School

Northeastern UniversityDepartment

Finance & InsuranceCourse Code

FINA 2201Professor

Ma LinlinChapter

4This

**preview**shows half of the first page. to view the full**3 pages of the document.**FINA 2201 Chapter 4: Analysis of Financial Statements

1

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

Turnover Inventories

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

results

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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