FINA 2201 Chapter Notes - Chapter 4: Trend Analysis, Net Income, Asset Turnover
DepartmentFinance & Insurance
Course CodeFINA 2201
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FINA 2201 Chapter 4: Analysis of Financial Statements
Liquidity ratios: shows the firm’s ability to pay off debts that are maturing within a year.
Asset management ratios: shows how efficiently the firm is using its assets.
Debt management ratios: shows how the firm financed assets as well as the firm’s ability to repay its long-term debt
Profitability ratios: show profitably the firm is operating and utilizing its assets.
Market value ratios: bring in the stock price and of what investors think about the firm & its future prospects.
Liquidity Ratios: show the relationship of a firm’s cash and other current assets to its current liabilities
Will the firm be able to pay off its short-term obligations as they come due?
Indicates extent to which current liabilities are covered by assets expected to be converted to cash in the near future.
Liquid Asset: An asset that can be converted to cash quickly without having to reduce the asset’s price very much.
Current = Current Assets Quick (Acid Test) = Current Assets – Inventories
Ratio Current Liabilities (Ratio Current Liabilities
• Large values imply that the firm has enough assets to pay its bills on time low probability of insolvency
Debt Management Ratios: A set of ratios that measure how effectively a firm manages its debt.
Will the firm be able to pay off its short-term and long-term obligations as they come due?
How much of every $ is financed by debt
Debt Ratio = Total Liabilities Times Interest = EBIT
(Leverage) Total Assets Ratio (TIE) Interest Expense
• Large Debt Ratio High probability of default Large TIE Low probability of default
Asset Management Ratios: A set of ratios that measure how effectively a firm is managing its assets
Are assets actively and efficiently used to generate returns?
How much of every dollar will generate sales?
Turnover Ratios: how many times the particular asset is “turned over” during the year
Inventory = Sales
Fixed Assets = Sales Total Assets = Sales
Turnover Net fixed assets Turnover Total assets
Days Sales Outstanding (DSO): Indicates the average number of days after making a sale before receiving cash
Days Sales = Receivables = Receivables
Outstanding (DSO) Average sales per day Annual sales/365
Profitability Ratios: Group of ratios that show combined effects of liquidity, asset management & debt on operating
How profitable is the firm?
Operating = EBIT Profit = Net Income Basic Earning Power = EBIT
Margin Sales Margin Sales (BEP) Ratio Total Assets
Return On Assets: Net Income Return on Equity = Net income
(ROA) Total assets (ROE) Total Equity
DuPont Equation: ROE = Profit Margin * Total asset turnover * Equity Multiplier
Net Income * Sales * Total Assets
Sales Total Assets Equity
• Focuses on profitability (PM), asset utilization (TA TO), and debt utilization (equity multiplier).
• shows the relationships among asset management, debt management, and profitability ratios.
Market Value Ratios
how do investors perceive the futures?
Price/Earnings = Price Market/Book = Market price per share
Ratio Earnings per share Ratio Book value per share
How much investors are willing to pay for $1 How much investors are willing to pay for $1
of earnings (The higher, the better) of book value equity (the higher, the better)
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