Two types of ratio comparisons can be made: cross-sectional and time-series. 2-4 Cross-sectional & time series analysis Cross-sectional analysis involves the comparison of different firms’ financial ratios at the same point in time. Called benchmarking, has become very popular. Comparison to industry averages (These figures can be found in the Almanac of Business and Industrial Financial Ratios, Dun & Breadbasket’s Industry Norms and
Key Business Ratios, Business Month, HEN, HOSE,… ) 0 Time-series analysis evaluates performance over time. Developing trends can be seen by using multilayer comparisons. 2-5 Combined analysis ; Combine Cross-sectional & time series ; A combined view makes it possible to assess the trend in the behavior of the ratio in relation to the trend for the industry. 2-6 Note to financial analysis 0 Ratios with large deviations from the norm only indicate symptoms of a problem. Ratio analysis merely directs attention to potential areas of concern; it does not provide conclusive evidence as to the existence of a problem.
A single ratio does not generally provide sufficient information from which to Judge the overall performance of the firm. Only when a group of ratios is used can reasonable Judgments be made. 0 The ratios being compared should be calculated using financial statements dated at the same point in time during the year. If they are not, the effects of seasonality may produce erroneous conclusions and decisions. 2-7 0 preferable to use audited financial statements for ratio analysis. 0 The financial data being compared should have been developed in the same way.
The use of differing accounting reattempts-?especially relative to inventory and depreciation-? can distort the results of ratio analysis, 0 Results can be distorted by inflation, which can cause the book values of inventory and depreciable assets to differ greatly from their true (replacement) values. Without adjustment, inflation tends to cause older firms (older assets) to appear more efficient and profitable than newer firms (newer assets). 2-8 Five Major Categories of Ratios 1. Liquidity: Can we make required payments? 2. Asset management: right amount of assets vs.. Sales? . Debt management: Right mix of debt and equity? 4. Profitability: Do sales prices exceed unit costs, and are sales high enough as reflected PM, ROE, and ROAR? 5. Market value: Do investors like what they see as reflected in PIE and M/B ratios? 2-9 1 . Current Ratio and Quick Ratio Current ratio assets liabilities the higher the current ratio, the more liquid the firm is considered to be. Quick (Current 0 Inventoried s) A quick ratio of 1. 0 or greater is occasionally recommended, but as with the current ratio, what value is acceptable depends largely on the industry. 2-10 2.
Asset management – Inventory Days and Inventory Turnover Inventory Days is the number of days’ cost of goods sold represented by inventory ; Inventory Turnover tells how efficiently a company turns its inventory into sales Cost of Goods So old Inventory Turnover = (CEQ. 2. 18) Inventory 2-11 ; Asset Efficiency – Asset Turnover Asset Turnover As less Asset Tu remover= (CEQ. 2. 15) Total Assets F ‘x deed Asset Tu run over = (CEQ. 2. 16) F ix deed Assets 2-12 ; Working Capital Ratios – Accounts Receivable Days ; The firm’s accounts receivable in terms of the number of days’ worth of sales that it represents Accounts Race Viva b lee Days 0