1. FINANCIAL STATEMENTS ANALYSIS
• Is an assessment of the financial position of a
business in past, present and future
FINANCIAL RATIOS ANALYSIS
• Is a relationship of one number with another
number
2 TYPES COMPARISON
i. INDUSTRY AVERAGES
- Ratios of one firm are compare with other firms
within the same size & at the same time.
ii. TREND ANALYSIS
- Compare ratios of present with previous years
CATEGORIES OF RATIOS
a. Liquidity Ratios
b. Efficiency Ratios
c. Leverage Ratios
d. Profitability Ratios
e. Market Ratios
a. Liquidity Ratios
Purpose – to determine firm’s ability to meet its
maturing obligation (pay its current liabilities)
i. Current Ratio (CR) = Current assets
Current Liabilities
ii. Quick Ratio/Acid test Ratio
= CA – Inventories – Prepaid expenses
CL
Tamoi Janggu 1
2. Low ratio- indicate firm may have difficulty to pay current
liabilities on time (less liquid)
High ratio – firm may sacrificing some return because too
much financial capital is tied up in CA (more liquid)
If CR is high but QR very low – indicate that firm may have
too much stock
b. Efficiency Ratios/assets management ratio/activity
ratios
Purpose – to measure how effective firm in managing
its assets to generate sales
i. Inventory Turnover Ratio (IT)
= COGS OR = Sales
Closing Stock Closing Stock
- IT shows number of times inventory is sold out
and re-stock or “Turned over” per year
- High IT – is good, it may indicate high sales
volume/superior selling practices
- Low IT – indicate excess or obsolete inventories
ii. Average Collection period (ACP)
ACP = Account Receivable X 360 days
Credit Sales
- measure length of time taken to collect money
from debtors
Low ACP – is good, it indicate that firm manage
to collect money in a short period i.e credit policy
is good
High ratio – contra from the above
Tamoi Janggu 2
3. iii. Fixed Assets Turnover (FAT)
FAT = Sales.
Net Fixed Assets
-Low FAT – indicate firm not fully utilized it
fixed assets to generate sale.
iv. Total Assets Turnover (TAT)
TAT = Sales
Total Assets
Low ratio- indicate firm not generating sufficient
volume of sales in relation to its total assets
investments.
c. Leverage Ratios/gearing ratios
Purpose – to measure how much debts (liabilities) is
use in business to buy (finance) assets
i. Debt ratio (DR) = Total Liabilities
Total Assets
High ratio – is not good because the firm expose
to high financial risk
- firm may have problem to borrow money in the
future
ii. Time Interest Earn (TIE) = EBIT
Interest Expense
Low TIE – indicate firm is less ability to pay its
interest by using EBIT
Tamoi Janggu 3
4. d. Profitability Ratio
Purpose – to measure the effectiveness of the firm to
generate profit in relation to sales, assets employed and
shareholders investment.
i. GPM = Gross Profit
Sales
Low ratio- may indicate excessive sales discount
ii. Net Profit margin (NPM)
NPM = Earning available to common s/holders
Sales
- high ratio indicate firm is good in controlling
administration expenses
iii. Return on Assets (ROA)
ROA = Earning available to common s/holders
Total assets
Low ratio may indicate
– assets is not efficiently utilized or
- profit is very low
However, further analysis is necessary
If NPM is not good – it could be because:
- high COGS (i.e markup is not sufficient) or
- if GPM is adequate- low NPM is because of
high administration expenses
If NPM is good but GPM is low- it could be
because of low sale or high COGS.
iv. Return on Equity (ROE)
ROE = Earning available to common s/holders
Common Equity
= ROA (Du Pont
equation) 1 – Debt ratio
Tamoi Janggu 4
5. ** Common equity = OSC + Reserves + Retained
profit
- it measure the firm’s return compare to total
equity.
e. Market Ratios
- To measure the firm’s stock price to its earnings,
cash flow and book value per share
i. EPS = Earning available to common
s/holders Number of ordinary share issued
- Shows number of ringgit earned for each share for
the period
ii. Dividends per share (DPS)
DPS = Ordinary dividends
Number of shares issued
- indicates the actual cash received by investor on
their investment.
iii. Price/Earnings (P/E) Ratio
PE = Market price per share
EPS
- Shows how much investors are willing to pay per
dollar of reported profit
Limitations of Ratios Analysis – page 58
i. Multiple lines of business
ii. Different accounting practices
iii. Industry average may not provide a desirable target
standard
iv. Seasonal factors
v. Ratios can be too high or too low
vi. “Window dressing” techniques.
vii. Combination of good and bad ratios.
Tamoi Janggu 5
6. User of Ratios Analysis
i. Creditors
Short term creditors
– interested in firm’s ability to pay loan promptly i.e
liquidity ratio is important to them
Long term creditor
- interested in firm’s ability to pay interest regularly &
principle once matured
- also on liquidating value of the firm
- i.e interested in debt ratio & TIE
ii. Management
- to analyze, plan & control
- interested in all of the ratios
iii. Equity Investors
- interested in firm’s efficiency & growth prospects &
high dividends
iv. Others – government, IRB, suppliers, employees &
public at large
Tamoi Janggu 6
