Financial Ratios Analysis and Interpretation

Ratio analysis is a useful management tool that will improve your understanding of financial results and trends over time, and provide
key indicators of organizational performance. Managers will use ratio analysis to pinpoint strengths and weaknesses from which
strategies and initiatives can be formed. Funders may use ratio analysis to measure your results against other organizations or make
judgments concerning management effectiveness and mission impact
Ratios can be divided into four major categories:
o Profitability Sustainability:
Profitability ratios measure a company’s ability to use its capital or assets to generate profits. Improving profitability is a constant
challenge for all companies and their management. Evaluating profitability ratios is a key component in determining the success of
a company. It is important to note that all profitability ratio calculations are based on earnings before taxes.
o Operational Efficiency:
How efficiently are you utilizing your assets and managing your liabilities? These ratios are used to compare performance over
multiple periods.
o Liquidity:
measure a company’s ability to meet its maturing short-term obligations. In other words, can a company quickly convert its assets
to cash without a loss in value if necessary to meet its short-term obligations? Favorable liquidity ratios are critical to a company
and its creditors within a
business or industry that does not provide a steady and predictable cash flow. They are also a key predictor of a company’s ability
to make timely payments to creditors and to continue to meet obligations to lenders when faced with an unforeseen event.
o Leverage (Funding – Debt, Equity, Grants):
To what degree does an enterprise utilize borrowed money and what is its level of risk? Lenders often use this information to
determine a business’s ability to repay debt.

1- Liquidity Ratios Interpretation

1- Current ratio = current liabilities (XX  Measures your ability to meet short term obligations with short term assets., a useful indicator
current assets

Times) of cash flow in the near future.

 For each 1 LE of the company’s current liabilities the company has XX of current assets to
cover it.
 A higher number is preferred because it indicates a strong ability to service short-term
obligations.
  The current ratio for X company indicates the company's ability to service short-term
obligations is (satisfactory or unsatisfactory).
 A ratio less than 1 may indicate liquidity issues. A very high current ratio may mean there is
excess cash that should possibly be invested elsewhere in the business or that there is too much
inventory. Most believe that a ratio between 1.2 and 2.0 is sufficient.
Overall Decreased Trend:
If the result is less than industry average or is decreased from last year, so the comment will be:
The firm has a great risk in related to its ability to satisfy its short term obligations which is critical
indication for both creditors & shareholders.
Overall Increased Trend:
If the result is greater than industry average then: From shareholder standpoint, a high current ratio
could mean that the firm has a lot of money tied up in non-productive assets.
From creditor’s point of view, an encouraged indicator that the claims of short term obligations are
covered by assets that expected to be converted to cash fairly quickly.
Quick ratio =  The extent to which a firm can meet its short term obligations without relying upon the sale of
current assets−inventroy−Prepaid expenses
its inventories.
current liabilities
(XX times)  This is often referred to as the “acid test” because it only looks at the company’s most liquid
assets only (excludes inventory) that can be quickly converted to cash).
 For each 1 LE of the company’s current liabilities the company has XX of Quick assets to
cover it.
 A higher number is preferred because it suggests a company has a strong ability to service
short-term obligations.
 This ratio is a more reliable variation of the Current ratio because inventory, prepaid expenses,
and other less liquid current assets are removed from the calculation.
 A ratio of 1:1 means that a social enterprise can pay its bills without having to sell inventory.

(XX 
Cash & Cash Equivalents Measures the adequacy of available cash
Cash Ratio = current liabilities
 for each 1 LE of Current liabilities, the company has XX of cash to cover it.
times)  If more cash exist, it means there’s a poor asset utilization for a company to hold large amounts
of cash on its balance sheet.

Inventory to working capital=  This ratio measures the dependency of working capital on inventory. A lower number for this
inventory ratio is preferred indicating that a company has a satisfactory level of working capital and
current assets−current liabilities inventory makes up a reasonable portion of current assets.
percentage
 The inventory to working capital ratio x company indicates this ratio is in line with company
goals.
 In general, the lower the ratio, the higher the liquidity of a company is.
2- Profitability Ratios

Gross profit margin=

sales−cost of good sold  How much profit is earned on your products without considering indirect costs.
sales
(Percentage)  This ratio measures the gross profit earned on sales and reports how much of each sales dollar
is available to cover operating expenses and contribute to profits.
 For each 1 LE of sales the company generates XX piasters of Gross profit before subtracting
operating expenses, gains, losses & taxes.
 The percent gross profit for X company is a good indication of financial health for the
company.

Operating profit margin =  profitability without concern for taxes & interest.
earnings before interst & 𝑡𝑎𝑥𝑒𝑠 (𝐸𝐵𝐼𝑇)
 This ratio measures how much profit a company makes on each sales dollar received and how
sales
(Percentage) well a company could potentially deal with higher costs or lower sales in the future.
 For each 1 LE of sales the company generates XX piasters of operating income before
subtracting gains, losses & taxes.
 The percent profit margin on sales for X company indicates sales may not be contributing
enough to the company's bottom line.

(Percentage) 
net income How much money are you making per every $ of sales.
Net profit margin = sales
 This ratio measures your ability to cover all operating costs including indirect costs.
 profits per dollar of sales
 XX % of the company's sales are converted to net profits.
  If the percentage is low, it means the company is using more debt to finance operations which
leads to increased interest rates. (now and in the future).

Return on stockholders’ equity (ROE) =  This ratio expresses the rate of return on equity capital employed and measures the ability of a
net income company's management to realize an adequate return on the capital invested by the owners in a
(Percentage)
total stockholders′ equity company.
 This is one of the most important ratios to investors. Are you making enough profit to
compensate for the risk of being in business? How does this return compare to less risky
investments like bonds?
 Shareholders earn XX% on their investment in the company.
 The percent rate of return on equity for X company indicates management may not be
effectively managing the profits earned based on the owners’ investment in the company.
 When the percentage is in line with company’s goals, it means the company is making enough
net income (profit) to compensate the risk of being in business.

Return on Investment (total assets) (ROI)  Measures your ability to turn assets into profit.
net income
= (Percentage)  The company's assets are generating XX% annual rate of return on investment.
total assets
 A higher number reflects a well-managed company with a healthy return on investment.
(ROI) =  Heavily depreciated assets, a large number of intangible assets, or any unusual income or
gain from investment−cost of investment expenses can easily distort this calculation.
cost of investment  The percent rate of return on investment for X company indicates there is a need for
(Percentage) improvement in this area to ensure the company can remain competitive and continue to
operate successfully.
 A low ratio compared to industry may mean that your competitors have found a way to operate
more efficiently.
 After tax interest expense can be added back to numerator since ROA measures profitability on
all assets whether or not they are financed by equity or debt.
 If percentage is low, it means there’s poor management performance due to utilizing its assets
in a inadequate way. (the firm is paying more interest expenses which decreases net income.

Earnings per share (EPS) =  earnings available to the owners of common stock
 The profit of each share is XX LE.
 (XX 
net income A higher number is preferred, suggesting a company can easily meet interest obligations and
# of shares of common stock outstanding can potentially take on additional debt. Note that this particular ratio uses earnings before
times) interest and taxes because this is the income amount available to cover interest.

Market Ratios

Price-earnings ratio =
market price per share  attractiveness of firm on equity markets
earnings per share
 Measures the relationship between the current market price of the stock and its earning per
(XX times)
share
 The market price is XX times its profit.
 The investors are willing to pay xx times for each dollar of earnings per share the firm
generated. The higher means more trust in the firm.

Market to book ratio =

market price per share  Measures stock market power and market gain.
book value per share
 A ratio higher than one indicates high quality earnings.
(XX times)

3- Debt / Leverage / Solvency (Capital

Structure) Ratios:

Debt Ratio / Debt-to-total-assets ratio =  the percentage of total funds that are provided by creditors
total debt
(Percentage)  XX% of the company's assets are financed using sources other than Equity (Credit - Loans).
total assets
 The trend indicates the firm's ability to reduce its debt. This ratio measures what proportion of
debt a company is carrying relative to its assets.
 A ratio value greater than one indicates a company has more debt than assets. Naturally,
companies and creditors prefer a lower number.
 The debt to total assets ratio for X company indicates the company should be able to withstand
losses without harming creditor interests or could obtain additional financing if desired.

Debt-to-equity ratio =  Compares capital invested by owners/funders (including grants) and funds provided by lenders.
total debt
(Percentage)  The more equity there is, the more likely a lender will be repaid. Most lenders impose limits on
total stockholders′ equity
the debt/equity ratio, commonly 2:1 for small business loans.
  This ratio measures the financial leverage of a company by indicating what proportion of debt
and equity.
 a company is using to finance its assets.
 Too much debt can put your business at risk, but too little debt may limit your potential.
Owners want to get some leverage on their investment to boost profits. This has to be balanced
with the ability to service debt.
 the percentage of total funds provided by creditors versus by owners.
 For each dollar in shareholders' the company is holding XXX$ in debt.
 A lower number suggests there is both a lower risk involved for creditors and strong, long-
term, financial security for a company.
 The debt to equity ratio for X company indicates a solid performance in this area for the
company.
Long-term debt-to-equity ratio =  the balance between debt and equity in a firm’s long-term capital structure.
long−term debt
total stockholders′ equity
Times-interest-earned ratio =  the extent to which earnings can decline without the firm becoming unable to meet its annual
profits before interest & 𝑡𝑎𝑥𝑒𝑠 (𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒)
interest costs
total interest charges
 It shows how much times the company profit before paying interests and taxes can cover the
interest (The firm can pay X times its interest expenses)

Leverage / Equity Multiplier ratio =  Assets are XX times the equity

profits before interest & 𝑡𝑎𝑥𝑒𝑠
(XX times)
total interest charges

4- Activity / Efficiency / Asset

Management Ratios

Inventory turnover =  The number of times you turn inventory over into sales during the year or how many days it
Net sales
(XX times) takes to sell inventory.
inventory of finished goods
 This is a good indication of production and purchasing efficiency. A high ratio indicates
𝐶𝑂𝐺𝑆 inventory is selling quickly and that little unused inventory is being stored (or could also mean
(XX times)
inventory of finished goods inventory shortage). If the ratio is low, it suggests overstocking, obsolete inventory or selling
 issues.
 whether a firm holds excessive stocks of inventories & whether a firm is slowly selling its
inventories compared to the industry average
 The company's inventory is sold out and restocked XXX times a year
 A low turnover implies weak sales and excess inventory. A high ratio implies either strong
sales and / or large discounts.

(XX 
sales How efficiently your business generates sales on each dollar of fixed assets. (sales productivity
Fixed assets turnover = fixed assets
times) and plant and equipment utilization).
 An increasing ratio indicates you are using your assets more productively.
 For each 1 LE of fixed assets, the company generates XX LE of sales revenue.
 This ratio is similar to the sales to assets ratio, but it excludes current assets, long-term
investments, intangible assets, and other non-current assets.
 A higher number is desired, indicating that a company productively uses its fixed assets to
produce sales.
 Sales to net fixed assets for X company indicates the company is not making use of its fixed
assets to effectively generate sales.

(XX 
sales How efficiently your business generates sales on each dollar of total assets (whether a firm is
Total assets turnover = total assets
times) generating a sufficient volume of business for the size of its asset investment).
 An increasing ratio indicates you are using your assets more productively.
 Each dollar invested in the company's Assets is generating XXX$ worth of sales a year. A
higher number is preferred, indicating that a company is using its assets to successfully
generate sales. This ratio does not take into account the depreciation methods employed by
each company and should not be the only measure of effectiveness of a company in this area.
 Sales to assets for X company indicates the company's performance in this area is lacking and
management should consider taking measures to improve this ratio.

Accounts receivable turnover =  the average length of time it takes a firm to collect credit sales (in percentage terms)
annual net credit sales
(XX times)  How many times the company transfers receivables into cash during the year.
accounts recievable
  The higher the turnover, the shorter the time between sales and collecting cash.
 What are your customer payment habits compared to your payment terms? You may need to
step up your collection practices or tighten your credit policies.
 These ratios are only useful if majority of sales are credit (not cash) sales. A higher number is
preferred because it indicates a shorter time between sales and cash collection.
 The accounts receivable turnover for X company suggests this ratio is (or may not be) on target
with company objectives.

Average collection period =  the average length of time it takes a firm to collect on credit sales (in days)
accounts recievable
or  The company turns receivables to cash each year every XX days.
total credit sales /365 days
365  Important for company performance evaluation.
(XX Days)
Receivable turnover  An increase in the number of days’ receivables are outstanding indicates an increased
possibility of late payment by customers.
 Companies should attempt to reduce the number of days’ sales in receivables in order to
increase cash flow. The general rule used is that the time allowed for payment by the selling
terms should not be exceeded by more than 10 or 15 days.

Days sales in inventory =  Measures the number of days’ worth of inventory that a company has on hand at any given
365
(XX Days) time.
Inventory turnover
 It shows how many times you could turnover your inventory in terms of days.
 This is a good indication of production and purchasing efficiency. A high ratio indicates inventory is
selling quickly and that little unused inventory is being stored (or could also mean inventory shortage).
If the ratio is low, it suggests overstocking, obsolete inventory or selling issues.

Accounts Payable Turnover =  The number of times trade payables turn over during the year.
Cost of Sales
 The higher the turnover, the shorter the period between purchases and payment. A high
Average Accounts Payable
turnover may indicate unfavorable supplier repayment terms. A low turnover may be a sign of
cash flow problems.
Days in Accounts Payable =  Compare your days in accounts payable to supplier terms of repayment.
Average Accounts Payable
(XX Days)
Cost of sales x 365
 𝐶𝑎𝑠ℎ
Days of Cash = 𝑁𝑒𝑡 sales ÷ 365 (XX days)  Indicates the number of days of cash on hand, at present sales levels.

The following list includes several suggestions X company should consider to improve the liquidity ratios:
1- Reduce days in accounts receivable to improve current assets by evaluating accounts receivable on a more frequent basis and
take a more assertive stance in the collection of accounts receivable and delinquent accounts.
2- Prepare thorough cash forecasts and evaluate the company's ability to meet goals on a regular basis.
3- Consider paying off short-term obligations if the cash position of the company is favorable.
4- Consider converting short-term debt to long-term debt.
5- Reduce levels of non-moving inventory.

The following list includes several suggestions X company should consider to improve the accounts receivable turnover and
days sales in receivables ratios:
1- Prepare aging schedules to determine how long receivables have been outstanding. The company should review these on a
regular basis to look for patterns in delinquent accounts. Communicate with customers and apply increasing pressure to pay as
the number of days outstanding increases.
2- Develop a strategy to deal with problem customers and delinquent accounts.
3- Invoice customers in a timely manner.
4- Enforce credit policies to require credit references of new customers; to evaluate the credit currently extended to each
customer, and to update credit terms for your valuable and problem customer accordingly.
5- Implement customer incentives to encourage prompt payment such as discounts and additional products.

The following list includes several suggestions Liberty Medical Group should consider to improve the sales to assets and sales
to fixed assets ratios:
1- Consider leasing rather than purchasing assets, or consider purchasing used equipment.
2- Carefully evaluate all asset purchases to determine how the asset will directly and indirectly affect sales. Be sure to consider
maintenance costs, warranties, salvage values, and the impact of changing technology in relation to the purchase of new
equipment.
3- Consider liquidating under-utilized assets or developing alternative uses to generate revenue from under-utilized assets.
4- Maintain detailed records for all assets the company currently owns or leases.
5- Ensure all equipment is properly maintained and evaluate its overall condition and effectiveness within operations at least once
a year.
6- Eliminate any unnecessary, extravagant assets. Assets should have a direct or indirect impact on sales.
 7- Set monthly or quarterly sales goals and provide incentives to salespeople.
8- Create customer promotions, offer discounts and expand product lines to encourage sales.

The following list includes several suggestions X company should consider to improve the profitability ratios:
1- Require management to utilize budgets to track expenses on a regular basis, and identify those that are out of line. Assign
specific individuals or departments to be responsible for different cost centers.
2- Reduce operating costs. In general, one dollar saved in expense is worth at least three or four extra sales dollars generated.
3- Negotiate with vendors to lower costs and have companies submit bids for large capital expenditures.
4- Consider leasing instead of purchasing assets or consider purchasing used equipment.
5- Consider liquidating under-utilized assets or creating alternative uses to generate revenue from under-utilized assets.

The following list includes several suggestions X company should consider to improve the coverage ratios:
1- Examine the company’s debt to uncover areas needing improvement and create a long range action plan to address these areas
and pay down debt.
2- Increase equity by increasing earnings.
3- Minimize the overall amount of debt to decrease interest expenses.
4- Reduce interest payments by evaluating financing alternatives and possibly refinancing existing debt.

Balance Sheet
Cash
Includes cash and short term investments with an original maturity less than one year, including restricted cash
Marketable Securities
Includes debt and equity financial instruments including trading securities, securities held to maturity, and securities available for
sale which are intended to be sold in the short term
Trade Accounts Receivable
Includes total accounts receivable, less allowances
Inventory
Includes total inventory, net of any allowance
Prepaid Expenses
Includes cash paid in advance for services or supplies
Current Assets
Sum of all current assets - those assets that are reasonably expected to be realized in cash or sold or consumed within a year or
within the normal operating cycle of the company
Long-Term Investments
Includes investments, not including marketable securities
Property and Equipment
Tangible assets held by a company for use in the production or supply of goods and services, for rental to others, or for
administrative purposes that are expected to provide economic benefit for more than one year
Accumulated Depreciation
The cumulative amount of depreciation and amortization that has been recognized in the income statement, generally shown as a
deduction from the historical cost of fixed assets
Net Property and Equipment
Property and equipment less accumulated depreciation
Intangible Assets
Assets, excluding financial assets, that lack physical substance, net of accumulated amortization
Other Non-Current Assets
Includes non-current assets not otherwise defined
Non-Current Assets
Sum of all noncurrent assets - those assets that are not reasonably expected to be realized in cash or sold or consumed within a year
or within the normal operating cycle of the company
Notes Payable
Includes written promises to pay, the portions of which are due one year or less in the future
Trade Accounts Payable
Recurring obligations of a business that arise from the acquisition of merchandise, materials, supplies and services used in the
production and/or sale of goods and services
Compensation
Includes unpaid obilgations of regular compensation received by employees as a condition of employment
Other Accrued Liabilities
Includes obligations for expenses that have been incurred, but not yet paid
Income Taxes Payable
Includes unpaid obligation of all income taxes
Current Portion of Long-Term Debt
The sum of all debt which is due within one year or less
Other Current Liabilities
Includes current liablities not otherwise defined
Current Liabilities
Total obligations incurred as part of normal operations that are expected to be repayed during the following year
Long-Term Debt
Includes notes and obligations that provide for repayment over a term longer than one year
Deferred IncomeTaxes
Includes the long-term effect on income taxes attributable to taxable temporary differences
Other Long-Term Liabilities
Includes long-term liabilities not otherwise defined
Long-Term Liabilities
Total obligations incurred as part of normal operations that are expected to be repayed beyond one year or one business cycle
Capital Stock
Includes securities representing an ownership interest in a company
Additional Paid-In Capital
Includes amounts received at issuance in excess of the par or stated value of capital stock and amounts received from other
transactions involving the company's stock or stockholders
Retained Earnings
Includes the undistributed earnings of a company
Treasury Stock
Includes shares of a company that have been repurchased by a company
Other Equity
Includes equity not otherwise defined

Statement of Income
Sales
Includes revenues arising from the sale of goods and/or rendering of services in the normal course of business, reduced by sales
adjustments, sales returns and allowances, and sales discounts
Cost of Sales
Includes costs incurred to produce goods for sale and/or to deliver services and may include direct materials, direct labor, overhead
and depreciation
Gross Profit
Sales less cost of goods and/or services sold
Owners Compensation
Expenditures for salaries of officers
Depreciation Expense
Includes the amount of expense charged against earnings by a company to write off the cost of property or equipment over its useful
life
Selling Expenses
Includes expenses directly related to the selling of products or services
Other Operating Expenses
Includes operating expenses not otherwise defined
Operating Expenses
Generally recurring costs associated with normal operations and currently chargeable against revenue except for the portion of said
expenses which can be clearly related to production
Operating Profit
Gross profit less operating expenses
Other Income
Includes revenue from non-operating activity
Other Expenses
Includes expenses from non-operating activity
Earnings before Interest and Taxes
Sum of operating profit and non-operating income and expenses
Interest Expense
Includes interest expense on deposits, long-term debt and all other borrowings
Earnings before Taxes
Sum of operating profit and non-operating income and expenses, including interest expenses
Provision for Income Taxes
Provision for all current and deferred income taxes
Net Income
All income less all expenses