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Financial Ratios
MF Daniel Martínez
Catholic University of Guayaquil
Financial Analysis
Why do it?
– Identify strengths & weaknesses of your business
May be financial, production, marketing, etc.
Build on your strengths
Improve your weaknesses
Balance Sheets
– Current Balance Sheet
– 3-5 Historic Balance Sheets & Pro forma
Income Statements
– May use tax records as a proxy
– Current Year’s Income Statement
– 3-5 Year’s Historic Income Statements & Pro forma
Cash Flow Statements
– Not necessary for ratio analysis, but extremely helpful!!
Types of Financial Analysis
Ratio Analysis
– Calculate “industry accepted” ratios for your firm
– Compare your performance to industry “norms”
Farm Financial Standards Council (FFSC)
Trend Analysis
– Analyze your financial ratios over a period of time
3-5 years
– Look for positive and negative trends
Uses of Ratio Analysis
Profit Ratios
Liquidity Ratios
Activity Ratios
Leverage Ratios
Shareholder-Return Ratios
Profit Ratios
Main ratios:
– Debt/equity ratio
– Gearing ratio
– Interest and dividend cover
Gearing as indicator of default risk
Debt financing introduces financial risk because it
implies fixed commitments in the form of interest
payments and principal repayment and exposure to
interest rate movements.
Table 1 Long-term solvency risk ratios
Gearing
Short-term liquidity risk ratios
Main ratios:
– Current ratio and acid-test ratio
– Credit given and credit obtained
– Days inventory outstanding
Liquidity tests focus on the make-up of working
capital and the activity level of its components
Low liquidity implies financial risk as inability to
service short-term debt payments may lead to higher
interest expense and, eventually, bankruptcy
Table 2 Short-term liquidity risk ratios
Current ratio =
Days inventory
=
outstanding
Shareholder-Return Ratios
EPS
Net profit m
Gross opera
Figure 1 Capital employed
Assets Financing
Fixed assets Equity
Capital employed
Capital employed