ratios that measure a firm s financial leverage are known as _____ ratios. This is a topic that many people are looking for. star-trek-voyager.net is a channel providing useful information about learning, life, digital marketing and online courses …. it will help you have an overview and solid multi-faceted knowledge . Today, star-trek-voyager.net would like to introduce to you Understanding Financial Ratios. Following along are instructions in the video below:
“Let us look at how investors or people outside of business use the financial statements statements that the business produces to determine whether they should invest money in that business money to the business or do business with that business. The only thing they have to go away is what the income statement. Which is a revenue and expenses and profitability of the business and the balance sheet. Which tells us what the business owns who it is and how much investment.
The shareholders have in the business using those statements. Now we now apply what s called ratio. Analysis. The ratio analysis is a way of expressing a relationship between different parts of both financial statements.
A ratio is simply a mathematical relationship between one quantity or one part of the income statement or balance sheet and any other part of an income statement and balance sheet. This relationship is a series of ratios that we are just beginning to introduce now these ratios are actually in three categories. One there is the profitability ratios that measures the income and the operating success of the business that s your income statement. Here in revenue minus expenses gives me my net income.
Then there are the liquidity ratios these answers the questions what short term ability does this firm have to pay its obligations and that of course is the liquidity. We look at the current assets and we relate them to the current liabilities. The current assets being what we have in cash or near cash to pay our current liabilities. Our accounts.
Payable or salaries payable and so on then we look at it and there are ratios that are more long term in nature. They measure the ability of the company to survive over the long term those are our debt to equity ratios. Our debt to total asset ratios. These are the three categories of ratios now we re going to introduce them now and later on we add more ratios in each of these categories.
Now one of the first questions an investor would ask when looking at the financial statements of a company. What are the earnings and if i invest in this company and only share. The company then what would the earnings per share. Be aboard better known as the eps and this measures.
The net income. Earned for each share of common stock remember common stock represents ownership in the company. Here. We have best buy 2009.
Net income both here s the amount of shares 2008. They started off with 481 thousand went down to 411 2009 and went up to 414 now in calculating the earnings per share. The investor would take the net income from the income statement. Minus any preferred stock dividends now we re not going to come across stock dividends at this level that would be later analysis and we would relate that to the average common share.
So therefore in 2008. The net income is 1407 no preferred shares the average share at the beginning was 411 at the end 482. So we had those two together and divided by 2 and we see that the eps in 2008. Was 3 dollars and 15 cents for every common shareholder.
Now in 2009. Or every common share that a shareholder would own in 2009 again earnings per share is the net income minus the preferred dividends and the average amount of outstanding shares and the earnings per share in this case is 2 dollars and 43 cents. So you can see it went down considerably. And that would be a concern for people reading the financial statements.
But you see you wouldn t see this and just look at the financial statements. You d only begin to see. When you relate the earnings to the number of outstanding common shares now in profitability ratios of course. We are looking at the income statement in this case and in liquidity ratios and the solvency ratios.
We use the balance sheet. Now. The quiddity ratios of course relate the current assets as the cash or near cash items to the current liabilities and later on when we look at who owns these total assets. We re going to do solvency.
We re going to relate the amount of long term debt to the total amount of assets and see how solvent. The company is and the first question is a question of liquidity and that is liquid. Means the most liquid asset is cash and we presented the current assets in order and the order in which they turn themselves into cash. We call when we did that in lecture and on classified balance sheet and in that way now.
We can relate the ability to pay the current liabilities by looking at the current assets related to current liabilities. So let s go back and look at bestbuy current assets in. 2009 was right here 8192. 8192.
But look at the current liabilities..
Eight thousand four hundred and thirty five so they have more liabilities than they have in current assets. And so the difference between the current assets and the current liabilities is what is called in business. Working. Capital.
Now be careful is term capital u. Comes up a numbered times in a county and i tell you accounting is a language of business. You have capital equipment. The capital invested in a company you have to be careful the definition.
What does a person use in the word capital actually mean when they use the term working capital. It means the excess of current assets over current liabilities. And as i showed you in the past and in the previous screen. There is no excess there is a deficit and so when the working capital is positive there s a good likelihood paid des.
But best buy has a negative working capital of 243. That is the liabilities are 243 million. More than the current assets and this is very serious so for liquidity ratios. We look at working capital and we also look at what s called the current ratio and that s simply the relationship of current assets over current liabilities.
If the current asset is equal to current liability. The ratio would be one to one well in this case the current. Assets 8 1. 9 to current liabilities.
8. Million 435. 097. 2 1.
And so therefore for every dollar current like best buy has nine point ninety seven cents of current assets in order to pay and compared to last year last year. It was a dollar eight to one so you can see that they re having more difficulty here with the liquidity ratio. It has gone down considerably. Now the other thing about ratios is they really take on meaning.
When you compare them to other companies or industry..
Average in this case over here we compared. It to the year before 2008. Now if we compare it to our competitor hh greg in 2009. Look they had a dollar 68 in current assets for every dollar of liabilities.
Now there are companies that do industry averages and they present those industry averages called a dow industrial averages and they present industry averages and you can look at your industry. And for all companies in your industry. The average current ratio is one point five to one so from this you can see if you were management of best. Buy you have a problem here.
And you may have a problem in paying your short term debts. If you re an investor you d be kind of concerned about this. But that s what the liquidity ratio helps you look at next. We look at solvency and using the balance sheet.
Again. Solvency is the ability to pay the interest on your debt. As your debt comes due now. This is long term debt.
Solvency ratio measures the ability of the company to survive over a long period of time if you re solvent if you re insolvent that means you are bankrupt. So of course you don t want to do business with a company that s going to be looking at bankruptcy possibly in the future. And this is why you look at the solvency ratios now a key solvency ratio is the company s total debt or that is total liabilities as the relationship or ratio to total assets. So the formula here is total liabilities over total assets and looking back at the financial statements.
You can see here total liabilities. 11. Million 183 over total assets. Which is 15 million 826.
The same as up here as compared to last year. Where we had total liabilities. 8. To 7 for total assets.
58. So now when we look at. Bestbuy we have total liabilities. 11 million 153 over total.
Assets. 15000. 826. So you can see that 71 of the assets are owned by people outside the business now how does that compare to last year last year was 65 percent.
So the shareholders owned more last year than they do this year of the total assets. Now how does that compare to the industry. When the industry is around 64 percent are not the industry. The competition.
The industry is 57. So this ratio means that for every dollar of assets. It s financed by 71 cents of debt and that is your solvency ratio so again to recap three categories of ratios profitability. Here we look at earnings per share solely at this point in time then liquidity ratio.
You must know working capital and the current ratio and the solvency ratio to date. Now would be debt to total assets. And that s how investors would begin to look at and analyze they try and get under the skin of the corporation by using the balance sheet and income statement. And comparing one part to another and for the rest of the course.
We will slowly introduce more ratios or how so you see how important it is in producing financial statements that you follow what s called generally accepted accounting principles. You present the financial statements. The same all around the world. Because you presentation is governed by these rules.
So that the investors can feel comfortable that these financial statements were presented in the format that is consistent with the way they ” ..
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