Financial

Ratio
Analysis
 Financial Ratios
Financial ratio evaluation can be used to
answer questions such as:

●Is the enterprise profitable?

●Can the enterprise pay its financial
obligations on time?
●How is the enterprise financed?
●Is a company a good credit risk?
 Financial Ratios
Definition
●generated from the figures
presented in financial statements
●performed to draw a more
comprehensible understanding of
the company’s overall condition
and performance
Financial Ratio
Analysis
a quantitative way to gain
insights into various parameters
that the company may use to
measure different performance
levels
Financial Ratio
Analysis
 Financial Ratios
Uses and Purpose: Tracking Performance

● Individual financial indicators are

determined on a period-by-period basis
to identify performance trends.
● Example:
○ an increase in the ratio of liabilities
to assets may indicate that a
company may be overloaded with
liabilities and exposed to default risk
 Financial Ratios
Uses and Purpose: Decision-
Making
● to compare financial measurements
with those of major competitors and
industry average
● Example:
○ comparing returns on investment
between companies can help
analysts or investors decide which
companies are using their assets
more efficiently.
 Liquidity Ratios
● a type of financial ratio
used to determine a
company's ability to repay
current liabilities
● Examples:
○ Current ratio
○ Working capital
●measures a
company's ability to
pay short-term
obligations
●tells how a company Current
maximizes its current Ratio
assets to satisfy
currently maturing
obligations
Liquidity Ratios

Current Ratio Formula

The current ratio is also known as the

company's working capital ratio. The
current ratio formula is shown below:
Liquidity Ratios

Interpreting the Current

Ratio
Current Ratio Brief Description

Current Ratio = 1 the current assets are equal to current liabilities; it

is sufficient to cover maturing obligations
Current Ratio > 1 the current assets are more than the current
liabilities; a portion of the current assets will remain
after paying all current liabilities
Current Ratio < 1 the current assets are insufficient to cover the
current liabilities
Assume that your balance sheet shows current
assets amounting to ₱34,500 and current
liabilities totaling ₱24,900. Applying the
formula, you can calculate the current ratios as
follows:
Liquidity Ratios

●the resulting figure after

deducting current
liabilities from current
Working assets
Capital ●an indicator of a
company's liquidity,
operational efficiency,
and short-term financial
position
Liquidity Ratios

Working Capital Formula

 Interpreting Working
Capital
If a company has positive working capital, it
has the potential to invest and grow. On the
other hand, if its current assets do not exceed its
current liabilities, it may have difficulties
repaying its creditors and funding growth.
Continuing with the previous example and
applying the working capital formula, the
calculations will result in the following value:

Since the resulting figure is positive, your working capital is

sufficient to fund current operations and has room for
future investments.
 Profitability Ratios
used to assess a company's
ability to generate revenue
relative to its income,
operating expenses, balance
sheet assets, or equity-
related accounts using data
at a particular time
 Profitability Ratios

● evaluates the ability

to generate profits
before considering the
selling and Gross Profit
administrative
expenses Ratio
● measures the ability
to sell products in a
cost-effective method
 Profitability Ratios

Gross Profit Ratio Formula

The formulas involved in calculating the gross profit
ratio are the following:
 Calculating and Interpreting the Gross Profit
Ratio

Your income statement shows the following

accounts and their respective values: Sales for
the month amounted to ₱55,000. There were
various returns made by customers due to
some orders with factory defects, amounting to
₱5,000, and the cost of goods sold amounted
to ₱27,650.
First, you have to calculate the value of the net sales as
follows:

No sales discounts are given, so only the sales returns

and allowances are deducted from sales to get the net
sales.
The gross profit ratio is typically displayed as a percentage
as it is more convenient to present it this way, especially for
analytical purposes.

You can conclude that your gross profit is 0.447 or 44.70% of net
sales.
Profitability Ratios

●calculates the profit

percentage in relation to
the total revenue
Net Profit ●measures the net profit
Ratio that the company obtains
on a per-peso-of-revenue-
gained basis
 Net Profit Ratio Formula

● Net profit is calculated by deducting total company

expenses from its total revenue.
For example, your business recorded net profit and net
sales amounting to ₱29,976 and ₱124,900, respectively.

Your business's net profit ratio is 24% of total income for

the period.
Efficiency Ratios ●a measure that
indicates how
efficiently a company
uses its balance sheet
assets to generate
revenue and cash
●Also known as activity
ratio
● the number of times a
company collects its
average accounts
receivable on a yearly Accounts
basis Receivable
● to measure how efficiently Turnover
a company recovers the
credit it offers to its
customers
Accounts Receivable Turnover
Formula
Interpreting the Accounts Receivable
Turnover

●It gives the company a good idea of how

efficiently it is recovering the debt owed by
credit customers to the company.
●The smaller the resulting number, the
higher the efficiency of collection.
 Calculating and Interpreting the
Account Receivable Turnover

Your company reported net sales of ₱45,000,

of which 64% were from credit customers.
Furthermore, your beginning accounts
receivable amounted to ₱7,400, and your
ending accounts receivable amounted to
₱8,570. Follow the steps below to calculate
the accounts receivable turnover.
 Calculating and Interpreting
the Account Receivable
Turnover
First, calculate the average account
receivable.
Substitute the values and use the formula to calculate the
accounts receivable turnover:
From this, you can conclude that the company
collected its accounts receivable 3.61 times
per year. You can further analyze this by
calculating the average number of days it takes on
average to collect the receivables from when the
customers took up the credit to when they paid it.
To do this, divide the total number of days a year by
the accounts receivable turnover. 365 divided by
3.61 will give you approximately 101 days or over
three months.
 ●indicates the number of
times a company sells and
replenishes inventory over a
Inventory specific time
Turnover Ratio
●used to calculate the days it
will take to sell an existing
inventory
Inventory Turnover Formula
 Interpreting the Accounts
Receivable Turnover

● A higher inventory turnover is preferable to a

lower one, as high turnover indicates strong
sales. Effective inventory management depends
on knowledge of inventory turnover.
● The analyst must consider the industry
standards ( i.e., selling perishable and fast-
moving inventories vs. selling high-end luxury
items with lower inventory turnover)
 Calculating and Interpreting the Inventory
Turnover

Assume that in 2021 you have a beginning

and ending inventories of ₱150,000 and
₱90,000, respectively, and a cost of goods
sold amounting to ₱1,200,000.
 Calculating and Interpreting the Inventory Turnover

First, you have to compute the average

inventory for the year as follows:
Substitute the values to get the inventory turnover for
the year.
 It means that inventory was sold and
restocked ten times for the year. Another way
to state this is the business sold that inventory
within approximately 36.50 days or 1.22
months. This result is derived by dividing 365
days by the inventory turnover.
Financial
Ratio
Analysis