Ratio Analysis, Part 2

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Posted by geemiz | Posted in MAS | Posted on 06-12-2010

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This article is the continuation of the two part article on learning ratio analysis. The first part of the article which was posted few days ago discusses the meaning of ratio analysis and other terms of ratio analysis like financial statement analysis and the technique being used. Now we are going to continue learning about the two other techniques of financial statement analysis which is the Profitability ratio and the Solvency Ratio.

Profitability Ratio
This is the company’s ability to gain profit.

Rate of Return or Return on Investment – measures the net income generated by each dollar of investment.

    Rate of Return = Income/Investment

Return on Sale or Profit Margin – measures the amount of income generated by each net sales.

    Profit Margin = Income/Net Sales
    Gross Profit Ratio = Gross Profit/Net Sales
    Net Profit Ratio = Net Profit/Net Sales

Return on Total Assets – overall measure of profitability.

    Return on Asset = Income before Interest and Taxes/*Average Total Assets
    Or
    Return on Asset = (Net Income+Interest Expense+Income Tax)/*Average Total Assets

Return on Owners Equity – measures the amount earned on the owners equity.

    Return on Owners Equity = Net Income /*Average Owners Equity

For Corporations with one class of share:

    Return on Stockholders’ Equity = Net Income/*Average Stock Holders’ Equity

For Corporations with Preferred shares:

    Return on Stock Holders Equity = (Net Income Preferred Dividends)/*Average Common Stockholders’ Equity

Earnings Per Share – measures net income earned on each share of common stock

    Earnings Per Share = (Net Income Preferred Dividends)/Weighted Average number of Common Shares

Price Earnings Ratio – reflects investors’ assessment of a company’s future earnings.

    Price Earnings Ratio = Price per Share/Earnings per Share

Dividend Yield – measures dividend per dollar share.

    Dividend Yield = Dividend per Share/Price per Share

Payout Ratio – measures the percentage of earnings distributed in the form of cash dividends.

    Payout Ratio = Common Dividend per Share/Earnings per Share

Solvency Ratio
The company’s ability to pay all its debts, whether such liabilities are current or non-current.

Times Interest Earned – determines the extent to which operation cover interest expense.

    Times Interest Earned = (Income before Tax+Interest Expense)/Interest Expense

Debt Equity Ratio – indicates the percentage of total Stockholders’ Equity provided by creditors. If the debt equity ratio is exactly equal to 1 this means that creditors and owners provided an equal amount of capital but if the ratio increase above 1 the amount of risk assumed by creditors increases.

    Debt Equity Ratio = Total Liabilities/Total Stockholders’ Equity

Debt Ratio – indicates the percentage of total assets provided by creditors.

    Debt Ratio = Total Liabilities/Total Assets

Equity Ratio – indicates the percentage of total assets provided by the owners.

    Equity Ratio = Total Owners Equity/Total Assets
    Or
    Equity Ratio = 100% Debt Ratio

Hints in Solving Ratio Analysis
• In computing for price earnings ratio use the market price per share at the end of the period.
• In computing the book value per share always deducts the preferred stock from the total stockholders’ equity.
• In computing for long term assets and the only given are the following: current liabilities, long term liability, working capital and debt equity ratio; compute for the total stockholders equity then add to total liability an deduct current asset.
• If the problem is looking for current liability and the given are only inventory and prpeaid expense, current ratio and acid test ratio. Current ratio minus acid test ratio and the answer is divided from inventory.
• To compute for total sales and the given are only average receivable, turnover of the year and the percentage for cash sales what you do is multiply turnover of the year by the percentage of cash sales then add turnover of the year then multiply by the average receivable.

Most probably these are the formulas to remember in solving financial statement analysis and the things to remember in solving missing information’s.

Meet geemiz


Geezelle Maningo - A Cebu based travel blogger and the other half of GeeMiz Travel blog. She has been traveling around the Philippines and Asia since 2010 with her husband. A casual trekker/hiker since 2017 and has been blogging since 2008. A digital marketer during workdays and a bookworm on lazy days - she co-founded Cebu Book Club.

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