Financial Ratio Analysis

Dennis L. Thompson, CPA

Nine Ratios that Measure Effect Current Assets/Current Liabilities
Current Liabilities/Net Worth

Total Liabilities/Net Worth

Inventory/Working Capital

Accounts Receivable/Working Capital

Long Term Liabilities/Working Capital

Net Profit/Net Worth

Net Sales/Fixed Assets

Net Sales/Working Capital

Six Causal Ratios Fixed Assets/Net Worth

Days Sales in Accounts Receivable

Accounts Receivable/(Credit Sales/360)

Net Sales/Inventory

Net Sales/Net Worth

Net Profit/Net Sales

Misc Assets/Net Worth

The Meaningful Interpretation of Financial Statements Donald E. Miller

Fixed Assets/Net Worth

Measures extent that Net Worth consists of

long term, non current assets.
Can have negative impact on Working
Capital and Current Ratio.
Might be increasing Fixed Costs through
borrowing.
Might be distorted by low Net Worth
Accounts Receivable/(Credit
Sales/360)- Collection Period
Measures efficiency of Company receivable
collections.
Early warning system for delinquent
accounts.
Important to measure against Industry
competitors.
Need to subtract cash sales to arrive at net
Credit Sales.
Low number can be indicative of restrictive
Credit Policy, thus reducing profit.
Net Sales/Inventory=Number of
Times
Measures how quickly Inventory is turning
over.
Low turnover indicates potential writeoffs.
Also could indicate potential shrinkage.
Could adversely impact Cash Flow.
However, with Inventory management,
need to seek a balance of too much and
not enough.
Net Sales/Net Worth
Measures extent Companys sales are
supported by invested capital.
High ratio can mean that Company is
supporting sales through debt, i.e., Fixed
Costs.
Can negatively impact Break-Even point.
Can increase chances of Company failure
because of Fixed Costs.
Over emphasis on sales can lead to selling
to marginal customers.
Net Profit/Net Sales
Impacts all the other ratios.
Profits add to Net Worth
Losses increase the need for Long Term
Borrowing, which can impact Working
Capital.
Losses threaten Companys ability to
survive.
Misc Assets/Net Worth
Examples : Loans to Employees
Prepaid Expenses
Usually not a significant part of Balance
Sheet.
Dont want to tie up much Captal in these
type of assets.
Current Assets/Current Liabilities
Standard used to be 2:1
Working Capital = Current Assets-Current
Liabilities.
Problem with Current Assets
Includes Inventory
Includes Receivables
Summary
Financial Ratio Analysis can serve as an
early warning system.
Ratio Analysis assumes that Accounting
information is accurate.
Improve your Companys chances for
improved Profitability or even Survival by
conducting Ratio Analysis.
Especially important to compare your
Company to Industry Standard Ratios.