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FINANCIAL RATIO ANALYSIS
Financial Ratio Analysis
William F. Slater, III
ACC 529 – Accounting for Managerial Decision Making
University of Phoenix
Week 5 Assignment for ePortfolio
Michael Greenen, C.P.A, C.F.P. - Instructor
July 1, 2003
mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

ACC 529 - Financial Ratio Analysis - William F. Slater, III Page 2 of 19
Table of Contents
Table of Contents
Abstract
Introduction
Memorandum
Profitability of Sample Company
Sample Company ROI for 2000
Stock Performance
Activity of Sample Company
Leverage of Sample Company
Liquidity of Sample Company
What Is Necessary to Assess the Company?
What Ratios Have the Most Value?
What Other Factors, Beyond Ratios, Need To Be Considered?
How Would Your Assessment Criteria Change If The Company In a Different Industry
Changes in Assessment Method
Conclusion
References
Appendix A – Sample Company’s Financial Statements from 1999 – 2001
Appendix B – Financial Ratio Analysis of Sample Company

Abstract
This research paper will evaluate Sample Company using review standard financial ratio analysis
techniques and assess its potential as a good investment. This is written in the form of a memo to the
CEO of an Alabama-based firm, looking for sound financial advice with regards to whether of not
buying stock in Sample Company is a sound investment.
Introduction
This research paper will reveal the financial analysis techniques used to evaluate the financial
performance of the Sample Company, and evaluate the company’s worthiness as an investment. The
paper is divided into three sections. The first section is the memo, which is the main body of the
paper. The second section, Appendix A, includes as a reference contains each of the sets of the four
financial statements that show Sample Company’s performance from 1999 to 2001. The third
section, Appendix B, contains the actual financial ratio analysis techniques, showing the company’s
performance in 2000 and 2001, the percent change in performance between these years, a short
description of the meaning of each ratio, as well as a short assessment of the company’s change in
performance between 2000 and 2001. Using these appendices to support the financial analysis ideas
expressed in the memo, the reader should feel that they have a complete set of facts to substantiate
these ideas and provide a reference for them.
Memorandum
Date: July 1, 2003
To: Randall K. Black, CEO
Absolutely Alabama Investments
From: William F. Slater, III, Consultant
Slater Technologies
Subject: Financial Analysis Using Ratio Analysis and Recommendation
Dear Randall:
Thank you for the opportunity to review Sample Company’s financial statements and make

this ratio analysis, as well as some recommendations about possible investment in this
company.
Using financial statements from 1999, 2000, and 2001, along with standard financial ratio
analysis, I have been able to develop what I believe is a clear picture of this company’s financial
performance. Note that the financial analysis was done using the financial report data from publicly
available financial statements for the years 2000 and 2001. I have included these statements for your
review in Appendix A
Appendix B contains other measures of Sample Company’s financial performance, as
expressed in standard financial ratio analysis techniques using figures from the financial reports in
Appendix A.
Profitability of Sample Company
First, let’s look at the Return on Investment (ROI) for 2000 and 2001, using the Dupont Model,
which is margin times turnover. Margin is net income divided by the sales, and turnover is sales /
average total assets (Marshall, 2002).
ROI = MARGIN x TURNOVER
OPERATING INCOME Operating Income Sales

= x
AVERAGE TOTAL ASSETS Sales Average Total Assets
Input: 498 498 8,251

= x
7,196 8,251 7,196
Result:
6.9% = 6.0% x 1.15
ROI = MARGIN x TURNOVER
OPERATING INCOME Operating Income Sales

= x
AVERAGE TOTAL ASSETS Sales Average Total Assets

Input: 924 924 10,359

= x
8,659 10,359 8,659
Result:
10.7% = 8.9% x 1.20
At over 55.1%, the increase in ROI between 2000 and 2001 is remarkable and shows that
Sample Company increased its sales while increasing the utilization of its assets used to generate
these sales. And to achieve these results, the sales, operating income and average total assets had to
all increase proportionately. In the short term, this would be a good trend, but if it continues, it
could be a sign that Sample Company is not keeping a big investment in assets, because not that as
the denominator in this ROI calculation, a low asset figure can be used to help drive up the overall
result. Meaning that if this trend continues, it may be an indication of increased operations rather
than improvement in asset efficiency.
Stock Performance
The common stock value increased 54.8%, from $42/share to $65/share, between 2000 and
2001. This is an indicate that the market likes what it sees in the performance and the management
of Sample Company. In addition, it paid 1.2% in dividends for the past two years. Another key
indicator, the Price to Earnings Ratio, fell from 12.0 to 10.7. This is not enough to be alarming. In
fact, some investors, myself included, feel that lower Price to Earnings Ratios are not necessarily a
good thing. The reason being that if a company is struggling to pay out large earnings per share, to
make the denominator in the P/E equation large enough to keep the P/E ratio low, then often such
financial pressures can take the attention of the management away from the company’s operations
and other important issues, like surviving as a going concern in a tough business climate.

Activity of Sample Company
The activity ratios measure the company’s management of asset levels and sales (Marshall,
2002). Between 2000 and 2001, Sample Company showed positive performance with its average
days sales by over 25% and decreased its number of day sales in accounts receivable over 2%.
Together, these ratios show the efficiency of collection relative to the average age of receivables.
The inventory turnover fell by 5.9% and the fixed asset turnover increased by 18.8%. These
turnover figures overall would suggest that assets are being used efficiently to produce sales.
Leverage of Sample Company
Leverage is the use of debt to finance company assets (Marshall, 2002). When a company
uses leverage, it incurs an additional component in its operations, put it also increases the ROE
relative to the ROI. Between 2000 and 2001, Sample Company’s debt ratio increased 32.3% and its
debt / equity ratio increased 21.5%. An assumption of greater debt in order to produce the overall
increase in performance that Sample Company delivered in 2001 could almost be expected. A very
encouraging sign is the 31% increase in the ratio of the times interest earned ratio, because it
indicates that Sample Company has an increasingly strong capability to pay the interest on its debts
with the income it is producing. This is a positive sign for investors and could help in part to
account for the overall increase in stock price.
Liquidity of Sample Company
The liquidity of a company is the ability to meet its loan obligations as it relates to its current
assets and its current liabilities (Marshall, 2002). Appendix B shows that we have analyzed three
important liquidity ratios: 1) Current Ration, 2) Acid Test, and 3) Working Capital. Of these three,
the best indicators of liquidity, when trying to show trends, are the Acid test and the Current Ratio.
A current ratio of 2 and an acid test of 1.0 are considered “adequate liquidity” (Marshall, 2002).
Sample Company’s Acid Test numbers for 2000 and 2001 were .84 and .79, and its Current Ratio
numbers for 2000 and 2001 were 1.45 and 1.54. Each sets of these ratio figures indicate that Sample

Company could possibility have some difficulties in meeting its financial obligations, so these
numbers will be important to watch closely in the future.
What Is Necessary to Assess the Company?
Besides doing this detailed financial ratio analysis, it would critical to research the annual
reports for 1999 – 2001 and read the explanatory notes and other financial information. There we
would find an inside look at organization beyond the numbers, and the bases for how these financial
reports were assembled. These notes contain essential information about its significant accounting
policies. These policies can and should include information about the depreciation methods that was
used, employee benefits, amortization of intangible benefits, earnings per share, stock option and
purchase plans. Other types of information that should be disclosed are details of other financial
statement amounts (such as detailed explanations of long-term debt), other disclosures such as any
possible accounting principle change, business combinations (mergers, acquisitions, dispositions),
contingencies and commitments (i.e. disclosures of possible pending lawsuits), events subsequent to
the balance sheet date, impacts of inflation, business segment information (i.e. geographic segments),
and a possible management’s statement of responsibility.
Other financial information that can found in these reports: a statement showing
management’s discussion and analysis, a summary of past financial data, an independent auditor’s
report, and a compilation report.
Without the explanatory notes and other financial information, the true picture of an
organization’s financial circumstances cannot be known.
Finally, we would want to take additional time to run a Dun and Bradstreet report on the
company, to I would want to know how the company pays its bills and treats its creditors.
Specifically, I would like to see these Dun and Bradstreet reports on the company: D&B Rating,
PAYDEX®, and Score Tables. The US D&B (5A to HH) ratings reflect company size based on net
worth or equity as computed by D&B. These ratings are assigned to businesses that have supplied
D&B with current financial information (Dun & Bradstreet, 2003).

There is also a Financial Stress Score. The Financial Stress model predicts the likelihood of
a firm ceasing business without paying all creditors in full, or reorganizing or obtaining relief from
creditors under state/federal law over the next twelve months. Scores were calculated using a
statistically valid model derived from D&B's extensive data files (Dun & Bradstreet, 2003).
There is also a Commercial Credit Score. The US Commercial Credit Score predicts the
likelihood of a firm paying in a delinquent manner (90 + days past terms) during the next 12 months,
based on the information in D&B's file. The score was calculated using statistically valid models
derived from D&B's extensive data files (Dun & Bradstreet, 2003).
Dun and Bradstreet reports are among the most respected in the world. Also, if I know how a
company treats its creditors, then I will have some idea of how serious the company is about its
reputation and about being in business. These reports would give us a greater sense assurance
knowing that we now have obtained objective information from one of the world’s most respected
sources of financial analysis. To obtain these reports easily, we can go to Dun and Bradstreet at
http://dunandbradstreet.com/us/ and order a report on the company using a credit card transaction
over the web.

What Ratios Have the Most Value?
Which ratio has the most value, really depends on what aspect of the company you are
attempting to measure. For the aggressive investor, that ration will likely be the ROI. For a person
who is evaluating the risks associated with the ability of the company to remain solvent, a ratio like
the acid test, or the debt ratio will have considerable importance. So the answer to the question of
which ratio has the most value is really who is asking and what do they hope to find. To paraphrase
a common quip on standards, the nice thing about ratios is that you have so many to choose from.
What Other Factors, Beyond Ratios, Need To Be Considered?
As mentioned above in the section on what is necessary to evaluate the company, we would
want to obtain annual reports and also Dun and Bradstreet reports. In addition to all this, we would
want evaluate such things as the performance of the company’s competitors, the standard average
financial ratios for the industry this company is in, and measure Sample Company’s performance
against these averages. Other factors would be the company’s image in the community, any possible
litigation the company is involved in either as plaintiff or defendant, customer testimonials (good and
bad), the market behavior of the market the company is in, any offshore threats to competition,
workforce demographics and availability, and a detailed review of the company leadership, including
the executive staff (president and vide presidents), and the board of directors.
What Type of Industry Do You Think The Organization Is and Why?
I think this is probably a manufacturing company because the following indicators are within
the range of what would be a manufacturing concern (Marshall, 2002):
Ratio Sample Company Manufacturing Typical

2001 Value Value

ROI 10.7% 10% to 15%
ROE 16% 10% – 15%
Margin 8.9% 10% – 15%
Asset Turnover 1.2 1.0 to 3.0

How Would Your Assessment Criteria Change If The Company In a Different

Industry
The table below shows how my assessment would change if the industry of this company
were different.
Changes in Assessment Method
Industry Change in Assessment Comments

Retail? No change, but closer attention to Inventory turnover and activity
activity ratios and inventory ratios are key indicators of
turnover efficiency in sales and in managing
receivables.
Merchandising? No change, but closer attention to Inventory turnover and activity
activity ratios and inventory ratios are key indicators of
turnover efficiency in sales and in managing
receivables.
Service? No change, but closer attention to Fixed asset turnover and activity
activity ratios and fixed asset ratio are key indicators of efficiency
turnover in sales and in managing
receivables.
e-Commerce? Similar analysis but closer attention Before the bust, the dot coms had a
to activity ratios, liquidity, and serious problem with trying to
leverage, in addition to serious realize revenue too quickly, and
scruitiny on ROI projections. overstated revenue from reselling
(Marshall, 2002)
And a lot of emphasis on other
criteria such as the worthiness of the
business model, the target market,
who the investors are and why they
think the company has a chance, etc.

Conclusion
So we have seen that a lot of ways to analyze a company’s financial performance. It’s not
“rocket science,” but it does take a lot of time and a willingness to crunch the numbers using a
spreadsheet, some well organized financial reports, and a good set of ratio guidelines. It also takes a
dedication to the truth and being willing to dig deeper than what the average person reads in a 500-
word column in the business section of the newspaper.
Finally, would I recommend the purchase of Sample Company’s stock as an investment?
The answer is a qualified “Yes”. After more careful research, if my findings were consistent with
the financial analysis in this report, then I absolutely would be in favor of buying this company’s
stock.
Please advise if you have questions or require additional explanation.
Regards,
William F. Slater, III

References
Dun and Bradstreet. (2003). Retrieved at www.dunandbradstreet.com.
Marshall, D.H., McManus, W.W., Viele, D.F., Anthony, R.N., Hawkins, D.F., and Merchant, K.A.
(2002). Accounting: What the Numbers Mean, Fifth Edition with Selected Material from
Accounting: Text and Cases, Tenth Edition. University of Phoenix Edition – McGraw-
Hill Primus: Boston.

Appendix A – Sample Company’s Financial Statements from 1999 – 2001
STATEMENT 1
SAMPLE CO.
Consolidated Results of Operations
For the Years Ended December 31
(dollars in millions except per share data)
2001 2000 1999
Sales $ 10,359 $ 8,251 $ 7,362
Operating costs:
Cost of goods sold 8,011 6,523 6,064
Selling, general, and administrative expenses 1,242 1,071 980
Research and development expenses 182 159 178
$ 9,435 $ 7,753 $ 7,222
Operating profit $ 924 $ 498 $ 140
Interest expense 264 209 197
$ 660 $ 289 $ (57)
Other income 182 170 160
$ 842 $ 459 $ 103
Provision for income taxes 262 118 21
Profit of consolidated companies $ 580 $ 341 $ 82
Equity in profit (loss) of affiliated companies 36 (22) (6)
Profit--before extraordinary tax benefit $ 616 $ 319 $ 76
Extraordinary tax benefit from foreign tax credit carryforwards - 31 -
Profit $ 616 $ 350 $ 76
Profit per share of common stock before extraordinary tax benefit $ 6.07 $ 3.20 $ 0.77
Profit per share of common stock after extraordinary tax benefit $ 6.07 $ 3.51 $ 0.77
Dividends paid per share of common stock $ 0.75 $ 0.50 $ 0.50

STATEMENT 2
SAMPLE CO.
Changes in Consolidated Ownership
(dollars in millions)
2001 2000 1999
Common stock:
Balance at beginning of year $ 827 $ 714 $ 696
Common shares issued, including treasury shares reissued:
2001--1,317,485; 2000--2,601,322; 1999--452,959 83 113 18
Treasury shares purchased: 2001--1,326,058 (86) - -
Balance at year-end $ 824 $ 827 $ 714
Profit employed in the business:

Balance at beginning of year $ 2,656 $ 2,363 $ 2,349
Add: Profit 616 350 76
Deduct: Dividends paid and payable 88 57 62
Balance at year-end $ 3,184 $ 2,656 $ 2,363
Foreign currency translation adjustment:

Balance at beginning of year $ 82 $ 72 $ 23
Aggregate adjustment for the year 23 10 49
Balance at year-end $ 105 $ 82 $ 72
Ownership at year-end $ 4,113 $ 3,565 $ 3,149

SAMPLE CO.
Consolidated Financial Position
At December 31
(dollars in millions except per share data)
2001 2000 1999
Current assets:
Cash and short-term investments $ 74 $ 155 $ 166
Receivables 2,669 2,174 1,808
Refundable income taxes 114 130 92
Deferred income taxes and prepaid expense allocable to
the following year 474 224 208
Inventories 1,986 1,323 1,211
$ 5,317 $ 4,006 $ 3,485
Current liabilities:
Short-term borrowings $ 1,072 $ 623 $ 696
Payable to material suppliers and others 1,495 1,351 1,182
Wages, salaries, and contributions for employee benefits 485 431 450
Dividends payable 30 19 12
Income taxes 118 48 10
Long-term debt due within one year 235 286 122
$ 3,435 $ 2,758 $ 2,472
Net current assets $ 1,882 $ 1,248 $ 1,013
Buildings, machinery, and equipment--net 2,802 2,467 2,431

Land--at original cost 107 96 97
Patents, trademarks, and other intangibles 71 47 60
Investments in and advances to affiliated companies 288 227 185
Long-term receivables 902 665 413
Other assets 199 123 90
Total assets less current liabilities $ 6,251 $ 4,873 $ 4,289
Long-term debt due after one year 1,953 1,287 1,134

Deferred income taxes 185 21 6
Net assets $ 4,113 $ 3,565 $ 3,149
Ownership (Statement 2):

Common stock of $1.00 par value:
Authorized shares: 200,000,000
Outstanding shares (2001--101,414,138; 2000--101,422,711
[after deducting 23,470 and 2,961 treasury shares, respectively];
1999--98,832,079) at paid-in amount $ 824 $ 827 $ 714
Profit employed in the business 3,184 2,656 2,363
Foreign currency translation adjustment 105 82 72
$ 4,113 $ 3,565 $ 3,149

STATEMENT 4
SAMPLE CO.
Consolidated Statement of Cash Flows
(dollars in millions)
2001 2000 1999
Cash flows from operating activities:

Profit $ 616 $ 350 $ 76
Adjustments for non-cash items:
Depreciation and amortization 434 425 453
Other (74) 144 86
Changes in assets and liabilities:
Receivables (777) (699) (765)
Refundable income taxes 15 (34) 1
Inventories (598) (124) (68)
Payable to material suppliers and others 348 252 (14)
Other--net (39) (80) (4)
Net cash provided by operating activities $ (75) $ 234 $ (235)
Cash flows from investing activities:

Expenditures for land, buildings, machinery, and equipment $ (793) $ (493) $ (331)
Proceeds from disposals of land, buildings, machinery, and equipment 30 32 16
Investments in and advances to affiliated companies (24) (65) (52)
Other--net (50) (25) 41
Net cash used for investing activities $ (837) $ (551) $ (326)
Cash flows from financing activities:

Dividends paid $ (77) $ (50) $ (49)
Common shares issued, including treasury shares reissued 4 6 3
Treasury shares purchased (86) - -
Proceeds from long-term debt issued 371 503 156
Payments on long-term debt (298) (102) (307)
Short-term borrowings--net 965 (91) 578
Net cash provided by financing activities $ 879 $ 266 $ 381
Effect of exchange rate changes on cash $ (48) $ 40 $ 41

Decrease in cash and short-term investments $ (81) $ (11) $ (139)

Appendix B – Financial Ratio Analysis of Sample Company
Standard Financial Ratio Analysis

for Sample Company
Percent
Assessment 2000 2001 Change Description
Profitability
ROI (%) Great 6.9 10.7 55.1 Rate of Return on
assets invested
ROE (%) Great 10.4 16 53.8 Rate of return of
Assets provided
by owners equity
Margin (%) Great 6 8.9 48.3 Net income
resulting from
each dollar of
sales
Earnings Per Great $3.51 $6.07 72.9 Profit earned on
Share ($) each share of
common stock
Price to Good 12 10.7 -10.8 Market price of
Earnings (Ratio) share / earnings
per share,
measures how
expensive
Dividend Payout Good 14.2 12.4 -12.7 Proportion of
(%) earnings that
were paid as
dividends to
common
shareholders
Dividend Yield Good 1.2 1.2 0.0 Part of
(%) stockholders'
ROI: rate of return
from annual cash
dividend
Market Price per Good $42.00 $65.00 54.8 Change in Market
share ($) Price of stock
during the year

Percent
Assessment 2000 2001 Change Description
Activity
Inventory OK 5.1 4.8 -5.9 Efficiency of the
Turnover firm's inventory
(Times) management
practices
Fixed Asset Good 3.2 3.8 18.8 Efficiency with
Turnover which assets are
(Times) used to generate
sales
No. of Days in Good 96.2 94 -2.3 Average age of
Accounts accounts
Receivable receivable and
(days)
Average Days OK $22.61 $28.38 25.5 Relative efficiency
Sales ($) of the firm's
collection policies
relative to credit
trems
Leverage
Debt Ratio Not so good 35.9 47.5 32.3 Total Liabilities /
(Total Liabilities +
Owners' Equity)
Debt/ Not so good 26.5 32.2 21.5 Total Liabilities /
Equity Ratio Total Owners'
Equity
Times Interest Good 3.19 4.18 31.0 Earnings before
Earned (Times) interest and
taxes / Interest
expense (Ability
to pay its interest)
Liquidity
Current Ratio Marginal 1.45 1.54 6.2 Liquidity more
(Ratio) comparable over
time
Acid Test (Ratio) Marginal 0.84 0.79 -6.0 Conservative
assessment
Working Capital Great $1,248 $1,882 50.8 Firm's ability to
($) meet its
obligations when
they come due
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ACC 529 - Financial Ratio Analysis - William F.

Slater, III Page 1 of 19

FINANCIAL RATIO ANALYSIS

Financial Ratio Analysis

William F. Slater, III

ACC 529 – Accounting for Managerial Decision Making

Week 5 Assignment for ePortfolio

Michael Greenen, C.P.A, C.F.P. - Instructor

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

buying stock in Sample Company is a sound investment.

these ideas and provide a reference for them.

Date: July 1, 2003

To: Randall K. Black, CEO

Absolutely Alabama Investments

From: William F. Slater, III, Consultant

Subject: Financial Analysis Using Ratio Analysis and Recommendation

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

Appendix B contains other measures of Sample Company’s financial performance, as

Profitability of Sample Company

average total assets (Marshall, 2002).

Sample Company ROI for 2000

ROI = MARGIN x TURNOVER

OPERATING INCOME Operating Income Sales

Input: 498 498 8,251

Sample Company ROI for 2001

ROI = MARGIN x TURNOVER

OPERATING INCOME Operating Income Sales

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

Input: 924 924 10,359

than improvement in asset efficiency.

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

Activity of Sample Company

Leverage of Sample Company

Liquidity of Sample Company

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

numbers will be important to watch closely in the future.

What Is Necessary to Assess the Company?

possible accounting principle change, business combinations (mergers, acquisitions, dispositions),

and a possible management’s statement of responsibility.

report, and a compilation report.

organization’s financial circumstances cannot be known.

D&B with current financial information (Dun & Bradstreet, 2003).

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

over the web.

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

What Ratios Have the Most Value?

What Other Factors, Beyond Ratios, Need To Be Considered?

What Type of Industry Do You Think The Organization Is and Why?

the range of what would be a manufacturing concern (Marshall, 2002):

Ratio Sample Company Manufacturing Typical

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

ROI 10.7% 10% to 15%

ROE 16% 10% – 15%

Margin 8.9% 10% – 15%

Asset Turnover 1.2 1.0 to 3.0

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

How Would Your Assessment Criteria Change If The Company In a Different

Changes in Assessment Method

Industry Change in Assessment Comments

mhtml:file://C:\Users\Mutaz\Desktop\khalid\ACC 529 - Financial Ratio Analysis - Wi... 13/12/2010

word column in the business section of the newspaper.

Finally, would I recommend the purchase of Sample Company’s stock as an investment?