ST-1.

Key Terms
a. Liquid Asset- is an asset where its price need not to be reduce very
much to be converted into cash quickly.
b. Liquidity Ratios are ratios that shows the relationship between the
firms cash and other current assets and current liabilities.
Current ratio represents the capability of the firm to pay its current
liabilities with its current assets. This is calculated by dividing the
firms current assets by its current liabilities.
Quick Ratio or Acid Test represents the capability of the firm to pay its
current liabilities if ever their sales go down which is why inventories
are deducted from the firms current assets and then divided to its
current liabilities.
c. Asset Management Ratios are ratios that measures the firms
management of its assets effectively.
1. Inventory Turnover Ratio indicates how many times a particular
asset is being turned over during the year. It is calculated by
dividing sales by inventories.
2. Days Sales Outstanding Ratio shows the average length of time the
firm must wait after making a sale before it receives cash. It is
calculated by dividing accounts receivables by average sales per
day. Average sales per day may be calculated by dividing the firms
annual sales by 365 days.
3. Fixed Assets Turnover ratio measures how effectively the firm uses
its plant and equipment. It is calculated by dividing sales by net
fixed assets.
4. Total Assets Turnover Ratio measures the turnover of all the firms
assets and is calculated by dividing sales by the total assets.
d. Debt Management Ratios are ratios that measures the firms
management of its liabilities effectively.
1. Debt Ratio shows the percentage of funds provided by creditors. It is
calculated by dividing the firms total debt by its total assets.
2. Time-Interest-Earned Ratio measures the extent to which operating
income can decline before the firm is unable to meet its annual
interest costs. It is calculated by dividing the firms earnings before
interest and taxes by interest charges.
e. Profitability Ratios are ratios that shows the combined effects on
operating results of liquidity, asset management, and debt.
1. Operating Margin gives the operating profit per dollar. It is
calculated by dividing the firms operating income or earnings
before interest and taxes by its sales.

2. Profit Margin is also known as the net profit margin which is

calculated by dividing net income by sales.
3. Return in Total Assets is the ratio of net income to total assets.
4. Basic Earning Power Ratio shows the earning power of the firms
assets before the influence of taxes and debt. It is calculated by
dividing operating income or earnings before interest and taxes by
total assets.
5. Return on Common Equity measures the rate of return on
investment of common stockholders. It is calculated by dividing the
firms net income by the common equity.
f. Market Value Ratios relate the firms stock price to its earnings and
book value per share.
1. Price or Earnings Ratio shows how much investors are willing to pay
per dollar of reported profits. It is calculated by dividing price per
share by earnings per share.
2. Market or Book Ratio indicates how investors regard the company. It
is calculated by dividing market price per share by book value per
share. Book value per share is calculated by dividing common
equity by shares outstanding.
g.
1. DuPont Equation is a formula that shows that the rate of return on
equity can be found as the product of profit margin, total assets
turnover, and the equity multiplier. It shows the relationships among
asset management, debt management, and profitability ratios.
2. Benchmarking is the process of comparing a particular company
with a set of benchmark companies. It is to know what position is
the firm standing by comparing themselves to other firms or
competitors in the same industry.
3. Trend Analysis is an analysis of a firms financial ratios over time. It
is used to estimate the likelihood of improvement or deterioration in
its financial condition.
h. Window Dressing Techniques are techniques employed by firms to
make their financial statements look better than they really are.

ST-2 Debt Ratio

Debt
Debt
$ 120 M
=
=
=0.333=33.3
Assets Debt + Equity $ 120 M + $ 240 M

ST-3 Ratio Analysis

a. Find:
1. Accounts Receivable
Accounts Receivable
DSO=
Sales/365
40.55=

AR
1,000 M /365

AR =40.55 ( $ 2.74 M )=$ 111.1 M

2. Current Assets
Current Ratio =
3.0=

Current Assets
Current Liabilities

Current Assets
$ 105.5 M

Current Assets=3.0 ( $ 105.5 M )=$ 316.5 M

3. Total Assets
Total Assets=Current Assets+ Assets
$ 316.5 M + $ 283.5 M

$ 600 M
4. ROA
ROA=Profit Margin Total Asset Turnover

Net Income
Sales

Sales
Total Assets

$ 50 M
$ 1,000 M

$ 1,000 M
$ 600 M

0.05 1.667=8.3333
5. Common Equity
Assets
ROE=ROA
Equity
12.0 =8.3333
Equity=

$ 600 M
Equity

8.3333 $ 600 M
12.0

 $ 416.67 M
6. Quick Ratio
Quick Ratio=

Current AssetsInventories
Current Liabilities

Quick Ratio=

Current Assets(Current AssetsCashequivalentsAccts Receivable)

Current Liabilities

$ 316.5 M$ 100 M$ 111.1 M

$ 316.5 M
Quick Ratio=
2.0

7. Long term debt

Total Assets=Total Liabilities+ Equity
$ 600 M =Current Liabilities+ Longterm Liabilities+ Equity

$ 600 M =$ 105.5 M + Longterm Liabilities+ $ 416.67 M

Longterm Liabilities=$ 600 M $ 105.5 M $ 416.67 M

Longterm Liabilities=$ 77.83 M

b. Kaizers average sales per day were ($1,000M/365) = $2.74M. Its DOS
was 40.55, so AR is (40.55$2.74M) = $111.1M. Its new DSO of 30.4
would cause AR to be (30.4$2.74M) = $83.3M. The reduction in
receivables would be ($111.1M-$83.3M) = $27.8M, which would equal
the amount of cash generated.
1. ROE
New Equity=Old EquityStock brought back
$ 416.67 M $ 27.8 M
$ 388.9 M

Thus,
New ROE=
2. ROA
New ROA=

Net Income $ 50 M
=
=12.86 (versus old ROE of 12 )
New Equity $ 388.9
Net Income
$ 50 M
=
=8.74 (old 8.33 )
Total AssetsReduction AR $ 600 M $ 27.8 M

3. Total Debt/Total Assets Ratio

The total debt is the same as the new debt.

Before Asset Reduction

Debt=Total claims-Equity
=$600M-$388.9M
=$183.3M
After Asset Reduction
New Debt=New Total claims-New equity
=$572.2M*-$388.9M
=$183.3M
*New Total Assets=Old Total Assets-Reduction in AR
=$600M-$27.8M
=$572.2M
Therefore,
Debt
$ 183.3 M
=
=30.6
Old Total Assets $ 600 M
while
New Debt
$ 183.3 M
=
=32.0
New Total Assets $ 572.2 M