Financial Statement Analysis
by INE
1) If we divide users of ratios into short term lenders, long term lenders, and stockholders, which ratios would each group be most interested I, and for what reasons?
• Short term lenders o Will be most interested in the firm’s ability to repay debt so they would be interested in the liquidity ratios, Current ratio and Quick ratio. • Long term lenders o Will be most interested in ▪ Debt to total assets but also in ▪ Liquidity ratios • Current ratio • Quick ratio • As they want to be sure the business can meet its commitments ▪ Profitability ratios • Profit margin • Return on assets • Return on equity • As they are interested in the long term health and thus ability to repay that the firm has. 2) Explain how the Du Pont system of analysis breaks down return on assets. Also explain how it breaks down return on stockholder’s equity.
Profit margin is Net Income / Sales Asset Turnover is Sales / Total Assets Return on Assets is Profit Margin * Asset turnover Return on equity is return on assets / (1- debt / Assets) The Du Pont system stresses that a satisfactory return on assets may be achieved through high profit margin or rapid turnover of assets or both. With the Du Pont system the use of debt is also important as this affects the return on equity. 3) If the accounts receivable turnover ratio is decreasing, what will be happening to the average collection period?
The average collection period will be getting longer. 4) What advantage does the fixed charge coverage ratio offer over simply using times interest earned?
Fixed charge coverage measures the firm’s ability to meet all the fixed
1) If we divide users of ratios into short term lenders, long term lenders, and stockholders, which ratios would each group be most interested I, and for what reasons?
• Short term lenders o Will be most interested in the firm’s ability to repay debt so they would be interested in the liquidity ratios, Current ratio and Quick ratio. • Long term lenders o Will be most interested in ▪ Debt to total assets but also in ▪ Liquidity ratios • Current ratio • Quick ratio • As they want to be sure the business can meet its commitments ▪ Profitability ratios • Profit margin • Return on assets • Return on equity • As they are interested in the long term health and thus ability to repay that the firm has. 2) Explain how the Du Pont system of analysis breaks down return on assets. Also explain how it breaks down return on stockholder’s equity.
Profit margin is Net Income / Sales Asset Turnover is Sales / Total Assets Return on Assets is Profit Margin * Asset turnover Return on equity is return on assets / (1- debt / Assets) The Du Pont system stresses that a satisfactory return on assets may be achieved through high profit margin or rapid turnover of assets or both. With the Du Pont system the use of debt is also important as this affects the return on equity. 3) If the accounts receivable turnover ratio is decreasing, what will be happening to the average collection period?
The average collection period will be getting longer. 4) What advantage does the fixed charge coverage ratio offer over simply using times interest earned?
Fixed charge coverage measures the firm’s ability to meet all the fixed