BCOM-EVENING TOWN CAMPUS FINANCIAL
STATEMENT ANALYSIS
RATIO ANALYSIS
Ratio analysis is among the most popular and widely
used tools of financial analysis. A ratio expresses a mathematical relation between two quantities. While
computation of a ratio is easy, its interpretation is more complex.
Ratios are tools to provide us with insights into underlying conditions. Analysis of a ratio can reveal
important relations and bases of comparison in uncovering conditions and trends difficult to detect the
individual components that make up the ratio. In order to use ratio analysis fairly when evaluating firms,
each company should be evaluated in comparison with its industry peers.
Ratios whose denominator is total assets/ total sales can be read off from vertical common size balance
sheets/income statements.
(A) Activity ratios:
This category includes several ratios which give an indication of how well a firm
utilizes various assets such as inventory and fixed assets.
1. Receivables turnover - A parameter evaluating how the firm extends credit to
its customers. This ratio indicates the total sales realized by the firm for each unit
credit sale.
annual sales
Receivables turnover =
average receivables
2. Days of sales outstanding – The inverse of the receivables turnover multiplied
by 365 is the days of sales outstanding, which is the average number of days it takes
for the customers to pay their bills. A collection period which is too high means that
the customers are taking too long to pay their bills while one which is too slow
implies that the credit terms are too stringent, which might be hampering sales.
365
Days of sales outstanding =
Receivables turnover
3. Inventory turnover – A measure of the firm’s efficiency with respect to its
processing and inventory management is inventory turnover.
Cost of goods sold
Inventory turnover =
average inventory
4. Days of inventory outstanding - The inverse of the inventory turnover
multiplied by 365 is the days of inventory on hand, which is the average number of
days it takes for the firm to liquidate its inventory. A processing period which is too
1
, high might mean that too much capital is tied up in inventory, and it could be
obsolete while one which is too low implies that the firm has inadequate stock on
hand, which could hurt sales.
365
Days of inventory outstanding =
I nventory turnover
5. Payables turnover – This is a measure of the use of trade credit by the firm.
purchases
Payables turnover =
average t rade payables
6. Number of days of payables = the average amount of time it takes for the
company to pay its bills.
365
Number of days of payables =
Payables turnover
7. Total assets turnover - The amount of sales generated for every shilling’s worth
of assets. It is calculated by dividing sales in shillings by assets in shillings and is a
measure of the effectiveness of the firm’s use of its total assets to create revenue.
revenue
Total assets turnover- Average total assets
¿
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8. Fixed assets turnover - A financial ratio of net sales to fixed assets. The fixed-
asset turnover ratio measures a company's ability to generate net sales from fixed-
assets. A higher fixed-asset turnover ratio shows that the company has been more
effective in using the investment in fixed assets to generate revenues.
revenue
¿¿
Fixed assets turnover- Average net
assets ¿
¿
9. Working capital turnover– As measure as to how effectively a company uses its
working capital to generate sales. It shows the revenue realized for every shilling
that the firm has in working capital.
revenue
Working capital turnover - Average working capital
¿
¿
Working capital = current assets – current liabilities.
(B) Liquidity ratios:
2
STATEMENT ANALYSIS
RATIO ANALYSIS
Ratio analysis is among the most popular and widely
used tools of financial analysis. A ratio expresses a mathematical relation between two quantities. While
computation of a ratio is easy, its interpretation is more complex.
Ratios are tools to provide us with insights into underlying conditions. Analysis of a ratio can reveal
important relations and bases of comparison in uncovering conditions and trends difficult to detect the
individual components that make up the ratio. In order to use ratio analysis fairly when evaluating firms,
each company should be evaluated in comparison with its industry peers.
Ratios whose denominator is total assets/ total sales can be read off from vertical common size balance
sheets/income statements.
(A) Activity ratios:
This category includes several ratios which give an indication of how well a firm
utilizes various assets such as inventory and fixed assets.
1. Receivables turnover - A parameter evaluating how the firm extends credit to
its customers. This ratio indicates the total sales realized by the firm for each unit
credit sale.
annual sales
Receivables turnover =
average receivables
2. Days of sales outstanding – The inverse of the receivables turnover multiplied
by 365 is the days of sales outstanding, which is the average number of days it takes
for the customers to pay their bills. A collection period which is too high means that
the customers are taking too long to pay their bills while one which is too slow
implies that the credit terms are too stringent, which might be hampering sales.
365
Days of sales outstanding =
Receivables turnover
3. Inventory turnover – A measure of the firm’s efficiency with respect to its
processing and inventory management is inventory turnover.
Cost of goods sold
Inventory turnover =
average inventory
4. Days of inventory outstanding - The inverse of the inventory turnover
multiplied by 365 is the days of inventory on hand, which is the average number of
days it takes for the firm to liquidate its inventory. A processing period which is too
1
, high might mean that too much capital is tied up in inventory, and it could be
obsolete while one which is too low implies that the firm has inadequate stock on
hand, which could hurt sales.
365
Days of inventory outstanding =
I nventory turnover
5. Payables turnover – This is a measure of the use of trade credit by the firm.
purchases
Payables turnover =
average t rade payables
6. Number of days of payables = the average amount of time it takes for the
company to pay its bills.
365
Number of days of payables =
Payables turnover
7. Total assets turnover - The amount of sales generated for every shilling’s worth
of assets. It is calculated by dividing sales in shillings by assets in shillings and is a
measure of the effectiveness of the firm’s use of its total assets to create revenue.
revenue
Total assets turnover- Average total assets
¿
¿
8. Fixed assets turnover - A financial ratio of net sales to fixed assets. The fixed-
asset turnover ratio measures a company's ability to generate net sales from fixed-
assets. A higher fixed-asset turnover ratio shows that the company has been more
effective in using the investment in fixed assets to generate revenues.
revenue
¿¿
Fixed assets turnover- Average net
assets ¿
¿
9. Working capital turnover– As measure as to how effectively a company uses its
working capital to generate sales. It shows the revenue realized for every shilling
that the firm has in working capital.
revenue
Working capital turnover - Average working capital
¿
¿
Working capital = current assets – current liabilities.
(B) Liquidity ratios:
2
