Hello all! Ok, here's the situation:
I have a business assignment due next week, which I'm halfway through (ie I've done up all the financial reports I need to; the Balance Sheet, General Ledger (summary), Profit and Loss Statement and Receivables - Aging Summary). The second half of the assignment is about analysing these using ratio analysis (with these ratios in particular):
Profit margin
Return on assets
Current ratio
quick asset ratio
Debt ratio.
My problem is that I have the formulas for these, but haven't a clue how to use them!! This may seem really dumb, but the lecturers haven't gone into much detail with these things, not even telling us which Financial report to use, etc. can anyone help?
Need Help Analysing Financial Reports with Ratio Analysis
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- Hephzibah
- Posts: 1494
- Joined: Thu Oct 14, 2004 9:00 am
- Location: Australia
Okay, you have the statements done, but just need to know how to use the ratios?
I'll write up a quick explanation and post it in a few minutes.
I'll write up a quick explanation and post it in a few minutes.
The cake used to be a lie like you, but then it took a portal to the deception core.
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Kaligraphic - Posts: 2002
- Joined: Wed Jul 21, 2004 12:00 pm
- Location: The catbox of DOOM!
Okay, I wrote this pretty quickly, and then a certain individual wanted to play with the router. Anyway, here it is.
*edit* Okay, I'm sure you know this, but the Profit and Loss Statement is the same thing as the Income Statement. I just noticed that we used slightly different terminology there. */edit*
Okay, I've included short explanations of each ratio because that makes it easier to remember how to use them. It's been almost a year since I finished my last accounting class, but I had a very good instructor, so I remember most of it.
The profit margin is the firse of the three components of Return on Equity in the DuPont framework. It is (Net Income)/(Revenue). This ratio comes from your income statement. In the income statement, you go down to the bottom and find the net income. This will be the amount that the company's bank account goes up or down. (Note: this does not take into account dividends paid by the company. Dividends go on the statement of retained earnings, and are irrelevent to net income and to the profit margin.) Anyway, you take this net income number, and you go up to the top section of your income statement, where you have only revenues. You divide the net income by the total revenues, and that tells you, out of all the money you took in, what percentage you kept. So, if a company had revenues of $50,000, and a net income of $1,000, then the profit margin is calculated as 1,000/50,000, or 1/50, or 2%. So you keep 2% of the money you collect.
Return on assets is a little more interesting because it uses two statements. Basically, it is (Net Income)/(Total Assets) - in other words, how useful are our assets. The net income comes again from the income statement, and the total assets comes from the balance sheet. If a company has $50,000 in cash, $50,000 in inventory, and $400,000 in PP&E (property, plant & equipment), for a total of $500,000 in assets, and made, after expenses, $100,000 in net income, then the return on assets comes to 100,000/500,000, or 1/5, or 20%. Thus, return on assets is 20%, meaning that every dollar of assets the company owns gains them 20 cents.
The current ratio is (Current Assets)/(Current Liabilities). Basically, it's a matter of how liquid the company is. You have, no doubt, been taught to separate current and long-term assets and liabilities on the balance sheet, so just take the number for current assets from there, and divide it by the number for current liabilities. This tells you whether the company is likely to have enough money to pay all of the bills that will be due within the year.
The quick asset ratio is the only one that I'm not 100% on, but as I recall, it's basically the current ratio, except without including inventory in the assets. (i.e. only using cash, cash equivalents, and short-term receivables) Anyway, if that's correct (and I think it is), it'll come from the balance sheet, and the denominator will be the same as the current ratio. This is basically a worst-case equivalent of the current ratio - for a scenario where inventory does not move, or becomes extremely devalued.
The debt ratio is (Total Liabilities)/(Total Assets) and is shown as a percentage. Basically, out of all of your assets, how much to you owe to others. It comes entirely from the balance sheet. You take the total liabilities from the balance sheet, and divide that by the total assets on the balance sheet. So, if a company's total assets come to $500,000, and the company's total liabilities come to $250,000, then the debt ratio is 50% because 250,000/500,000 is 1/2, or 0.50, or 50%. This means that the company has, so to speak, borrowed the money to buy half of its assets.
*edit* Okay, I'm sure you know this, but the Profit and Loss Statement is the same thing as the Income Statement. I just noticed that we used slightly different terminology there. */edit*
Okay, I've included short explanations of each ratio because that makes it easier to remember how to use them. It's been almost a year since I finished my last accounting class, but I had a very good instructor, so I remember most of it.
The profit margin is the firse of the three components of Return on Equity in the DuPont framework. It is (Net Income)/(Revenue). This ratio comes from your income statement. In the income statement, you go down to the bottom and find the net income. This will be the amount that the company's bank account goes up or down. (Note: this does not take into account dividends paid by the company. Dividends go on the statement of retained earnings, and are irrelevent to net income and to the profit margin.) Anyway, you take this net income number, and you go up to the top section of your income statement, where you have only revenues. You divide the net income by the total revenues, and that tells you, out of all the money you took in, what percentage you kept. So, if a company had revenues of $50,000, and a net income of $1,000, then the profit margin is calculated as 1,000/50,000, or 1/50, or 2%. So you keep 2% of the money you collect.
Return on assets is a little more interesting because it uses two statements. Basically, it is (Net Income)/(Total Assets) - in other words, how useful are our assets. The net income comes again from the income statement, and the total assets comes from the balance sheet. If a company has $50,000 in cash, $50,000 in inventory, and $400,000 in PP&E (property, plant & equipment), for a total of $500,000 in assets, and made, after expenses, $100,000 in net income, then the return on assets comes to 100,000/500,000, or 1/5, or 20%. Thus, return on assets is 20%, meaning that every dollar of assets the company owns gains them 20 cents.
The current ratio is (Current Assets)/(Current Liabilities). Basically, it's a matter of how liquid the company is. You have, no doubt, been taught to separate current and long-term assets and liabilities on the balance sheet, so just take the number for current assets from there, and divide it by the number for current liabilities. This tells you whether the company is likely to have enough money to pay all of the bills that will be due within the year.
The quick asset ratio is the only one that I'm not 100% on, but as I recall, it's basically the current ratio, except without including inventory in the assets. (i.e. only using cash, cash equivalents, and short-term receivables) Anyway, if that's correct (and I think it is), it'll come from the balance sheet, and the denominator will be the same as the current ratio. This is basically a worst-case equivalent of the current ratio - for a scenario where inventory does not move, or becomes extremely devalued.
The debt ratio is (Total Liabilities)/(Total Assets) and is shown as a percentage. Basically, out of all of your assets, how much to you owe to others. It comes entirely from the balance sheet. You take the total liabilities from the balance sheet, and divide that by the total assets on the balance sheet. So, if a company's total assets come to $500,000, and the company's total liabilities come to $250,000, then the debt ratio is 50% because 250,000/500,000 is 1/2, or 0.50, or 50%. This means that the company has, so to speak, borrowed the money to buy half of its assets.
The cake used to be a lie like you, but then it took a portal to the deception core.
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Kaligraphic - Posts: 2002
- Joined: Wed Jul 21, 2004 12:00 pm
- Location: The catbox of DOOM!
Thanks again mate, this means alot to me 
No problem, happy to be of help.
The cake used to be a lie like you, but then it took a portal to the deception core.
-
Kaligraphic - Posts: 2002
- Joined: Wed Jul 21, 2004 12:00 pm
- Location: The catbox of DOOM!
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