 days for a company to collect its receivables the question is is it good or is it bad dependence of credit terms or case credit policy num company if your company is granting 60 days okay to your clients your customers okay so it's good within 60 days of customers right per what if only terms is 30 days only so it means to say 30 days long in vinegar and credit terms and yet it takes you almost 60 days to collect so it's not good because your money is tied up to your receivables instead of using your money nine other profitable endeavor so um when you have this kind of result as a financial manager or analyst and you have to dig deeper or a bucket it takes you this long to collect the receivables so some of the reasons could be uh hindi strict implementation credit policy for the company okay or my problem when it comes to approval credit terms now let's proceed to payables turnover it is equal to net purchases over accounts payable so the assumption here is that purchases is 70 of cost of goods sold so what is seventy percent of two million eighty thousand that's one million four hundred sixty one thousand six hundred divided by three hundred eighty two thousand which is your accounts payable so the answer is three 3.83 times or it takes four times a year to turn over the company's payable so generally the higher your payables turn over the better average payment period the month talks about um how fast or how slow is your company when it comes to paying its obligations so the formula is 365 days divided by payables turnover so 365 days divided by three point eighty three times so the result is 95 days so what does it mean it takes you 95 days before you could pay your obligations so the question is is it good or is it bad for the company well again depending on the credit terms or contract suppliers is 60 days that means you say it now so your average paper period measures the number of days that it takes for you for your company to pay its obligation and this payment period is meaningful only in relation to the average credit terms extended to your company now let's proceed to total assets turnover the formula is sales divided by your total asset is your company efficient when it comes to managing its total assets to generate sales for the company okay so the higher a firm's total asset turnover okay the more efficiently its assets have been used so masmatic acetone total assets turn over mass mabilis replenish again total assets into sales now um stability ratio are also known as some debt ratios so the formula is total liabilities divided by total assets is 45.7 percent what does it mean forty five percent okay or almost forty six percent of your total assets is financed by your creditors mangaling sa utang so that means to say guiding more than 50 of your total assets are contributed by the owners regarding themselves equity so the higher this ratio the greater the amount of other people's money being used to generate profits are also known as leveraging now next that equity ratio the formula is total liabilities okay companies at that ratio your denominator is your total assets so that equity so numerator is debt total liabilities and your denominator is your equity or your stockholders equity so how much is your total liabilities it's 1 million 643 000 divided by stockholders equity of one million nine hundred fifty four thousand okay so that's 84.08 percent so what does it mean it means that creditors they provide 85 cents for every one peso provided by shareholders it measures a company's financial leverage and this resource should be used to compare companies within the same industry so definitely in that equity ration you would depend on the industry where company belongs to so many industries equity ratio normally 84.08 so a higher d ratio is often associated with high or from the owners okay so for a conservative investor with low risk tolerance bas baghi sahaniya accompanies that equity ratio of less than one let's proceed to times interest earned ratio the formula is earnings before interest and taxes also known as your operating income okay ebit or operating income divided by your interest expense okay as you can see here your the operating profits of bartlett companies 418 000 and the interest expense is 93 000 so that means to say bartlett company can pay its interest expenses 4.5 times using its operating profit kyber macbook company non-interest expense gaming i'm operating profit definitely yes in fact for every one peso of interest expense marriage some four passes and 50 centavos interest so the higher your times interest earned ratio the better now profitability ratios gross profit margin your denominator would be total sales revenue so gross profit is 986 000 okay divided by 3 million 74 000 so you would like to know how profitable the company is after it deducts cost of goods sold from its sales revenue supermap attack 32.1 percent is the gross profit margin so the bentamona 100 pesos iba was small your cost of good soldier 32 pesos and 10 centavos that means to say the cost of goods is 67 pesos and 90 centavos so 100 pesos minus 67 pesos and 90 centavos is equal to 32 pesos and 10 centavos so so the higher your gross profit margin the better now let's proceed to operating profit marginal when computing for the operating profit margin operating expenses so 418 000 divided by your net sales revenue so that's thirteen point six percent okay so animals gross profit margin or operating profit margin definitely gross profit margin a higher operating profit margin is preferred now net profit margin is equal to net profit over over total sales revenue so 221 000 is the net income after you have deducted all the cost of goods sold operating expenses interest expenses and taxes and even a preferred shares dividends okay so 221 000 divided by the sales revenue of 3 million 74 000 so we now get 7.2 percent so for every 100 peso sales deductions like opecs interest expenses income taxes prefer dividends 7 pesos and 20 centavos all right or 7.2 so the higher the net profit margin is the better is 7.2 percent good for the company well generally it's good positive view 7.2 percent but again um you have to compare it okay basis where are you going to compare it what if over the past five years that the range loans are one to two percent bring that profit margin more so you can say in the this year but assume that profit margin mo so ideally look for a company with a growth of at least seven percent with no more than two years of declining earnings of five percent during the past 10 years okay now earnings per share in a month we talk about the net income minus preferred dividends or also known as eacs or ax earnings available for common shareholders you net income after ibaba was my own dividends for the preferred shareholders individually and there's a total number of common shares home and stockholder all right so 221 000 this is the net income after medacyan prefer dividends divided by the total number of shares owned by common shareholders we get an earnings per share of 2.90 that means to say for every share of stock that you owed in the company oh it's earning two dollars and ninety centavos a higher eps okay it's indicative that investors will pay more for a company with higher profits so the higher the eps the better so when choosing stocks if you're interested in investing in a company always choose stocks with high earnings per share so return on assets is equal to earnings available for common shareholders also known as your net income after you deduct your preferred dividends divided by the total assets earnings per share it's divided by the total common shares outstanding support computing return on assets return so divided by your total assets so 221 000 divided by 3 million 597 000 return on assets is 6.1 so it measures the overall effectiveness of management in generating income using its available assets choose a company with a higher roa now return on common equity is earnings available for common shareholders divided by the common stock equity okay it measures the return earned on common stockholders investment interfere so the formula is yen so 221 000 is your net income after deducting preferred dividends divided by your common stock equity so you look at the stockholders equity if there are um accounts like preferred stocks ibalvas muyansa total stockholders equity because we would like to know how much loan you know ownership of the common shareholders so common stock paid in capital and leading earnings so that's 191 000 plus 420 000 plus 1 million 135 000 for a total of 1 million 754 000 so the roe is 12.6 percent it measures the return earned uncommon shareholders investment in the company now let's proceed to market ratio okay earnings per share it talks about but nikita's about that's earnings per share and among price earnings per share mahal or kamura okay so p e ratio is equal to market price per share divided by the earnings per share you know we computed the earnings per share which is 2.90 what if the market price of that stocks is 32.25 centavos meaning to say in buying and selling price in the stock market or in the market is 32.25 centavos so that means to say 11.1 times for every peso that you earn you are actually paying 11 peso and 10 centavos that's how expensive it is to buy that stock so the higher your per the more expensive the stock is a low p e ratio could indicate that you know stagnant companies growth the company is burdened with excessive debt and that the stock would be could be undervalued and people are unhesitant not to invest in this type of company but a company with a high p e ratio could be overpriced meaning that asian perceived value people would like to own or buy shares of stocks of that company it could have dependable future earnings growth brought on by recent expansion or acquisition your product line making it a good choice for growth investors now price earnings growth number and what we compare here is what we computed a while ago which is your p e ratio which measures how expensive or how affordable the shares of stocks are and of course the eps growth rate so for example for 2011 and 2012 the earnings per share is 1.81 dollars and 2.90 dollars respectively so that's a growth of 60 percent right so 11.1 times pe ratio divided by 0.6 that means to say point 18 is the price earnings growth ratio it determines a stock's value while considering the company's earnings growth and a pg ratio of more than one could imply that a stock is too expensive okay when we talk about book value we refer to common stock equity so your stockholders equity minus the preferred stocks over the number of common shares outstanding so your common stock equity is one million seven hundred fifty four thousand divided by seventy six thousand two hundred sixty shares or twenty three dollars book value book value is also known as intrinsic value mechanical and value no stocks known company it's twenty three millions dollars market value would not be billionaire 32 that means to say people are willing to pay 32 dollars in exchange for a 23 common shares amen so book value is used to find high growth companies that are undervalued so the higher the book value the better anno fifty pesos twenty three dollars in book value so your numerator is the market value and the denominator is your book value okay so the market price per share of common stock divided by the book value per share of common stock so people are buying this stock at 32.25 in exchange for 23. so this is 1.40 times okay it indicates that investors are currently paying 1.40 times for each dollar of book value of the company's stock in peso it's as if you are paying 1 peso and 40 centavos and in exchange for a 1 peso book value of companies of the company's tax okay warren buffett believes that you have to look for undervalued stocks pakistan being undervalued stocks market value now company 820. 23 dollars book value at the television worth no company or maglab 32.25 dollars is 23 now dividend yield ratio is equal to dividend per share divided by the market price so the dividend per share is already given so it's one dollar and 29 centavos so divided by the market price given that in canada so that's four percent so a higher uh figure signals that the company is doing well and it could signify a long-term investment as companies dividend policies are generally fixed in the long run now next dividend payout from the total earnings per share which is two dollars and ninety cents distribute nasa among shareholders or dividends per share so it measures the percentage of earnings given out as dividends there are two things that the company can do with its related earnings getting in the meeting rated earnings to distribute dividends or restricted earnings and retained earnings for other objectives of the company like expansion um to buy another business or to reinvest in the business or to take a more profitable activity so that's it that's end of my presentation i hope you learned a lot from financial ratio analysis