Financial Ratios and Analysis

Financial Analysis
Financial analysis is the process of evaluating businesses, projects, budgets, and other finance-
related transactions to determine their performance and suitability. Typically, financial analysis is
used to analyze whether an entity is stable, solvent, liquid, or profitable enough to warrant a
monetary investment.
Tools of Financial Analysis
A. Ratio Analysis
Is a quantitative method of gaining insight into a company's liquidity, operational efficiency, and
profitability by studying its financial statements such as the balance sheet and income statement.
1. Liquidity Ratios – measure the ability of a company to pay currently maturing obligations
and meet unexpected cash needs.
a. Current Ratio (also called Working Capital Ratio)
b. Acid Test Ratio or Quick Ratio
c. Accounts Receivable Turnover
d. Inventory Turnover
2. Solvency Ratios (also known as stability ratio) – measure the ability of an entity to
survive over a long period of time. Indicates wether a company’s cash flow is sufficient to
meet its short and long term liabilities.
a. Time Interest Earned
b. Debt Ratio
c. Equity Ratio
d. Debt To Equity Ratio
e. Equity To Debt Ratio
3. Profitability Ratios – measure the ability of an entity to earn income over a period of
time or show how efficiently a company generates profit and value for shareholders.
a. Gross Profit Margin
b. Operating Profit Margin
c. Net Profit Margin or Return on sales
B. Vertical analysis
Is a technique for evaluating financial statement data that expresses each item in a financial
statement as a percentage of base amount.
C. Horizontal analysis
Is a technique for evaluating a series of financial statement data over a period of time. This involves
sidewise comparison. This shows changes from year to year. When two years are being compared,
the earlier year is used as the base year.
D. Trend Analysis (Also known as time series analysis)
Is a statistical technique used to examine and analyze patterns, changes, or trends in data over a
period of time. Trend analysis would require comparable data of at least three years.
LIQUIDITY RATIOS
1. Current Ratio = is one way to assess the overall liquidity of a company by comparing current
assets to current liabilities.
This ratio will help measure the company’s ability to pay it’s short term obligations using
current assets.
How current ratio is calculated
Current Ratio = Current Assets__

Current Liabilities
Note: Current Assets and Current Liabilities data can be found at the Balance Sheet or also
known as Statement of Financial Position.
Example:
Assuming the current assets of a company is 100,000.00 and the current liabilities is
25,000.00. Compute and Analyze the current ratio and discuss the company’s liquidity
position.
Current Ratio = 100,000.00__ = 4:1

25,000.00
What does this ratio 4:1 shows?
This shows that for every peso of liabilities in the company , the company has 4x the assets to pay.
Which is a good indication of the company’s liquidity position, and that the company can pay its
current liabilities based on the ratio.
2. Quick Ratio (also known as Acid Test Ratio) = measure a company’s ability to meet its short
term obligations with its most liquid assets and therefore excludes inventories from its
current assets. In other words this measures the company’s ability to pay its immediate
current liabilities.
What if the company has payables tomorrow? Will it be able to pay?
How quick ratio is calculated?

Quick Ratio = Cash + Marketable Securities + Short Term Receivables
Current Liabilities
Assuming the company has :
Cash = 500,000
Marketable Securities = 150,000
Short Term Receivables = 200,000
Total Current Liabilities = 450,000
Compute and Analyze the quick ratio and discuss the company’s liquidity position.
Quick Ratio = 500,000 + 15,000 + 200,000

450,000
= 850,000
Quick Ratio = 1.89:1
What does this ratio shows?
This shows that the company has 1.89 quick assets available to pay every 1 peso current liabilities
and that it can pay its immediate or quick liabilities.

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Financial Analysis

Tools of Financial Analysis

D. Trend Analysis (Also known as time series analysis)

Current Ratio = Current Assets__

Current Ratio = 100,000.00__ = 4:1

What does this ratio 4:1 shows?

How quick ratio is calculated?

Quick Ratio = 500,000 + 15,000 + 200,000

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