Financial Ratios

• Liquidity Ratios:

Current ratio is a liquidity ratio that tells investors and analysts about the company’s
ability to pay their short-term expenses.
Current Ratio= Current Assets/ current liabilities
Liquid Ratio: is an absolute liquidity ratio that takes out inventory from the ratio and it
also explains how the company’s will be able to pay its short-term expenses.
Liquid ratio = Current Assets-Inventory=
Current Liabilities

Liquidity Ratios:
 Analysis: If Current ratio have increased from 1.26 to 1.33. This increase indicates that Honda’s ability to meet its short-term
debts have improved. The balance sheet shows its cash, accounts receivable, has increased from the last year and short-term
liabilities have decreased meaning it has paid its short-term liabilities. Which has led to increase in current ratio from 1.26 to
1.33. The ideal current ratio is 2:1. Honda current ratio is 1.33 which means that the company has $1.33 of current assets to
pay its current liabilities.
 Liquid Ratio: is an absolute liquidity ratio that takes out inventory from the ratio and it also explains how the company’s will
be able to pay its short-term expenses

Liquid ratio = Current Assets-Inventory= 7,301,010- 1,560,568= 0.99 For the year 2020
Current Liabilities 5,790,088

 Liquid Ratio =7,579,091-1,545,600/5715457= 1.06 For the year 2021.

 Analysis: Liquid ratio have slightly improved from 1 to 1.06. Ideal liquid ratio is 1:1. Inventory is not included in the liquid
ratio. The same reasons which apply to current ratio also applies to Liquid ratio
Investment Ratios:

Return on Capital employed:

The return on capital employed indicates how much operating income a company is generating for each dollar of capital invested. Companies
prefer higher ROCE is, because it indicates for each dollar of capital employed more profits are generated. ( Bekaert, G. J., & Hodrick, R.J., (2014),)
Return on capital employed =operating profit / Capital employed

 =633,637/14671377

 =0.043. *100= 4.3 %

 Capital employed = 13,160,455 +1510922 = 14671377

 = 4 % for the year 2020 14671377

 = 660,208/ 14,341,939 +1863634= 660,208/16205573=.04

 .04*100=4% for the year 2021.

3.2 Analysis: Return on capital employed has remained the same from 4.3% to 4%, which indicates a company is not using its capital efficiently
and is not generating a high return on the investment. Long term debt has increased as compared to the last year from 4221229 to 4715361.
2 Investment Ratios( return on Capital employed)
 The return on capital employed indicates how much operating income a company is generating for each dollar of capital
invested. Companies prefer higher ROCE is, because it indicates for each dollar of capital employed more profits are
generated. ( Bekaert, G. J., & Hodrick, R.J., (2014),)
 Return on capital employed =operating profit /Capital employed
 3.Efficiency Ratios
 Inventory Turnover Ratio
 Inventory turnover measures the number of times a company sells and buys its inventory over a specific amount of time.
 Cost of Goods sold/ Average Inventory
11,851,659/1,560,568=7.5 times for the year 2020

Its day’s inventory equals 365/ 7.5 = 48 days

This showed that Honda is taking 48 days on average during the year to turn its inventory into sales which is a good number. Honda is selling its goods faster.

10,439,689/1,545,600= 6.75 for the year 2021

Its day’s inventory equals:

365/6.75= 54 days

3.3 Analysis:

The inventory turnover ratio has decreased from 7.5 to 6.75 and days increased from 48 days to 54 days which indicates that Honda has not been able to
improve its inventory turning into sales which means less sales for the business.
 Accounts Receivable Turnover Ratio
 The accounts receivable turnover ratio tells all the stakeholders how efficiently a company is turning
its receivables into cash. (Jason Fernando ,2023).
 Net Credit Sales/Average Accounts receivable=
 OR Average Accounts Receivable/Net Credit Sales*365
 The accounts receivable turnover ratio tells all the stakeholders how efficiently a company is turning its receivables into cash
Average Accounts Receivable/Net Credit Sales*365 = 633,909/ 14,931,009*365=15 Days.

15 days for the year 2020

For the year 2021= 801,814/ 13,170,519*365= 22days.

3.4 Analysis: This ratio indicates in year 2020 Honda customers are taking 15 days to pay which
is good period. This ratio has decreased for the year meaning it Honda customers are now taking
longer to pay which should be improved as it was in the year 2020.Honda can offer its
customers cash discounts so that they can pay earlier. Honda can charge interest on overdue
accounts when interest is charged customer will pay before time.
 Accounts payable Turnover ratio
 The accounts payable turnover ratio measures how quickly a business is able to make payments to
creditors and suppliers ( Jason Fernando ,2023)
 = Net credit Purchases/Average accounts Payable
 OR Average Trade Payables /Net credit purchases *365
 Net Credit Purchases = Total Purchases - Cash Purchases - Purchases Returns.
Average Trade Payables /Net credit purchases *365

Net Credit Purchases = Total Purchases - Cash Purchases - Purchases Returns.

= 958,469 /11,851,659*365= 29.5 days. For the year 2020

 = 1,088,061/ 10,439,689*365-= 38 days for the year 2021

 Analysis: The Accounts Payable Turnover ratio has increased from 29 days to 38 days. This indicates that Honda has started
to take more time to pay of its trade payables. This indicates that Honda suppliers may start charging interest on delayed
payments which is disadvantageous for the organization and hence suppliers may refuse to supply to Honda. Honda by
making use of delayed payments is not taking an opportunity to make use of cash discounts
 Profitability Ratios:
Gross Profit Margin
• The gross profit margin ratio shows businesses how much they have earned after paying for the direct costs such as labor, materials, and other
production ratios
Gross Profit/Net sales *100=3079350/ 14,931,009=0.21*100= 20% For the year 2020

= 2730830/ 13,170,519 = 0.21*100= 21%

This ratio remains the same for the two years. This ratio indicates the gross profit earned for every $100 sales. This ratio
indicates that 20% of the gross profit is available for the business to pay its other expenses in the company. The company can
improve this ratio by increasing the selling price of automobiles or reduce the trade discount offered to the customer. The
company can reduce the purchase cost or the manufacturing cost to increase the Gross Profit Margin.
• Net Profit Margin
• Net profit margin) is a financial measure that evaluates the net income of the companies or profit that
is generated from the overall revenue

Net Profit/Net sales*100 = 509,932/ 14,931,009*100=0.034*100=3.4% For the year 2021

= 695,444/ 13,170,519*100=5.2% for the year 2021

There is a slight increase in the net profit margin. The financial statements show that the company Gross profit has increased
from the year 2020 due to which Honda net profit margin have improved

Return on Assets:
 ROA shows investors how efficiently they are using their assets to generate profits. Higher ROA
shows that business is performing well in generating its profits. (Jason Fernando ,2023)
 net income ÷ average total assets
509,932 / ¥20,461,465 = 0.025*100= 2.5% for the year 2020.

= 695,444/ 21,921,030= 0.032*100= 3.2%

The return on assets has increased slightly from 2.5% to 3.2%

The return on assets have slightly increased from 2% to 3% due to the increase in net income from 509932 to 695444
The limitations of financial ratios

 No two companies are the same

 No two companies are exactly alike, and that is especially so when they are operating in different industries.
 As discussed in the previous lessons, capital-intensive companies like airplane manufacturers rely more heavily
on debt, have less liquid assets and tend to grow more slowly than, for example, software companies.
 These factors will affect how ratios such as debt to equity or return on capital should be interpreted when you are
deciding whether to buy or sell their shares.
 Companies that carry a lot of inventory, which they can in theory sell quickly for cash, (retailers, for example)
similarly require a different approach when interpreting things like the current ratio than when you are looking at
a construction company.
 Size matters
 Companies also require a different approach depending on their size.
 Small-companies companies often pay more for their debt than large-companies , and this will affect the way
formulas like interest coverage ratios need to be interpreted. They also tend to have faster growth prospects, and
this will change the way things like the discounted cash flow model are calculated.