Financial Ratios
This page is prepared by Prof. Tim Richardson for his students.

This page last updated 2016 Oct 3rd
 
Ratios - an introduction Financial Ratios are mathematical calculations of how a firm has measured some activities, and compared those activities to other inputs, time periods, resources etc.

In an increasingly complex world were people are doing business on a global basis, with competition from many direct and indirect competitors, it becomes more and more difficult for investors and business partners to evaluate the "financial health" of a company when they don't have the ability to meet the executives and have probing discussions about what has been happening.
 

International finance in the 2nd decade of the new millenium, ie 2010+, involves fast decisions about companies all over the world for international investors, government fuind managers, stock traders etc.- ratios help these investors and fund managers make decisions in order to have the opportunity to avoid losing money in companies that may have trouble, and make money with companies that are profitbale now, and in the near future.
In the absence of "going to the source" to find out how a company has been doing presently, and may do in the future, business executives have turned to a series of calculations, when taken together with other objective and subjective information, can give a better indication of a company's success or failure, than if you did not have this info.

So the basic point is, 
Financial Ratios by themselves will not tell you perfect information about a company - but if you have nothing else to go on, except numbers and stats about product, money spent etc., you can use these ratios to make some conclusions that can give you a fairly good idea.

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Ratios - an introduction
 
 

Limitations

Ratios, without context, are not enough information on which a business person can make a confidendent decision. Ratios need to be provided in the context within which the "numbers" are generated... a reference point is needed, as in some sort of historical time period.

Secondly, the financial health" of a company is more than just a series of mathematical calculations about sales and expenses, 
 
For example, Inventory Turnover Ratios look at how enterprises manage inventory levels. If inventory turnover is too low, it suggests that a company may be have too much product in its warehouse waiting to be shipped, or overbuilding its inventory or that it may be having issues selling products to customers. If the time period in which one looked at this was short, it might not allow for an understanding of the "geographic environment", meaning bad winter weather could cause some products to be held in a warehouse longer than usual due to bad driving weater which effects shipping times.

Again, the financial health" of a company is more than just a series of mathematical calculations as we can see in the example of companies that have had dynamic leadership which allowed the company to do well, even though there might have been times when the "books" were not attractive to institutional investors.

examples
Steve Jobs and Apple
Richard Branson and the Virgin companies
Donald Trump
etc.

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The Financial Ratios that are most commonly discussed in business are those listed below.
Please understand that there is some "variety" in the usage of terms to describe categories of ratios, use your discretion in understanding what ratios belong to what category or group

 o Leverage Ratios (also called Debt Ratios)(Leverage Ratios are also referred to as a type of "Solvency Ratio"), including
            o Capital Acquisition Ratio
            o Capital Employment Ratio
            o Capital Structure Ratio
            o Long-term debt/capitalization Ratio
            o Debt-to-equity Ratio

 o Liquidity Ratios, including
            o Current Ratio
            o Quick Ratio (or "Acid Test"
            o Cash Ratio

 o Efficiency Ratios (also known as Operating Financial Ratios),
   (also sometimes titled Asset Utilization Ratios or Asset Management Ratios)
            o The Days Sales Outstanding Ratio
            o Inventory Turnover Ratio (also referred to as Asset Turnover Ratios)
                        o Receivables Turnover
                        o Inventory Turnover
                        o Inventory Period
                        o Average Collection Period
            o Accounts Payable to Sales (%)
            o Total asset turnover (TAT) Ratio
            o Fixed asset turnover (FAT) Ratio
            o Sales Revenue per Employee

 o Profitability Ratios, including
            o Gross Profit Margin
            o Operating Profit Margin
            o Return on Assets
            o Return on Equity
            o Return on capital employed ("ROCE")

 o Investor Ratios (also known as Market Value Ratios), including
            o Earnings per share ("EPS")
            o Price-Earnings Ratio ("P/E Ratio")
            o Price / Cash Ratio
            o Dividend Yield (also known as Dividen Policy Ratios)
                        o Dividend Yield
                        o Payout Ratio
            o Book Value per Share
            o Market Value per Share
            o Market / Book Ratio

Leverage Ratios (also called Debt Ratios)
click to view larger pic of group members Oct 2011   students
Dana A., Jelyn A.
Karlo C., Rana H.
Gursimran (Sim) G.
 

presented to the CCT 224 class a description of Leverage Ratios using the theme of "Who Wants to be a Millionaire".
The presentation had  "high production value" as they created a detailed PPT from which they showed how a person could play the game, by answering questions about Leverage Ratios, and win the million dollars.

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Leverage Ratios

A quick snapshot to show the elaborate PPT the student presenters created to mimic the questions in the game, and use those questions to go through the main points describing Leverage Ratios 

click Leverage Ratios

- they even managed to get in some audience participation by having the students shout out what one of the answers should be to a question
- which was a very good example of "engaging the audience"

Their .pdf explaining Leverage ratios is at
 witiger.com/internationalbusiness/
LeverageRatios.pdf


 
Understanding Canadian Business 7th Edition by Nickels et al

Chpt 16

"Leverage (debt) ratios measure the degree to which a firm relies on borrowed funds in its operations. A firm that takes on too much debt could experience problems repaying lenders or meeting promises made to shareholders. The debt to ownersí equity ratio measures the degree to which the company is financed by borrowed funds that must be repaid."

Debt to Owners's equity =   Total liabilities
                                           Owners equity

"Any number above 100 percent shows that a firm has more debt than equity"

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Liquidity Ratios
click to see larger Oct 2011,   students
Colby H., Murtaza H.
Heba I., Tashfia I.
Nancy K.

presented to the CCT 224 class a description of Liquidity Ratios

Colby did a good job as the lead off speaker and he and Murtaza and Heba energetically explained their concepts through a board game which they had handed out to the class. The group also emphasize "something interesting learned...". Tashfia found an interesting article which discussed cash ratios.

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Understanding Canadian Business 7th Edition by Nickels et al

Chpt 16

"Liquidity refers to how fast an asset can be converted to cash. Liquidity ratios measure a companyís ability to turn some assets into cash to pay its short-term debts (liabilities that must be repaid within one year).These short-term debts are of particular importance to creditors/lenders of the firm, who expect to be paid on time. Two key liquidity ratios are the current ratio and the acid-test ratio."

"The current ratio is the ratio of a firmís current assets to its current liabilities. The numbers used to calculate this ratio can be found on the firmís balance sheet"

Current Ratio =   current assests
                          current liabilities

"Usually a company with a current ratio of 2 or better is considered a safe risk for creditors/lenders granting short-term credit, since it has over two times more current assets available to pay their current liabilities."

Acid Test Ratio = cash + accounts receivable + marketable securities
                                                  current liabilities

"This ratio is particularly important to firms with relatively large inventory, which can take longer than other current assets to convert into cash. It helps answer such questions as: What if sales drop off and we canít sell our inventory? Can we still pay our short-term debt? Though ratios vary among industries, an acid-test ratio over 1.0 is usually considered satisfactory"

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Efficiency Ratios (also called Operating Financial Ratios)
. Oct 2011   students
Ermir K., Karolina K.
Patrick L., Jennifer (Yan Chi) L.
Eric M.

(pic coming) 

presented to the CCT 224 class a description of Efficiency Ratios - did a good skit, unfortunately their "media" did not work out OK, but sometimes that is just bad luck - the info they had was good, but because the "technology" did not work, there was no engagement with the audience at all - each group should therefore always have a back-up-plan / contingency, such as a hand out, for these situations

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Profitability Ratios
click to see bigger Oct 2011   students
Patrick M., Ulana O.
Tanmay P., Brett P.
Ayesha S., Ravi S.

presented to the CCT 224 class a description of Profitability Ratios

Their presentation was pretty interesting in how they made a "skit" called "Chickens Pen" which was based on Dragon's Den 

- good imagination - good graphics, good story line and good use of members in the group to explain all the parts of Profitability Ratios

 

click on this link to see the PDF they compiled on Profitability Ratios
 witiger.com/internationalbusiness/
profitability-ratios.pdf

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Understanding Canadian Business 7th Edition by Nickels et al

Chpt 16

"Profitability (performance) ratios measure how effectively a firm is using its various resources to achieve profits. Company managementís performance is often measured by the firmís profitability ratios. Three of the more important ratios are earnings per share (EPS), return on sales, and return on equity"
 

Basic earnings per share (EPS) =   Net income after taxes
                             Average number of common stock shares outstanding
                          

"The basic earnings per share (basic EPS) ratio helps determine the amount of profit a company earned for each share of outstanding common stock. "

 

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Investor Ratios (also called Market Value Ratios)
click Oct 2011   students
Tim S., Delaney S.
Hamna T., Rocky T.
Aanchal V., Harry Y., Kian Y.

presented to the CCT 224 class a description of Leverage Ratios

 witiger.com/internationalbusiness
/InvestorRatios.pdf 

Liked the fact each group member wore clear name tags which allowed the prof and the audience to know who was saying what.

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http://www.youtube.com/watch?v=6bEvpSyru5g Investor Ratios - the video

The best thing about this group's presentation was the video they posted on YouTube 
 http://youtu.be/6bEvpSyru5g 
which specifically emphasized what each person learned during this process which was "useful and interesting".

One of the key things any professor wants to know is that if the students actually learned something useful and interesting during the course of doing some assignment, if you specifically state this in the process of writing up an assignment, it is very VERY helpful to the person evaluating your mark.

Ratios - Alberta Govt Source
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Investopedia.com
Financial Ratios
Tutorial Online
by Richard Loth
http://lothinvest.com
 

 
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