Financial Ratios
FINANCIAL RATIOS
LIQUIDITY RATIOS
Current Ratio: = current assets / current liabilities
▪ The higher the ratio, the greater the "cushion" between current obligations and a firm 's ability to meet them. ▪ Use: An indication of a company 's ability to meet short-term debt obligations; the higher the ratio, the more liquid the company is. Current ratio is equal to current assets divided by current liabilities. If the current assets of a company are more than twice the current liabilities, then that company is generally considered to have good short-term financial strength. If current liabilities exceed current assets, then the company may have problems meeting its short-term obligations. For example, if XYZ Company 's total current assets are $10,000,000, and its total current liabilities are $8,000,000, then its current ratio would be $10,000,000 divided by $8,000,000, which is equal to 1.25. XYZ Company would be in relatively good short-term financial standing. ▪ Good: If total assets are greater than liabilities ▪ Bad: If total liabilities are greater than assets ▪ Who uses it and or what purpose? Analysts use current ratio in financial statement analysis. ▪ How it can be manipulated and what causes it to vary? Changes in trend o the Current Ratio can be misleading. If the current ratio exceeds 1:1 an increase in equal amount in both current assets and current liabilities ( by acquiring inventory into an account) results in a decline in ratio, whereas equal decreases ( by paying an accounts payable) Results in increased current ratio. ▪ How can Management leverage this knowledge? Management can manipulate current ratio by taking deliberate steps to produce a financial statement that presents a better current ratio at the balance sheet data than the average or normal current ratio during the rest of the year. For Example: near the end of an accounting period a firm might delay normal
LIQUIDITY RATIOS
Current Ratio: = current assets / current liabilities
▪ The higher the ratio, the greater the "cushion" between current obligations and a firm 's ability to meet them. ▪ Use: An indication of a company 's ability to meet short-term debt obligations; the higher the ratio, the more liquid the company is. Current ratio is equal to current assets divided by current liabilities. If the current assets of a company are more than twice the current liabilities, then that company is generally considered to have good short-term financial strength. If current liabilities exceed current assets, then the company may have problems meeting its short-term obligations. For example, if XYZ Company 's total current assets are $10,000,000, and its total current liabilities are $8,000,000, then its current ratio would be $10,000,000 divided by $8,000,000, which is equal to 1.25. XYZ Company would be in relatively good short-term financial standing. ▪ Good: If total assets are greater than liabilities ▪ Bad: If total liabilities are greater than assets ▪ Who uses it and or what purpose? Analysts use current ratio in financial statement analysis. ▪ How it can be manipulated and what causes it to vary? Changes in trend o the Current Ratio can be misleading. If the current ratio exceeds 1:1 an increase in equal amount in both current assets and current liabilities ( by acquiring inventory into an account) results in a decline in ratio, whereas equal decreases ( by paying an accounts payable) Results in increased current ratio. ▪ How can Management leverage this knowledge? Management can manipulate current ratio by taking deliberate steps to produce a financial statement that presents a better current ratio at the balance sheet data than the average or normal current ratio during the rest of the year. For Example: near the end of an accounting period a firm might delay normal