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l04.fall10 - Lecture 4 page 23 RATIO ANALYSIS Purpose of...

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Lecture 4 page 23 RATIO ANALYSIS Purpose of Ratio Analysis: To evaluate the firm’s financial performance. To determine the strengths and weaknesses of past investment and financing decisions. Are assets being used efficiently? Is the firm operating in its optimal capital structure range? Are the firm’s receivables, payables, inventory, cash, etc. being managed efficiently? CLASSIFICATIONS OF RATIOS: 1. Profitability ratios 2. Asset management (turnover) ratios 3. Debt managment (long-term solvency) ratios 4. Liquidity (short-term solvency) ratios 5. Market value ratios Profitability Ratios (some examples): Profit margin on sales = Net income / sales Return on Equity (ROE) = net income/stockholders’ equity = EAT/stockholders’ equity Return on Assets (ROA) = net income/total assets - Richard T. Bliss, Babson University and Terry D. Nixon, Miami University
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Lecture 4 page 24 =EAT/total assets Asset management (turnover) Ratios (some examples): Total Asset Turnover = Sales/Total assets Inventory Turnover = Sales/Inventory DSO = Days sales outstanding = Accounts Receivable/(Annual (credit) Sales/365) = Accounts Receivable/Average sales per day Debt Management (long-term solvency) Ratios (some examples): Times Interest Earned ratio = Interest Coverage ratio = EBIT/Interest expense
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