FINANCIAL STATEMENT ANALYSIS
LESSON 3
Ratio Analysis
Learning objectives
At the end of the lesson participants should be able to;
Identify the necessary ratio suitable for a particular situation
Compute different ratio
Interpret different ratio and explain how they relate to underlying financial statements
Explain the limitation in application of ratio
Lecture outline
Introduction to ratios
Liquidity ratios
Profitability ratio
Efficiency ratios
Gearing ratios
3.1 Introduction
A ratio is an expression of relationships between two factors. Ration in financial statement
facilitate analysis and interpretation of the various factor in the accounts. These help to examine
in detail the overall picture portrayed by the financial statement.
Importance of ratio
Provides greater clarity and meaning to the financial statement by bringing out information
that was not apparent.
Enhance comparison of the firms performance with similar firms in the industry
Provide a basis of evaluating the organization operational efficiency
Provide information suitable for timely quality and informed decision making
Form the basis for future forecast and planning by providing trends and performance pattern
Indicate the profitability and solvency of the organization by eliminating the informational
overload
Ensures effective cost control
Classification of ratio
There are five categories of ratios as follows
1. Profitability ratios
2. Liquidity ratio
3. Capital structure ratio
4. Activity ratio
20
, FINANCIAL STATEMENT ANALYSIS
5. Share holder or investor ratio
3.2 Liquidity ratios
Liquidity ratios measure the ability of a company to repay its short-term debts and meet
unexpected cash needs.
Current ratio
The current ratio is also called the working capital ratio, as working capital is the difference
between current assets and current liabilities. This ratio measures the ability of a company to pay
its current obligations using current assets. The current ratio is calculated by dividing current
assets by current liabilities.
2013 2012
Current assets 38,366 38,294
Current liabilities 27,945 30,347
Required:
Calculate the current ratio and interpret it
Acid-test ratio
The acid-test ratio is also called the quick ratio. Quick assets are defined as cash, marketable (or
short-term) securities, and accounts receivable and notes receivable, net of the allowances for
doubtful accounts. These assets are considered to be very liquid (easy to obtain cash from the
assets) and therefore, available for immediate use to pay obligations. The acid-test ratio is
calculated by dividing quick assets by current liabilities.
2013 2012
Cash 6,950 6,330
Accounts receivable, net 18,567 19,230
21
LESSON 3
Ratio Analysis
Learning objectives
At the end of the lesson participants should be able to;
Identify the necessary ratio suitable for a particular situation
Compute different ratio
Interpret different ratio and explain how they relate to underlying financial statements
Explain the limitation in application of ratio
Lecture outline
Introduction to ratios
Liquidity ratios
Profitability ratio
Efficiency ratios
Gearing ratios
3.1 Introduction
A ratio is an expression of relationships between two factors. Ration in financial statement
facilitate analysis and interpretation of the various factor in the accounts. These help to examine
in detail the overall picture portrayed by the financial statement.
Importance of ratio
Provides greater clarity and meaning to the financial statement by bringing out information
that was not apparent.
Enhance comparison of the firms performance with similar firms in the industry
Provide a basis of evaluating the organization operational efficiency
Provide information suitable for timely quality and informed decision making
Form the basis for future forecast and planning by providing trends and performance pattern
Indicate the profitability and solvency of the organization by eliminating the informational
overload
Ensures effective cost control
Classification of ratio
There are five categories of ratios as follows
1. Profitability ratios
2. Liquidity ratio
3. Capital structure ratio
4. Activity ratio
20
, FINANCIAL STATEMENT ANALYSIS
5. Share holder or investor ratio
3.2 Liquidity ratios
Liquidity ratios measure the ability of a company to repay its short-term debts and meet
unexpected cash needs.
Current ratio
The current ratio is also called the working capital ratio, as working capital is the difference
between current assets and current liabilities. This ratio measures the ability of a company to pay
its current obligations using current assets. The current ratio is calculated by dividing current
assets by current liabilities.
2013 2012
Current assets 38,366 38,294
Current liabilities 27,945 30,347
Required:
Calculate the current ratio and interpret it
Acid-test ratio
The acid-test ratio is also called the quick ratio. Quick assets are defined as cash, marketable (or
short-term) securities, and accounts receivable and notes receivable, net of the allowances for
doubtful accounts. These assets are considered to be very liquid (easy to obtain cash from the
assets) and therefore, available for immediate use to pay obligations. The acid-test ratio is
calculated by dividing quick assets by current liabilities.
2013 2012
Cash 6,950 6,330
Accounts receivable, net 18,567 19,230
21
