Question

How do you evaluate each of the four groups of financial ratios, including liquidity ratios, asset efficiency (asset management) ratios, capital structure (solvency) ratios, profitability ratios, and market value ratios? Use examples to describe formulas, explain calculation steps and sources of data (input from which financial statement—income statement or balance sheet), and state final answers.

Answer 1

(A): Liquidity Ratios- These ratio tell the liquidity position of company, how much company is having cash or cash equivalents that can be easily converted into cash at the time of emergency. Higher ratio is good.

Quick ratio = Liquid assets / Current liabilities

Liquid assets = Cash, marketable securities, account receivables

Current liabilities = Accounts payable, notes payable, salaries payable, short term loan (less than 1 year)

(B): Asset efficiency (asset management) ratios- These ratios tell how efficiently company is using its assets to generate sales or revenue. Higher ratio is good.

Asset turnover ratio = Total Sales / Average total assets

(C): Capital structure (solvency) ratios- These ratios tell company's solvency position, if the company is able to meet its long term debt or not? Lower debt ratio is good for the company. Ideal debt ratio is .40 or below.

Debt-Equity Ratio = Total debt / Total shareholders equity

(D): Profitability ratios- These ratios tell how much a company is profitable. Higher ratio is good.

Net profit margin = Net profit / Net Sales

(E): Market value ratios- These ratios are used to tell the current share price of the company and earning per share. These ratios tell whether a company's stock is undervalued or overvalued.

EPS = Net profit / Total shares outstanding

Market value per share = Total market value of company / Number of shares outstanding

Note: (For ratio calculation, you can choose the income statement and balance sheet of any company and can calculate)