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    Module 2 - Topic 4

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    Moon Light
    This document provides information on computing and interpreting various financial ratios. It defines eight categories of financial ratios: liquidity, activity, profitability, leverage, and valuation/growth ratios. Specific ratios discussed include current ratio, acid-test ratio, cash ratio, net working capital, receivables turnover, days sales outstanding, inventory turnover, days inventory outstanding, accounts payable turnover, days payable outstanding, operating cycle, and cash conversion cycle. Formulas for calculating each ratio are provided.

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    Module 2 - Topic 4

    Uploaded by

    Moon Light
    67 views8 pages
    This document provides information on computing and interpreting various financial ratios. It defines eight categories of financial ratios: liquidity, activity, profitability, leverage, and valuation/growth ratios. Specific ratios discussed include current ratio, acid-test ratio, cash ratio, net working capital, receivables turnover, days sales outstanding, inventory turnover, days inventory outstanding, accounts payable turnover, days payable outstanding, operating cycle, and cash conversion cycle. Formulas for calculating each ratio are provided.

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    This document provides information on computing and interpreting various financial ratios. It defines eight categories of financial ratios: liquidity, activity, profitability, leverage, and valuation/growth ratios. Specific ratios discussed include current ratio, acid-test ratio, cash ratio, net working capital, receivables turnover, days sales outstanding, inventory turnover, days inventory outstanding, accounts payable turnover, days payable outstanding, operating cycle, and cash conversion cycle. Formulas for calculating each ratio are provided.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    67 views8 pages

    Module 2 - Topic 4

    Uploaded by

    Moon Light
    This document provides information on computing and interpreting various financial ratios. It defines eight categories of financial ratios: liquidity, activity, profitability, leverage, and valuation/growth ratios. Specific ratios discussed include current ratio, acid-test ratio, cash ratio, net working capital, receivables turnover, days sales outstanding, inventory turnover, days inventory outstanding, accounts payable turnover, days payable outstanding, operating cycle, and cash conversion cycle. Formulas for calculating each ratio are provided.

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    of 8

    PRINTABLE LEARNING MATERIAL

    Module 2- Topic4: Financial Ratios

    LEARNING OUTCOME:
    Compute, analyze, and interpret financial ratios such as current ratio, working capital,
    gross profit ratio, net profit ratio, receivable turnover, inventory turnover, debt to equity
    ratio, and the like. (ABM_BF12-IIIb-9)

    Understanding Financial Ratios

    According to Accounting verse, Financial Ratios Financial ratio analysis is performed


    by comparing two items in the financial statements. The resulting ratio can be
    interpreted in a way that is more insightful than looking at the items separately.

    Financial ratios can be classified into ratios that measure: (1) profitability, (2) liquidity,
    (3) Activity ratios, (4) leverage, and Valuation Growth Ratios

    List of Financial Ratios:

    Take note that most of the ratios can also be expressed in percentage by multiplying
    the decimal number by 100%.

    (Lifted from: https://auditnca.com/view/57/ratio-analysis-notes)


    1. Liquidity Ratios- helps in measuring the ability of a company to take care of its
    short-term debt obligations. A higher liquidity ratio represents that the company is
    highly rich in cash.

    (The formula's below are lifted from: https://www.accountingverse.com/managerial-accounting/fs-


    analysis/financial-ratios.html)

    a. Current Ratio: Evaluates


    the ability of a company to pay
    short-term obligations using
    current assets (cash,
    marketable securities, current
    receivables, inventory, and
    prepayments).

    (The image is lifted from:https://www.accountingformanagement.org/current-ratio/)

    Current Ratio = Current Assets ÷ Current Liabilities

    b. Acid Test Ratio: Also


    known as "quick ratio", it
    measures the ability of a
    company to pay short-
    term obligations using the
    more liquid types of
    current assets or "quick
    assets" (cash, marketable
    securities, and current
    receivables).
    (The image is lifted from: https://www.wallstreetmojo.com/quick-ratio-formula/

    Acid Test Ratio = Quick Assets ÷ Current Liabilities

    c. Cash Ratio: Measures the ability of a


    company to pay its current liabilities using
    cash and marketable securities. Marketable
    securities are short-term debt instruments
    that are as good as cash.

    (The image is lifted from: https://www.educba.com/cash-ratio-


    formula/)
    Cash Ratio = ( Cash + Marketable Securities ) ÷ Current Liabilities

    d. Net Working Capital:


    Determines if a
    company can meet its
    current obligations with
    its current assets; and
    how much excess or
    deficiency there is.
    (The image is lifted from:
    https://www.educba.com/working-
    capital-formula/)

    Net Working Capital = Current Assets - Current Liabilities

    2. Activity Ratio/ Management Efficient Ratios- are used to determine how


    efficiently the financial assets and liabilities of an organization have been used
    for the purpose of generating revenues.

    (The definition and formula's below are lifted from: https://www.accountingverse.com/managerial-


    accounting/fs-analysis/financial-ratios.html)

    a. Receivable Turnover:
    Measures the efficiency of
    extending credit and collecting
    the same. It indicates the
    average number of times in a
    year a company collects its open
    accounts. A high ratio implies an
    efficient credit and collection
    process. (The image is lifted from:
    https://www.wallstreetmojo.com/accounts-
    receivables-turnover-ratio/)

    Receivable Turnover = Net Credit Sales ÷ Average Accounts Receivable

    b. Days Sales Outstanding: Also known as "receivable turnover in days",


    "collection period". It measures the average number of days it takes a
    company to collect a receivable. The shorter the DSO, the better. Take
    note that some use 365 days instead of 360.
    Days Sales Outstanding= 360days/ 10
    = 36 days
    Days Sales Outstanding = 360 Days ÷ Receivable Turnover

    c. Inventory Turnover: Represents the number of times inventory is sold


    and replaced. Take note that some authors use Sales. In lieu of Cost of
    Sales in the above formula. A high ratio indicates that the company is
    efficient in managing its inventories.
    Inventory Turnover = Cost of Sales ÷ Average Inventory

    d. Days Inventory Outstanding: Also known as "inventory turnover in


    days". It represents the number of days’ inventory sits in the warehouse.
    In other words, it measures the number of days from the purchase of
    inventory to the sale of the same. Like DSO, the shorter the DIO the
    better.
    Days Inventory Outstanding = 360 Days ÷ Inventory Turnover

    Days Inventory Outstanding= 360 days/ 10.44


    = 34 days

    e. Accounts Payable Turnover:


    Represents the number of
    times a company pays its
    accounts payable during a
    period. A low ratio is favored
    because it is better to delay
    payments as much as possible
    so that the money can be used
    for more productive purposes.
    (The image is lifted from:
    https://www.educba.com/accounts-payable-
    turnover-ratio/)

    Accounts Payable Turnover = Net Credit Purchases ÷ Ave. Accounts Payable

    f. Days Payable Outstanding: Also known as "accounts payable turnover


    in days", "payment period". It measures the average number of days spent
    before paying obligations to suppliers.
    Days Payable Outstanding = 360 Days ÷ Accounts Payable Turnover

    g. Operating Cycle:
    Measures the number of
    days a company makes 1
    complete operating cycle,
    i.e. purchase merchandise,
    sell them, and collect the
    amount due. A shorter
    operating cycle means that
    the company generates
    sales and collects cash faster. (The image is lifted from: https://www.educba.com/operating-
    cycle-formula/)

    Operating Cycle = Days Inventory Outstanding + Days Sales Outstanding

    h. Cash Conversion Cycle:


    CCC measures how fast a
    company converts cash
    into more cash. It
    represents the number of
    days a company pays for
    purchases, sells them,
    and collects the amount
    due. Generally, like the
    operating cycle, the
    shorter the CCC the
    better. (The image is lifted from:
    https://www.educba.com/cash-
    conversion-cycle-formula//)

    Cash Conversion Cycle = Operating Cycle - Days Payable Outstanding

    i. Total Asset Turnover: Measures the


    overall efficiency of a company in
    generating sales using its assets. The
    formula is similar to ROA, except that net
    sales is used instead of net income. The image
    is lifted from: https://www.educba.com/asset-turnover-ratio-
    formula/)

    Total Asset Turnover = Net Sales ÷ Average Total Assets

    3. Leverage Ratios/ Solvency Ratios- can be defined as a type of ratio that is


    used to evaluate whether a company is solvent and well capable of paying off its
    debt obligations or not.

    (The formula's below are lifted from: https://www.accountingverse.com/managerial-accounting/fs-


    analysis/financial-ratios.html)

    a. Debt Ratio: Measures the portion of company assets that is financed by debt
    (obligations to third parties). The debt ratio can also be computed using the
    formula: 1 minus Equity Ratio.
    Debt Ratio = Total Liabilities ÷ Total Assets
    (The image is lifted from: https://www.educba.com/debt-ratio-formula//)
    b. Equity Ratio; Determines the portion of total assets provided by equity (i.e.
    owners' contributions and the company's accumulated profits). Equity ratio can
    also be computed using the formula: 1 minus Debt Ratio. The reciprocal of equity
    ratio is known as equity multiplier, which is equal to total assets divided by total
    equity. (The image is lifted from: https://www.educba.com/equity-ratio-formula//)
    Equity Ratio = Total Equity ÷ Total Assets

    c. Debt-Equity Ratio: Evaluates the capital structure of a company. A D/E ratio of


    more than 1 implies that the company is a leveraged firm; less than 1 implies that
    it is a conservative one. (The image is lifted from: https://www.educba.com/debt-to-equity-ratio-
    formula/)
    Debt-Equity Ratio = Total Liabilities ÷ Total Equity

    d. Times Interest Earned: Measures the number of times interest expense is


    converted to income, and if the company can pay its interest expense using the
    profits generated. EBIT is earnings before interest and taxes.
    Times Interest Earned = EBIT ÷ Interest Expense
    (The image is lifted from: https://www.educba.com/times-interest-earned-formula/)

    4. Profitability Ratios- helps in measuring the ability of a company in earning


    sufficient profits.

    (The formula's below are lifted from: https://www.accountingverse.com/managerial-accounting/fs-


    analysis/financial-ratios.html)

    a. Gross Profit Rate: Evaluates how


    much gross profit is generated from
    sales. Gross profit is equal to net sales
    (sales minus sales returns, discounts,
    and allowances) minus the cost of
    sales. (The image is lifted from:
    https://www.educba.com/gross-profit-margin-formula/

    Gross Profit Rate = Gross Profit ÷ Net Sales


    b. Return on Sales: Also
    known as "net profit margin"
    or "net profit rate", it
    measures the percentage of
    income derived from dollar
    sales. Generally, the higher
    the ROS the better. (The image
    is lifted from:
    https://www.educba.com/return-on-
    sales-formula/)

    Return on Sales = Net Income ÷ Net Sales


    c. Return on Assets: ROA is used
    in evaluating management's
    efficiency in using assets to
    generate income. (The image is lifted
    from: https://www.educba.com/profitability-
    ratios-formula/)

    Return on Assets = Net Income ÷ Average Total Assets

    5. Valuation and Growth Ratios is used for the purpose of determining the returns
    that an organization generates for its investors.

    (The formula's below are lifted from: https://www.accountingverse.com/managerial-accounting/fs-analysis/financial-


    ratios.html)

    a. Earnings per Share: EPS


    shows the rate of earnings per
    share of common stock.
    Preferred dividends are
    deducted from net income to get
    the earnings available to
    common stockholders. (The image
    is lifted from:
    https://www.educba.com/earnings-per-
    share-formula/)

    Earnings per Share = ( Net Income - Preferred Dividends ) ÷ Average Common


    Shares Outstanding

    Licensing & Attributions / References


     AuditNCA. (n.d.). Retrieved January 18, 2021, from https://auditnca.com/view/57/ratio-analysis-notes
     Accountingverse.com. (2020). Retrieved January 4, 2021, from
    https://www.accountingverse.com/managerial-accounting/fs-analysis/financial-ratios.html
     Image of Ratio Analysis. https://www.educba.com/ratio-analysis-types/
     Santoyo, Alfredo, Lim, Edralin & Patiu, Liberty. (2018) Business Finance. MaxCor Publishing House Inc.

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