Lecture Notes on Financial Ratios and Analysis

Introduction

• Lecture focused on different financial ratios and their significance in analyzing company performance.
• Discussed types of ratios: Profitability, Liquidity, Debt, Working Capital, Inventory Turnover, and others.

Types of Ratios

• Profitability Ratios: Used to measure a company's ability to generate profit as compared to its revenue, expenses, and equity.

  • Gross Profit Ratio: Measures the gross profit as a percentage of sales.
  • Net Profit Ratio: Indicates the percentage of revenue that remains as profit after all expenses.
  • Operating Profit Ratio: Focuses on earnings before interest and taxes relative to revenue.

• Liquidity Ratios: Evaluate the ability of a company to cover its short-term obligations.

  • Current Ratio: Current Assets divided by Current Liabilities.
  • Quick Ratio: Current Assets minus Inventory divided by Current Liabilities.

• Debt Ratios: Measure the extent of a company's financing through debt.

  • Debt to Equity Ratio: Total Debt divided by Total Equity.

Working Capital Ratio

• Definition: Working Capital = Current Assets - Current Liabilities.
• Importance: Determines the operational liquidity available to a business.

Key Calculation Concepts

1. Inventory Turnover Ratio:
   • Formula: Cost of Sales / Average Inventory.
   • Indicates how many times inventory is sold and replaced over a period.
2. Inventory Period:
   • Formula: 365 / Inventory Turnover Ratio.
   • Indicates the average time inventory remains in stock before being sold.
3. Debtor Turnover Ratio:
   • Formula: Credit Sales / Average Debtors.
   • Shows how efficiently the company collects cash from its debtors.
4. Creditor Turnover Ratio:
   • Formula: Credit Purchases / Average Creditors.
   • Indicates how quickly a company pays its suppliers.

Cash Operating Cycle

• Formula: Inventory Period + Debtor Period - Creditor Period.
• Significance: Measures how efficiently a company manages its working capital.

Limitations of Ratio Analysis

• Dependence on historical data which may not reflect current conditions.
• Variations in accounting policies can distort comparisons.
• Dependence on external sources for information can lead to inaccuracies.

Practical Application

• Application of the discussed ratios with examples from the previous lecture.
• Emphasis on calculating ratios accurately and interpreting them in context.

Key Takeaways

• Higher inventory turnover ratios indicate efficient operations.
• Shorter inventory periods are preferable as they suggest quick sales.
• Effective management of receivables and payables positively impacts the company's cash flow.

Practice Problems

• Calculated various ratios based on given company data.
• Group exercises involved solving problems related to financial ratios and performing ratio analysis on different companies.

Conclusion

• Importance of understanding and applying financial ratios to analyze a company's performance.
• Practical exercises to be continued in the next session to reinforce concepts.

---