DEFINITION OF 'RATIO ANALYSIS'

Quantitative analysis of information contained in a companys financial

statements. Ratio analysis is based on line items in financial statements like the
balance sheet, income statement and cash flow statement; the ratios of one item
or a combination of items - to another item or combination are then calculated.
Ratio analysis is used to evaluate various aspects of a companys operating and
financial performance such as its efficiency, liuidity, profitability and solvency.
!he trend of these ratios over time is studied to check whether they are
improving or deteriorating. Ratios are also compared across different companies
in the same sector to see how they stack up, and to get an idea of comparative
valuations. Ratio analysis is a cornerstone of fundamental analysis.
"hile there are numerous financial ratios, most investors are familiar with a few
key ratios, particularly the ones that are relatively easy to calculate. #ome of
these ratios include the current ratio, return on euity, the debt-euity ratio, the
dividend payout ratio and the price$earnings %&$'( ratio.
)or a specific ratio, most companies have values that fall within a certain range.
* company whose ratio falls outside the range may be regarded as grossly
undervalued or overvalued, depending on the ratio.
)or e+ample, if the average &$' ratio of all companies in the #,& -.. inde+ is
/., with the ma0ority of companies having a &$' between 1- and /-, a stock with
a single-digit &$' would be considered undervalued, while one with a &$' of -.
would be considered overvalued. 2f course, this ratio would typically only be
considered as a starting point, with further analysis reuired to identify if these
stocks are really as undervalued or overvalued as the &$' ratios suggest.
*s well, ratios are usually only comparable across companies in the same sector,
since an acceptable ratio in one industry may be regarded as too high in another.
)or e+ample, companies in sectors such as utilities typically have a high debt-
euity ratio, but a similar ratio for a technology company may be regarded as
unsustainably high.
Ratio analysis can provide an early warning of a potential improvement or
deterioration in a companys financial situation or performance. *nalysts engage
in e+tensive number-crunching of the financial data in a companys uarterly
financial reports for any such hints.
#uccessful companies generally have solid ratios in all areas, and any hints of
weakness in one area may spark a significant sell-off in the stock. 3ertain ratios
are closely scrutini4ed because of their relevance to a certain sector, as for
instance inventory turnover for the retail sector and days sales outstanding
%5#2s( for technology companies.
6t is a form of )inancial #tatement *nalysis that is used to obtain a uick
indication of a firm7s financial performance in several key areas. !he ratios are
categori4ed as #hort-term #olvency Ratios, 5ebt 8anagement Ratios, *sset
8anagement Ratios, &rofitability Ratios, and 8arket 9alue Ratios.
Ratio *nalysis as a tool possesses several important features. !he data, which
are provided by financial statements, are readily available. !he computation of
ratios facilitates the comparison of firms which differ in si4e. Ratios can be used
to compare a firm7s financial performance with industry averages. 6n addition,
ratios can be used in a form of trend analysis to identify areas where
performance has improved or deteriorated over time.
:ecause Ratio *nalysis is based upon *ccounting information, its effectiveness
is limited by the distortions which arise in financial statements due to such things
as ;istorical 3ost *ccounting and inflation. !herefore, Ratio *nalysis should only
be used as a first step in financial analysis, to obtain a uick indication of a firm7s
performance and to identify areas which need to be investigated further.
!he pages below present the most widely used ratios in each of the categories
given above. &lease keep in mind that there is not universal agreement as to
how many of these ratios should be calculated. <ou may find that different books
use slightly different formulas for the computation of many ratios. !herefore, if
you are comparing a ratio that you calculated with a published ratio or an industry
average, make sure that you use the same formula as used in the calculation of
the published ratio.
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3ost of >oods #old ?@.,...
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2perating e+pensesA
#elling '+penses ?-,...
*dministrative '+penses B-,...
!otal 2perating e+penses @.,...
2perating 6ncome
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6nterest '+penses 1/,...
6ncome :efore !a+es
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6ncome !a+ '+penses
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*ccounts Receivables Cet B.,-..
6nventory ?1,...
#upplies ?,@..
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=essA 5epreciation %-E,...(
)i+ed *ssets ??F,...
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#hareholders 'uity
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Reserves and #urplus //D,...
=essA 3losing #tock %-.,...(
!otal #hareholders 'uity /@D,...
3urrent =iabilities
:ills payable -,...
*ccounts payable ?-,D..
"ages payable @,-..
6nterest payable /,D..
!a+es payable E,1..
Gnearned revenues /,E..
!otal 3urrent =iabilitiesA E1,...
:ills &ayable /.,...
:onds payable B..,...
!otal =iabilities FF.,...
RatiosA
1. "orking 3apitalA
H3urrent =iabilities 3urrent *ssets
H @D,... E1,...
H /@,...
/. 3urrent RatioA
H 3urrent *ssets $ 3urrent =iabilities
H @D,... $ E1,...
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H I%3ash J !emp. investments J *ccounts Receivable( $ 3urrent =iabilitiesK
H I% /1.. J 1.. J 1.,... J B.,-..( $ E1,...(K
H -/F.. $ E1...
H ..@E
B. *ccounts Receivable !urnoverA
H Cet 3redit #ales for the year $ *verage *ccounts Receivable for the year
H -..,... $ B/,...
H 11.D.
-. 5ays #ales in *ccounts ReceivableA
H ?E- 5ays in a year $ *ccounts Receivable !urnover for the year
H ?E- $ 11.D.
H ?..EF days
E. 6nventory !urnoverA
H 3ost of >oods #old for the year $ *verage 6nventory for the year
H ?@.,... $ ?.,...
H 1/.EF
F. 5ays #ales in 6nventoryA
H ?E- 5ays in a year $ 6nventory !urnover for the year
H ?E- $ 1/.EF
H /@.@1
@. 5ebt to 'uityA
H %!otal =iabilities $ !otal #tockholders 'uity( A 1
H B@1,... $ /@D,... A 1
H 1.EE A 1
D. >ross &rofitA
H >ross &rofit $ Cet #ales
H 1/.,... $ -..,...
H /B
1.. Cet &rofitA
H Cet &rofit $ Cet #ales
H /?... $ -..,...
H B.E
11. 'arnings per #hareA
H Cet income after !a+ $ "eighted *verage number of #hares 2utstanding
H /?... $ 1..,...
H ../?
1/. Return on #tockholders 'uityA
H Cet 6ncome for the year after !a+es $ *verage #tockholders 'uity
during the year
H/?... $ /F@,...
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2ther Recurring 6ncome ?,@.1.@E
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Reported Cet &rofit ??B.-/
'arnings :efore *ppropriation 1,EFF.?1
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Retained 'arnings 1,./@.F-
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Total ??,ED/.1@
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:ook 9alue of Gnuoted 6nvestment 1@,1.B.D/
8arket 9alue of Quoted 6nvestment /-?..F
3ontingent liabilities 1/,B1D.?.
Cumber of 'uity shares outstanding %in =acs( ?/,1@E.@.
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1. "orking 3apitalA
H 3urrent *ssets 3urrent =iabilities
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/. 3urrent RatioA
H 3urrent *ssets $ 3urrent =iabilities
H D,E@..?E $ 1E,.B/./B
H ..E.
?. Quick RatioA
H I%3ash J !emp. investments J *ccounts Receivable( $ 3urrent =iabilitiesK
H..?E
B. 6nventory !urnover RatioA
H 3ost of >oods #old for the year $ *verage 6nventory for the year
H @.@D
-. 5ays #ales in 6nventoryA
H ?E- days in a year $ 6nventory !urnover ratio
H B1..-
E. 5ebt-'uityA
H !otal =iabilities $ #tockholders 'uity
H ??,ED/.1@ $ 1D1EF.E-
H 1.FE
F. >ross &rofit RatioA
H >ross &rofit $ Cet #ales
H [email protected]
@. Cet &rofit RatioA
H Cet &rofit $ Cet #ales
H ..@F
D. 2perating &rofit RatioA
H 2perating &rofit $ Cet #ales
H -/.-E
1.. Return 2n Cet "orth
H Cet &rofit *fter !a+ $ Cet "orth
H B.--
11. Return 2n long !erm )unds
H Cet &rofit *fter !a+ $ =ong !erm )unds
H /.DB